strategies in the internet economy: value creation and

Strategies in the Internet Economy:Value Creation and Mirages (*)

Bertrand MUNIEREcole Normale Supérieure de Cachan, Paris

GRID, UMR, CNRS

Introductory Background

What has come to be designated as "the New Economy" is an incrediblyheteregeneous set of economic enterprises with its own style of new youngmillionaires, with its uncertainty, its hopes and its actual and potentialdesillusions. To some analysts, it spreads out of a new industrial revolution,to others it merely supports a financial bubble. To the latter, it will at bestgive way to a new handling of information for traditional businesses. To theformer, it opens a new world of business which we barely perceive today.As a matter of fact, it is not even clear what the truly new features of theNew Economy are. In this paper, we shall ignore intranet issues as to howtraditional businesses might benefit from the new information technologiesto reorganize their internal structure and functioning. We shall also restrictourselves to the Internet market economy as the core of the new economy.

It also is seriously questioned whether financial markets can be efficientwhen confronted to such a deep epistemic uncertainty. There is fear thatthese markets, under the influence of the many gurus they let thrive, havegrossly overvalued some of the start-ups of this "New Economy", many of

(*) Professor, Ecole Normale Supérieure de Cachan (Paris), France, and Head of the researchGroup on Risk, Information and Decision (GRID, UMR CNRS 8534). This paper has greatlybenefited from discussions with member of GRID, notably M-L. CABON, L. DEVEAUX,B. LELOUP, C. PARASCHIV & J-CH. TAVANTI. Any remaining error would obviously be ours.Financial Support from CNET (Research Contract Nr. 98 1B 460/ENS Cachan/FranceTelecom/CNET) is gratefully acknowledged.

COMMUNICATIONS & STRATEGIES, no. 40, 4rd quarter 2000, p. 91.

which do not reap any profit and are barely expected to do so in a distantfuture. Finally, doubt has arisen even about the appropriateness of this"new economy": Does it create value? Many have also voiced a fear thatmarkets might not be as effective and legitimate in the new world ofbusiness which we are witnessing.

The present paper aims at discussing several aspects of thesequestions which, in fact, epitomize variations of the same theme: how todiscriminate between real value creation in the Internet Economy and themirages it might trigger, at the business level as well as at the collectivelevel. The first section will try to distinguish between the so many differentactors in the new economy and offer an interpretation of what can beregarded as the most important activity of the internet economy and itslikely evolution. The second one will deal with some of the invoked miragesof the Net economy, namely the "irrational" overvaluation of Internetstartups by investors and markets dysfunctioning under the newtechnological conditions, in light of the discussion in the first section. Someconcluding comments are presented in the third section.

Actors and Value Creating Strategies in the Internet Economy

A seemingly kaleidoscopic world

One can use many criteria to distinguish between actors in the NewEconomy: technological status (access providers, portals, final sites),access price charged (free sites versus pay sites), type of activity (productsonline sellers, etc.), types of connections established (business toconsumers, business to business) are among the most quoted ones.

The main activities on the web are represented on figure 1.

• Free sites are the ones which can be accessed without paying a fee.They are primarily financed through advertising fees or/and throughsubscription in some limited cases. But one should sharply distinguishbetween free final sites – mostly of an official or scientific nature – and thefree intermediate or finalized sites. The latter are dispensing information onquality, performances, price, etc. of some good(s) to help consumerschoose between variants of a product or different products. Clearly, they

92 COMMUNICATIONS & STRATEGIES

are often financially related to the corresponding online suppliers, but notalways. On the other hand, free finalized sites are among the mostimportant sites on the web. They provide information formatted in such away that it helps buying goods or services. Price comparisons are amongthe most useful informations provided by such sites. In the analysis below,we leave aside free final sites.

• Pay sites are only accessed through the payment of a fee. But they areto be subdivided between the three same categories as the free finalizedsites: on line products and services suppliers (typically: booksellers online),final information sellers (sites helping to compute a driver’s road itinerary,etc.) and the category of "pure piloting" sites, which we define andcomment upon further down.

Figure 1 - An economic representation of activities on the web. Solid lines divide actors into finer categories.

Arrows indicate the type of production of each category of sites.

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Information sellers

Final information(experience good)

Products andcommercial services

online sellers

Free final sites

Pay sites

Intermediateinformation

(search)

No matter whichgoods and/or services

Given goodsand/or services in

such or such sector

Free finalized sites

Access provider

Pure piloting sites:- simple tips

- tips + inference- intelligent of meta-piloting sites

The impact of the new technology has to do with the way demand,whether from final consumers or from businesses, is connected with supply.In the "old" type of economy, consumers never consider to visit all possible"brick and concrete" shops offering the good or service they look for inorder to compare prices and qualities in the most general sense. In the"new economy", they can do so at negligible costs (BAKOS, 1997). Toovercome the mentioned difficulty, it is customary in the old economy to use"proxies" like brand, marketing devices (loyalty rewards, etc.), advertising,etc. designed to "pilot" consumers amidst the forest of suppliers, productstypes, products qualities, etc. But these proxies – we almost have forgottenabout it – have been designed to overcome the difficulty that consumers,due to search costs, never will be able to visit all possible suppliers. Thispostulate becomes if not obsolete at least way too strong in the Interneteconomy. This does not mean that advertising and the other proxiesalready mentioned become useless but that, under their current design andas long as can be seen, they are considerably less effective and importantfor at least part of the consumers. As soon as the consumer can check in aminute a number of possible goods corresponding to his/her needs, theirprices and their features, why would he/she bother to try evoking the adshe/she has seen, or trust more one brand than another? This mightrepresent a considerable change from the traditional situation as well asfrom the usual array of management tools.

The true revolution, however, will have to do with what could be called"pure piloting" sites. We define these sites as those for which the mainactivity consists precisely in providing consumers with as complete andrefined a scheme of information as possible on the demand and supplyhinterland by suggesting, designating, showing, analyzing, comparing, etc.products and/or services that might satisfy real or potential needs of theirs.The word "piloting" is used here to mean that the activity does not onlyconsist in providing information to each side on the other, but entails indeeda transformation process of demand as well as of supply. As a matter ofprinciple, piloting may be free (financing relies then purely on publicity) orcharged to the consumer (financing of the site relies then purely on apercentage of the price paid by the consumer) or charged to the producer(financing of the site relies then purely on a percentage of the price paid bythe producer) or mix any combination of these three possibilities. Pilotingcosts are not zero, by any means, but may be essentially of a fixed type forlarge ranges of number of clients served. One can intuitively feel that ifmajor competitive advantages can be found in the new economy withrespect to the old one, they should lie precisely in pure piloting. How can


such competitive advantages be analyzed? Should future activityconcentrate on piloting and thus reduce the web’s diversity of actors, andwhy?

Competitive advantage and the emergence of pure piloting

How should comparative advantages be assessed in the new economywith respect to competitors? Three factors should be brought to attentionhere: density, thinness, relevance.

