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  • 1. 1 Exploring the Origins of New Transaction Costs in Connected Societies Andreina Mandelli 2003 Chapter 9 (draft).snoitazinagro ni smetsys dna tnemeganam egdelwonk )sde ,tsurTnenoviI ajriM dna iratouH aneeL-ajiaM( nI.snoitazinagro ni smetsys dna tnemeganam egdelwonk )sde ,tsurTnenoviI ajriM dna iratouH aneeL-ajiaM( nI.snoitazinagro ni smetsys dna tnemeganam egdelwonk )sde ,tsurTnenoviI ajriM dna iratouH aneeL-ajiaM( nI.buP puorG aedI IntroductionThere is a considerable amount of literature in management science, which claims that the digitaleconomy is a frictionless economy, where hierarchies and institutions disappear replaced bydynamic and self-organized webs of companies and consumers, freely meeting on this new web ofopportunities (Bakos, 1997; Hagel, 1999; Hagel and Singer, 1999; Evans and Wurster, 2000).The implications of this vision (that here we call the "paradigm of the frictionless Internet economyand society") are huge. It may influence the way managers build market strategies and manageorganizations, but also the way policy-makers address relevant issues concerned with the so-calleddigital divide in the knowledge society (Norris, 2000; Compaine, 2001).This idea is not new. As Agre (2001) reminds us, conservative legal scholars, back in the seventiesviewed social progress, teleologically, as the progressive reduction of transaction costs, and thus(they argued) the perfect approximation of ideal markets. But Rullani (1998) warns against thisfundamentalist approach to Internet society, because it simply reintroduces the ideology of theinvisible hand of the market and social darwinism, against any idea of collective action.In previous works (Mandelli, 2001b) and in this study we have addressed the frictionless vision,challenging the communication symmetry fallacy, on which is based the idea that the networkeconomy is automatically eliminating the information and institutional hierarchies (even though westill believe that the Internet introduces radical changes in the way economic institutions are builtand the way businesses are conducted). We claim that the complexity of our interconnected world,the evolutionary nature of trust and learning dynamics, and the economics of mediation (theeconomics of relationships plus the economics of information infrastructure), play a major role inboth the creation and reduction of these new hierarchies in digital society. The result is complex andnot deterministically driven by network technology.We challenge the frictionless paradigm, providing primary and secondary research support for theidea that in the digital society and digital economy there still are cognitive frictions and hierarchies.There is evidence about price dispersion and the role of hierarchical brands in digital economy;evidence about the failure of business models based on the frictionless assumptions, data abouteconomic concentration in the Internet industries and infomediation flows, and evidence aboutsocial frictions and new social transaction costs in building new relationships on digital webs.Research from different disciplines has already addressed this issue. We try to include thesedifferent empirical works in an unitary interdisciplinary framework (using theories elaborated insocial sciences, information sciences, management sciences and mass communication research) andprovide theoretical explanations for this new idea of the impact of technological networks onsociety, looking for sources of hierarchies in the complexity of the new social systems, and in theeconomics of information and economics of cognitive and social mediation.Trust in our study is not seen as an automatic driver of hierarchy reduction in digital society; its roleis more complex, since it contributes to both the reduction of old hierarchies and the formation of
  • 2. 2new ones. We add original empirical evidence supporting the path-dependent idea of the dynamicsof trust, using survey data on a random stratified sample of 288 Italian Internet users. Trust buildstrust. Bonding social capital drives both new bonding social ties and new bridging (out-of-the-community) relationships. But social capital building requires not only the investment of priorsocial resources; it also asks for network social infrastructures (diffusion of connectivity services),and for cognitive and time resources. The path-dependent nature of trust dynamics on digitalnetworks is also suggested by the role of values in influencing communication behavior andattitudes.The frictionless paradigm in the network economy and society: information symmetry and network- based forms of governanceThere is a major claim in the literature on digital markets (Evans and Wurster, 2000: Tapscott(1996); Litan/Rivlin 2001; Bakos 2001): with the emergence of the World Wide Web, a totally newbusiness environment, approaching the ideal-type of the pure market in microeconomics, isemerging. “One of the major features of the Internet revolution is its potential to make the wholeeconomic system, nationally and internationally, more competitive by bringing markets closer to theeconomists’ textbook model of perfect competition, characterized by large numbers of buyers andsellers bidding in a market with perfect information.” (Litan/Rivlin 2001, 315). Lower search costsin digital markets "will make it easier for buyers to find low-cost sellers, and thus will promoteprice competition among sellers.” (Bakos 2001, 71).The Internet as a whole is conceived as one big open market, in which network communicationreduces the transaction costs significantly (especially those related with search costs) and thereforeit creates a new frictionless market, where every economic agent can find what he needs with verylimited costs associated to these cognitive searches and encounters (Evans & Wurster, 2000; Hagel,1999; Bakos, 1997). It is the web of the "organizational plasticity" and the Electronic BusinessCommunities (Tapscott et al., 2000), the era of the Communities of consumption, of the empoweredconsumer and reverse marketing (Bressler and Grantham, 2000; Hagel, 1999; Hagel and Singer,1999; Levine, 1999; Kelly, 1997).In the vision in which transaction costs are eliminated, market-like relationships, but networked bycooperative spirit, are going to increase their relevance also in the organizational settings. "Thevalue chains that define a business, the supply chains that define an industry, the customerrelationships and brands that define a franchise, and the organization charts that define hierarchy,power, and the boundaries of the corporation are all premised on the glue of information. That glueis progressively melting. The edifices of value chain, supply chain, customers, organization, etc. (allof which are taken as givens in conventional strategy) are progressively deconstructed, breaking upinto separate entities busily conducting arms-length transactions" (Evans and Wurster, 2000, 5,6).The Internet economy, according to these authors, is also eliminating the universal trade-offbetween richness and reach --- richness being the quality of the information and relationshipsavailable and reach being the number of units of relationship. The trade-off used to be simple butabsolute. Your business strategy either could focus on rich information - customised products andservices tailored to a niche audience - or could reach out to a large market, but with dilutedinformation that sacrificed richness in favour of a broad appeal. Much of business strategy rests onthis fundamental trade-off. Now, Evans and Wurster (2000) say, the new economics of informationis eliminating the trade-off between richness and reach, blowing apart the foundations of traditionalbusiness strategy. The consequence at the governance level of management is huge. Frictionlessnetwork-based teams and market relationships tend to substitute hierarchical organizations andeconomic institutions.The same intellectual framework is also usually used for predicting the diffusion of a community-based new social order. Since the Internet will lower the barriers of time and space incommunication, people will build new communities of interest and new communities of emotions
  • 3. 3much beyond the limits of their local environment (Rheingold, 1993). These communities, forauthors like Hagel (1999) become the basis for the business model of the Internet economy. "Thereal opportunity on the Internet is not just doing what you have always done cheaper and faster, butinstead the real opportunity is to rethink at a fundamental level the business models that you employon this new platform... Virtual communities actually started as spontaneous social events onelectronic networks ... We believe these spontaneous social events provide the foundation for a veryattractive business model." (Hagel, 1999, 1)In this vision this aggregation and cooperation dynamics of virtual communities provide the groundfor a significant power shift, from the company to the consumer, which completely reverses theinformation flow and the power in brand relationships, due to the new information symmetry anddemocracy (almost) automatically brought about by the digital network. "We have a strong beliefthat the network is enabling a different kind of market that we characterize as a reverse market. ... Inthese reverse market situations, we believe it is about customers finding the right vendors at theappropriate time" (Hagel, 1999,3).In order to exploit economically these communities of consumers, Hagel and Singer (1999) suggestthat companies transform themselves in infomediaries, agents who act on behalf of the consumersfor providing them with the information they need, through the collection and the management ofall the consumers data and profiles. This is the point where Hagel and Singer (1999) argumentmeets Evans & Wursters (2000). For the latter authors the most successful business model on theInternet is the "affiliation" infomediation model, because the information economy eliminates thetrade-off between reach and richness strategies, between efficiency and efficacy strategies (both atthe consumer and company level) and give competitive advantage to relationships built on trustinstead of short-term self-interest. On the digital networks customers are going to have more andmore power, just because the interconnectedness reduces significantly the information managementcosts and generates network externalities. Based on these assumptions the so-called "communitybusiness model" has