2.4. The Internet

It could be argued that the Internet is a medium for transporting information and that it should therefore have been discussed in the last subsection. This is, of course, true. Yet, we have decided to discuss the Internet as a separate factor because too many of today’s fundamental changes in business are closely related to the development of the Internet.

Today, all digitalised information can be transported via the Internet at almost no cost. The Internet is, of course, not a one-way medium and thus does not only allow for the transport of information, but also for communication, i.e., the mutual exchange of information. From the point of view of firms, three main channels of communication can be distinguished meaningfully: (1) intra-firm communication, (2) communication with other firms (Business-to-Business, B2B), and (3) communication between the firm and its customers (Business-to-Consumer, B2C).

Although the Internet allows firms to exchange information with anybody who has access to a computer, some communication is intentionally restricted to the boundary of the firm. So-called intranets that are based on the Internet can be an important tool for saving on organisation costs. It is important to note that the Internet does not only allow for savings on transaction costs – to be discussed in a minute – but also for savings on organisation costs. This means that ex ante little can be said about the direction in which the optimal size of the firm develops to the diffusion of the Internet. Whether firms become larger or smaller depends on the relative magnitude of the savings in transaction costs compared to those in organisation costs.

During the Internet boom, B2C was expected to grow rapidly. In the meantime, B2B has grown much faster. It has helped many companies to substantially save in their sourcing activities.

The Internet allows for both firms and private consumers to gain more transparency with regard to (1) the range of available products, (2) their quality, and (3) their price. Thanks to search engines such as Google or Altavista, many products can be searched for on a global scale. Markets that used to be very untransparent have turned into transparent ones. Take the market for antiquarian books: a couple of years ago, many used book dealers did not even have an incentive to publish lists of the books they had in stock. Now, the stock of many antiquarian bookstores can be browsed through within seconds. The transparency-enhancing effect is, however, not confined to products whose existence one is already aware of. The Internet can also be used to gain an overview over the specifications of many different products. In many cases, this will lead to increased demand substitutability.

The Internet can also be used to get information concerning the quality of goods one is considering to acquire. If I look for a certain book on “amazon.com”, I will not only get a description of the book, its title page, some sample pages and so forth, but also a number of critiques from people who have (supposedly) read the book. If I am uncertain as to what travel guide to buy, this information can be decisive for my purchase. In the meantime, some portals have specialised on collecting and providing customer reports on a wide range of products (“ecomment.de”). Suppose a potential consumer has collected some information on the products
available for her needs and has compared qualities using the Internet. She would now like to buy the product, of course, at the lowest possible price. Again, some portals have specialised in finding the lowest price on the net (“BestPrice.com”). Increased transparency can be expected to channel demand to low-cost suppliers. It will therefore increase price competition.

The paradigmatic textbook case for monopoly power is this: a supplier has a monopoly and is facing atomistic, unorganised consumers. Traditionally, consumer interests have indeed been notoriously difficult to organise. The Internet has not only decreased the costs of running an existing hierarchical structure (as discussed above) but has also increased the chances of people with similar interests to coordinate their behaviour for the first time. Examples are portals that offer lower prices as the number of customers increases. In the pre-Internet days, costs of finding consumers interested in buying identical products used to be prohibitive. Due to the low cost of using the Internet, this has changed.

These costs of getting organised have not only been decreasing for final consumers. Producers who co-operate in their sourcing activities are able to establish buyer power and will often be able to substantially reduce costs. The best-known example for this is Covisint (Covisint.com), a venture of a number of automobile companies. Cost-savings are, however, not confined to the demand side of the market: Thanks to the Internet, suppliers can often penetrate markets without having to incur heavy investments in the creation of a distribution network, a brand, etc.

Many orthodox classifications become outdated due to developments induced by the Internet. Synthetic creations like “prosumer” or “coopetition” are evidence of that development. “Prosumer” is a mixture of consumer and producer and shows that this traditional division tends to become flawed. “Coopetition” is a mixture between “cooperation” and “competition” with a similar bent. It has been observed that the traditional distinction between “markets” and “hierarchies” is not sufficient for describing the complexities of real life anymore: Markets tend to get ever more organised (“ebay.com”), hierarchies tend to get an increasing number of market-like elements. This is a trend that has long been analysed by representatives of Transaction Cost Economics under the heading of “hybrid forms” (Williamson 1985).

The Internet can be expected to lead to additional demand concerning policy changes: as a distribution channel, national borders are often negligible (the sale of software products that are distributed via the net is an example). At other times, they do play a certain role. One can order from the Internet pharmacy Doc Morris via the Internet. Delivery of the product, however, still has to rely on traditional distribution channels and national borders can still function as barriers to trade. But the possibility of lower prices can be expected to lead to further demands concerning liberalisation and deregulation. In many cases, it can be expected to lead to lower prices and higher consumer welfare.