• Density is measured by how many different products and theirsuppliers and how many clients a site can connect together. Products orservices may be listed in the site or reachable through hyperlinks betweenthe site and its partner sites (online sellers in particular). Density is the mostobvious advantage a site can offer with respect to a traditional brick andconcrete business. For example, many people still see Amazon.com as abooks seller. But if Amazon has any value, it ows it probably more to theundeterminateness of the boundaries of what it sells : books, toys, CDs,and… whatever. Jeff Bezos keeps saying that it wants its business to bethe largest supermarket online in the world, featuring a number of products,including the ones it does not have. As the latter may still be the largestcategory, what other definition would make Amazon.com more of a purepilot than of a bookseller? Conversely, Cdnow.com was once the largestCDs seller in the US, but it lost that position (to Amazon)… because theconsumer doesn’t want to be limited to one single product: density wasoverlooked, and clients turned away. Piloting is not simply marketing itsown products on the web !

Clearly, Internet offers the possibility of almost infinitely multiply densitywith respect to traditional retailers. Amazon has more goods for sale thanany of the American supermarkets hold. This is because density in itself islargely independent of any physical storage.

• Thinness is the degree with which detailed and accurate information isbeing offered by e-commerce to consumer’s choice. It is also a domain inwhich the Internet economy can provide consumers with unparalleledperformance at very affordable costs. Moreover, whereas traditionalphysical commerce has always had to face some quite constraining trade-off between density and thinness on grounds of costs in storage,description support, memory storage, extraction capabilities, etc., electronic

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connections allow for an entirely different course. E-commerce cantechnically provide its clientele with density and thinness without enormouscosts. Shopbot’s quality is in this respect a decisive technical and economictool of strategy in the new economy.

• Relevance is best epitomized by the ability of the traditionalconnoisseur-bookseller. Having read extensively, titles of books evoke inhis mind knots of a network upon which the art of writing is arrayed. As aman of deep and broad background, he quickly forms not only appropriatemodels of his clients taste and aims, but also models of how characteristicsof literature works will interplay with these tastes, goals and values. In thisrespect, he is ablest among all to determine the best set of books topresent to a specific person in his clientele. In an even more complexinteraction, he guesses what interesting changes in his clients tastes orvalues might be triggered by reading some given piece of writing. In short,he is the ablest pilot between individual demand and the whole supply fromthe art and science of writing.

Clearly, e-commerce will ever lack this connoisseur-seller, whether inbooks, wines or anything else, because too complex a system would beneeded here to perform such a sophisticated activity. But it can try tomimick him as closely as possible. Intelligent agents do already a prettygood job in this respect. Learning about the set of books to offer to arelatively stable clientele is not insuperable for them. Learning about tastesof such a clientele is feasible, although it could be improved. Presentmodels look at individuals having bought a given number of similar booksand at which other books these individuals have also bought. The idea isthat an overlap of preferences between two individuals leads to conjecturethat the overlap is larger than what has been observed (ex : moviecritic.comor: firefly.com). The rule is far from the sophistication a human mind asdescribed above can perform, but it has the advantage to instantaneouslyprovide the client with suggestions, even though the latter are only vaguelylikely to seduce him or her. And it can be complemented by otherinformations also instantaneously brought to the client like written opinions(by any reader rather than by established critics, i.e. a very quickinformation, although of ambiguous value) etc. Clearly, it is not difficult toimagine that one can do much better in the present state of the technology,even though one cannot dream of getting anywhere close to the idealpicture given above.


The new technologies allow to go quite a way towards relevance withoutbeing able to match the connoisseur’s role in this respect. This constitutes infact one of the biggest challenges they bump into (1).

Internet piloting will however work in this respect like an (unintended inour example, intended in cases like forum sites, etc.) self-organizing system:it will let networks of somehow similar individuals emerge, with a sociologicalambiguous statute around the ones of a fans club, of a political party, of anideological group, of a society with given goals, of a sect, etc. Belonging to itcan sooner or later become conscious to the individual (in forums or in sitesexplicitly providing individuals with "self-defining items" like military ormilitary-like equipment or clothing of a given type). In other cases, theindividual will be largely unaware of it (like in the example above of bookspreferences) or perhaps even completely unaware for ever (in the virtuallyinfinite market segmentation allowed to intelligent agents actually learning ontastes of the individuals in the clientele). Whether conscious or unconscious,aware or unaware, the individual in such virtual networks is deprived of thebenefit to personality forming which the complexity of actual human contactand exchange provides. Virtual networks of individuals will never be groupsof individuals on Athen’s Agora. They will be only substitutes, sometimesuseful, sometimes poor and misleading, sometimes detrimental. Here is aside-effect of Internet that society will nilly willy have to cope with sometimes.

Whereas density and thinness call in electronic commerce for little trade-off, as has been argued above, relevance clearly implies somewhere a trade-off with the two other factors of specific competitive advange in the Interneteconomy. In some specific domains "which necessitate a very completepersonal adaptation" of preferences, whether on physical goods (restaurants,elegant clothing) or on experience services (art pieces, personal workingtools, etc.), it even makes density and thinness poor competitive advantagesof internet commerce (MUNIER, 1985). Generally speaking, relevance is tosome extent antagonistic to density and thinness and softens the competitiveadvantage of virtual commerce with respect to brick and concretedistribution.

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(2) Relevance is yet the most important factor of the three, while density and thinness arefairly obvious and easy to acquire advantages. EVANS & WURSTER (1999) use relatedconcepts, but fail to identify the third and most important internal factor of competitiveadvantage, as well as the external factors. Moreover, density and thinness should relate, inour view, to preferences transformation by Internet. SAVAGE (1972) already discussed theimportance of being fine and tight for a preference relation. Morgenstern wrote in the Sixtieson similar ideas. This motivates our terminology, which sets the course to more formalizedmodels of the Net economy.

Degrees of density, thinness, relevance together with external factors ofthe chosen strategy and technology of the site help also specificy whateconomists would call the production function of a site, which relate themaximum state of attainable outputs given a combination of inputs andhence the cost-structure of the site. In building its site’s software, an e-commerce firm should pay closest attention to such characteristics (alongothers). Competitive advantage in e-commerce largely lays in these.

An asymptotically common pattern of activity?

Why should numerous entrepreneurs with innovative ideas (types ofservices that the new economy gives way to and which were excluded inthe old economy) and many entrants into the new competitive scene realizethat they should give priority to pure piloting?

Incumbent producers have little choice: if they want to survive, they haveto create the conditions of it, by entering online business and/orestablishing partnerships with pure pilots. We show hereunder why. Ofcourse, small publishers (or entrants) do not mind Amazon selling online:this gives them a chance to have their books sold and read, without havingto make the enormous investment of buying a well located window (orrenting space in it) in the largest shopping mall of the city. But incumbentsdo mind Amazon. Due to internet pilots, their brands will not bring them inthe future as large an advantage over entrants or small little knownproducers as it used to do, for the books of the latter will appear on Amazonthe same way as theirs will. Small almost anonymous producers won’tsuffer anymore the disadvantage to have neither a pretty maid, nor alearned connoisseur serving books in the lavish bookstore that great andestablished publishers may afford to own or to be associated with. Internetputs producers pretty much on the same starting line when it comes to sellor buy their products.