been widely applied in the Internet projects, both in the Business to Consumer(BtoC) and the Business to Business (BtoB) area, building business models based on communitiesof consumers and independent infomediary marketplaces.This network-based idea of economic coordination is also applied to inter-firm relationships on thesupply chain (Hagel and Singer, 1999). In its most radical version (Adler, 2001), this network-basedmodel of inter-firm relationships envisions a future in which the new governance form ultimatelychallenges the foundations of the capitalist form of society while simultaneously creating thefoundations of a new, post-capitalist form. Challenging the frictionless paradigmThe frictionless vision of the network society surely grasps the novelty and disruptive character ofthe Internet communication models and their impact on the economy, but we believe it doesntcome to terms with the complexity of the Internet society, its economics and its changes. We needa more fine-grained analysis of these changes, trying to understand more precisely the nature ofthese new forms of governance and their new hierarchies (Mandelli, 2001b)We claim that the frictionless paradigm doesnt describe the complexity of the Internet societybecause: 1) Its not true that network connections automatically drive information symmetry and power- shift in relationships; 2) Its not true that network connections automatically create social cooperation and relationships based on trust; 3) Its not true that relationships based on trust are necessarily non-hierarchical. Trust, delegation and legitimacy
  • 4. 4Delegation is a tool for managing complexity in complex systems. In Castelfranchi and Falcone(1999) trust means delegation. This is why, differently from what it is true for the majority ofscholarly definitions of trust (Castaldo, 2002), we propose to focus on what the trustor misses,instead of what he chooses. He misses variety. The trustor gives up power, when he gives up theexploration of potentially better alternatives of cognitive mediation. At the system (or sub-system)level delegation is the structure of power relationships in the system. So trust can drive cooperationbut this doesnt necessarily mean that trust lowers relationship hierarchies.Trust is not the opposite of hierarchy because trust is a form of hierarchy (cognitive selection). Butit is also variation. All cognitive hierarchies are at the same time selections (delegation, reduction ofvariation) and increase in variation (symbolic value added by cognitive mediations and newassociations). Mediation and delegation are not the same concepts, even though they are connected.Mediation focuses on the constructivist value added by symbolic interaction in the cognitive andsocial encounters. Delegation focuses on selection and complexity reduction.If we analyze the infomediation role of trust, we can more easily understand its relationship withdelegation and power (Mandelli, 2001). Weber (1919) defined power as "the possibility of imposingones will upon the behavior of others." In later studies (French and Raven, 1959), power explicitlyincludes the ability to influence values and beliefs. French and Raven (1959) define power as theability to influence others to believe, behave, or to value as those in power desire them to or tostrengthen, validate, or confirm present beliefs, behaviors, or values.But power is not all the same. Since Webers work on legitimacy (1919) the source of delegationhas been one of the core research questions in social studies. Coercive power is based on the threatof force. Force is not limited to physical means; it is also social, emotional, political, or economic.We know that delegation (opposite to coercion) can be based not necessarily on tradition andcharisma, but rather on shared rules and professional specialization. Weber defined authority as the"means by which dominance was cloaked with legitimacy and the dominated accepted their fate."Legitimacy can be based on charismatic affect, tradition, or legal/shared rules.Also according to French and Raven (1959), power manifests itself in several forms; among theseare: expert power, reward power, legitimate power, referent power, and coercive power. In theirstricter definition legitimate power results from one’s being appointed to a position of authority.Such legitimacy is conferred by others and this legitimacy can be revoked by the original granters.Referent power is the affective tie to ones community or group. Expert power is based on the ideathat experts are in a better position for selecting the best solutions for the collectivity.In Morris (2001 "something is legitimate if it is in accord with the norms, values, beliefs, practicesand procedures accepted by a group." (p. 2) In his perspective legitimacy is not concerned with self-interest. "... the legitimacy of any feature of a social structure is indicated by the fact that it issupported by those who have nothing to gain from it, even by those who would benefit from someother structure" (p.5)These ideas on how human communities legitimate power and delegation are crucial forunderstanding how democratic institutions can be built on power asymmetries and delegation.Representative democracy government mechanisms are based on delegated decisional power. Itmay be important also for understanding the legitimacy of coordination of social asymmetry andinfomediation.According to Schudson (1973) the shared rule and professional type of delegation is the way newsmedia legitimate their gatekeeping role in society. News values (Gans, 1979) define theprofessional and the social responsibility rules of the game. Complexity in this case is managed bydelegated selection; selection is based on negotiated agendas at the policy level and shared social-responsibility rules (McCombs et al., 1997; Semetko and Mandelli, 1997). In this view cognitiveand cultural hierarchies (information and value delegation) come out from professional delegationand civic trust. Symbolic coercion (authority non legitimated) comes from the information divide,based on the differential access to the gatekeeping system, influenced by economic, cognitive, andsocial resources (Mc Combs et al., 1997).
  • 5. 5In our digital society the sources of information are multiplied and more difficult to select. Differentkind of new infomediaries on digital networks have entered the scene (in particular portals andvirtual communities). These higher-level social actors have different agendas and value priorities.We must understand the logics of these new cognitive policy arenas in digital societies andeconomies. This goal is too broad to be addressed in this work. Here we focus on one of its corecomponents: the role of trust in delegation and cooperation. The symmetry fallacy, the new transaction costs and the economics of mediationWe argue that the reason why the dominant intellectual framework in Internet economics doesnthelp face the challenges of management in complex digital networks is because it is based on whatwe call "the communication symmetry fallacy" (Mandelli, 2001b and 2002b). This is the idea thattechnological symmetry between all pairs of nodes in digital networks (the potential totalconnectivity provided by the digital infrastructure of networks) create a cognitive and relationalsymmetry in the same pairs of nodes. It is the old "communication as transportation" metaphor,critiqued in mass communication research (Carey, 1989), now applied to the networked world.As mediations are not simply content channels, relationships are not automatic. They are context-based and are the outcomes not only of choices, but also of inertia, randomness and learning(Nelson and Winter, 1982; Dimaggio and Powell, 1991; Macy, 1998; Rullani and Vicari, 1999;Castelfranchi, 2000). Choices can be instrumentally and not instrumentally driven (Castelfranchi,1998), but they are not "order for free". They cost technology, information, trust, values, attentionand time resources at the node level, even when the cooperation between those pairs of nodes isself-organized/ not coordinated centrally (Mandelli, 2002).Friction-free relationships and friction-free markets are not more common on the digital web than intraditional communication spaces, because transaction costs at the node-level on digital networksare not eliminated, they are just changed. For the particular cognitive logistics of the Internet(Mandelli, 1997; Mandelli, 1998), it can be easier to reach out somebody (once we know where tolook for) and switch from him to another partner, but it can be much more difficult, though, toestablish an efficient and long-lasting relationship, considering the complexity of these dynamicencounters, their uncertainty, and the cognitive and social resources we have to bring into(Mandelli, 1998; Jarvenpaa and Leidner, 1998).The communication symmetry idea doesnt take into account the complexity of social and cognitivenetworks we are creating thanks to the technological web, and the individual and system-level needfor new hierarchical (though dynamical and flexible) structures of selection and delegation, made ofdifferent layers of dynamically interconnected cognitive worlds (Mandelli, 2001).The availability of a technologically frictionless communication channels doesnt increaseautomatically information and relationship variety for social mediation. We reduce our access todiversity in relationships because of cultural inertia (Dimaggio and Powel, 1991) or according toour need of economizing on cognitive investments (Neuman, 1991; Mandelli, 1997b and 2002).But we also reduce our access to diversity because of the information asymmetries structured by theeconomics of infomediation and content (Neuman, 1991; Mandelli, 1998; Shapiro and Varian,1998; Vicari, 2001).But if network society is not the all symmetrically connected society that the new frictionlessparadigm envisioned, it is also very different from the only-locally connected societies of the past.If societies are communication networks, the structure of the network matters. Digitalcommunication provides a different infrastructure and structure to our network society. If we studyInternet relationships using the approach suggested by connectionism applied to virtuality (Vicari,2001), we can recognize new hierarchies at the level of the structural architecture of connections, atthe level of the stock of resources available to the individual nodes in relationships, and at the levelof the connection activation mechanisms (Mandelli, 2001).
