INTERNET AGE TRANSITION

Channel strategy as Internet strategy

Beyond choosing a role in the new channel system, companies must still identify how they will compete and on what resources and capabilities, that is, they must formulate a strategy. Our research suggests that companies may choose from a set of four distinct strategic options when they make the transition from traditional to Internet channels. They may compete, control, combine, or coordinate.

Compete

In this strategy, companies choose to compete in a particular intermediary role. For example, PriceScan has concentrated on delivering objective price information across online and offline markets. Leveraging its core competence at gathering and disseminating pricing information, PriceScan has diversified its services across multiple industries. Another example is Priceline, a new specialist in the market making role that is leveraging its patent on a reverse-auction like process to compete in market making across airline tickets, automobiles, loans and even groceries.

Payment enablers such as Amex, Visa, and Mastercard, and fulfilment providers such as FedEx, UPS, and the Postal Service also compete through specialisation. It is important to note that each specialist competitor must cling to its core competence and forsake all others. Growth comes not from offering many services but from offering the core service in many industries and sectors, as PriceScan and Priceline have done, and from continuous improvement in processes and technology that help leaders maintain market share.

Control

Instead of offering a core competence in many industries, some infomediaries attempt to control the flow of resources in a single industry by focusing on the role that provides the greatest amount of leverage over relationships in the channel – what might be called the linchpin role. For example, eBay dominates in customer-to-customer commerce not because its technology is unique but because its relationships with customers are so strong that it can dominate other channel members by controlling access to those customers. In the same way Chemdex controls the online channel for chemical reagents, eSteel for rebar and sheet metal, and the Seafood Exchange for fish.

Once an infomediary controls a channel, it can capture additional value from partnerships. For example, AOL controls access to a customer base of close to 10% of all online users. Although AOL's main business is online access, a single partnership with Tel Save garnered $100m of new revenue. Other revenue generating AOL partners include ABC, the New York Times, BarnesandNoble.com, and Amazon.

Firms that seek to control a channel must keep their customers in the fold, either by providing superior service or by making it costly to leave. Portals do both by allowing users to personalise their interface with information of particular interest to them – for example, portfolio performance, news, and weather. Of course, personalising the interface requires some investment of time, and users who defect must leave that investment behind. Electronic retailers have also created high switching costs (and provided greater convenience) by capturing customer billing and shipping information.

Market share may be the key to a successful control strategy. The concept of increasing returns is common to many online control players. The online world's 'law of increasing returns' is driven by both internal and external factors (network externalities). Internally, most online companies have high fixed costs for infrastructure and marketing, but a low variable cost to serve. Network externalities come from new users creating value for subsequent new users. For example, a large customer base makes buyer agents more valuable to new customers.

But increasing returns can fail, and control can be elusive. An 80%-plus market share was not enough to save Netscape, a company that for a time seem ready to break the hegemony of Microsoft. Nets.Inc. also seemed to have the right talent, funding, and position, but this early business-to-business market maker ran out of steam shortly after its founding. Even AOL's continued dominance is uncertain in the face of competing technologies like cable-modem Internet player Excite@Home, browser-maker Microsoft, and Web portals like Yahoo!

Combine

In the past, high transaction costs made it economical to combine different channel roles within a single organisation. Although transaction costs have fallen, there are still some economic incentives to combine roles. Even Amazon benefits by combining buyer agency with a certain amount of market making and fulfilment capability. Although thwarted in its attempt to buy distributor Ingram, Amazon has recently invested in physical warehouses to reduce the delivery time of its books to certain areas of the US. And some traditional retailers have leveraged their existing model quite fluidly into the Internet space. The British supermarket Tesco moved quickly into online selling, and now has over 80,000 registered users for its direct shopping model. It has even become an Internet Service Provider (ISP), offering Internet access to its customers.

Another motivation to combine roles is to exploit cross-subsidies for competitive advantage. Cross-subsidies enable companies to give away the value in one activity in order to secure greater margins or value in another activity. Cross-subsidies occur in most industries and often make customers feel (rightly) they have got something for nothing. While less effective in the new economy, cross subsidies remain a part of online selling. For example, the electronics market maker NECX provides free buyer agency by showing customers the best prices available from its competitors – even when competitors' prices are better than their own – in the belief that customers will in the end prefer NECX's total package. All this suggests the need to give serious consideration to combining as a strategy, even in a world that is allegedly being torn apart by eCommerce.

Coordinate

A coordination strategy creates a one-stop shopping experience – facilitating the creation of customer solutions without the need to own resources. Coordination is a particularly strong strategy in three situations: (1) there are many undifferentiated infomediary competitors, (2) inter-firm cooperation is low, and (3) variety is required in the channel. Catalogue retailers have understood this strategy for years. They added value by creating options, allowing customers to specify a preferred shipper and form of shipment (that is, next-day air, surface, and so on) and a preferred payment provider. Nowadays, in addition to payment and shipping, online customers can choose the context in which they wish to participate, the company that will inform their purchase decision, and the market in which their transaction should occur.

1 - 800 - Flowers has leveraged information technology to become the service of choice for long-distance flower and gift delivery. It has succeeded by creating a network of over 2,500 allied independent agents, market makers, and fulfilment providers. Garden applies the same strategy to link over 40 grower/suppliers, and a large number of fulfilment and payment partners, to their online base of customers.

Another approach to coordinating the channel is to assign roles to specific sole-source providers, as IBM's eChemicals does. This newly formed channel uses select specialised partners in each role: Yellow Freight is the partnering fulfilment provider, SunTrust Banks Inc. is the payment enabler, and eChemicals itself is the market maker and coordinater. By leveraging its strong brand and information-management capabilities across channel roles, IBM is able to garner a larger share of the channel rents than if it were simply to compete in a particular role. Successful coordination typically requires a direct interface to the customer and the capacity to integrate multiple specialised providers dynamically. The latter requires efficient information-management capabilities to exist or be built across channel roles