So, what to do for incumbents? One strategy seems to refuse enteringthe web business, i.e. refrain from having its books sold online (say, byAmazon) and advertise that they are sold "only in real good bookshops" (3),


(3) This might not be easy to do. Again, Amazon offers a good example: when it came toFrance, having failed to buy one similar online company in the country, it offered to buycatalogs or database on French books. But no one accepted to sell any database. So,Amazon bought one copy of every French book on (brick and concrete) publishers’ catalogs(publishers may not refuse that on legal grounds) and recorded them. Another close exampleis Cdnow’s effort to block out BargainFinder browsing for best prices, which failed (DE LONG& FROOMKIN, 1998). Such a blocking strategy is therefore mentioned here only forcompleteness’ sake.

another one seems to enter the new economy and go online. This is agametheoretic situation. Which outcome can we guess?

Let us look at the type of game which arises in such conditions. If theincumbent refuses to enter e-commerce and if all other publishers,including entrants, were to do the same, the payments could be stylized by(1,1), i.e. 1 for the incumbent, 1 for each other publisher, where "1" meansthat the corresponding player gets its usual result (presumably more for theincumbent than for each small publisher or entrant, but that plays no rolehere). If some incumbent refuses, but other publishers go online, thisincumbent will lose a large part of its clientele to others and entrants, whowill be in a much better situation. The converse will be true if otherpublishers and entrants refuse the web, whereas the incumbent goesonline alone. Finally, if everyone goes online, competition will becomesharper and everyone might face a partial loss in its usual surplus.

Table 1 - Incumbent producer’s entrance game to the Internet

Such a game configuration is well known and has been extensivelystudied: it is a "prisoner’s dilemma" type of game. Two different types of"equilibria" appear:

- one yields the (1; 1) outcome and is supported by a substantial degreeof cooperation between players (either through effective agreementbetween them (4) or after a number of repetitions of the game).- the other one reflects, to the contrary, an ‘isolated rational’ behaviorfrom each of the players (5), yielding the (0,5; 0,5) outcome.

The second equilibrium however is much more likely to occur, for thecorresponding strategies are dominating ones for each player respectively.This simple gametheoretic analysis suggests therefore that it will be very

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Small Publisher or Entrant

Refuse the web Go online

Incumbent Refuse the web (1 ; 1) (-0,5 ; 2)

Go online (2 ; -0,5) (0,5 ; 0,5)

(4) This kind of outcome refers to what has been called "Cooperative Game Theory", butrepetition leads to a similar result in "Non cooperative Game theory". Needless to say, suchagreements are forbidden by Law.(5) In gametheoretic terminology, a Nash equilibrium.

unlikely that any incumbent producer stays out of the Web, even if it hadthe capacity to keep its own products out of the online business.

Once online, however, a second challenge will be encountered by theproducer. Will it sell online only its own products, or should it go beyondthat stage and either mandate a "pure pilot" to sell its products along withall others or become itself a "pure pilot", and establish its own site to sellnot only its own products but also the ones of other producers includingcompetitors, so that its main activity online will be to pilot consumersbetween demand and supply?

We use the same framework to reflect on such an issue. This time,however, valuing the outcomes of some strategic couples will require somemore discussion than above. In the online game, online producer I isassumed to be a competitor of online producer II. Each one of them hastwo possible strategies: sell only its own products or let also the products ofits competitor be sold alongside its own ones, either on its own site or on a"pure pilot’s" site with which it can enter into a partnership.

Table 2 - Online producers’ game

If each one of them sells only its own products - and assumingtemporarily here that no one else enters the market online -, little will bechanged with respect to the physical situation: piloting the consumers willstill depend primarily on publicity, brand image, loyalty rewards and all theusual marketing actions. We set this outcome as (1; 1). If both sell or let sellboth products (and, presumably, all their close substitutes), competition willbe harsher because online consumers will be made more clearly aware ofexistence of and differences between the different products and brands.Economic theory predicts that, in general situations, more of the globalsurplus will flow to consumers rather than to producers, hence the (0,5; 0,5)stylized outcome. But what will happen if player I sells only its own productswhereas player II chooses to let both products (and all substitutes) be soldon the same site? Clearly, competition will be increased, as before, butdensity as defined above will play its role and most online consumers willpresumably go over to player II, who should then receive X>1. Theoutcome will be of the (0,5; 2) type, as in the previous game. But thinness


Online producer II

Own products All products

Online producer I Own products (1; 1) (-0,5; X)

All products (X; -0,5) (0,5; 0,5)

and relevance play here in the other direction (after all, who could, betterthan the producer itself, give detailed, well-documented, and relevant,information on its own product?). Thus, some compensation, indeed evenovercompensation, might occur. One might as well have X<1, and theoutcome might be of the (0,5, 0,75) or of the (0,5 ; 0,25) type.

Predicting an issue to this game seems therefore more difficult than tothe previous one.

If X>1, two different "equilibria" will exist as above and, again, the mostlikely will be the isolated rational one (All products sold by or on behalf ofeach producer).

If X<1, two equilibria will still exist, but both will be isolated rational ones(Nash equilibria) and it is impossible to decide from a gametheoretic pointof view which one will be more likely to be preferred, for no strategy willdominate the other for any player.

However, from a business psychology point of view, one might expectthat every producer will think that there is a way to get around that difficultyand to restore X>2: sell online all products, but develop its own site tointroduce an unfavorable bias in information against the competitor’sproducts! Producer 1 will perceive game structure 1, whereas producer 2will perceive game structure 2 as represented on table 3.

Table 3 - Asymmetrically perceived game by online producers

Game structure 1 (perception of producer 1)

Game structure 2 (perception of producer 2)

Clearly then, each producer perceives a dominating strategy from hisown point of view (6), and the outcome (0; 0) will in fact be most likely as intable 1 game, but for reasons that are different from the situation in table 1.

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(1; 1) (-0,5; 0,25)

(2; -0,5) (0; 0)

(1; 1) (-0,5; 2)

(0,25; -0,5) (0; 0)

(6) Of course, such a strategic equilibrium would not be sustainable for a long time, as arguedfurther down. But it will anyway not be tested, as the (0,0) equilibrium will ensue, as shown here.

Whatever the reasons (7), this basic and quick game theory analysissuggests that online producers won’t confine online sales to their ownbrand’s products. If they were to do it, the market would threaten to excludethem. Markets may be sometimes accused of being a relatively poor tool toproduce value creative firms, but they are a very performing tool to excludelower value creating businesses!