  • 6. 6We can easily grasp this, applied to the so-called digital divide problem in the network society(Norris, 2001; Dimaggio and Hargittai, 2001; Cawkell, 2001). People have access to thetechnological connections of the new social network (they become Internet users) depending ontheir social and cognitive resources (technology adoption, education, computer literacy).Researchers call this the first dimension of digital divide (Norris, 2000). Also, they have access tothe information and the relationships on the network, depending on their ability to reach(technologically and cognitively) content and other people and being reached by content and otherpeople. This content and relationship access (the "democratic divide" in Norris, 2000) is limited bythe infomediation/gatekeeping systemi and its business model (figure 1, Mandelli, 2001). A generalportal is less precise than a specialized navigation service. A walled-garden portal like AOL limitsmore the options and the diversity of navigation sources than the other types of portals or freenavigation on the World Wide Web. But this access is also limited by users language, and usersstock of available tangible (money) and intangible resources (attention, time, cognitivesophistication, social capital). Individual Cognitive Individual network Cognitive network e ivid tic d ocra Dem Individual Cognitive Infomediary network Content Te ide Inf ch oa div div cc ess ide ch Te Individual div Cognitive ide network Individual Content Cognitive Content = Technological connection network = Communication connectionFigure 1 Hierarchies on the network - source: Mandelli, 2001The infomediation structures on digital networks can be very different (Mandelli, 1999); they canbe very complex (different distributed layers and actors of infomediation, all connected byhypermedia rings of collaborative services) or very top-down and simple like in the walled-gardenmodel. They respond to specific functions (trade-off between cognitive efficiency and diversityaccess for the user) and have different legitimacy for their gatekeeping role (Mandelli, 2001).Besides accessing the content differently, Internet users can also interact with content and peopledifferently, depending on whether the formats of the channel and the medium are designed to allowinteractivity, but also whether they are able and interested in doing it, according to rational and non-rational rules of activation.Each elementary and second-level node on the network faces transaction costs (costs of cognitivemediation) when they activate connections with other nodes and sub-systems. These transactioncosts are made by all the resources invested in the symbolic mediation:
  • 7. 7 • Monetary cost of connection (if the infomediation infrastructure is not based on free- connection business models) • Time • Attention • Knowledge • Social capital • Freedom (privacy)Knowledge is to be conceived both as cognitive sophistication (education and technological literacyfor individuals) and cognitive frameworks. Social capital is defined in Putnam (1993, 167) as those"features of social organization, such as trust, norms and networks, that can improve the efficiencyof society by facilitating coordinated actions."All the intangible resources produce costs, even though knowledge and social capital are subjectedto the law of increasing returns (Shapiro and Varian, 1998), meaning that their value doesntdecrease with the use. Knowledge and social capital dont devalue with the use, but they requireoften huge investments to be built, that is they create sunk costs. Networks still have sunk costs atthe node level, but these sunk costs are different than before; they are mostly based on intangibleinvestments. We know that sunk costs drive lock-in strategies (Shapiro and Varian, 1998) and thisis one of the major sources of hierarchy on the social and economic networks.More in general, the new transaction costs have the following sources: • The cognitive complexity of the increasingly interconnected system; • The economies of scale (supply side and demand side) and scope in the information production; • The tangible and intangible resources required for accessing the content and the infomediation infrastructure of the network; • The tangible and intangible resources requested by the relationships with the connected nodes. New hierarchies in the network societySince the spread of the frictionless paradigm in Internet research, few authors have disputed itsmajor claims from different fields (Shapiro and Varian, 1998; Porter, 2001; Norris, 2000 and 2001;Mandelli, 1998 and 2001b), even though not in a unitary framework. The core argument of thefrictionless paradigm is the idea that the Internet eliminates transaction costs and communicationasymmetries. If we challenge the idea that the Internet eliminates transaction costs andasymmetries, we seriously cast doubt on the entire frictionless paradigm.In this work for economic paradigm we intend (as in Rullani, 1998) a coherent abstract system oftechnology, organizational model, type of marketing and labour relationships; "an abstractframework that theory can build and practice can use ... an intelligent reducer of the social andnatural complexity, which is selected by a cognitive filter that drives it toward the production ofvalue. ... a kind of collective intelligence." (Rullani, 1998, 30).We accept the call in Rullani (1998) for challenging the fundamentalist answer to the crisis offordism, which mixes a naive mythology of digital revolution with social darwinism. CitingHabermas he reminds us that this fundamentalism "... which is nurtured by technology and naturelaws, is in search of a program of technological transformation driven by the force of self-organizedsystems, with abdication of the political power and the sacrifice of collective action. It is onlyapparently a liberal form of post-fordism; actually it is an authoritarian form ... because, without theold constraints, the new dynamic technostructures and the interests which lead these socialtransformations can easily dominate all the others." (p. 27).For achieving this goal we need to clarify what we mean with the term hierarchy. In this work weuse three ideas of "hierarchies":
  • 8. 8 • The first one is strictly linked to the idea of information asymmetry, the unequal access to relevant knowledge by relational parties; relevant for this study is the unequal access to both diversity and richness of information; • The second one is the idea of power asymmetry in dyadic relationships, based on selection and delegation (when people explicitly, even though not always because of their willingness, give up variety options in their content and social encounters, even if they have access to them); • The third one is, at the network level, the more complex idea of organizational hierarchy, as the governance institutional alternative to the market form of coordination, in the transaction-cost theory approach to organization (Williamson, 1975). The not-so-frictionless digital economyResearch extensively found that relationships between consumers, relationships between companiesand relationships between companies and consumers in the digital economy dont follow thepatterns predicted by the frictionless model of the Internet economy, both in BtoC and BtoBmarkets. As we are going to review in the following paragraphs, there is solid evidence that: • Inter-firm networking has demonstrated to be constrained by cultural and social frictions; • The community business model in e-commerce has proved widely unsuccessful both in BtoC and BtoB; • Information and organizational concentration has demonstrated to be an important competitive lever also in the digital economy; • Price discrimination in digital economy has been found, supporting the idea that brands have a differentiation role also in the uncertain territories of the Internet markets; • The establishment of new relationships on digital networks requires the investment of relevant cognitive and social resources.These results may be interpreted as the support to the idea that the Internet is "business as usual".Here we try to bring theoretical support and evidence for the opposite view. The Internet diffusiondoes indeed call for a change in business management and marketing paradigms, but in a different(and more complex) way than it is predicted by the frictionless and reverse-marketing vision.We claim that in the Internet economy there are different kinds and degrees of digital hierarchies,because there is not easy and equal access to knowledge, because there still are transaction costsand social resource scarcity, and because organizational concentration in the content andinfomediation activities still matters. The sources of the new hierarchies are to be found just in thenetwork nature and economics: the economics of content and gatekeeping (infomediation), thecognitive logisticsii of the web, the increasing complexity of social networked systems and theeconomics of individual cognitive mediation and selection (bounded rationality and boundedsociability). Hierarchies in the inter-firm networksAdler and Kwon (2002) propose to go beyond the dicothomy between the market and the hierarchyorganizational concepts, in the study of post-capitalism. In their vision networks are not justhybrids, they are a new ideal-typical forms of organizing, with its new corresponding coordinationmechanism: trust.Several authors predict that dynamical network-based organizational forms will replace hierarchicalorganizations (Saxenian, 1994; Fukuyama, 1995 and 1999; Adler, 2001; Adler and Kwon, 2002), ina world where complexity makes fixed contracts and hierarchical ties incapable to address thegrowing need to adapt to environmental changes, and technology offer easier way to build dynamicconnections. We address this issue more in depth in Mandelli (2003). Here we focus on empirical
  • 9. 9studies that provided evidence challenging the idea that technological networks can easily andalmost automatically transform in network-based coordination.In the BtoB Internet world, vertical e-marketplaces managed by independent infomediaries wereassumed to become the new network business model (Bakos, 1998; Kaplan and Sawhney, 2000). Itis widely recognized now that the main reasons why these open network-based marketplaces havefailed were their inadequacy to deliver a superior value proposition to the members, and a lack of alegitimated and trusted system of knowledge-sharing (Grewal et al., 2001; Devine et al., 2001¸Hoffman et al., 2002). In Grewal et al. (2001) study on a vertical e-marketplace in the jewelryindustry, the researchers applied the motivation-ability framework (Merton, 1957) to inter-firmcooperation, and found that motivation to cooperate was both efficiency-driven and legitimacy-driven (as also suggested by the new-institutionalism theoretical framework, see DiMaggio andPowell, 1983). None of these expectations were met.The new supply-chain collaboration formulas (in which the incumbent players orchestrate thenetworks) have proved more successful (Hoffman et al., 2002): Devine et al. (2001) report thatthough buyers can shop for a better price elsewhere, they have found that they are rarely inclined todo so and prefer private exchanges. Customer relationships built on trust (and supported bynondisclosure agreements) are essential for knowledge sharing (for example if suppliers have tomonitor a customer’s sales and inventory levels, to forecast product demand, and to assure thedelivery of goods or services as needed). Also McDuffie and Helper (forthcoming), in their study ofglobal Internet consortia, found that social interaction patterns (different by company history,country, laws, institutions, geography and resources) have been critical variables in these networkprojects. These new networks are not "business as usual" but neither frictionless webs ofrelationships. They provide a completely new, more efficient and richer, communicationenvironment to previous economic communities, consolidated by accumulated knowledge and trust.One lesson that we can draw from this experience is that managers cannot build communities inlaboratory; they emerge historically from the complex dynamics of relationships in industries andsociety. Also Internet business networks are built on frictions. Communities are built on socialcapital and willingness to share knowledge, and these two assets are not readily available.Institutions emerge when they offer to all the economic actors added value compared to thealternatives. In this case, open community-based value networks failed