Economics , Operations, Information & Technology , Supply Chain

Reshaping Industries with Internet Supply Chains

In an excerpt from their book, Garth Saloner and Michael Spence explore the ways managers can use technological innovations to add value.

August 01, 2001

We live in an extraordinary time. The Internet and related technologies have opened new forms of communication, reduced the costs of many kinds of market interactions, and brought firms and consumers around the globe into closer proximity than ever before. At the same time, many of the impediments to efficient market performance are being swept aside.

This is creating a tremendous amount of economic value. As with any dramatic technological change, the most obvious and earliest effects are incremental—we find easier and less costly ways of doing the things we were already doing. Over time, however, the shifts are more drastic as we discover that we can do new things or completely restructure how we conduct age-old business. So, too, the current technological change will drastically affect business transactions. Although it will take time to work its way through the system, it is restructuring entire supply chains and markets and the industries, firms, and labor forces that participate in them.

The complexity of these changes makes it difficult for managers to plan accordingly. When the entire landscape is changing, navigating by just peering at the road ahead is dangerous. You need to head for higher ground to try to understand the major forces at work and their likely impact.

The vision of improvement in supply change management is not new, and neither are attempts to realize it. The vision is this: Information about what consumers want is rapidly relayed back to manufacturers who, using just-in-time techniques and flexible manufacturing technology, quickly produce and deliver the product to the customer. By linking all the relevant economic actors electronically, the Internet makes this vision much more plausible.

One of the best examples of this approach is Dell Computer’s custom assembly and distribution of personal computers. Selling direct to end-consumers, Dell’s strategic approach has several advantages. It largely avoids having to estimate demand. By producing to order, Dell can customize the product to precisely what the customer wants and essentially eliminate finished-goods inventories throughout the supply chain

The Internet and World Wide Web lend themselves to this kind of process. The ability to check for component compatibility in real time is valuable. Also, the richness of the Web and the ease with which a menu-driven interface can serve up exactly the information desired (product attributes and comparisons, for example) provide information that is very hard to match across a dispersed set of retail stores whose salespersons have varying degrees of skills. Moreover, the Internet store is always open.

What is striking about the Dell example, however, is not how successful a model it is, but how few other examples there are that deploy the new technologies to restructure the entire process by which supply chains operate. So far, this has largely been a distribution revolution rather than a manufacturing one. Most electronic commerce has involved changing how existing goods and services find their way down the supply chain to consumers, rather than how they are produced in the first place.

In supply chains, value is added as goods and services flow from the most basic input providers (raw materials manufacturers, for example) to final consumers. While goods and services flow largely down the chain, information flows in both directions. For example, information about what is demanded at successive stages passes up the chain while information about supply conditions such as availability, pricing, time-to-manufacture, and so on passes down. It is precisely because this is an information-intensive process that the Internet holds the potential to significantly increase the amount of value created.

Benetton is a spectacular example of a firm that coordinates a supply chain that includes every step in the manufacture and distribution of its clothes, all the way from styling and sourcing of materials through the operation of the retail stores. Yet although Benetton coordinates all of these steps it actually performs very few of them. Apart from dyeing (which is a core capability necessary to produce the hallmark Benetton colors), running a very large automated distribution center in Italy, and ensuring that designs embody the Benetton “look,” Benetton owns none of the many firms that form its supply chain. It outsources manufacture, independent agents do sales, and most stores are independent franchises. Benetton mostly serves as a vertical architect, coordinating the functioning of the rest of the chain.

This form of supply chain governance enables the vertical architect to focus on what it is good at and select suppliers that are best of breed for each of the other steps. In an increasingly global market, the vertical architect can choose suppliers for each part of the supply chain from those regions that specialize in them and where factor costs are the lowest.

But coordinating the activities of sequential firms in a supply chain generally requires changes in business process that may be time-consuming and costly. These include restructuring information flows, incentives, roles, and responsibilities. More importantly, they require adaptation by multiple firms, each of which has its own routines, organizational structure, strategy, and objectives. Change across the boundaries of firms is notoriously more difficult than within a single firm.