Physical producers – or group of producers – will therefore enter Internetcommerce, and let Internet activity be open to other’s goods and services.This is not to say that they will abandon their physical activity, obviously,but that it is in their interest to help generate portals to offer their goodsand those of others. This is true, whether in the business to consumersactivity – in which we have taken our examples up to here – as in thebusiness to business trade. This is true not only in trading outputs, but alsoin trading inputs. Thus, the case could similarly be made that it is in theinterest of producers to create portals to trade in their inputs and in those ofothers. An example is provided by the recent portal of subcontractorsopened by four major automobile firms (General Motors, Ford, Daimler-Chrysler and Renault-Nissan). In each case, it is important to note thatthose portals do not aim simply at selling – or buying – some goods orservices, but at piloting firms between demand and supply. Some kind ofnegotiation and of re-framing (of preferences, etc.) will enter the picture atsome point (like in traditional procurement, e;g.).

Physical distributors (as opposed to producers) have not been explicitlyconsidered in the above analysis. But is not difficult to see that they willhave to face the same two dilemmas. It is not difficult either to check thatthe same reasoning holds for them in both cases like it held for physicalproducers. There is however one major difference here. Indeed, virtualdistribution should cannibalize quite a large part of traditional distribution(about 25% according to some authors) (LANGDON, 2000), whereasphysical producers will, as such, continue to exist the same way as before.This represents a serious threat, not only to traditional distribution, but alsoto urban life and development, with the exception of some specificdomains" which necessitate a very complete personal adaptation "ofpreferences (relevance), whether on physical goods like restaurants, formalor luxury clothing (the bankruptcy of Boo.com in the summer of 2000 is one


(7) If both producers hesitate between both game structure perceptions, whatever theirbeliefs, the outcome will the same, i.e. (0, 0). This is why game theorists might prefer to moresubtly view the situation as one leading to a Bayesian Nash equilibrium with two supports ofbeliefs. The basic idea is quite close to the interpretation given here above.

possible illustration, other sites like customtaylor.fr might have difficultiesalso, etc.), or on experience services like art pieces, personal worktools,etc. (MUNIER,1985). Most American cities might not suffer too much fromthis phenomenon (8), but some serious changes might affect European andAsian urban life (9) .

The conclusion of the above analysis is that most actors in Interneteconomics will end up doing pretty much the same sort of thing, i.e. pilotingconsumers between demand and supply. Of course, some actors mightbetter succeed than others. Competitive advantage is also enhanced byexternal factors.

External strategic factors in Internet pure piloting

Piloting might be financed in different ways and happen with differentdenominations yielding as many ‘window services’, as will be explainedfurther down. It should be also noticed that, as long as they distribute alarge scope of products, Internet pilots should as a matter of principle beless linked to any producer than to consumers. Exceptions do not representany stable business model. To the contrary, promising business modelsshould rely on financing from consumers, offer services which hardly canfind a counterpart in the brick and concrete economy, all this in costconditions that also differentiate them from the traditional economy. In sucha way, the Internet economy should be able to sell services and hencedeliver value to the economy as a whole.

Financing strategy of piloting sites

Some pilots will be dependent on one producer (or on a group ofproducers) because they will have been created by some producer(s) in thefirst place (we have examined the producer’s entrance game into Internetabove). It has been even mentioned that some producers might have theidea to bias the information they provide consumers with against theircompetitors products or services. Some other pilots will rely on publicity andmight be induced to bias their informations and suggestions as well. But

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(8) Some authors argue that they might indeed profit of it, for hyper- and super-markets wouldbe more affected than shops and urban centers might correlatively be revived. See LANGDON(2000).(9) Can we imagine what would become of Paris without any other shops than restaurants,chic clothing and touristical trash ones? What about Vienna, London without Harrod’s? Theycertainly would not be turned into ghost cities, but they might be substantially affected.

what pilots sell is an experience service – creative adaptation of demandand supply – and clientele can be maintained only if confidence isestablished and renewed. Should consumers discover that some goods aresystematically over recommended with respect to others, they wouldchange to another pilot.

Pay pilots might emerge to help consumers hedge against suchpotential a misfortune, like pay TV has emerged from the low quality of freeTV programs. Other pilots will discover quickly that advertising not onlyarise suspicion from consumers but does not pay much if it has to beshared between too many actors on the net, all the more because marginalincome from ads for the company advertised is decreasing with marginalproduct, i.e. with total quantity (10). Finally, many pilots should discover alsothat royalties on sold products bring a safer income than publicity andconstitue a more distinctive way to make money with respect to theconsumer (who might be fed up by publicity at some point and decreaseloyalty). They might end up being the successful model of value creation.

This is all the more true, because such an income source is compatiblewith another very important source of income, which exploits the value ofthe data base generated by piloting. Such a data base will have all themore value, the more density, the more thinness and, to some extent, themore relevance, because the pilot will have built into its site a learningprocess on preferences, purchasing history, etc. This shows how suchfinalized or intermediary free sites sit at the interface of the traditional andof the virtual commerce.

Finally, density, thinness and relevance should be acquired at low coststo make e-business profitable. In this respect, partnerships with suppliersand other pilots are of a particular interest. They save advertising expenses– one major source of failure of e-business startups – while being most ofthe time more effective incomewise (a hyperlink to one’s site at manypartners and conversely might bring in many more clients than costlycontinued advertising). They also save running huge storage facilities bydrawing on existing physical suppliers and simply deriving commissionsfrom the sales they will give way to. Such arrangements can be combinedwith loyalty programs on behalf of the physical suppliers, though pure pilotsshould be here careful not to be the fool of some physical producer.


(10) Analysts extrapolating over long periods the present upward tendency in total quantity ofadvertising will go wrong at some point. It is already common to read statements by siteowners to the effect that people do not click on advertising stripes on top of screens.

In other words, strategic rules on Internet have to cope with (i) offeringservices which the traditional economy does not offer, at least in terms ofthe density, thinness and relevance it can afford and (ii) to avoid the coststhe traditional economy has to incur in terms of massive transactionalmarketing, in terms of inventory holding, in terms of logistics and correlativesalary.

Recent bankruptcies or strategic reorientations illustrate one or severalof these points. For example, Altavista has recently abandoned its efforts toproduce editorial contents and fired 25% of its total employment toconcentrate on density through substantial improvements of its shopbots.Lastminute.com lacked in density and had underestimated the sunk costsof development, advertising and marketing. As a result, Lastminute has notbeen until now profitable. This is why – having been lucky enough to raisehuge funds at a time where this was possible – it recently bought itscompetitor Degriftours. The latter is profitable because it works as anInternet pilot which has been able to avoid the massive costs Lastminutedid not. We have already mentioned the bankruptcy of Boo.com, but wemention it here again, for it epitomizes what should never be done onInternet : replicate an activity which the brick and concrete economyperforms quite well, underestimate costs in salary charges, walls, logistics,which have to be added to the inevitable development costs of a site. Onecan predict without too much risk of being wrong that quite a few suchbankruptcies will happen in a near future for similar reasons.