to deliver higher value to theinvolved nodes than it was possible through more hierarchical organizations. Social capital is therelative advantage of the new hierarchical formats; the cost of building trust was the transaction cost(and the main reason of failure) of the previous open formulas.This phenomenon can be better understood using the conceptual tools offered by the research on therole of trust in building competitive advantage in post-fordist economies (Barney and Hansen, 1994;Vicari, 1995; Costabile, 2001; Busacca and Castaldo, 1996) and the literature on social inter-firmnetworks (Grandori and Soda, 1995; Kogut and Zander, 1996; Koka and Prescott, 2002). Trust, inthe resource-based view of management, is considered one of the intangible assets of firms, whichbuild on it for achieving differentiation and sustainable competitive advantage. It works as strategic(and not-easily-replicable) asset just because it is not readily produced.Also the organizational network literature provides support for the idea that social capital is not aneasy-to-build asset. Koka and Prescott (2002) define social capital, in organizational contexts, interms of the information benefits available to a firm due to its strategic alliances. Using longitudinaldata on the population of strategic alliances formed during the period 1980-1994 by firms in theglobal steel industry, they provide evidence that social capital yields distinctly different kinds ofinformation benefits in the form of information volume, information diversity and informationrichness. But these benefits are different because the distribution of social capital is not equal.Networks are not all the same. Not all the members of a network are the same. Some members aremore equal than the others.The resource-based approach (Barney and Hansen, 1994) has had a significant impact on how wesee the way firms leverage their resources and capabilities, in particular knowledge and social
  • 10. 10resources, for building competitive advantage. The emergence of intangible resources as a majorcomponent of firm capital, often overshadowing traditional capital (Barney and Hansen, 1994;Vicari, 1995; Costabile, 2001; Busacca and Castaldo, 1996) has contributed to refocusing strategicmanagement on organizational advantage (Nahapiet and Goshal, 1998). The firm has been thereforeredefined as “a social community specializing in speed and efficiency in the creation and transfer ofknowledge” (Kogut and Zander, 1996). The trade-off between market and hierarchy, is illuminatedby a new perspective. The reason why organizations emerge is not to leverage tangible resourcesanymore, but rather to leverage the intangible unique sources of competitive advantage: knowledgeand social capital. This approach to institution formation can be applied to both firms and networks.Even in the over-studied Linux case (Browne, 1998; Axelrod and Cohen, 1999; Moon and Sproull,2000) of open-source and distributed software development, researchers found that the project wasworking because it was based on specific and not-generalizable resources: a natural communitywith strong commitment (what can be more affectively motivating than the goal to outperfomMicrosofts operative system?), trust and diffuse expertise.Also speaking about organizational social ties we can fall in the symmetry fallacy we have alreadydescribed for information flows, when we take a technologically deterministic stance.Technological connections dont necessarily create social connections. Network-based relationshipsdon t simply stem from technological connections. They are output of choices, but also socially andculturally emergent phenomena. Their structures are influenced by the history of prior relationshipsand the stock of available social resources. In Adler and Kwons (2002) perspective "Social capitalis the resource available to actors as a function of their location in the structure of their socialrelations" (p. 18)Networks are not cost-free coordination formats. We can consider social capital as both a cost and abenefit of relationships (Adler and Kwon, 2002). It is a cost because it requires investments but also"it needs maintenance" (Adler and Kwon, 2002, 22). Networks have coordination costs, which stemfrom the organizational complexity of these new forms of organizing (Gulati and Singh, 1998).Network formation is a path-dependent, evolutionary process, and trust can help diminishtransaction costs only after a complex and long history of social investments (Lorenzoni andLipparini, 1999).Also, social capital in networks can create frictions and inertia, instead of liberating creativity andinnovation. Local cultural and social forces can hamper the ability of networks to go beyond theoriginally local base, in search of optimization coming from the diverse and global reach of the newtechnologically connected networks (Powell et al., 2002). Tsais (2000) study shows that also inintra-organizational networks, prior network centrality, trustworthiness, and strategic relatednesssignificantly affect the rate of new linkage creation and network structure.One of the examples often used to show the relevance of the network-based model of inter-firmgovernance is the "local distretti" form of organizing of the Italian small companies (Saxenian,1994). These local network-based industrial systems are characterized by flexibility but also by theability of adaptively learning in a cooperative context. But in these network-based systemsrelationships are not symmetrical (Grandori and Neri, 1999; Brown et al., 2002; Dagnino andPadula, 2002), and cooperative learning is complemented with control and command, reproposingthe old role of the bigger and more powerful firms in the construction of new dynamic networks inlocal and global economies (Gottardi, 1998). The structures of networks evolve and change overtime, and they can be designed and managed by network leaders (Lorenzoni and Lipparini, 1999).Technological diffusion increased the geographical outreach of the networks originally only localbut this also increased the importance of the local leader firms and their role in leading vastnetworks of smaller and subordinated firms (Gottardi, 1998). This system integrates competitionand cooperation, but "it is governed by the leaders" (Gottardi, 1998, 142).Also the cases of wide global networks of smaller firms organized by powerful orchestrators asNike and Cisco (Brown et al., 2002) confirm this highly hierarchical option of network-basedgovernance forms. The hypothesis that networks drive almost automatically cooperative behavior
  • 11. 11doesnt correspond to empirical evidence. Studying the importance of the relational dimension ofinter-firm exchanges, Wathne et al. (2001) found that interpersonal relationships between buyersand suppliers serve as a switching barrier but are considerably less important than both firm levelswitching costs and marketing variables.Gulati and Singh (1998) found that previous social ties reduce coordination costs and the need forhierarchical control, but they also found that reciprocal interdependence (we can call it complexityof the system) increases need for coordination hierarchy.In short, networks are not simply a more democratic and socially rich alternative to hierarchies,coordinated through trust instead of price or authority. They include elements of markets andhierarchies, and are coordinated through different control mechanisms: prices, trust and authority.Control mechanisms require investments at the node level and at the social level. The real noveltyof networks doesnt seem to be the differential degree of hierarchy, but the differential degree ofinterconnection (complexity) and flexibility (dynamism of connections) of the systems.This is consistent with the recent call of researchers (Dagnino and Padula, 2002) for studying theinterconnected (and not dichotomical) role of competition and cooperation in networks. Theysuggest rebalancing the focus of research attention, in order to study the "variable-positive-sumgame" and the potentially "unfair" nature of the network mutual exchanges (Dagnino and Padula,2002). The concentration in the content and infomediary industry: the new gatekeepersAccording to Shapiro & Varian (1998), the economic impact of the Internet and corporate computernetworks is similar to that of earlier networks such as the railways, telephones and bank machines.The authors claim that information rules are simply more radical versions of the rules that havealways applied to high-fixed-cost, low-marginal-cost industries. Information industries in general --Media companies, Internet companies, software companies-- all have in common the combinationof high fixed costs, low marginal costs and network externalities (the more people use thenetwork service the more people will find it worth using it). This generates huge economies of scaleat the supply side (economies of scale in the production and distribution of information - the so-called first-copy economies in Neumann, 1991), and at the demand level (benefits for the individualmembers of the network are dependent on the size of the network itself), as well as huge economiesof scope (the more the same customer buys from you the less is the unitary cost of your relationshipwith her).The rules of the information economy, plus the scarcity of the attention resources at the node level(their bounded rationality), drive market concentration, not distributed market power. Thisinformation economy creates not only emergent information hierarchies but also explicit strategiesfor controlling the navigation options and information diversity accessible by customers. Pricediscrimination, product versioningiii and lock-in strategiesiv (though hurting the interests of thecustomers because they reduce their access to diversity), generate higher profits for the company.The world of the information economy, from this standpoint, is made by huge corporations andtrapped customers. The result can be a second-level digital divide: a "democratic divide" (Norris,2000)."Small foundations and educational institutions simply can not compete with the vast productionbudgets of major commercial portals like Yahoo and Excite. Further, if people want to find suchnon-commercial spaces, they may find it difficult due to search engines that steer people to thecontinually growing number of commercial web sites." (Neuman et al. 1999). This drive towardconcentration is accelerated by the more diffused business model on the net: the advertising-basedbusiness model. Since the infomediaries (portals of all sorts) need advertising revenues, they tend tobuild big audiences and this - along with the economies of scale - makes the competition for sharesof web traffic very intense. On the other side, the economies of scope and the business modelsbased on affiliation commercial agreements drive the development of the so-called "walled-garden"
  • 12. 12model of the information assortment. This means that the big portals tend to reduce the number ofinformation sources accessible and to control the rules of search results in order to respond to theexpectations of commercial partners (big manufacturing firms, retailing and information brands onthe net).The resulted concentration of what we call the "activated navigation options" on the World WideWeb is clear from the following chart (figure 2). It refers to the distribution of the total attentioninvested by the users on the web in Europe, measured in monthly usage minutes. Number of web usage minutes per month, by number of companies to which usage is attributable - Europe (Jupiter, 2001) 120 100 80 50% of all minutes 60 60 % of all 40 minutes 20 0 March 1999 March 2000 March 2001Figure 2 Concentration in European Internet infomediationOnline consumers respond to overload of information by dedicating their attention to a very limitedfraction of online shops. They select and give up diversity. Netratings in September 2002 calculatedthat the average Internet user accesses only 49 domains in a month. We know that the number ofavailable domains on the web were more than 36 million already in 2001 (source: Coleyconsultancy, 2002)This doesnt sound new for students of mass communication. From media economics we know thatinformation economies drive concentration. This is true for the interactive networks as it was true inthe old content and information industries (Neuman, 1991).We also add another reason, often disregarded, why we should be aware of the potential increase ofeconomic concentration, specific to the era of the Internet; we first studied this phenomenon appliedto marketing (Mandelli, 1998). The Internet not only decreases connection costs. It also decreasescoordination costs. Digital technologies not only foster the efficiency of cooperation processes(knowledge conversion through electronic socialization), they also increase the efficiency of theexplicit and codified forms of knowledge conversion (Mandelli, 1998): knowledge externalizationand re-combination using Nonaka and Takeuchis (1995) words. It is like to say that, if it is true thatthe Internet technology reduces the transaction costs concerned with the distant and dynamiccooperation (therefore fostering the market-type coordination of the interdependencies), it is alsotrue that it reduces the cost of organizational hierarchy-based coordination based on structures andstandards of infomediation. The trade-off that generates new institutions doesnt disappear. It movesat a new and lower absolute cost level.This helps also explain why the predicted disintermediation on the Internet is not in sight. Carr(2000) writes that like many of the early assumptions about electronic commerce, this one hasproved "laughably wrong." It is now becoming clear that business is undergoing precisely theopposite phenomenon - what Carr (2000) calls "hypermediation". Transactions over the Webinvolve all sorts of intermediaries, not just the familiar wholesalers and retailers, but contentproviders, affiliate sites, search engines, portals, Internet service providers, software makers, andmany others (Mandelli, 1998). And it is these middle men that are capturing most of the profit(Carr, 2000). You could easily imagine this outcome of the Internet changes, if you studied the