For example, any of the adaptations that adjacent firms in the supply chain must make are specific to the relationships between those firms. Once the partner firms have invested in compatible technology and processes, they have created costs if they switch to other partners. Fear of being locked in by switching costs often makes firms reluctant to enter into these relationships in the first place. It is no wonder, then, that considerable effort is going into technical solutions that lower switching costs.

Additionally, while new technologies like XML provide templates that enable firms to share information yet maintain compatibility with legacy systems, each industry has to agree on industry-specific implementations of these templates. A variety of initiatives are under way, both proprietary and open, to develop standards. An example is RosettaNet, a not-for-profit organization attempting to set XML standards, primarily in the electronics industry.

The new technologies facilitate the steady and incremental improvement of existing supply chains, but they can also dramatically restructure them. Electronic markets—Internet-based groups of buyers and suppliers within an industry, geographic region, or affinity group—have proliferated enormously over the past few years.

These markets take a variety of different forms and they tackle different sets of problems. Consider: Boeing and Airbus in the aerospace industry and General Motors and Toyota in the automobile industry share many of the same suppliers. This is true both within each industry and across them. GM and Toyota typically share auto parts suppliers, whereas the common GM and Boeing suppliers usually sell more generic items like paper, pens, and personal computers, supplies that many industries use.

Another important distinction, which can relate to either industry or inter-industry markets, is whether the intermediary enables transactions or simply provides information that facilitates interaction. The more important of these intermediaries are clearly those that can facilitate transactions. The opportunity to create value from trading hubs like these is potentially huge.

QRS Corporation is a case in point. A business-to-business hub in the relatively fragmented U.S. retail industry, the Emeryville, Calif., company provides electronic-commerce and merchandising-management services to many of the nation’s leading retailers and their suppliers—companies such as Macy’s, Talbot’s, J.C. Penney, Wal-Mart, Sears, and Federated Department Stores, and Liz Claiborne, Donna Karan, Sara Lee, and Polo. QRS facilitates electronic data exchange between its customers, provides a database of 80 million vendor bar codes for retailers to download, enables retailers and vendors to track sales data and arrange and track the shipment of goods, and captures and analyzes in-store scanner data.

But you don’t have to run a hub to profit from it. Member companies also stand to gain. If a hub is created so a large set of firms interconnect through it, each company pays the costs of setting up its systems to connect to others only once and yet enjoys the potential gains of transacting with all of the others who have joined.

The value of the hub increases geometrically with the number of users who connect to it. For example, if there are 10 suppliers and 10 buyers, there are 100 potential trading relationships. But if there are 100 buyers and suppliers, the number of potential trading relationships leaps to 10,000. The important point, however, is that if the 100 buyers and suppliers had to set themselves up to trade with one another bilaterally, 10,000 trading relationships would have to be established if any buyer were to have the ability to interconnect to any seller.

The consequent reduction in transaction costs creates tremendous value, and this reduction is related to another that is potentially even greater in its impact: If it becomes significantly less costly for firms to enter into trading relationships, they may enter into many more than they otherwise would. More buyers and sellers will find one another. Over time this may even change the structures of some of the supplier industries. To the extent that access to distribution has inhibited entry, providing open, centralized markets may lead to more firms and not just more intense competition among existing firms.

One of the most difficult parts of creating and dominating a marketplace, however, is getting critical mass in the first place. Firms are nervous about making the investments necessary to join a marketplace in case others do not follow. Who wants to be stuck with the market equivalent of an eight-track tape player? One way to get momentum in such situations is to enlist the support of a player that brings a large volume of transactions to the marketplace and by virtue of its importance to the industry is a focal point that others will want to join. While few firms have this stature in the global economy as a whole, many have it within their own vertical markets. Thus large industry leaders like General Motors began to emerge as contenders to form marketplaces, typically prodded and supported by providers of the underlying technology—firms like Ariba, CommerceOne, i2, IBM, and Oracle. Once industry leaders began to put a stake in the ground, others were quick to rally around for fear of being left out.

