ELC 498

DAY 4Capturing Value:Market Structure and Competition

Agenda

Questions??3rd PerspectiveCapturing Value: Market Structure and

Competition

4 Perspectives

1. Technological Drivers Of Change

2. Creating Value: Economics Of Internet-based Commerce

3. Capturing Value: Market Structure And Competition

4. Creating And Capturing Value In The Supply Chain

Overview

Capturing value is all about “who wins” in the economic markets

Intense competition creates value for consumers

Different Industries have different market structures Horizontal (chap 3) Vertical (chap 4)

Of particular interest is markets that demonstrate DSIR (demand side increasing returns)

Conventional Factors

Determine market structure Number of firms Size distribution of firms Nature of competitive strategies

What is the optimum size for a firm in a given market? Economies of scale

Big live … small die off Low Barriers to entry

Many new entrants

Bottom line What determines increasing returns (size, experience,

technology) determines market structure

The eCommerce market

Increasing returns are more affected by distribution than manufacturing

1. Design and development of website2. Ordering process3. Fulfillment and logistics

Low barrier to entry Low cash needs Ability to outsource tech

Results : Many (too many) entrants into the marketplace

Increasing returns?

4 Problems (not obvious) Customer service is harder and more expensive for

eCommerce Certain business models have high organizational costs While ecommerce may reduce some transactional costs;

larger reductions can be realized by larger infrastructures (i.e. centralized inventories

Driving traffic to the website can be difficult and expensive High CAC and branding costs

The strong get stronger and the weak perish Incumbency advantage Experience effects Brand building

eCommerce markets

Information is also subject to increasing returns Consumption does not effect volume or value Encyclopedia knowledge creates an incumbency advantage

Google, cnet, wikiopedia

Positive feedback model Word of mouth (mouse) Experience branding

Future results (oligopoly plus) Few large players Many fringe firms

We are not there yet but are well on our way Failure to reach critical mass can lead to death spirals

Demand side increasing returns (DSIR)

The product’s or service’s benefits to each user increases with the number of other users

Creates a Winner take all market2 sources of DISR

CompatibilityNetwork effects

Compatibility effects

Computer programs and document formatsMicrosoft Word vs. WordPerfect

VHS and Beta tapesBluRay and HD DVD Standardization benefits

Open standardsDe facto standards

Network effects (full mesh)

A

C

B

D

N(N-1) ~ N2

Network effects (partial mesh)

A

Y

X

C

B

vv

Network effects (intermediary)

Intermediary

A

A

A

A

A

A

Network Effect (clearing house)

F

E

D

C

B

A

ClearingHouse

eCommerce DSIR

E-mailIMC2C auctionsPeer to peer networksClearing houses and payment systems

DSIR and Market structure

Size installed base determines user acceptance

High Switching cost deters user from switching between substitute products

Players in a Markets that has large installed base and high switching cost tends towards a winner take all market structure “There can be only one”

DSIR feed back

Technology is attractive to new users

Technology gets largerShare of new purchases

Technology has the largest # of users

Installed base grows

DSIR example strategies

Community buildingProduct reviewsGet big fast

Lower cost – free?Co-locationBrand building

Competition

Many factorsHighly concentrated industriesLow switching costs on the web

Everyone is a few clicks awayLower search costs

High competition should lead to price convergenceLocal gas prices

Contestable markets

New firm can enter market easilyNew (or existing) firm can gain market by

offering competitive pricingContestable markets should tend to the

“law of one price”One would think that eCommerce is a

contestable market

Price reality check

Price dispersion for online products is high (~30%)

Some is due to introductory pricing Gain DSIR attributes

Some is due to electronics markets not reaching equilibrium (yet) Too early to tell

eCommerce does not eliminate all sources of differentiation Quality, service & trust Site composition

Online vs. off line Competitive advantage

Online Low cost leader Knowledge of customer

behavior -> personalization

Create new CA Product differentiation

Offline Low cost leader Leverage existing CA Price (value)

differentiation

Capturing value through pricing

eCommerce brings Pricing that can be changed dynamically Pricing that can be tailored to individual buyers Buyers can negotiate pricing Groups of buyers can determine pricing Auctions are easy

Ecommerce companies must be able to charge customers something approximating what the individual is willing to pay

Problems with fixed pricing

All products marginal costs Fixed price assumes that the price exceeds

marginal cost by a certain factor Fixed pricing assumes that all buyers have

same willingness to pay There may be consumers they would be willing to

pay for the product There may be consumers that are willing to pay

mire than the marginal cost but less than the fixed cost

What happens if the marginal cost decrease as volume of sales increases?

Problems with dynamic pricing

Requires knowledge of consumerSome consumer remain anonymousDichotomy of buyers having more product

knowledge while supplier have more consumer knowledge

Acquisition and Storage of consumer data is controversial

Dynamic pricing my be illegal

Dynamic pricing examples

Group discount purchasing Co-op

Auctions (forward and reverse) Coupons and loyalty discounts

Amazon charged existing customer more than new customers

Revenue management systemsAirline and hotels

Summary

Online markets have greater variety than off-line

efficiency matters (on-line and off-line) Some on-line markets are fragmented, others

are concentrated DSIR is an important consideration Low Barriers to entry created fluidity on the

market (Incumbents are unable to entrench) Market niches be less competitive There will be many innovative pricing schemes

in future eCommerce markets