  • 13. 13different but contemporary changes in transaction costs and coordination added value for bothdistributed-direct relationships and for hierarchical and intermediated links brought about by digitalnetwork technologies (Mandelli, 1998). Brands as hierarchiesThe frictionless vision of the digital economy tends to focus on the elimination of the informationfrictions, and predict a cooperative, dynamic, network-based coordination, without studying in moredepth the real role of trust. In this vision, trust is seen as automatically linked to cooperation andsymmetry in relationships, whereas we propose to consider the role of trust also in buildingrelational hierarchies, when power in the relationship is asymmetric, as it happens in brandrelationships.Shapiro and Varian argue against the idea that brands will be replaced by perfect competition."Visionaries tell us that the Internet will soon deliver us into that most glorious form of capitalism,the friction-free economy ... we agree that the Internet will make shopping easier than ever, butmuch of the talk about friction is fiction. (Shapiro and Varian, 1998, 142) Frictions are embedded inbuying history and switching costs. They write: "You don t have to drive to the store to order a newcomputer, but your choices for the future will still be hemmed in by the selections you made in thepast. Like it or not, in the information age, buyers typically must bear costs when they switch fromone information system to another. ... When the costs of switching from one brand of technology toanother are substantial, users face lock-in. ... Lock-in can be a source of enormous headaches, orsubstantial profits, depending on whether you are the one stuck in the locked room or the one inpossession of the key to the door." (Shapiro and Varian, 1998, 143)Porter (2001) starts from another perspective. He doesn t study the specific rules of the informationeconomy, even though he ends up admitting that the Internet can increase competition andchallenge competitive advantages based on traditional sources of market differentiation. But whathe doesnt accept is the idea that in this new turbolent economic environment firms do not haveopportunities for differentiation. Unique products and unique brands will have the same power (ifnot more) as they had in the past.Research efforts have found support for the idea that there are lock-ins and information hierarchiesat the brand-consumer relationship level, in digital economy. According to Reicheld and Schefter(2000), who studied consumer behavior in this new marketspace “price does not rule the web,loyalty does” (p. 106). Several studies have tested the hypothesis of perfect price competition onthe Internet (Smith et al., 1999; Brynjolfsson and Smith, 2000; Pan, Ratchford and Shankar 2001;Chen and Hitt, 2001; Johnson et al., 2000; Latzer and Schmitz, 2001; Ancarani and Shankar, 2002).They found that price discrimination and the role of brands in market relationships were verysimilar on the Internet as in the traditional markets. "... several studies find significant pricedispersion in Internet markets. This price dispersion may be explained by heterogeneity in retailer-specific factors such as branding and trust, retailer efforts to build consumer lock-in, and variousretailer price discrimination strategies" (Smith et al., 1999, 26). Lack of trasparency might be notthe only source of price dispersion; people might be easily willing to spend more money for thesame product, even though perfectly informed about the alternatives, if they invest in a brandedrelationship, trusting the company about future differences. Brynjolfsson and Smith (2000) write:"In light of both existing theory and the earlier results on price levels and price changes, thedispersion in posted prices is surprisingly high. ... At the same time dispersion in weighted prices islower on the Internet than in conventional outlets — reflecting a dominance among certain heavilybranded retailers. Given these findings, we analyse potential sources for the high degree of pricedispersion on the Internet. We conclude the Internet price dispersion may arise from two differentsources of retailer heterogeneity: heterogeneity in customer awareness, and heterogeneity in retailerbranding and trust. We also note that, far from being equalized, these differences among sellers maybe amplified on the Internet as compared to conventional channels." (Brynjolfsson and Smith, 2000)
  • 14. 14These results are particularly important because they come from studies on products consideredhomogeneous, like books and CDs (we believe that the same study applied to more complexproducts would have found even higher price dispersion). But this also may support the idea that ina relationship economy the source for differentiation doesn t come necessarily from the coreproduct, but rather from the service that surrounds it (Mandelli, 1998). Research results from Lynchand Ariely (2000) and Shankar, Rangaswamy, and Pusateri (2001) support this hypothesis, sincethey found lower price sensitivity on the Internet when more information is offered. Rajgopal et al.(2000) found that the quality of user experience can build a relationship competitive advantage. Inan experience economy (Pine at al., 1999) what we buy is not the product but the complexexperience associated to this buying behavior. If so, it is even more difficult to predict a perfectcompetition in the Internet markets, since an interactive environment makes the task of buildingcomplex services and experiences around simple products easier than before (Mandelli, 1998).Amazon doesn t compete on books. It competes on the quality of their services, and on thesophistication of the user experience on their web-site (ease of navigation, personalization services,feedback from the readers, etc.).Latzer and Schmitz (2001) give the following examples for providing evidence for lower thanexpected market transparency: 1) Search engines cover only a small fraction of web-sites (0,03% according to Bergman, 2001) and e-commerce companies have means to manipulate the perception of the search results (Sullivan, 2001); 2) This is the reason why the traffic is very concentrated (they provide data for the Austrian market similar to those provided in the previous paragraph of this chapter; 3) Consumers tend to search very few shopping-sites and the fraction of shoppers that stop their search after the first site visited is high (Johnson et al, 2000); 4) The most important criterion for consumer choice in BTOC e-commerce is brand name not prices (they provide primary evidence from a survey conducted on a national sample of Austrian users and meta-analytical research data supporting this hypothesis).Brynjolfsson and Smith (2000) warn that unexpected (and contrary to frictionless hypothesis)results could be due to the immaturity of the Internet markets and easily change in the future. Wetend to not agree. Even though it could happen that shopping bots and distributed intelligence in themarket will diffuse and make prices more transparentv, it is not likely that brands will become lessimportant, since the source for differentiation and cognitive hierarchy (the need to shortcut incomplexity and the need to trust somebody in the light of an uncertain future) doesnt.Trust in brands is the major driver of infomediation selection on the web, along with trust in socialties. Using data from the World Internet Project surveyvi on a sample of Italian users, we foundthat - when asked what influences their choice of information sources on the Internet - 36% of themanswered that they choose information sources based on their reputation; 34% use the same sourcethey use offline; 31% is influenced by word-of-mouth. These data confirm the importance of bothcognitive and social hierarchies (delegations) in managing complexity on information-overloadeddigital networks. Relationship changes in digital economyEven though we have found support for the idea that there are information, power and organizationhierarchies in digital markets, we dont think this should be interpreted as the proof that the Internetdidnt disrupt the traditional way of doing business. Digital marketing is not a reverse marketing,but it is neither traditional marketing.Porters contribution (2001) to the debate helps give up simplistic ideas about the irrelevance ofdifferentiation in the new network economy, and re-focus on the importance of making the rightstrategic choices when facing the relevant economic trade-offs. But these trade-offs are differentthan before. We need to understand how we can create this uniqueness in the new economic and
  • 15. 15technological context. What is dangerous from a theoretical and practical standpoint is the risk thatwe fall in a sterile contraposition between two equally useless views of the Internet economy: "thefrictionless idea" and the "business as usual" mind-set.We also find that Shapiro & Varian gave an invaluable contribution to the study of the informationeconomy rules, but they perhaps focused too much on the information side of the digital economyand overlooked the other side of the economics of mediation: the relationship side. The networkeconomy is an infomediation/content economy but also a relationship economy. There are newrelationship costs and benefits to consider, and new trade-offs to evaluate. A relationship economyperspective could help explain for example why network externalities do not always operate in largecommunities. Network externalities dont depend on the size of the network (number of membersfunctionally connected) but on the size of the participating members (Mandelli, 2001, Grewal et al.,2001). We claim that information rules are not enough to guide action in the digital economy,because they stress the importance of forced relationships (lock-ins) in order to build economies ofscope, without considering the importance of active and socially rich participation, in order toleverage cooperation economies. Also, Information rules dont focus the attention on variables,which we believe is critical in a network economy: social exchanges, with their costs and theirbenefits. We call for an integration of the study of the content-side of the network economy with thestudy of its relationship-side, in the complexity of a all-connectable (not necessarily all-connected)world.The study of the role of brands in the digital economy can help highlight some of the importantcharacteristics of this relationship economy. Brands in traditional marketing is the managerial toolfor building differentiation in the relationships with the customers, in order to justify pricepremiums and build attitudinal and behavioral loyalty (Busacca and Castaldo, 1996; Rust et al.,2000; Busacca, 2000; Chaudhuri and Holbrook, 2001; Costabile, 2001), in exchange for their roleas cognitive selectors (shortcuts) and uncertainty reducers (trust). This "management of complexity"role of brands is