In contrast to these negative examples, pilots doing well and alreadypiling up value correspond to the model we have analyzed above, like pricecomparison sites which sell their database for targeted advertising, of whichKelkoo and Budgetelecom are examples. A similar strategy is followed byJobandadverts.de, which not only sell ads, but also questions directed at itsdatabase. Auction sites are perfect examples of why pilots do well andonline sites with similar activity but endowed with walls, logistics, salaries,etc. do not. The only ones of such sites which are profitable follow theEbay.com business model, where income flows in when an object is offeredto online auction and again when the object is sold, but where i) advertisingstripes do not represent any dominant part of revenues and ii) no logistics,no walls, no massive advertising bear on revenues. If profitable firms arethe ones following the "pure piloting" model, one can predict that sooner orlater, most surviving sites will belong to the same category.

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Window services for piloting activity

If many actors can be expected to end up doing more or less the samething on Internet – which decidedly deserves the name of shopbotseconomy – they will nevertheless do it under different denominations, eachof these denominations relating to a specific service on which the site isfocusing. Of course, this service will be delivered to the clientele, but it willnot be the one effectively sold on the market and yielding money to itssupplier. To that extent, we call here this service a "window denomination"or a "window service". This does not mean that it is indifferent whether suchor such window service is offered to determine how much value creationhappens. The fact that this service is bundled together with another one orother ones may determine the clientele to visit the site. Hence, choice of thewindow service partly determines value creation whether or not explicitly ordirectly paid for by clients.

The less a market for a window service exists in the traditional economy,the more real will be value creation by the site offering it. An example of awindow service which does not exist and cannot exist in the traditionaleconomy (due to something economists subsume under "transactioncosts") is the wishlist service. It amounts to making immediately available tothose interested the list of presents someone would love receiving, with animmediate connection to online sellers: you can have your carefullyupdated list on some site and make it accessible to the persons youdetermine. Conversely, you might see whether such or such person has alist on the site that you might use to honor her with a present. In the brickand concrete economy, such a service would be very hard to offer, becauseit would have to be in a shop having a huge number of potential gifts.Storage costs would immediately be prohibitive if a special brick andconcrete shop were to exist, except when presents to be offered belong toa given specific category, like in the case of wedding presents, where a fewspecialized shops exist. Alternatively, transaction costs would be prohibitivefor the client ready to offer something, if lists were to exist in many differentshops for a same person.

Such a service may therefore be a good candidate to what can betermed a "window service", hiding a "pure pilot" and hence potential valuecreation, but from other sources in effect than from the window-servicedirectly. Accordingly, if some sites in this category meet the other conditionsmentioned above, they should be good examples of value creation.Examples are wishlist in the US and millemercis in Europe. Such wishlistsservices are obviously window services. This window service provides, in


itself, a service that cannot be served in the traditional economy, as hasbeen argued. In addition, it helps customers make up their preferences andmake these preferences thinner and thinner, which adds also to surplusforming and thus to value creation. It brings income under the form ofcommissions from online producers and/or online sellers and to someextent from correlative "targeted" advertising. Moreover, the main part ofvalue it can generate is an incredible data base for direct marketing andtargeted publicity of high value. Such database producing activities arespecific aspects of the value creation "hidden behind the window" of thewishlist service. More generally speaking, the true source of value creationlies here in a set of engineering tools to foster and make thinner demandand supply interplay, i.e. pure piloting.

Of course, financial strategies remain decisive tools for success. If suchentrepreneurs think of massive transactional publicity to attract clients, theyhave a good chance of being soon bankrupts. If they insist on running theirown inventory and logistics, the same might very well hold true. If, on theother hand, they avoid these basic mistakes and work hard on partnerships,they are likely to meet with success.

Simple gametheoretic tools appear as useful to predict some aspects ofthe future industrial organisation of the net economy, as has been shown inthis section. It can therefore be only surprising that so many different typesof Internet business models have been given a chance to raise as muchmoney as they have. One possible explanation is that standard tools ofmicroeconomic theory have glaringly led investors to misinterpret valuecreation in the Internet economy.

Mirages in the Net Economy? A MicroeconomicAppraisal

Fluctuations of financial markets regarding Internet stocks support theopinion that startups of the Internet economy had been, at least in a firstperiod, overvalued. Such an overvaluation has to be meant with respect tosome benchmark of "rational" valuation of firms. But one can wonder whyrational rules used to evaluate stocks on technological markets would bedifferent from the rules usually put forward on other markets. Biasedexpectations on costs, as has already been argued, help to explain theovervaluation. In this respect, overvaluation can be termed irrational. But

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these expectations are only part of the story. Techniques used in Internetbusiness culture together with investors risk psychology, as experimentaleconomics has taught it to us in the last twenty years, explain the otherpart. In this respect, overvaluation can be regarded as indeed rational. Weexplain why in this section. Let us first recall the frame of analysis whichinvestors quite rationally can rely upon.

Real option theory and "rational" valuation of Internet startups

Using real option theory to decide whether or not to invest in a firmrequires some assumptions which are open to discussion (11). But itnevertheless gives some interesting clues as to the factors which shouldinfluence the evaluation of a startup by an investor. In a continuous timemodel (SCHWARTZ & M. MOON, 2000), the value of the firm is the discountedvalue (under the risk-neutral interest rate) of the anticipated cash-flowavailable at a given date where the firm could be liquidated and all cash-flows distributed. Under the hypotheses usually used in financial optiontheory (revenues are assumed to follow a Wiener stochastic process) andsome more specific assumptions (the process is assumed to converge afterthe starting time to its long term average, costs and taxes are assumed tobe an affine function of revenues), it turns out that the value of the firm is afunction:

V= V(R, µ, L, X, t) [1]

where R stands for (intensity of) sales revenues, µ for the anticipated rateof growth of R, L for the (instantaneous) loss carry-forward (12), X for theamount of cash available, t the dates at which each of the former variablescan be estimated. These variables are not independent of each other, ascan be easily seen. If (each variable being indexed in t) Y = (R- COGS –SG&A – other costs) (1-τ), where t stands for rate of profit taxation (13),then, either dL = -Ydt (L>0) or dL = max (-Ydt, 0), while dX = Y dt. ApplyingIto’s lemma to the V(·,·,·,·) formula leads to the dynamics of the value and of


(11) The basic idea is to consider investing in the company. The value of the ‘underlying’stock depends then on the inflow of revenues (net of costs) which can be obtained fromexercising the option, i.e. from investing. (12) If the loss carry-forward is positive at some time t, the tax rate in t is zero.(13) For readers not familiar with American accounting, COGS stand for costs of goods soldand SG&A stands for selling, general and administrative expenses. In the case of Amazon,the latter seem to have developed substantially above the linear tendency observed in 1996-1998 starting early 1999.

the volatility of the company, the latter depending on the volatility of R, of µand of their mutual correlation. A discrete version of such a model allows touse Monte-Carlo simulation and to solve for the value of the company onthe basis of initial values (observable from published company’s accountsor other sources, or based on argued for estimates), and of a value of T.