CREATING AND CAPTURING VALUE from business-to-business supply chain improvements offer fascinating areas of opportunity and frustration for electronic commerce. Some analysts expect the large number of marketplaces already established to continue to grow for at least the next few years. However, as many of them fail to get traction, their funding is likely to dry up, and the consolidation that has already swept through the business-to-consumer sector is likely to follow here.

The survivors may well be those that have the domain expertise to help firms overcome the organizational and political inertial forces that plague markets attempting to build critical mass, rather than those that have the “coolest” technology. Moreover, the firms that do succeed may well be those that follow incremental strategies, like building out extranets, for example, rather than those that attempt to get entire industries to coalesce at once.

The financial difficulty in which so many firms in this space find themselves is not necessarily an indictment of the phenomenon. Nor is it an indication that value will not be created here. Value may be created but captured by others—existing suppliers and buyers, for example. Or, as these markets shake out, there will often be only one or two marketplaces in each market sector left standing. In a few cases, the victors may be the winners that take all. Either way, however, in this area we are closer to the beginning of the road than to the end.

Casing the Innovators

Included in our book, Creating and Capturing Value, are 22 case studies that contain a wealth of information about technologies, industries, issues, firms, strategies, organizational structures, and the issues electronic commerce poses for students and practitioners. Many are also available on the Web at, where they can be searched by title.

“ERP Overview” and “SAP and Online Procurement Cases” discuss enterprise software systems and analyze how one of the leading firms, SAP, is positioned to compete in the online procurement market. “Siebel Systems, Inc.” describes the booming customer relationship management market and its leading firm. “QRS Corporation” provides background on electronic data interchange and examines the role of an important intermediary. “AOL: The Emergence of an Internet Media Company” examines the role of portals, and the “” case discusses the “last mile” problem in fulfillment and delivery.

Other cases describe issues related to changes in market structure and function, including the growing role played by online auctions (“Online Auctions in 1999”), electronic markets (“E-Markets 2000”), and pricing and branding (“Pricing and Branding on the Internet”). They also deal with channel structure and channel conflict (“” and “Nike: Channel Conflict”) and disintermediation (“Disintermediation in the U.S. Auto Industry”).

Another group of cases centers around the opportunities and challenges that e-commerce poses for both established and new companies and the markets for talent and advice that these companies can draw on (including Web development, consulting, venture capital, and so on in “E-Commerce Building Blocks”). “Karen Brown Books” describes the opportunities and risks involved in a possible deal between a travel portal and a traditional publisher of travel guides. “” discusses the evolution of competition in the brokerage industry, including both online and traditional firms, and provides the context for understanding each group’s competitive strategy.

Additionally, “” shows how a firm can exploit the Internet to create a novel business strategy and discusses partnering, global expansion, and acquisition issues. “HP E-Services Solutions” examines the challenges a traditional IT provider faces in responding to e-commerce opportunities. To acquire new technology or develop an e-commerce operation, it has to decide whether to organize as an internal venture or a new, separate firm. “Cisco Systems” examines the novel approach that company has taken to fund and then spin in new technology. Finally, “Tradeweave” integrates many of these topics and analyzes the opportunity, strategy, and organization involved in launching an e-commerce venture.

A final group of cases examines how firms’ nonmarket environments affect their e-commerce strategies and behavior. These cases, written by our colleague David Baron, consider privacy issues (“DoubleClick and Internet Privacy”), intellectual property (“Ebay and Database Protection”), and taxation (“Internet Taxation”).

Many of the cases were written by our MBA students and casewriters. While we supervised most of them, our colleague Haim Mendelson supervised the ERP and Webvan cases, and Robert Burgelman was responsible for AOL and E-Markets.

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