built around their ability to offer efficient relevant information during the customersearch activity, and constant value (functional and affective) in the relationship experience. Theresult is a superior economic return for the firm. Brand trust and brand affect jointly determinepurchase loyalty and attitudinal loyalty. Purchase loyalty leads to greater market share, andattitudinal loyalty leads to price premium for the brand. (Chaudhuri and Holbrook, 2001).On the Internet this value-appropriation role of brands is built one-to-one, in terms of micro-segmentation, versioning and dynamic pricing based on the individual value equations of thecustomers. But value-appropriation cannot forget the value-creation side of relationships. Pricediscrimination based on the one-to-one perceived value of the same product by different consumerstries to exploit the dynamic adjustment power of the economic web, but it falls short of the mostimportant asset: legitimacy. Value is not an absolute matter. It is dynamic and relational (it isadaptive). And when we speak about trust and brands in digital economy we dont refer only to theidea that trust and brands can build long-lasting loyal relationships (Reicheld and Schefter, 2000;Urban, Sultan and Qualls, 2001; Shankar, Smith and Rangaswamy, 2002). We are speaking aboutthe different nature of delegation and selection of variation that works online, compared to thetraditional one, and we speak about the legitimacy of this selection following the neo-institutionalistapproach (DiMaggio and Powell, 1983). We can consider the so-called "case of dynamic pricing" This case is widely used in public relations studies, because it is a good example ofhow companies on the Internet can easily fall in viral communication crises. We are, instead, heremore interested in the reason why this crisis exploded.Amazon was found to be selling the same DVD movies for different prices to different customers. Itwas a test of the dynamic pricing philosophy (which states that customers should be chargedaccording to their perceived value of the products and their means), built on the information aboutthe buying habits of 23 million consumers. But customers evaluate and talk. One of them realizedthat if he excluded the cookie software on his computer, which identified him as a regular Amazoncustomer, the price of the DVD of Julie Taymors "Titus" fell from $24.49 to $22.74. Chatting on
  • 16. 16the web site, he diffused the news. The reaction of other Amazon customers, also inother newsgroups, was powerful. They were particularly distressed by the idea that Amazoncharged higher prices to loyal customers (The Washington Post, September, 27, 2000).It is out of doubt that Amazon has strong brand power (power symmetry not just informationsymmetry) in the relationship with its customers, but this was not enough for letting them exploitthe economic leverage of dynamic price discrimination. Customers, who accepted to pay a higherprice when they decided to delegate variation reduction to the brand company in exchange for betterservice and future reassurance, refused to pay a higher price when they perceived that this pricediscrimination was not legitimated.Research indicates that capabilities and resources create competitive advantage when they arevaluable, rare, and imperfectly imitable (Barney, 1986). This is the case of brands also in digitalmarkets, but in these more complex and connected environments this competitive leverage must benurtured with more intelligence, collaboration and transparency. Brands must be more intelligent(because through the learning network with business partners and consumers they can enrich theircognitive control of the market), and collaborative (because the values associated to the brand mustbe socially negotiated and mediated by the emergent and self-organized meaning that the peripheryassigns to them). Collaborative marketing (Mandelli, 1998) doesnt mean that brands are nothierarchies anymore. It means that brand hierarchies are different: more legitimated and at the sametime more able to cope with complexity.But brands and trust are not cost-free. If we analyse this in the framework of the economics ofmediation, we understand that brands still are valuable intangible resources for firms that they caninvest in cognitive economic exchanges. Brands still play the role of signaling trustability, drivingcustomer selection and customer loyalty, which activate the economies of scope at the node level(one-to-one), and therefore generating value for the brand companies. But for their formation theyrequire investments of tangible and intangible capital. Brands are built investing in product quality,quality of communication and quality of customer experience. They are sunk costs for firms.Also for consumers, brands drive both benefits and costs, both value capture and value invested. Forconsumers they work as trust-based shortcuts (benefits connected to the reduction of complexityand transaction costs for search and evaluation of different options), value associations (benefitsconnected to the symbolic area of consumption), but also information and power hierarchy(reduction and sacrifice of diversity).So there still are brand trade-offs, both for firms and for customers. But these trade-offs areevolutionary and negotiated at a more complex level than before. They are a matter of policydecisions, and policy decisions as we know (Lowi, 1964) are complex outcomes of planned andeveryday negotiations in local, culturally and socially embedded policy arenas.Internet economy cannot be frictionless, because it s a complex economy and a complex economylives of delegation (even though not always vertical delegation), which is a form of hierarchy. Buthierarchies are not all based on domination and coercion. Selection in a simple and authoritarianenvironment may be a matter of low transparency or trapping strategies; selection in a complex andconnected environment is a matter of delegation and cooperation, and this is true also for brandhierarchies (figure 3).
  • 17. 17 LEGITIMACY Low High Low Free navigation EFFICIENCY Walled-garden portals Professional media/ Traditional Collaborative shopping bots branding and intelligent High brandingFigure 3 Efficiency and legitimacy in Internet infomediation: the role of collaborative brandingSource: elaboration from Mandelli, 2001So the attention moves to the sources, dynamics and results of social delegation and cooperation. Trust, Delegation and bounded sociabilityAlso independently from the new economic governance debate, academics have called for moresystematic research into the role of trust in business relations, observing that: "It is clear thatresearch on trust needs to advance beyond a catch-all residual in the unexplained random error"(Koza & Lewin, 1998,85). But this is not an easy task, since there is not clarity around the conceptof trust itself. Regarding this gap, Mutti (1987: 224, cited in Castaldo, 2002, 2) writes that "thenumber of meanings attributed to the idea of trust in social analysis is disconcerting. Certainly thisdeplorable state of things is the product of a general theoretical negligence. It is almost as if, due tosome strange self-reflecting mechanism, social science has ended up losing its own trust in thepossibility of considering trust in a significant way".The notion of trust is widely used in different social science disciplines (sociology, economics,strategic management, organization, marketing, psychology) but often with different meanings.Castaldo (2002) has recently meta-researched the trust literature, and concluded that there is a lackof a clear and shared definition of the trust concept, even within the business research community.He did a meta-analysis of the different (70) definitions of trust, statistically clustering them, andproposing a multilevel construct-frame. He considered the construct profile (belief, attitude,willingness), the subjects involved in the relation (person, firms, institution), their profile (honest,competent, benevolent, committed), the role of risk, opportunism and vulnerability, and the trustingbehaviors. Even though not all the studies hypothesized a direct causal relationship among thesedifferent variables, many placed them in a logical sequence: "This sequence often regards trust asthe expectation, belief (and so on) that a subject with specific characteristics (honesty, benevolence,competencies, and so on) will perform actions designed to produce positive results in the future forthe trustor, in situations of consistent perceived risk." (Castaldo, 2002,8) So trust is mostlyconceptualized as the heuristics (beliefs that drives action) that help rationally bounded agents takerisky decisions. This heuristics in the definitions examined is more or less based on self-interest(contrasted to altruistic motivations) and based either on the evaluation of the personalitycharacteristics of the trustee or on their rational motivation to act positively for the trustor. But
  • 18. 18basically almost all the authors consider trust as a cognitive tool or state, which we use to guideaction in "the shadow of the future" (Axelrod, 1984).viiCastaldo (2002)s content analysis found out that the words most used in the different definitionswere: "action, will, expectation, belief". Very interestingly, cooperation was one of the least usedterms.These definitions have in our research framework important limitations: • They do not analyse the difference between bonding and bridging trust (trust in friends and trust in strangers); • They define trust as a state, a static phenomenon; • They dont consider the economics of trust, (there is no account for the costs of the invested resources in the process); • They are only focused on the rational-choice dimension of trust and don t consider the unthinking, emergent evolutionary component of trust dynamics.This is why Castelfranchi and Falcone s (1998 and 1999) model of trust dynamics is helpful. Weare particularly interested in • Their idea of trust as a dynamic process (trust builds trust), • Their conceptualization of trust as cooperation (trust requires the investment of social resources), • Their idea of trust as the antecedent of dynamic delegation (dynamic reduction of autonomy) • Their conceptualizations of trust as complex mediation (external trust builds internal trust)."Delegation necessarily is an action, a result of a decision, and it too creates and is a (social)relation among x, y, and z. There may be trust without delegation: - either the level of trust is notsufficient to delegate, or- the level of trust would be sufficient but there are other reasons preventing delegation (forexample prohibitions). So, trust is normally necessary for delegation, but is not sufficient:delegation requires a richer decision. There may be delegation without trust: these are exceptionalcases in which either the delegating agent is not free (coercive delegation) or he has no informationand no alternative to delegating, so that he must just make a trial (blind delegation)." (Castelfranchiand Falcone, 1998, 3)So trust drives cooperation but this doesnt necessarily mean that trust in relationships lowershierarchies.Castelfranchi identifies two fundamental problems (Castelfranchi, 1990), studying social interactionin multi-agent systems:• The Sociality Problem: “why should autonomous agents enter into social interactions?”(Castelfranchi, 1990: page 49)• The Adoption Problem: “how can an agent get his problem to become social, i.e., get it adopted byother agents?” (Castelfranchi, 1990: page 49).Castelfranchi (1990) suggests that "dependence" is the informal answer to the sociality problem andpower is the answer to the adoption problem. A ‘lack of power’ concerning their own goals (theirinability to achieve them by themselves alone, which make other agents have "power over" them)make agents dependent on other agents; these agents ‘power to influence’ someone else leads togoal adoption.According to this conceptualization, trust is not the opposite of hierarchy because trust is a form ofhierarchy (cognitive selection). All cognitive hierarchies are at the same time selections (delegation,reduction of variation) and increase in diversity and freedom (symbolic value added by cognitivemediations). Mediation and delegation are not the same concepts, even though they are connected.Mediation, in our way of using this concept, focuses on the constructivist value added by symbolicinteraction in cognitive and social encounters (cognitive and social associations). Delegationfocuses on selection and complexity reduction.
