1
CH 9 e-ECONOMY: e-Products
and e-Marketplaces
 e-commerce is already having a
noticeable impact upon market
structure a...
2
 ‘Anyone who fails to become an e-
business will become an ex-business’
(Phil Lawler, MD of Hewlett-Packard)
 ‘In 5 ye...
3
What kind of things we study
in e-economics:
 e-products
 e-marketplaces
 impact of e-economy on market
structure, bu...
4
e-Products
 An e-product:
 can be digitally encoded then
transmitted rapidly, accurately
and cheaply
 e.g. music, fil...
5
Consuming Information
 experience
 overload
 switching costs
 network externalities
Four key features of e-products:
6
Experience Products
 An experience good or service is
one that must be sampled before
the user knows its value
 inform...
7
Information Overload
 … arises when the volume of
available information is large
 …but the cost of processing it is
hi...
8
Switching Costs
 … arise when existing costs are sunk
 for example, changing supplier incurs
additional costs
 smart ...
9
Beneficial Network Externalities
 Many information goods are also
characterized by network externalities:
the value of ...
10
 Network externalities explain why
there is a sudden switch to a new
system when public opinion
suddenly has confidenc...
11
Critical Mass and Industry Takeoffs
 When network externalities are strong,
a large proportion of consumers may
not be...
12
Network Externality:
Threshold Network Size
13
Critical Mass
Critical mass effects change the quantity
demanded over time of a good with network
externalities. The qu...
14
Network Externalities
Suppose D1 represents the demand curve for a
product exhibiting network externalities
€
Quantity
...
15
Case: Apple’s Big Mistake
Even though Apple’s computers were
clearly technologically superior to the
alternatives well ...
16
Pricing of Information Products
 Most workers are employed in the
production of conventional goods and
services: cars,...
17
Information: the supply side
 Given substantial economies of scale,
we expect monopoly suppliers of
information produc...
18
 Efficiency requires that goods sell at
their marginal cost, and information
goods have low marginal cost
 However, b...
19
 A musical recording has
high fixed cost and low
marginal cost, a situation
similar to natural monopoly
 The profit-m...
20
Pricing Problems for Information
Goods
21
The Problem of Achieving Efficiency
with an Information Good
• The profit-maximizing
music company behaves
like a monop...
22
 Monopoly is a bad thing, other things
equal; it is inefficient to charge a price
that is above marginal cost. But the...
23
Property Rights in Information
 A patent gives an inventor a temporary
monopoly in the use or sale of an
invention; a ...
24
Public Policy towards Information
Goods
 Antitrust policy
 Only monopolization -- efforts to
create monopolies -- for...
25
Some strategies for pricing
information products:
 Two-part tariff
 an annual charge to cover fixed
costs, and a smal...
26
Competition vs. Collaboration
 A strategic alliance is a blend of co-
operation and competition, in which a
group of s...
27
What's
the attraction?
e-Marketplaces
 B2C, C2B, C2C, and B2B
 eMarketplaces differ widely in both
their complexity a...
28
eMarkets Evolution
EDI
1 - N
<1999
Internet
M - N
1999 – 2001
eMarkets
2000–2004
eMarkets
SC Integration
2001–2006
29
One BuyerOne Seller
Negotiation
Many Buyers
Auction
Many Sellers
Reverse
Auction
Exchange
or
Markets
Market Framework
30
 Business introductions
 Many e-marketplaces, such as
lotsofplastics.com, acts simply as an
electronic notice board, ...
31
 On-line or e-auctions
Just as in a normal auction
process, only in this case within
an e-market, the seller puts up ...
32
 e-exchanges
 Like a stock exchange, it matches
buyers and sellers via a bid and
offer price system
 The reverse auc...
33
 Originally it was thought that e-auctions
are most suitable for products or
services that are relatively basic
 in w...
34
 Other services. As well as buying and
selling, a number of e-marketplaces
are aspiring to greater things
 Many curre...
35
Who Gains What in an e-Marketplace?
 Perfect competition
globalization
prices become more transparent
competition g...
36
The Gains for Buyers
 essentially based on the significant
reduction in transaction costs
 bidding or auction process...
37
The Gains for Sellers
 access to new buyers and so
potentially increased sales volume
 as with the buyer, the seller ...
38
Gains for consumers from B2B
 As procurement costs are cut, the
costs of producing goods and
services should fall
Some...
39
Gains for the Economy:
New Economy?
 Increased productivity in the network
economy
 IT contributes approximately 50 p...
40
Gains for the Economy: New
Economy?
 Increased productivity shifts the
aggregate supply to right
A
S
AD
National outpu...
41
Long Cycles
Kontratiev, Schumpeter
1 cycle 1790 - 1844 Steam engine
2 cycle 1844 - 1895 Railroads
3 cycle 1895 - 1946 E...
42
Understanding the e-Economy
1 The information revolution is
changing our lives
 but few of its activities or market
ta...