The authors fed such a model with figures drawn from the Amazon case,with T=25, and ran a Monte Carlo simulation of the model alluded to aboveon that basis (SCHWARTZ & MOON, 2000). They show that the two sets ofparameters which have the largest impact on the value of the firm are costsparameters and parameters affecting the future growth rate in revenues.This is in line with standard expectations.

One first reason for overvaluation of internet startups (and of high-techstartups in general) can then immediately be seen. Estimates of costsparameters of net businesses are downward biased. What has been saidabove shows that, like in every new industry, costs structures are badlyknown. Besides, in the special case of the net economy, global costsdynamics are generally undervalued because investors do not realize thatcombining the exceptional levels of density-thinness performance of the Neteconomy with physical costs of inventory and general logistics meansreaching not only skyrocketing levels of investments, but – which is worse –deteriorating general and operations expenses. In the case of Amazon,SG&A have increased by 200% while sales were increasing by 50%(between december 98 and september 99). More recent data confirm thetendency. Operating profit before taxes reached a negative peak of–190.106 US $ in the last quarter of 1999 (the last figure incorporated inSCHWARTZ & MOON’s paper), but went way below -300.106 US $ for eachof the first three quarters of 2000. One may venture to say that at least partof the costs incurred had not been anticipated.

As for the volatility of future growth rate of revenues, economicpsychology has more to say than invoking simple biases in estimates.

Risk psychology as a rational explanation for "overvaluation"

The authors of the article mentioned rely on expected utility theory, i.e.use probabilities to form expectations of means and variances in play(using risk neutral probabilities boils down to a special case). All we knowfrom experimental economics does not validate that rationality assumption.Moreover, "business angels" and other investors in internet startups seem

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to have a specifically "agressive" psychology profile, to the extent that theylay value in "thick" positive tails, even if such distributions also have thicknegative tails and hence mediocre expectations. Such a profile isimpossible to interpret in traditional expected utility theory, but can bemodeled in the framework of the new rationality models which haveemerged on grounds of experiments in risk theory.

We recall here briefly the "rank dependent model", by now the mostpopular of these models. In this risk appraisal model, financial prospectsare not evaluated as an expectation. Rather, the individual looks for theminimal outcome first, and then add outcome increments weighted by nonlinear transforms of the decumulative probability distribution attached tothem. As a result, the psychological volatility σ * is sensibly larger than thevolatility σ computed on the basis of straight probabilities.

Let us take a simple example based on three scenarios:

- "Blue" (like Heaven) is the very favorable scenario (positive tail of thedistribution), leading to a µ3 value of µ- "Red" (like Hell) is the unfavorable scenario (negative tail, includingbankruptcy), leading to a µ1 value of µ- "Grey" (like difficult life on Earth) is the intermediate and most likelyscenario, leading to a µ2 value of µ at a given horizon. Assume, forsimplicity’s sake, E(µ) = µ2. The standard valuation of the probabilitydistribution is:

p1 µ1 + p2 µ2 + p3 µ3 [2]

or, equivalently: µ1 + (µ2 - µ1).(p2 + p3) + (µ3 - µ2).(p3)

where the investors realize that µ1 is certain, the increment (µ2 - µ1) hasonly probability to come about and increment only probability (p2 + p3) tocome about and increment (µ3 - µ2) only probability to obtain.

Experiments show that the psychology of risk is more subtle and callsfor a representation which can be better approximated by:

µ1 + (µ2 - µ1).θ (p2 + p3) + (µ3 - µ2).θ (p3) [3]

where θ (.) is a non linear monotonically increasing function ((θ: RR R),with θ (0) = 0, θ (1) = 1, and, ∀ p,θ'(p)> 0. The typical profile of an"agressive" investor looks like the curve on figure 2.

The θ (.) function in this simple discrete case has as a graph thepiecewise linear curve OABO’. The standard probabilities are the threesegments on the abscissa (determined by the abscissa values of A and B).


The h1, h2, h3 segments which are the images through θ (.) of the p1, p2, p3

segments respectively have an immediate interpretation. It can indeedimmediately be seen that equation (3) above can be rewritten as:

µ1 [θ (1) - θ (p2 +p3)] + µ2 [θ (p2 +p3) - θ (p3)] + µ3 [θ (p3) - θ (0)] [4]

or:

µ1 .h1 + µ2 .h2 + µ3 .h3 [5]

with, ∀ i,hi = θ ( pi) − θ ( pi ).

In other words, probabilities pi are being replaced psychologically bycoefficients hi in equation [2] above. The volatility computed in a standardway, as SCHWARTZ & MOON do, would be:

σ * ( ) = p1 .(µ1 - µ2)2 + p3.(µ3 - µ2)2

whereas the psychological value of the volatility would be:σ ** ( ) = h1 .(µ1 - µ2)2 + h3.(µ3 - µ2)2

But, in the relevant case of an "agressive" psychology - which wepresume characterizes investors in Internet start-ups - experiments show(see figure 2) that:

h1 >> p1 and h3 >> p3

Clearly: σ ** ( ) >> σ * ( ).

Figure 2 - Probability transformation curve in the rank dependent psychology

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i

3

∑i+∑

1

3

µ̃

µ̃

0'

B

A

h1

h2

h3

p1p2p30

µ̃ µ̃

Let us look at the relationship between volatility and share price(obtained under some hypotheses which we disregard here for the timebeing) obtained by SCHWARTZ & MOON (2000) on their figures 7 and 8,which we adapt here as our figure 3. The observed share price volatility atthe end of 1999 was close to 100%, implying a σ * (µ) ( slightly above .03,and a share price of 12.42 US $, according to SCHWARTZ & MOON (2000).The market value of the share meanwhile was 76 US $ approximately,representing a dramatic overvaluation with respect to model findings, andimplying an almost double volatility of the growth rate of sales and also ofthe share price, above 180% in the latter case. If σ ** (µ) had been used, itmight have got close to .05 and, instead of a 12.42 US $, it might haveimplied a share price close to the 30-40 US $ bracket.

Fig. 3 - Share price and share price volatility as functions of the volatilityof sales growth rate

(adapted from SCHWARTZ & MOON, 2000, pp.72-73)

The observed share price had been around 100 US $ in the spring of1999, and it went down to 27.7/8 US $ during the summer of the same year.During the first part of 2000, it recovered and reached 40 US $. The shareprice volatility seems also to have slightly decreased, while the σ ** (µ)volatility might have increased (the relationships between share price andσ ** (µ) have probably been slightly altered). Assuming nevertheless that


Priceobservedend 1999

Shared price

US $

400

300

200 200

100100

0.01 0.02 0.04 0.06 0.08 σ (µ)

Shared price volatility

Pricevolatilityobservedend 1999

PricePrice volatility

figure 3 has not undergone any too dramatic change in a few months, ashare price of 40 US $ implies a σ ** (µ) slightly above .05, which seemsonly slightly outside the interval identified above.