  • 19. 19Hierarchies are not all equal, since they are based on different forms of legitimacy of the mediationstructures. (Weber, 1919) The concept of social delegation to media and legitimated gatekeepers inmass communication research can fruitfully be associated to the concept of external trust inenvironments or third parties, who mediate the dynamics of delegation in Castelfranchi andFalcone, 1999 (figure 4). Mental states Action Core trust Internal core trust Delegation Evaluation of y before relying on it. Beliefs about y’s competence, self-confidence, motives for cooperating. willingness of cooperating, and persistence. External core trust trust in the environment Reliance The decision of relying on yFigure 4 Internal and external sources of trustSource: elaboration from Castelfranchi and Falcone, 1999 Trust dynamicsCastelfranchi and Falcone (1999) propose a model of social engagement and cooperation, whichinclude different views of goals and values driving collaboration. They may be instrumental and notinstrumental. This model describes a circular link between trust (the beliefs - the "state of mind"),cooperative actions (engagement) and social effects (consequences). Trust builds trust and "... has ahistory". Also, trust is not only based on our beliefs about people and their willingness/abilities tocooperate in the present and the future (internal trust), but also is based on beliefs about thetrustworthiness of the environment and third parties (external trust).Relational quality and trust formation are processes, guided by cooperation experience andavailable knowledge. "The interpretation of these experiences is a complex, multi-dimensionalproblem that is a function of the number, frequency, and gravity of their interactions; the differencebetween actual and expected outcomes; the nature of any transgressions; the intentions ormotivations attributed to a partners behavior; and any advance warning and/or post factoexplanation of its actions by the partner. Furthermore, they may affect the partners willingness torely on each other in terms of any one of the three elements that influence performance--organizational capacity, technical prowess, or integrity." (Arino et al., 2001).Trust comes out from relationships and it is built dynamically in the process. "Trust builds trust", asCastelfranchi puts it. Trust drives delegation but this is a dynamic delegation. If we focus only ontrust as the belief about future actions of the trustee, we tend to study the characteristics of thetrustee (trustability and reputation); we dont focus on what is relevant at the trustor level. And it isnot enough to analyse the characteristics of the trustors personality (the psycological and culturalvariables which influence the tendence to trust somebody). We also need to focus on the processthat builds this resource.
  • 20. 20In an early study on cooperation in distant-education settings (Mandelli, 1995) we found thatindividual cooperation on the net, when not supported by previous knowledge and personal trust,tends to be fragile. The same result was found in a study by Jarvenpaa and Leidner (1998) onglobal virtual teams whose members were separated by location and culture. They concluded that"... global virtual teams may experience a form of ‘swift’ trust but such trust appears to be veryfragile and temporal." (p. 1)Also in the organization literature social capital has been found as a pre-condition for thedevelopment of new alliances and greater trust. Networks are seen as repositories "... of informationon availability, competencies and reliability of prospective partners. ... The more the emergingnetworks internalize information about potential partners, the more organizations resort to thatnetwork for cues on their future alliance decisions, which are thus more likely to be embedded inthe emerging network. These new alliances, in turn, further increase the informational value of thenetwork, enhancing its effect on subsequent alliance formation" (Gulati and Gargiulo, 1999, 1440-1441).Trust is not a one-shot state of the relationship. It is a dynamical and iterative process: "... nothing isset in stone. All collaborations start with a set of givens between the partners such as who they are,what has been said about them, and what their prior experiences have been with each other. Whileinitial conditions are inherited, it would be wrong for management to assume that perceptions basedon these givens are immutable. From the moment negotiations commence through the start-up andinto the operation of the alliance, the relationship is a living entity subject to considerable growthand evolution, one that will be shaped by the partners behavior." (Arino et al., 2001) Bounded sociability and Internet social capitalIn order to test the idea that trust is not a costless resource, available in a frictionless socialenvironment, we have included Castelfranchi s concept of trust in the model we used to study theimpact of the Internet on sociability (Mandelli, 2002). We report the most important findings fromour study and elaborate on it, because they are relevant in order to help answer our researchquestion about the role of trust in building social hierarchies.We tested the idea that "trust builds trust", and were also interested in the role of cognitiveresources (cognitive energy and time) in this dynamics. Our model rests on the awareness thatcognitive and social resources are finite and their economies influence social investments andcooperation. Norris (2000b) suggests that social cooperation is influenced by the availability ofcognitive resources (cognitive abilities and time) and by the perception of self-efficacy in socialengagement.In organizational settings Adler and Kwon (2002) stated that social capital is influenced byopportunity, motivation and ability, and that structural connections (access) might be not enough forbuilding social ties; they also require the availability of the relationship and the cognitivedimensions of social capital. This framework, applied to individual level phenomena, suggestsconsidering the role of cultural and cognitive resources in the process. Motivation, social capitaland cognitive resources have also proved important predictors of cooperation in virtualcommunities of individuals (Kollock and Smith, 1998).This issue has long been studied by researchers interested in the effects of these new socialaggregations on social engagement (Putnam, 2000; Norris, 2002). As research results (Norris, 2000)point out, there is a reinforcement effect in Internet sociability; usually actors who become moreactive on the web are the most active even offline. The others may be left out of the process. Thereasons for this discouraging effect may be found (Norris, 2000) in: • Lack of commitment by the individuals; • Lack of individual cognitive resources (cognitive sophistication); • Lack of individual social resources (social capital).
  • 21. 21The economics of cognitive mediation suggest to pay attention not only to the net balance of theperceived benefits and costs in the cognitive exchanges (Simon, 1972; Neumann, 1991), but also tothe stock of available cognitive and social resources. If they are not available, the individual actorsor the policy-makers of the networks (the managers if we are in a business setting) must invest inbuilding them.Applying this framework to individual relationships on the Internet (see figure 5), we hypothesizedthat in the digitally all-connected world, access to interactive communication and virtualcommunity environments can foster the creation of social capital or destroy it, depending on theoriginal set of cognitive, social and cultural resources available (for the operationalization of all thevariables see Mandelli, 2002).Sociologists interested in Internet socialization processes helped highlight another important aspectof virtual social networking: the difference between bridging and bonding social ties. “Bridgingsocial capital refers to social networks that bring together people of different sorts, and bondingsocial capital brings together people of a similar sort. This is an important distinction because theexternalities of groups that are bridging are likely to be positive, while networks that are bonding(limited within particular social niches) are at greater risk of producing externalities that arenegative.” (Putnam, 2000)Also Fukuyama (1995), applying the same concept to organizational coordination, claims that onlytrust toward the world outside the family fosters innovation and development, while the familisticculture hinders the ability to extend the richness and diversity of one s social networks. In a worldwhere innovation and learning make the competitive difference (Vicari, 1991; Nonaka andTakeuchi, 1995; Rullani and Vicari, 1999), social networks of independent firms are seen as thefittest coordination model (McEvily and Zaheer, 1999).An interesting research question regards the impact of the diffusion of network-based technologieson these trends. At the individual level, there is the risk that virtual communities lead more towardbonding sociability, and impede bridging possibilities, because they connect people with the sameinterests and lifestyles (Stolle, 1998; Preece, 1999). The Net may consume trust, rather than produceit, according to Uslaner (2000). In fact the Internet make people connect more with familymembers, friends and people with the same interests, than strangers (Cole, 2001). This is consistentwith the so-called balkanization hypothesis, developed by Van Alstyne and Brynjolfsson (1997),who suggested to " ... examine critically the claim that a global village is the inexorable result ofincreased connectivity." Their conclusion comes from the analysis of the constraints posed by limitsof what is known as "bounded rationality" (Simon 1959). "... even in a lifetime, few people havesignificant relationships with more than a few thousand others. As long as human informationprocessing capabilities are bounded, electronic media are unlikely to dramatically change thistotal.(Van Alstyne and Brynjolfsson 1997, 3-4).Contrary to the simple equation between trust and networks, the balkanization hypothesis envisionsa networked world where bonding ties (ties with similar people) will hamper cooperation and inwhich variety and innovation at the system level will be lost. We also included this hypotesizedlink in our model (figure 5).In short we tested whether values, individual happiness, cognitive resources, time, trust in peopleonline, trust in Internet communication environments, and access to peoples social network throughthe Internet, influence people s use of the communication cooperative applications on the Internet(email, chats and virtual communities). Then we tested if all these variables, and bonding offlinesocial capital (relationships with family and friends) influenced changes in the number of regularrelationships on the Internet.
