Staring at the mechanical drawing on his computer screen, an engineer recognizes the need for a new part to improve his product design. Rather than calling a distributor, the engineer connects to an online service that provides substantial information: a roster of vendors that can meet his technical specifications; a product list ranked by price; schematic diagrams; and test results, product reviews, and comments from other engineers.
Satisfied with his information search, the engineer checks for the product’s availability at a large, public warehouse and places an order for a sample. A bank affiliated with the online network extends credit if needed and electronically invoices the engineer’s department. In turn, an EDI system pays the bill electronically. An express delivery firm delivers the part the next day.
A new customer/vendor relationship is established, but what (or where or who) was the channel of distribution? Over the next few years, advances in computer networking and software will radically transform the structure of distribution channels. While it is too early to declare salespeople an extinct species, technology will fundamentally change the role of manufacturers’ sales reps, distributors, and dealers. In the process, a complex mix of winners and losers will emerge.
Strategists often ignore the role that distribution channels play in determining corporate success.1 However, as Peter Drucker points out, "From being organized around the flow of things and the flow of money, [the economy] is becoming organized around the flow of information."2 As information transforms distribution, it will also transform entire industries.
The overarching vision meshing computer technology with the everyday business of buying and selling is being touted as "electronic commerce" (EC). Visions of consumer-oriented electronic commerce (TV shopping networks, CD-ROM product catalogs, etc.) have already attracted considerable media attention. However, the business-to-business market has greater resources and incentives to become the first user of true electronic commerce systems.
A viable electronic commerce system consists of five elements:
Although the effect will be revolutionary, the emergence of electronic commerce will be evolutionary. Many advances still need to be made in interface software, communications bandwidth, and security standards. Businesses will have to change purchasing procedures, marketing techniques, and product design processes.
However, many forerunners of electronic commerce already exist. A few companies list products and accept orders via online services such as Prodigy, CompuServe, or America Online. Since these networks lack security, multimedia, and payment features, they pose little challenge to traditional commercial distribution.
Over 200 companies offer CD-ROM-based product catalogs. However, few corporate customers have CD-ROM drives, and more important, the CD-ROM catalogs lack any online connections to vendors. The most ambitious venture so far is CommerceNet.3 Funded by several Silicon Valley companies and the federal government, CommerceNet operates over the Internet, the forerunner of the information superhighway. On CommerceNet, buyers can seek out detailed product information from individual companies, or they can become members of the Internet Shopping Network, an online distributor of computer products. CommerceNet is still working on the directories and software needed to sort through its growing electronic commerce database. Another entry is Pittsburgh-based IndustryNet. IndustryNet provides an information and shopping forum on the Internet for buyers and sellers of a wide variety of industrial products.
Times Mirror Cable Television and Digital Equipment Corporation are backing a more focused trial dubbed the Electronic Commerce Network.4 The network ties together several Phoenix-based aerospace/defense contractors, their suppliers, and university engineering departments that provide research and consulting services. Using an Ethernet connection running on the local cable system, the participants can use videoconferencing to discuss initial product designs and later make an online payment for the finished goods. While most of the commercial world is unaware of these developments, EC networks are about to change the fundamental structure of distribution.
To truly understand the impact of electronic commerce on distribution, three key issues need to be considered:
Who Will Run the Electronic Commerce Networks? The ownership and management of electronic commerce networks will clearly influence the acceptance of electronic commerce. The online airline reservation systems, some of the first examples of electronic commerce, provide interesting insights into the ownership issue. Leading airlines developed their own proprietary systems. With these reservation systems, carriers attempted to increase travel agent allegiance to the airline, build customer brand loyalty and, eventually, lower costs. Travel agents welcomed the productivity and customer service improvements. However, the agents feared the network might eventually give the airlines more power over them, particularly in negotiating commission levels. Also, the federal government felt that the systems were biased in favor of the airline running the system.
The reservation systems example leads to several key conclusions about ownership of electronic commerce networks:
Given these ownership factors and the current state of electronic commerce technology, the network managers and owners will likely come from:
1. Associations. Industry associations understand the industry buying and selling practices and lend the perception of independence. Associations would see the management of an electronic commerce network as justifying their ongoing role (and membership fees) in the industry. Strong associations, such as the National Office Products Association or the National Association of Home Builders could lead the development of EC networks in their industries. The Photo Marketing Association already has a rudimentary EC network running on CompuServe.
