The Mouse That Roared: On-Line Retail Sales Might Be Modest, but Don't Underestimate the Broader Impact of the Internet

Companies in economically advanced nations continue to invest large amounts of money in the Internet. But economists at the Organisation for Economic Cooperation and Development (OECD), the well-known research and policy group based in Paris, have administered a dose of reality. In their view, even in the most optimistic scenario, revenue from electronic commerce would total no more than $1 trillion by 2005 - or less than the annual sales flow of the US direct-mail business today. The news may shock companies that have spent nearly $2.5 trillion to build Internet infrastructure around the world since 1994. Few of them will be excited if their reward is only a modest increase in direct retail sales. Yet before they begin to pull the plug on this investment, they should consider the Internet's effect on their activities more comprehensively. For in truth, using direct retail sales transacted over the Internet as a proxy for its total impact on the world economy is akin to gauging the force of a hurricane by measuring only rainfall: many factors get left out of the equation. In the case of the Internet, they include lower interaction costs; the network effects created by increasing returns, in which the value of a product or service rises with the number of people who adopt it; and greater economies of scope and scale. Together, these forces are streamlining industry supply chains, cutting transaction costs both for vendors and customers, and driving a vast shift in market power from the sellers of goods and services to their consumers. The cost of interaction The Internet's single most significant effect is to cut the cost of interaction - the searching, coordinating, and monitoring that people and companies must do when they exchange goods, services, or ideas. The cost of searching for a mortgage, executing a bank transaction, and obtaining customer support, for example, drops by as much as 80 percent or more when these activities are handled electronically. Pervading all economies, costs of this sort account for more than a third of economic activity in the United States. Transaction costs, a subset of interaction costs, involve the flow of goods and services in one direction and payments in the other. During the late 1930s, the work of the future Nobel Prize winner Ronald Coase explained why transaction costs made the bundling of diverse activities into a single company economically rational at that time, even though the performance of the individual activities might be less than stellar. Now that the Internet is systematically reducing interaction costs, many companies are being forced to unbundle their business functions. In just three years, for example, AutoByTel has in effect become the second-largest auto dealer in the United States. Customers making purchases through the site buy at prices that generate only a 6 percent margin (rather than the more common 10 percent) for the dealer. The reason is clear. Before the Internet's recent expansion, geography limited customers to a small number of dealers - usually only one for each manufacturer in a sales area. But on the Internet, customers can easily and cheaply compare the prices and options offered by any number of dealers. As a result, AutoByTel and its on-line rivals are unbundling the sales and service roles of dealerships. Dealers' service and maintenance functions remain largely unchanged, but as customers make more and more purchasing decisions on the Internet, the dealers' role as a marketing channel is being replaced by a less valuable sales fulfillment role. On the business-to-business side, TPN Register, a joint venture of General Electric and Thomas Publishing, is one example of the way many large companies are transforming the purchasing function. Originally an internal project meant to improve GE's myriad interactions with its suppliers, the on-line trading network proved so popular that GE began offering it as a service to other companies. …