We therefore would argue that, had the model taken economic riskpsychology into consideration, the overvaluation of the share might nothave completely disappeared, but at least would have looked much lessdramatic as in SCHWARTZ & M. MOON’s (2000) paper. Internet stocks mightnot be as overvalued as analysts seem to believe, if account is taken ofinvestors psychology.

Some economists would of course claim that the investors pictured hereare "irrational". I do not want to take up this issue here, but no logicallycompelling argument forces us to believe that it is so (MACHINA, 1995;McCLENNEN, 1988; QUIGGIN, 1993; etc.) and most experimental results giveevidence that it isn’t so. Such investors are, indeed, consistent and thus‘rational’ in the economic sense.

Internet financial culture and value creation

Internet companies focus on growth of revenues, as was made clearenough in the preceding paragraph. They consistently call for innovation,human performance and hence incentives. At the same time, they have toemphasize the capability to raise funds with only a long term profitabilityperspective. All these factors are essential to the success of Internetstartups. To meet the challenge of assembling these factors together, anew business culture is needed. Such a business culture will consistentlyquestion some of the most current accounting practices, although such aquestioning refers to larger issues than Internet’s (JOHNSON & KAPLAN,1987).

To take a few examples, let’s mention first the fact that employeetraining and research and development are in standard GAAP "currentoperating expenses". In a long term perspective, however, they also areinvestments in Human capital as well as new technology development andshould be considered that way. Second, considering all the funds used oneway or the other to generate long term cash is a very strong incentive tofoster firm’s value. To consider cash brought in excess of the neededcompensation of those who brought the funds means taking care of theinterests of those persons. These are two of the reasons why "EconomicValue Added"-type of practices (or "Economic Profit" concepts) and thinking

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have pervaded the Internet economy and more generally high tech firms,especially in the US (14).

Value creation is therefore not just happening on different grounds in theInternet economy, as shown in the first part of this article, it is alsomeasured differently. Table 1 gives some insight in the differences betweenNOPAT in the usual sense and Economic Profit. These differences are veryoften forgotten about in discussions about economic profitability, which usethe terme "funds employed" and "cost of capital" in the same sense asusual. Yet, these differences are important in at least two respects:

1. They clearly show that economic profit has important implicationsrelating to the praise of long term growth of profitability (Human training isnot only a current cost), of profitable innovation, of strong and properhuman incentives in everyday operations (awareness that changes instocks have to be valued, for instance, when evaluating a decision). Ofcourse, as has already been mentioned, economic profit reinforcesmanagers awareness of stockholders interests. Growth is not sufficient toinsure firm’s value as long as the profitability of all funds employed does notmatch their financial compensation.

2. One even less noted feature of economic profit is its volatility. It is yetan interesting feature, to the extent that it triggers a proper feedback effecton firms evaluation. Indeed, economic profit is a more volatile measure thanNOPAT, as table 4 suggests: Most items to be added to the standardNOPAT computation are either positively correlated with NOPAT or resultof such complex causal chains that they may be regarded as close torandom "noises". The wider use on the "technological" stock markets(NASDAQ, etc.) of EVA considerations rather than ROI or other standardmeasures of profitability contribute to explain why these markets are morevolatile than more conventional ones.

But greater volatility implies higher valuation, as has been emphasizedin the preceding paragraph. Larger volatility estimates by investors referringto EVA or economic profit measures rather than to traditional analysis gotherefore another part of the way in destroying the idea that "overvaluation"of Internet stocks is necessarily "irrational".

Econometric studies reveal a much better correlation of economic profitapproaches with capital market returns on the US stock market than on the


(14) EVA was first defined and promoted by Stern Stewart & Co.

German one (WEIMER, 1988, reported in GÜNTHER, LANDROCK & MUCHE,2000). This might result from the larger number of high-tech and Internetrelated firms on the US stock market than on the German one.

Table 4 : Measuring Value Creation through Economic Profit

In any case, one can see that the impact on markets of the Interneteconomy might be quite differentiated. The way markets function in the Neteconomy deserves therefore some comments here before we canconclude.

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"Standard" Items from GAAP Corrective Items

SalesCost of Good SoldGross ProfitSales, General and Administrative costsNet Operating ProfitTaxesNet Operating Profit After Tax

LIFO Reserve IncreaseInterest expense, net of taxesLoss on sales of assets, net of taxes

Net Adjusted Operating Profit After TaxTraining costs, R&D Costs, net of taxesLess : Amortization of R&D

Readjusted NOPAT

Capital Charge in Operating Perspective:CashAccounts ReceivableInventory (net of LIFO Reserve) LIFO Reserve

Accounts Payable LIFO ReserveCurrent Assets Non amortized Cumulative R&D Investmt Current LiabilitiesNet Fixed AssetsNon amortized Cumulative R&D Investmt Total Capital EmployedCapital-Employed Charge

Readjusted NOPATCapital Employed chargeEconomic Profit

Internet markets and economic welfare

The new technological conditions for exchange may worry economistsabout the effectiveness and the legitimacy (due to efficiency) of markets. Aswe have argued that Internet is essentially about piloting consumers andproducers between supply and demand, we might as well examine step bystep these two aspects.

The supply side: pricing and shopbotting

Internet opens the way to two characteristics of pricing: one is anincredible dynamics of price adjustments capacity, notably because of"shopbots" (KEPHART & GREENWALD, 1998; PARASCHIV, DEVEAUX &LATOURRETTE, 2000). But the latter are not only of use to consumers, theyalso provide a way for sellers to immediately observe competitor’s prices.The other characteristics is a virtually infinite possibility of pricedifferentiation, which might be turned into price discrimination. Bothcharacteristics can therefore be a threat to market functioning andlegitimacy.

• Price setting and adjustmentThere is some evidence that dynamic price adjustments occur between

online sellers or between online sellers and physical sellers. For instance,between two sellers, if one seller raises its price, the other one does thesame by some equivalent or similar amount. Conversely, when one sellercuts its price, so does the other. This type of market behavior, called "pricematching", is well-known in the traditional economy and there is an alreadyold example in the informational economy, namely the one of the SABREinformation system, which allows airline reservations. Airlines have madean extensive use of price matching and it is difficult to hinder such behavior,be it only because when it happens downward, nobody (except airlines)complain. Can this be more harmful on Internet markets than on airlinesones? The two major differences are the number of incumbents, on onehand, and the type of entry costs on the other one. Between two cities, thenumber of airlines competing is sometimes low (2 or 3 airlines only), even ifmonopoly cases are not fequent. The number of competitors on Internet islikely to be much higher, and this will make price matching more difficultwithout an explicit cooperation which would be openly against the law.Besides, entry costs into the Internet economy are less substantial thanthey are for airlines, although they are in part sunk costs, i.e. costs whichcannot be compensated for if the entrant fails. The relative importance of


sunk costs in total entry costs is here one real issue. The bulk of these sunkcosts mostly consists in advertising and marketing, which can be hugewhen the incumbent is well-known. We have nevertheless argued in thefirst part of this paper that a large part of such costs can be avoided,notably through partnerships. Barriers to entry are thus not larger – to saythe least – on Internet than in the traditional economy.