2. Resellers. Resellers are in a better position to own and manage an entire network. Instead of just encouraging participation or maintaining the network, resellers could actually process, pick, pack, and ship the orders generated by their EC network. In the business-to-business markets, distributors, wholesalers, and franchisers already maintain extensive databases of product names, numbers, and prices. However, they would still have to work with manufacturers to develop the electronic equivalent of spec sheets, product literature, and other technical information.
3. Manufacturers. Manufacturers are likely candidates to set up and manage EC networks. More so than resellers, manufacturers that sell through direct sales forces are struggling with rising selling costs. EC networks can provide an extremely efficient sales mechanism. In addition, manufacturers may view EC networks as a means of reducing the relative power that their reseller channels exert. Manufacturers also want more direct feedback from their customers and dealers, feedback that an EC network could provide but that a reseller might not or could not provide.
However, manufacturers usually carry only their own brand(s). Therefore, manufacturers operating their own networks will really need a strong relationship to convince their resellers or end-users to jump on board.
4. Technology Companies. An EC network is a complex mix of telecommunications and computer hardware, software, networks, and services. Suppliers of these products are fascinated by EC networks, not only as a means of reaching their customers but as a huge emerging market for their products. Companies like Hewlett-Packard and Digital Equipment Corporation are exploring electronic commerce options through CommerceNet, through the Internet’s World Wide Web, and various pilot programs.
Systems integrators, such as EDS or Computer Science Corporation, might design and manage EC networks. Software companies like Microsoft, EDI specialist Sterling Software, or CBMS might position software as the linchpin in any EC network. CBMS is offering a unique system to help value-added resellers (VARs) reduce the complexity of procuring parts from the 15-20 vendors that make up a typical computer system. Even publishing companies like Ziff-Davis have announced EC ventures.
Microsoft deserves special attention. Microsoft’s new online service offers many EC features and Windows 95 provides direct access to the Internet. Despite its failed attempt to buy financial software leader Intuit, Microsoft is recruiting vendors that want to sell through its online service. As a product category, software is a natural first market for EC distribution since the actual product can be delivered electronically. Given Microsoft’s market position and visibility, its Windows 95 launch could jump-start the EC revolution.
5. Partnerships. The most likely organizational structure is a partnership. EC networks will require a broad mix of technology, capital, order handling and processing, trade financing, and the perception of independence. Few single companies can offer that mix.
A likely scenario for the emergence of electronic commerce is that at first, CD-ROM catalogs and bulletin board shopping services give businesses a taste of the future. Ambitious startups, such as CommerceNet, slowly expand their services and user bases. However, the first viable EC efforts will be proprietary systems linking a manufacturer with its distributors or a distributor with its retailers. Within a short period of time, these proprietary systems will include commercial end users.
Many people assume that the Internet will be the network of choice for electronic commerce. However, many senior managers interviewed by Frank Lynn & Associates do not want their buyers searching across the Internet, wasting time and buying unapproved brands or products. These executives also question the level of security available over the Internet. In response, several technology suppliers are offering to integrate electronic commerce modules into individual companies’ internal computer networks. Buyers would access a company-specific electronic commerce system to collect information and make product selections. A centralized purchasing manager would review these choices and funnel them into traditional channels or an external electronic commerce system.
Regardless of the media, end users will begin to recognize the benefits of electronic commerce, particularly its ability to search across multiple vendors’ offerings. However, end users will not want to learn separate systems or search each vendor individually. This will cause an "open system" approach to emerge across a specific industry or "community of interest," such as health care, commercial real estate, or office supplies. This system will be "open" in the sense that the system manager is independent of the products sold and permits any manufacturer, reseller, or end user to use the system.
Like most network structures, pressure will build to merge the growing number of industry-specific systems into larger, branded networks. This is exactly what happened with automated teller machine networks, the early telephone networks, credit cards, and the Internet itself. Networks have an inherent tendency to coalesce. As noted earlier, some companies, such as Microsoft, USWest, Time-Warner, AT&T, Bank of America, or MCI, may eventually create broad, brand-named EC systems. They will buy out smaller, regional or industry-specific systems and slug it out with the other big players. Ultimately, the EC systems will extend into the consumer market.
How Will Electronic Commerce Change the Structure of Distribution? Electronic commerce will create a massive restructuring of the current distribution system. The key elements of this restructuring are the barriers to entry, the cost structure, lower prices and shifting roles, consolidation, and channel conflict.