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Lecture 10

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Lecture 10

  1. 1. 1 CH 9 e-ECONOMY: e-Products and e-Marketplaces  e-commerce is already having a noticeable impact upon market structure and the behavior of business
  2. 2. 2  ‘Anyone who fails to become an e- business will become an ex-business’ (Phil Lawler, MD of Hewlett-Packard)  ‘In 5 years time, all companies will be Internet companies, or they won’t be companies at all’ (Andy Grove, Chairman of Intel) The Hype!!
  3. 3. 3 What kind of things we study in e-economics:  e-products  e-marketplaces  impact of e-economy on market structure, business and consumers
  4. 4. 4 e-Products  An e-product:  can be digitally encoded then transmitted rapidly, accurately and cheaply  e.g. music, films, books, sport …  Fixed costs of producing e- products are huge …  … but marginal costs of distribution are tiny  implying vast economies of scale
  5. 5. 5 Consuming Information  experience  overload  switching costs  network externalities Four key features of e-products:
  6. 6. 6 Experience Products  An experience good or service is one that must be sampled before the user knows its value  information is nearly always new  marketing needs careful attention  free samples  previews  establishing reputation
  7. 7. 7 Information Overload  … arises when the volume of available information is large  …but the cost of processing it is high  screening devices become crucial  search engines and shopping bots
  8. 8. 8 Switching Costs  … arise when existing costs are sunk  for example, changing supplier incurs additional costs  smart suppliers use strategies for locking in their customers  e.g. air miles, supermarket reward cards
  9. 9. 9 Beneficial Network Externalities  Many information goods are also characterized by network externalities: the value of the good to an individual is greater when a large number of people also use the good (e.g. fax machines, Internet, e-mail)  Note that congested trains or roads are unattractive networks. Externalities are not always positive. However, the first fax machine was invented over a hundred years ago, yet they did not become popular till everyone believed everyone else would have one
  10. 10. 10  Network externalities explain why there is a sudden switch to a new system when public opinion suddenly has confidence in the new network  Network externalities cause positive feedback, in which either initial success or initial failure is self-reinforcing: success breeds success, failure breeds failure
  11. 11. 11 Critical Mass and Industry Takeoffs  When network externalities are strong, a large proportion of consumers may not be willing to purchase a good unless the number of existing users exceeds a threshold network size  This leads to the critical mass effect, a sudden rapid increase in the network size  Networks with more users are more valuable to belong to ⇒ networks may therefore subsidize new membership
  12. 12. 12 Network Externality: Threshold Network Size
  13. 13. 13 Critical Mass Critical mass effects change the quantity demanded over time of a good with network externalities. The quantity demanded grows slowly until critical mass is reached; once reached the quantity demanded suddenly explodes.
  14. 14. 14 Network Externalities Suppose D1 represents the demand curve for a product exhibiting network externalities € Quantity D1 P1 Q1 With price at P1, quantity demand is limited. If price is reduced to P2, more people find the network attractive so not only is there a move along the demand curve, but there is also a shift in demand. P2 D2 Q2 Long-run demand is more elastic (D).D
  15. 15. 15 Case: Apple’s Big Mistake Even though Apple’s computers were clearly technologically superior to the alternatives well into the 1990s (devotees say they still are), they have always remained a small part of the market . Apple failed to recognize the strength of the network externalities that caused many users to stick with an inferior product that was widely used, especially given the fact that the superior alternative was considerably more expensive.
  16. 16. 16 Pricing of Information Products  Most workers are employed in the production of conventional goods and services: cars, houses, haircuts, and so on  But considerable resources are now also devoted to producing information goods—products whose value comes not from their physical characteristics but from the information they embody
  17. 17. 17 Information: the supply side  Given substantial economies of scale, we expect monopoly suppliers of information products1 :  Dominant firm with competitive fringe  e.g. Microsoft  Niche market monopolies 1 industrial economy was made up largely of oligopolies limited by their existing capacity
  18. 18. 18  Efficiency requires that goods sell at their marginal cost, and information goods have low marginal cost  However, because they have high fixed cost, they won't be created unless the producer can cover its cost of production by charging a price well above marginal cost  But like monopoly, this leads to an inefficiently low quantity of output
  19. 19. 19  A musical recording has high fixed cost and low marginal cost, a situation similar to natural monopoly  The profit-maximizing price, PM, is $5, the average total cost, ATCM, is $3, resulting in a per-unit profit of $2 Assumptions: FC = $1.5 million, MC = 0 The Profit-Maximizing Quantity of an Information Good
  20. 20. 20 Pricing Problems for Information Goods
  21. 21. 21 The Problem of Achieving Efficiency with an Information Good • The profit-maximizing music company behaves like a monopolist • Offering the good for free leads to a gain in total surplus of area E • However, if forced to provide the good for free, the music company is likely to forgo producing the good altogether
  22. 22. 22  Monopoly is a bad thing, other things equal; it is inefficient to charge a price that is above marginal cost. But the expectation of monopoly profits is necessary to induce the company to produce the good at all. Indeed, economists generally agree that when it comes to information goods, a temporary monopoly may be the necessary price of progress  Why temporary? As we will see, both law and natural forces tend to limit the duration of the monopolies associated with information goods
  23. 23. 23 Property Rights in Information  A patent gives an inventor a temporary monopoly in the use or sale of an invention; a copyright similarly gives the creator of a literary or artistic work sole rights to profit from that work  By creating temporary monopolies, patents and copyrights facilitate the production of some information goods  When this legal protection is not available, producers of information goods often manage to establish temporary monopolies by exploiting first-mover advantages
  24. 24. 24 Public Policy towards Information Goods  Antitrust policy  Only monopolization -- efforts to create monopolies -- forbidden  What is the dividing line between legal and illegal actions?  Setting standards  Need for common standards creates a justification for government intervention in the economy
  25. 25. 25 Some strategies for pricing information products:  Two-part tariff  an annual charge to cover fixed costs, and a small price per unit related to marginal costs  Versioning  the deliberate creation of different qualities to facilitate price discrimination  Bundling  the joint supply of more than one product to reduce the need for price discrimination
  26. 26. 26 Competition vs. Collaboration  A strategic alliance is a blend of co- operation and competition, in which a group of suppliers provide a range of products that partly complement one another  e.g. Microsoft and Intel  airline alliances: One World, Star Alliance etc.
