Business strategies in the New Economy

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Business strategies in the New Economy
Kilde Hjemmeside til Lars Sørgard (2003),
Konkurransestrategi, Fagbokforlaget

• What is New?
• A need for new business models?
• Strategic behaviour in eCommerce

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What is New?

• Emergence of a new industry ICT
• Convergence
• Microsoft, .
• The growth of the Internet
• Exchange of information
• Electronic commerce

3
New business models, or ..?

• From a text book in strategy
• E-retailers are perhaps utilizing the most
  revolutionary and unothodox business model. A
  number of e-tailers sell products at cost (or
  below) and make money by selling advertising on
  the merchants web side
• But this is a traditional Loss Leader strategy
• Grocery stores sell loss leaders to attract
  consumers

4
New technology, and ?

• Shapiro and Varian (1998), Information
• Rules
• Technology changes. Economic laws do not
• BUT Special characteristics for the
  industries in the New Economy

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Characteristics in the New Economy

• Network externalities
• Information goods
• Complementarities
• High fixed costs, (almost) zero marg. cost
• Durable goods
• RD intensive
• ..

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E-commerce - fierce competition?

• Consumers are better informed
• Can easily find the low price product
• Alternative distribution channels as shop-bots
• E-shops that compare prices
• ? Low prices and low brand loyalty?

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A business view

• The Internet is a nearly perfect market because
  information is instantaneous and buyers can
  compare the offerings of sellers worldwide. The
  result is fierce price competition, dwindling
  product differentiation, and vanishing brand
  loyalty.
• Robert Kuttner, Business Week 1998
• Why, then, high stock values on dot.com firms
  from the outset?

8
An empirical study

• Brynjolfsson and Smith (2000), Frictionless
  commerce? A comparison of Internet and
  Conventional Retailers, Management Science.
• 20 Books and 20 CDs in the US 98-00
• 16 Internet outlets and 16 trad. outlets
• 12000 price observations

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Empirical study price changes

• We expect low menu costs on the Internet
• Low cost associated with price changes
• They find that Internet retailers make
• smaller price changes and
• more price changes

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Empirical study price changes
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Empirical study price dispersion

• We expect more fierce competition and then less
  price dispersion on Internet
• They find slightly more price dispersion on
  Internet
• But price dispersion depends on the measures
  employed

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Price dispersion
Kernel Density Plots on De-meaned Price Data
Books
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Vanishing brand loyalty .. ?

• Amazon 75-85 market share in books
• Prices can be 40 higher than lowest market
  prices (DealTime.com)
• Prices and services as BN.com and Borders.com,
  but 10x market share

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Why brand loyalty?

• Personalised advertising
• Amazon Hello, Lars Sorgard. We have
  recommendations for you
• Trust
• Spatial and temporal separation between buyers
  and sellers
• Awareness and convenience
• 40 visit less than 10 sites/month
• YAHOO lists 7000 book sellers

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Price discrimination

• Versioning
• Sells different versions with different qualities
• The consumer can choose
• Self selection
• Serves different consumers with different
  versions

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Versioning Damaging products

• How to avoid cannibalization?
• Develops a high quality version
• Damages it to make a low quality version
• IBM printer
• Mathematica software

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Lower prices in eCommerce?

• Some studies YES
• Other studies NO
• Why may we observe higher prices?
• More information ? quick price response
• Less incentives to cut prices
• ? Larger potential for price collusion?

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Collude or not on Internet?
Profits
Deviate
Collude
Compete
Time
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Shopbots

• Picks the producer with the lowest price
• Leads to price sensitive consumers
• ?Bertrand-like competition?
• Low price firm wins the market
• ? Price close to marginal costs at least in
  these cases?

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Shopbots empirical study

• Ellison and Ellison (2001), Search, Obfuscation,
  and Price Elasticities on the Internet.
• Pricewatch.com price comparisons
• Investigates three different memory modules
• 128MB PC100 LOW quality
• 128MB PC133 MEDIUM quality
• Abit KA7 HIGH quality

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Estimates of price elasticitities
QUALITY
LOW
MEDIUM
HIGH
PL
- 51.8
-25.2
-19.0
PM
PRICE
-1.0
- 6.6
- 0.3
-1.5
-8.6
PH
0.4
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Some results

• Own price elasticity extremely high for low
  quality (- 51.8)
• Suggests fierce competition?
• Lower price on low quality results in an increase
  in medium and high quality sales
• Opposite of what we expect?
• ? Low price of low quality to attract consumers
  to its own site?

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An obfuscation strategy

• You click on the low price product
• Then you are warned
• Long delivery time
• Not recommended for, say, Windows
• ?? Some go for medium or high quality
• BUT Many still choose low quality
• Stuck with price sensitive consumers?

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Long run equilibrium

• We observe entry and exit, mergers acquisitions
• Vigorous competition for markets?
• ? Where will it end?

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Exit for traditional retailers?

• They have a competitive advantage in traditional
  products (physical products)
• Geographic location
• Logistics
• They, as well as the producers, responds by going
  online
• ? Traditional retailers will continue to play an
  important role

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Information goods

• Products that can be digitised (converted to
  bits)
• Music
• Video
• Text
• Will we observe a revolutionary change in the
  distribution system?

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Market dominance?

• Some characteristics may lead to few firms
• Network externalities
• High fixed costs and low marginal costs
• RD intensive endogenous investments
• ? We now observe the battle for market shares to
  win the market?

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Dynamics - speculation

•  Varians prediction for some industries
  (http//www.nytimes.com/library/financial/082400ec
  on-scene.html)
• Fierce price competition from the start
• Some firms are forced to exit
• Remaining firms succeeds in increasing prices?

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Example

• A joint venture between ToysRus and Amazon in
  August 2000
• eToy responded
• This is great news for us. Last year we had half
  a dozen rivals. Now our two remaining rivals
  (ToysRus and Amazon.com) are merging into one
• March 7, 2001 eToy filed for bankruptcy

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Reshaping competition policy?

• Reorientation of
• Merger policy and
• test for predation?
• Dynamic competition more important than short run
  price competition?
• Could the important question be
• Is entry by drastic innovation realistic?