1. Barriers to Entry. Electronic commerce will eliminate many of the barriers to entry formerly represented by distribution channels. For market leaders, a strong position in the distribution channel provides a defense against competitors. Channels have limited shelf space, mind share, or financial resources, and they do not like to spread themselves across too many suppliers. Channels also represent a barrier, particularly to smaller manufacturers that lack the volume and economies of scale to create end-user demand—a strong prerequisite for attracting resellers.
However, with electronic commerce, shelf space is virtually unlimited. Electronic commerce companies will want to put as many manufacturers as possible on their networks. In fact, the networks will probably compete on the basis of how many companies’ products they offer.
Entrenched manufacturers will certainly retain some advantage, possibly by providing more accurate or timely information, better graphics, or sophisticated analytical tools. However, electronic commerce overall will reduce the barriers that distribution channels traditionally offered the market leaders.
2. Cost Structure. Electronic commerce will substantially reduce the cost of channel marketing. Today, a typical manufacturer offers a real discount of about 25 percent to its distributors to cover their expense and profit requirements. The manufacturer incurs an additional cost (7-15 percent of its net revenue) to manage its reseller network. Overall, this means that about one out of every three dollars spent by the end user is related to channel activities. Electronic commerce will sharply reduce these costs on both an absolute and a percentage basis. The cost savings will come from three sources:
A. Elimination of the sales function. Frank Lynn & Associates estimates that selling expenses account for $0.35 of the $3 spent on channel activities. Electronic commerce will not wipe out all sales activities—as one New Yorker cartoon put it "no information superhighway, no matter how vast, will eliminate the art of the schmooze." But EC networks will entice many customers to reach for their computer mouse rather than a sales rep’s phone number.
B. More competition. Electronic commerce will give customers access to more suppliers. This increased supply will inevitably create more price competition. One electronic commerce project underway is run by the Lawrence Livermore National Laboratory to help reduce costs at Wright Patterson Air Force Base. The Air Force was not required to get bids for anything under $2,500 due to high purchasing costs. Under the Livermore system, the Air Force could not only efficiently request bids at any level, but a wider variety of suppliers could find out about the bids. In the first few months of the program, the Air Force has achieved 10 percent lower purchasing costs and substantial price savings.6 By eliminating significant buying and selling costs, electronic commerce will cause a significant drop in prices.
C. Improved communication. Long lines of communication between end users, channels, and manufacturers result in many inefficiencies. Manufacturers design, build, and ship products that customers do not want. Resellers hold safety stock to guard against unpredictable end-user demand. Product returns tie up all parties involved. Endless hours are spent configuring systems, checking order status, resolving misunderstandings. By consolidating information, empowering end users to seek their own answers, and making data searches easier, the cost of channel marketing will be greatly reduced.
3. Lower Prices, Shifting Roles. Electronic commerce will increase competition and lower marketing and sales expenses. Prices will also head downward because electronic commerce provides more information. End users have limited time for shopping. Typically, they reduce their search costs by quickly narrowing choices to a "short list," using the purchasing department’s "approved vendors list," or simply sticking with their existing brands.
Electronic commerce will provide quick, easy, and broad access to product and pricing information. The software will allow buyers to rank the information by a variety of pricing and product criteria. Armed with this broader set of information, buyers will insist on manufacturers meeting the best price/performance mix that shows up on the computer screen.
Interestingly, the promise of lower prices involves a restructuring of traditional buyer/seller roles. Electronic commerce will transfer more of the information function from the manufacturer or reseller to the end user. Normann and Ramirez point out how marketing innovators, such as IKEA, the Swedish furniture company, use this technique to reduce selling costs:
It [IKEA] offers a brand new division of labor...if customers agree to take on certain key tasks traditionally done by manufacturers and retailers—the assembly of products and their delivery to customers’ homes—then IKEA promises to deliver well-designed products at substantially lower prices.
Electronic commerce offers the same, new division of labor.7 If customers will search electronically for information instead of asking a salesperson, manufacturers can offer lower prices and probably better service.
4. Consolidation. Ultimately, electronic commerce poses a substantial threat to many resellers. Large resellers base their strategies on low, volume-driven pricing and one-stop shopping. Small resellers exist and thrive because they provide more personal and focused support.
Electronic commerce allows customers to shop and access information directly. With almost no support requirement other than logistics, large distributors will seek even greater economies of scale by moving into entirely new industries, acting as public warehouses. Michael Pickett, chief executive of Merisel, the large computer distributor, sees an era of "virtual distributors" transporting everything from PCs to polyethylene.8 The resultant economies of scale and the infrastructure requirements will likely cause mergers and bankruptcies among today’s large resellers.