  27. 27. 27 What's the attraction? e-Marketplaces  B2C, C2B, C2C, and B2B  eMarketplaces differ widely in both their complexity and objectives  Their principal aim, however, is to bring buyers and sellers together:  aggregation and matching  How might such marketplaces achieve these goals?  improved computational and communication capability due to improved ICT
  28. 28. 28 eMarkets Evolution EDI 1 - N <1999 Internet M - N 1999 – 2001 eMarkets 2000–2004 eMarkets SC Integration 2001–2006
  29. 29. 29 One BuyerOne Seller Negotiation Many Buyers Auction Many Sellers Reverse Auction Exchange or Markets Market Framework
  30. 30. 30  Business introductions  Many e-marketplaces, such as lotsofplastics.com, acts simply as an electronic notice board, bringing together buyers and sellers. Once they have found each other the transaction process is negotiated and settled off-line  On-line catalogues  A more sophisticated e-marketplace is where a seller places on-line their catalogue, detailing products, price availability and delivery. Buyers can then browse, place orders electronically and on certain sites make payments on-line
  31. 31. 31  On-line or e-auctions Just as in a normal auction process, only in this case within an e-market, the seller puts up for sale a given product or service and invites offers  eBay and uBid  Goindustry.com, a European e-marketplace for selling used and surplus machinery
  32. 32. 32  e-exchanges  Like a stock exchange, it matches buyers and sellers via a bid and offer price system  The reverse auction/procurement in e-marketplace  Here a buyer puts out a tender and invites suppliers to put in bids
  33. 33. 33  Originally it was thought that e-auctions are most suitable for products or services that are relatively basic  in which price is the most important determinant of sale BUT  non-price factors, such as the product’s quality, terms of delivery, warranty, reliability or after-sales service are often at least as important as the price  More recent auction systems, however, can now handle also multi-issue auctions
  34. 34. 34  Other services. As well as buying and selling, a number of e-marketplaces are aspiring to greater things  Many currently provide an industry news service. Some are seeking to establish greater collaborative working between industry members, in for example areas such as demand forecasting and logistics
  35. 35. 35 Who Gains What in an e-Marketplace?  Perfect competition globalization prices become more transparent competition gets harder lower prices  or more segmented markets? firms seeking monopoly power through product differentiation increased customer information  cookies etc. tailored products  increased price discrimination
  36. 36. 36 The Gains for Buyers  essentially based on the significant reduction in transaction costs  bidding or auction process likely to drive product or service prices down  buyers will be put into contact, not only with a wider number of suppliers but, with new suppliers as well  easy and direct access to new sources of supply will reduce the need to carry stocks
  37. 37. 37 The Gains for Sellers  access to new buyers and so potentially increased sales volume  as with the buyer, the seller is likely to experience significant reductions in transaction costs on each sale made
  38. 38. 38 Gains for consumers from B2B  As procurement costs are cut, the costs of producing goods and services should fall Some of these cost savings should be passed on to the consumers in lower prices
  39. 39. 39 Gains for the Economy: New Economy?  Increased productivity in the network economy  IT contributes approximately 50 per cent to GDP growth  It is anticipated that this will rise with the increase of e-business  Goldman Sachs estimates that the effect of B2B on aggregate supply (AS) will increase average growth rates by 0.25 per cent for the next 10 years
  40. 40. 40 Gains for the Economy: New Economy?  Increased productivity shifts the aggregate supply to right A S AD National output, Y Inflation, % National output will increase, unemployment decrease AND inflation rate can stay relatively low AS’
  41. 41. 41 Long Cycles Kontratiev, Schumpeter 1 cycle 1790 - 1844 Steam engine 2 cycle 1844 - 1895 Railroads 3 cycle 1895 - 1946 Electricity and motor vehicles 4 cycle 1946 - 1990 Cheap energy 5 cycle 1990 - Information technology
  42. 42. 42 Understanding the e-Economy 1 The information revolution is changing our lives  but few of its activities or market tactics are unprecedented 2 The revolution in technology has not required a corresponding revolution in economic theory

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