Finally, the real issue here is a of a different kind: who will prove to reactquicker, sellers or buyers? If buyers are quicker, there will be a very strongtendency for sellers to stick to low prices, for the sellers raising their priceswill be punished by losing immediately clients to their competitors. Theconverse is true if sellers are quicker than buyers, and this might be a realsource of concern. Hope lies in the fact that not all sellers will be as quickas the technology allows them to be online, be it only because some of thephysical economy sellers, will find it difficult to follow the game and will thustemper online sellers to raise their prices too much or too often. Hope liesalso in the fact that buyers learn more quickly than many theorists believe(even when they are smart buyers themselves).

• Price differentiationPrice differentiation or discrimination reaches unheard of possibilities

within the Internet economy. That might thus moves us far away from thehomogeneity-anonymity postulate of perfect markets.

Possibilities of discrimination are much higher on Internet than in thetraditional economy because identification of buyers is immediate andbecause information on the personality of buyers – in particular on theirpurchase history – is easier to acquire, as was pointed out in the first part ofthis article. Loyalty programs adds weight to these technical possibilities ina way which only too obvious. Such informations allow sellers to guess thewillingness to pay of the consumer by attempting some correlation with oneof its characteristics and offer therefore a basis to effective discrimination.

But possibilities of discrimination are also much higher than in thetraditional economy because technology offers unlimited possibilities to"degrade" products to deter higher willingness to pay consumers frombuying the cheaper product: cheaper versions of softwares let users wait anawful amount of time, low-priced information packages will be moreinconvenient to use, messages will be delivered with annoying delay, etc.(VARIAN, 1995). This sounds shocking to most of us. But should one forbidsuch moves? We know that "bundling" (selling products only in packages)is even easier on Internet than in the physical economy, at least for some

B. MUNIER 117

categories of goods, and it has results similar to those of productdegradation. Should we then also forbid bundling? How could we? In effect,prices may vary more easily in the Net economy than in the traditionaleconomy according to the identity of the purchaser and according to thequality of the good. But how harmful is it in the end?

The surprising answer is not only that such discrimination is not alwaysharmful in terms of common welfare, but also that it is often very useful toincrease consumers welfare – and hence global welfare, as the seller’ssurplus can only be higher. ARMSTRONG & VICKERS (1999) show that, aslong as markets are competitive enough and a few hypotheses can bemade, price discrimination increases welfare. The supply side is thus nottoo much of concern on the whole. Clearly, however, more research on ageneral methodology regarding price differentiation/discrimination would beneeded.

Effectiveness of the consumption side

The consumption side of the Internet economy can only benefit of beingcloser than ever to the perfect information postulate of idealized markets.We have argued above that consumers would not be kept away from thepossibilities of information which the new technologies offer them. Attemptsto do so have failed, as the example of some online CD sellers in the US –trying to lock out the shopbot Bargainfinder – has shown. And we mayargue that consumers look effectively for information. A recent pollconducted in fifteen European countries by some of the major Internetcompanies (Altavista, Microsoft, Real Media, Yahoo and maybe a fewothers (EXERTIER, 2000) showed that many Internet users in thesecountries (15) essentially look for information, and not look for physicalsupply. This suggest that they use the old strategy of going to the bestshops (today the best sites online), asking for information and then look forthe good somewhere else. There is every likelihood that, once the majorityof European websurfers discover the shopbots, they will use them to seewhere they can buy online the product in many cases.


(15) Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, Norway, Portugal,Spain, Sweden, Switzerland, The Netherlands, The United Kingdom.

Table 5 - What European Websurfers use Internet for

One may additionally count on learning by the consumers about the realnature of their preferences, on their risk attitudes, on the the quality of thesuppliers, on the reliability of pure pilots. But what about prices?

As was said above, there is every reason to think that this will becomewith learning a standard habit of European websurfers as it is becomingslowly one of the American ones.

And if by some reason, information on prices were not perfectlycollected by Websurfers? It still would be way above the level it can reachin the traditional economy, and would insure strongly competitive marketsbetween sellers. And when strength of competition reaches such a highlevel, as in the Net economy, while the price system is somehow distorted,that strength can become the major source of welfare, the price systemplaying only a role of the second order. Such a view has been maintainedby some authors, in a different framework than the neoclassical one(ALLAIS, 1989, p. 125-126).

Concluding remarks

Like in all drastic changes in economic development, the way value hasbegun to be created on the Internet has been awkward. Adaptations ofbusiness plans to the new technological environment have not drawn allnecessary conclusions from this radical change. At the same time, illusions

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Most regularly: Men Women

Work 70% n.a.Write to friends n.a.(*) 68%Look for information 70% 59%

Occasionally:Read the press 41% n.a.Send greetings 34% 39%

Never:Buy books or records (CDs, etc.) 66% 79%Send greetings 45% n.a.Read the press n.a. 43%

* n.a.: figure non available. Source : from (EXERTIER, 2000)

have misled quite a few of the first generation of new entrepreneurs, as isthe case when the course of affairs undergo such a substantial change. It isnot necessary to refer to a new industrial revolution (though the situationhas quite a few of the needed features). It is sufficient to think about whathappened in European businesses when the foreign exchange systemjumped from the adjustable peg structure to completely floating rates: ittook a few years and a long series of substantial losses until industrialmanagement lost its excessive enthusiasm of the beginning

As a consequence, some important corrections on the stock market hadto occur. Some bankruptcies of the new businesses had to happen, and lifehas been made less glorious to the ones starting now than to those whostarted five or ten years ago. More important Schumpeterian destructionsmight as a matter of fact happen also in the traditional economy in theyears ahead. Value creation has its price to be paid.

But there is no need to ignore the value already created and to becreated by innovations grounded on the new technologies. There is noneed to invoke some ill-defined "irrationality" beyond the simply excessiveconfidence of the first years already mentioned.

At the same time, business strategy as a teachable discipline has to bereevaluated in the new environment, as we have tried to show above, theensuing shifts in economic power have to be more accurately determined.Clearly also, some rules of the game – property rights among others –might have to be adjusted, a topic which has not been dealt with in thispaper, as has also been left aside the desirable type of pricing on Internet(MACKIE-MASON & VARIAN, 1994; DESMETS, 1999). More research is alsoneeded in industrial organization.

Yet, there are many reasons to believe that the new markets willfunction if anything more stringently than the traditional ones. Life might bemore difficult to producers and to sellers in general. The consumers shouldlearn on their part and seize the opportunity to extend their welfare, withoutnecessarily having a larger share of the global surplus. This can happenonly when net value is finally being created.


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