Electronic commerce will not replace all of the relationship and support elements now offered by small resellers. However, little reason exists for these resellers to hold much inventory or even to take title to products.
5. Channel Conflict. Consolidation will not happen overnight. Therefore, as manufacturers begin to use EC systems to reach end users directly, traditional resellers will complain loudly about channel conflict.
Fearing the EC capabilities of Windows 95, one reseller group sued Microsoft even before the product became publicly available. From a legal perspective, the dealers claimed that Microsoft was tying the purchase of its online system to the purchase of the operating system. Actually, the resellers feared that Microsoft was forcing them to sell the means of their own destruction. Microsoft could use the EC features built into Windows 95 to sell subsequent software directly to end users, bypassing the dealers.9
Conflict of this type is inevitable whenever one channel is eclipsed by another channel (e.g., superstores replacing small dealers, or distributors selling into accounts previously managed by direct sales forces). Electronic commerce is no exception. In fact, the emergence of dramatic conflict (especially prior to actual sales and especially legal action) is proof of the substantial changes EC networks will bring to traditional distribution. The conflict may slightly delay the growth of electronic commerce, but companies have developed a large repertoire of techniques for managing conflict among their channels.10
Traditional channel marketing systems will undergo a massive transformation in the next few years as online communication radically alters the way buyers and sellers exchange information. The transformation will give end users powerful new tools to seek out the best product at the best price with the best service. However, the role and the power of traditional channels will greatly diminish. Power will flow not only to the end user but to the EC network managers, and to those manufacturers that quickly understand the workings of the new EC channel.
The basis of competition will shift from companies with strong distribution channels to those with strong information systems. The winners will find means of graphically displaying data, updating data on a frequent basis, and responding to e-mail in a creative and real-time mode. The winners will also come from those companies that design products and that score well when filtered by online search engines.
Companies that want to participate in electronic commerce will need to recognize that the consumer market will take a back seat to the business-to-business market. To tap into the commercial electronic commerce channel, companies should move incrementally and broadly. Moving incrementally will hide potential conflicts while the company gains experience with electronic commerce technology. By experimenting broadly with CD-ROMs, the Internet, and private electronic commerce systems, companies can determine which approach best fits their strategic, customer, and technical requirements. As electronic commerce networks expand, companies must prepare to abandon proprietary networks and embrace emerging industry-wide networks.
Innovators see electronic commerce as a strategic opportunity: reducing transaction costs, eliminating barriers to entry, and shifting the basis of competition. However, entrenched manufacturers will find it difficult to transition from their established channels. To minimize conflict, vendors may downplay their efforts until industry-wide networks provide a cover. Traditional channels often accept change if they cannot focus their complaints against a single vendor.
The move to electronic commerce will replace the traditional inventory-based model with an information-based model. If manufacturers, wholesalers, dealers, and end users do not start envisioning their role in such a world, they will quickly find themselves without options.
1. Frank V. Cespedes, "Channel Management is General Management," California Management Review (Fall 1988).
2. Peter F. Drucker, "The Economy’s Power Shift," The Wall Street Journal (September 24, 1992), p. A16.
3. "In Search of the Paperless Contract," Business Week (August 29, 1994), p. 14.
4. John T. Mulqueen, "Going Hollywood," Communications Week (January 31, 1994).
5. Brian W. Arthur, "Positive Feedbacks in the Economy," Scientific American (1990), pp. 92-99.
6. Doug Van Kirk, "Government Lab Advances Electronic Commerce," Infoworld (January 17, 1994), p. 60.
7. Richard Normann and Rafael Ramirez, "From Value Chain to Value Constellation: Designing Interactive Strategy," Harvard Business Review (July-August, 1993), pp. 65-77.
8. John Longwell, "Pickett Outlines ‘Virtual Distribution’ Concept," Computer Reseller News (March 7, 1994), p. 6.
9. Don Clark, "Retailers Fear Microsoft Network Will Leave Them Out of the Loop," Wall Street Journal (February 13, 1995), p. B6
10. "Managing Channel Conflict," Frank Lynn & Associates, Inc. (1993).
* This article is reprinted from Strategy and Leadership (formerly Planning Review (November/December 1995) with permission from the Strategic Leadership Forum (formerly The Planning Forum), The International Society for Strategic Management.
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