  • 22. 22 Values Positive & and culture negative Internal trust, Use of changes External trust interpersonal in Self-confidence and offline Individual collaborative and wellness Diffusion of environments online Internet access on the Internet social in people’s capital social network Education, technology literacy and time Offline bonding social capitalFigure 5 A model of trust and social capital dynamics on the InternetSource: Mandelli, 2002The data were elaborated using multivariate regression statistical analysis, organized in a path-analysis sequence. The results confirmed the model hypothesized, but for the direct influence oftime constraint on sociability behaviorviii. The following figure (figure 6) represents the synthesis ofthe regression paths, which describe the most relevant regression relationships found (see themethodological appendix in Mandelli, 2002 for the statistical coefficients and levels ofsignificance). Using the Internet Values Technological Time used increased literacy to email regular social contacts Internet self-confidence - - Number of Time used Using the Made Internet friends to chat new increased - - friends Family contacts with External online bonding family & friends trust Internal ties Lack of Alienation trust - - Internet Younger access of age family & friends Using the - Internet decreased Education Southern contacts local with family = low significance culture & friends
  • 23. 23Figure 6 Empirical results on trust and social capital dynamics on the InternetSource: Mandelli, 2002The use of the interpersonal communication environments of the Internet (virtual communities andchats) can drive the creation of both bonding (within the community) and bridging (out-of-thecommunity) social capital. Using email and group communication people can foster relationshipswith family and friends -- but also with people they have never met before (new friends online).Also the path-dependent nature of the social capital building process is confirmed. There is areinforcing link between offline and online social capital. People who have stronger ties with familymembers and friends are more likely to increase their regular contacts with them after they startusing the Internet. But they do it, of course, if they can access them through email and otherinterpersonal communication tools of the web. The digital access divide may drive a social divide.Using chatrooms and virtual communities, people can make new friends. But not everybody usesthese collaborative applications. The use of these communication formats (and the consequenteffect on regular relationships) is mediated by age and internal trust (trust in the people they aregoing to interact with), that is people who think that is easier to meet other people online than inface-to-face are more likely to use the synchronous communication environments of the Internet(chat) and make friends online. Results also confirmed the link between internal and external trust.External trust (here operationalized as trust in the Internet community environments) helps createtrust in online people.Even though time stress showed no relationship with sociability outcomes, the data supported thehypothesis that the availability of cognitive and intangible resources influences cooperationbehavior and sociability phenomena. There was a significant relation between the increase in thenumber of regular contacts with people with the same hobbies, the same religious interests and thesame political interests, and the decrease in the number of regular contacts with other social groups.This, which we call a "switching bonding ties" effect, seems to capture the adaptation to socialchanges predicted by the balkanization hypothesis reviewed above, which predicts that the scarcityof intangible resources and the increased access to people with similar interests drive the reductionof ties with other social groups.In short, our study found that the Internet can foster or harm certain categories of socialrelationships, and therefore can have both positive and negative effects on the construction of socialcapital, depending on specific personal and social pre-conditions Our finding links the risk ofincreased society fragmentation not to alienation effects of the Internet, but instead to thoseadaptive and evolutionary selection effects necessary for managing the economics of cognitive andtime-based costs of relationships in complex interconnected social networks.Also culture matters. In our study Italian southern local culture explained different important resultsconcerned with Internet sociability. Time dedicated to chatting was predicted by southern residence(also by younger age, lower education, lack of family bonding ties, Internet civic self-confidenceand internal trust). Also the decrease in the number of regular contacts with family and friends waslinked to local residence. This negative sociability result was influenced by lack of Internetconnections of peoples family and friends. This is a confirmation of the idea that the firstdimension of digital divide (the differential Internet connectedness of people) has consequences onthe other dimensions of network connection.In short we found evidence for the idea that: • Trust is a dynamic process (trust builds trust); • The formation of trust is constrained by the stock of available cognitive and social resources; • The formation of trust is embedded in local culture.Thus, there seem to be a virtuous circle driving cooperation and the creation of new social capital incomplex social networks -- which describes the adaptive interplay among the stock of social,technological and cognitive resources with civic engagement, and which may also explain
  • 24. 24culturally-influenced Internet social effects. But this virtuous circle can become vicious, when thereis a gap or an instrumental/economic imbalance of social, technological, and cognitive resources atthe individual relationship level.Our conclusion from these results is that Internet users, as all citizens, have access to a newenvironment for socializing and cooperation. Confirming its mass media social function (Morrisand Ogan, 1995), the Internet is not neutral: it opens new, plural, parallel and also conflictual socialpossible designs of our individual and system-level life, because it changes the potential structuresof interpretations of the world and cooperative activities. It changes the transaction costs ofrelationships (the instrumental and not instrumental costs for social encounters on the complexinterconnected network) in a comples, not linear way, and it influences the stock of our social andcognitive resources. The outcome is neither simple nor unidirectional, contrary to what promisedby the information symmetry hypothesis on Internet diffusion. ConclusionsThe frictionless paradigm in the Internet research literature predicts the elimination of hierarchiesand the spread of new network-based forms of governance, based on the assumption that theInternet will diffuse access to information and relationships and the new transaction-cost-freenetworks will foster both dynamic exchanges and cooperation. We have challenged this viewproviding secondary and primary empirical evidence for new hierarchies created in networkedsocial systems, and giving theoretical justifications for these empirical findings.New hierarchies in network society are created out of the cognitive complexity of the systems,coupled with human bounded rationality and bounded sociability. Another complex effect comesfrom the contemporary impact of the network technologies on the economies of the infomediary-content infrastructures and the economies of relationships (economies of scope and networksexternalities). But the resulted new social organizations are not simply more hierarchical, becausethe increased interconnection (and the dynamics of social capital) also decreases cognitivehierarchies.Networks are not simply a more democratic and socially rich alternatives to hierarchies, coordinatedthrough trust instead of price or authority. They are complex systems in which differentcoordination mechanisms and different types of hierarchies are present. Hierarchies are noteliminated because transaction costs are not eliminated. Also in network economy we are rationallybounded, and we can also found the same scarcity effect in sociability processes. Transaction costs,and the need for cognitive and social hierarchies, might be reinforced by the uncertainty and thecomplexity of the new social systems. The real novelty of the new social and organizationalnetworks doesnt seem to be the different degree of hierarchy, but the different degree ofinterconnection (complexity) and flexibility (dynamism of connections) of the systems.The social side of these transformations is not captured by the approaches to network society thatempathize deterministic and radically liberist views of the relationship between technology andsocial change. On the social side of these transformations Powell (2001) sees a polarization ofsociety groups and emerging a "winner take all" ethics, " in which success creates increasingreturns; that is, the capabilities, skills, and experiences of those who have prospered rebound suchthat they are vastly better positioned and qualified than those left behind. This reinforcing cycle isvirtuous for the winners, vicious for the losers". Analyzing the negative social effects of theflexibility of networked organizations, at the expense of a downsized workforce, Harrison (1994)sees a "leaner but also meaner" social organization emerge from these changes. Calling thisphenomenon “concentration without centralization,” Harrison argues that firms that have masteredglobal network production couple a core-ring structure (characterized by a privileged solid centerconnected to a disadvantaged, and overexploited networked periphery) with the use ofcomputerized technology for coordinating flexible intra-firm and inter-firm networks. In his view
  • 25. 25the governance mix comprises both cooperation (with the strategic core of employees and partners)and domination (of the powerless periphery of the network).But Powell (2001) doesnt think that this unequal and hierarchic outcome of the network revolutionis intrinsic to the network society. It is an option, which is important to be aware of, but notautomatically emerging from the distributed capitalism. He writes: "... it is wrong, I believe, toargue that the new system is just a kind of decentralized Fordism or a wolf in sheep’s clothing. Weare undergoing a period of creative destruction, in which the established practices of one regimeare being replaced by new ones. ... but it is not at all clear that these inequalities are a necessarycomponent of the new form." (Powell, 2001, 29) Social order and social organization are politicaloutcomes, not technological recipes. Technology can foster flexibility but also coordination. It canhelp periphery to be connected with other peripheries and with the center, without loosingflexibility. Its a matter of design of the network; its a matter of negotiated structures of thenetworks.The network society can be a more hierarchical society or a more democratic one, depending on thesocial and policy decisions of individuals and groups, since also in the digital world there are trade-offs and alternatives, shaped by economic and social constraints and opportunities, and thereforealso in the digital society freedom and quality of life are built out of ethical and policy agendas andarenas.We accept the call of Rullani (1998) to challenge the fundamentalist idea that technology liberatesthe invisible hand of markets in societies, beyond the need for collective choice and action, andRullani and Vicari s (1999) call for a more complex understanding of the complex issues posed bythe exploding connectivity in societies. But, with them, we dont propose a conservative view of theimpact of new communication technologies on society and economies. We also believe thatnetwork technologies can open very powerful opportunities for change and improvement of thequality of individual life and societies. ReferencesAdler P. S., & Kwon, S. W. (2002). Social Capital: Prospects for a New Concept. Academy ofManagement review. Vol. 27, N. 1. 17-40.Adler, P. (2001). Market, hierarchy and trust: The knowledge economy and the future of capitalismOrganization Science. Mar/Apr 2001Linthicum.Agre, P. E. (2001). Hierarchy and History in Simons "Architecture of Complexity". WorkingPaper.Ancarani, F.; & Shankar, V. (2002) Price Levels and Price Dispersion on the Internet: AComparison of Pure Play Internet, Bricks -and-Mortar, and Bricks-and-Clicks Retailers. Workingpaper.Arino, A.; De La Torre, J.; Smith Ring, P. (2001) Relational quality: Managing Trust in CorporateAlliances. California Management Review. Fall 2001.Axelrod, R. (1984). The Evolution of Cooperation. New York: Basic Books.Axelrod, R.; & Cohen, M.D. (1999). Harnessing Complexity: Organizational Implications of aScientific Frontier. New York: Free Press.
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  • 33. 33Williamson, O. E. (1975). Markets and Hierarchies, Analysis and Antitrust Implications: A Study inthe Economics of Internal Organization, Free Press, New York, NY.i Returning to the original meaning built in the early discussions on the web, and beyond the later and more restrictedversions of the concept (Hagel and Singer, 1999), we define infomediaries (see Mandelli, 2001) as systems that makethe interaction of cognitive sub-systems (individual and second-level) possible and more efficient. These systemsprovide symbolic mediation (association), beyond functional connectivity. They were the media in the masscommunication era. They are the new infomediaries (portals, communities, content sites on the web) in the Internet era.ii We use this concept (Mandelli, 1997 and 1998) for describing the special logistics of information and relationships onthe Internet, not constrained by geography anymore but constrained by complexityiii The production of several versions of the same product in order to apply differential pricesiv A lock-in occurs when a consumer is faced by switching costs, costs he will incurr only if he decides to switchsupplier and brand. Among the lock-in strategies: loyalty programs, penetration pricing (free initial versions of theproduct with expensive upgrades)v Though this trend would be contrasted by the advertising-based business models of the infomediaries (Mandelli, 1999)vi The World Internet Project is an international research project, promoted by 25 research institutions in the world,which studies the impact of the Internet on society. See for details. The Italian section ofthe project is based at SDA Bocconi, the business school of Bocconi university in Milan, Italyvii Axelrod coined the phrase "shadow of the future" to describe the force that keeps a player cooperating, even whenthere is not immediate perceived utility coming out from this behavior, in light of future expected benefitsviii We believe that the influence of time constraint might have not been captured by the operationalization of thisconcept in our model (answer to the question: "Do you feel busier than the average person?"). Further research on thisissue is needed.