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Internet Technology (Part 2 of 2): The End of Channels and Hierarchies

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  1. Unbundling the Corporate Infrastructure for the Internet Hyperarchy
  2. The Future of Business and the Internet
  3. Harris Kern's Enterprise Computing Institute
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Once upon a time, it was easy to identify your competitors. They had brick-and-mortar stores like yours, or a print catalog. Their advertising appeared in the same publications. And they had the same production costs and distribution issues as your business. With the advent of the Net, however, other marketers can reach out and snag your customers one-to-one. This article describes this business change from hierarchy to hyperarchy, and explores how to start refocusing your thinking toward world marketing.
Placing special emphasis on a comprehensive approach combining organization, people, process, and technology, Harris Kern's Enterprise Computing Institute is recognized as one of the world's premier sources for CIOs and IT professionals concerned with managing information technology.
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Unbundling the Corporate Infrastructure for the Internet Hyperarchy

The Internet makes it possible to organize businesses in new ways, to offer new products and services, and to distribute those products and services to tens of millions of people almost instantaneously. And this holds for everyone with access to the Internet, whether Fortune 500 companies or individuals looking to market their talents or ideas. This redistribution of the information value-chain from the internal to the external leaves the average corporation with much less "protection" in the open market. Competitive advantage can disappear overnight. No longer are internal proprietary networks creating natural barriers of entry for distributing information. Those proprietary networks were often patterned after the organizations that created them. (For example, rich flow of information to the top and controlled specific flow to the bottom of the organization.) But information is now widely distributed to everyone and anyone with access to the Internet. Whether that access is provided at work or at home, it is as evenly distributed to the corporation's janitor as to the CEO. Of course, organizations can build artificial boundaries through intranets, virtual private networks, and filters, creating private segments of the World Wide Web for organizational use. But a corporate-wide web doesn't dilute in any way the overall power of the Internet as a whole.

The Corporate Structure Redefined

If the corporation is based on hierarchy, the World Wide Web is a hyperarchy, in which everyone communicates richly with everyone else on the basis of shared standards. Thus, the Internet network goes beyond just being able to provide content to those who choose to access it; it can provide very specific content to as wide an audience as required! There are no organizational pyramids on the Internet. There is no flow up or down. The flow is continuously in and out—not on a two-dimensional plane, but through an ever-expanding three-dimensional cube. In fact, since the content of the web is ever increasing over time, we can picture it geometrically as a four-dimensional hyperarchy. The concept of the hyperarchy challenges all hierarchies.

No single software program can achieve both richness and reach—see Part 1 of this series for a discussion of these terms—but, for the first time in the history of networks, the Internet can! As the Internet evolves from an informational model to a transactional model, it will have the same impact on the way the world does business in the 21st century as the assembly line did in the 20th century. In other words, the knowledge model expanded exponentially through the Internet hyperarchy has the same effect on a commerce model. Someone can buy or sell just about anything without having to rely on traditional distribution channels. At one time, these channels more often than not played as great a role in pricing and distribution as the manufacturing of the product itself.

Refocus of the Producer-Consumer Model

With the increase in software to create "state" transactions with standard databases, the Internet has matured from a large network of text-based knowledge and still image graphics to a transactional e-commerce model. In doing so, the Internet is revolutionizing how we do business and how we live our personal lives. Early e-commerce sites consisted of bulletin boards and auctioning software, allowing customers to announce their product requirements and accept bids. As security across the Internet improved, customers began to buy and sell traditional goods without venturing from their keyboards, drastically modifying the traditional economic basis for the producer-consumer model.

Historically, the producer-consumer model relied on the following economic definitions:

  • cost of production: Finding, collating, and consuming various resources (including labor) to produce marketable goods.

  • cost of distribution: The means of offering these goods to the open market for consumption.

Although the Internet has had a profound effect on both production and distribution, we will first concentrate on the latter. Intuitively, it's much easier to grasp why the cost of distribution should decrease dramatically with the advent of e-commerce. If a consumer can place a transaction directly with a producer without ever leaving home, this calls into question the need for one of the basic staples of any consumer economy: the store, or what we now call the brick–and-mortar business.

Traditionally, a typical distribution network consisted of a producer or group of producers who manufactured a durable good. Depending on the scope of their marketing and distribution, there would be a series of main distribution centers or warehouses at various geographical locations. Products would be shipped to these hubs in the most cost-effective manner. After goods arrived at these distribution centers, they were sent in turn to the applicable retail markets. Independent retailers were responsible for ensuring sufficient inventory to meet demand. Some manufacturers would use internal retailers, and most would supply as many external retailers as necessary to distribute their products. This is the conceptual model of the value-chain distribution network at work.

The value of the value chain comes from the fact that each unit in the chain has its own economic responsibility, which theoretically lends value to the overall producer-consumer network. Manufacturers must carefully measure the total and incremental costs of producing their products. Overproduction could result in spending more capital than can be recouped in sales. Low sales could result in underutilization of capital and a lower return on every dollar spent to produce.

Both the manufacturer and the distribution center must determine the most cost-effective way of transporting the manufactured goods to their designated locations. Since this "lane" exists between the two parties, both ends are responsible for maintaining the lane's economic viability. This is why, more often than not, most manufacturers also maintain their own distribution centers. These distribution centers, in turn, further distribute to the individual retail firms they supply. The distribution center's economics are based on its ability to successfully stock and supply these retailers at maximum economic efficiency. Optimally, the number of items going out should equal the number of items coming in. With no inventory, all costs generated by maintaining the network will provide incremental profit for each item distributed. If the entire system is running at maximum efficiency, the retailer can net pure profit by selling exactly as many items as the regional market demands at any given time.

Of course, all this is an ideal. Each link in the value chain produces real value by maximizing, as much as possible, its ability to create and supply goods to a demanding market. There are considerable variations on this theme, as manufacturers, distributors, and retailers all develop business plans that best suit their individual needs. Barnes & Noble doesn't manufacture anything, but its distribution centers are the economic generator that power many widespread publishers.

Occasionally, manufacturers rely entirely on outside distributors and retailers. In this model, individual distributors are purely the middleman. The entertainment industry has relied on this model for years. And, of course, there have been independents for as long as commerce has existed. But it's almost impossible to find a single organization or business that distributes, sells, and generates business successfully on a large scale.

The Realization of "On-Time Manufacturing"

The Internet is slowly altering this setup. A manufacturer could theoretically use the Internet as a free, universally-accessible distribution channel to sell whatever goods the manufacturer and its partners could produce. In fact, add the concept of the real-time feedback loop, and said manufacturer now has to make only the amount of goods demanded at any moment. And although the potential of "on-time manufacturing" has yet to be reached by everyone, the impediments to reaching this pinnacle—personalized items on demand—are slowly but surely falling by the wayside.

Revising Product Models

As the basic economic models of manufacturing, distributing, and retailing are being redefined by the Internet, it's becoming clear that a provider's competitive advantage will be determined product by product. Therefore, providers with broad product lines will lose ground to focused specialists. The phrase broad product lines conjures up images of megalith corporations, keiretsus, and multinationals, but the category more commonly includes single-brand manufacturers or producers in a specialized field. For instance, a magazine publisher, a traditional brick-and-mortar company, has built a substantial business publishing magazines in a variety of fields and interests. Each title is strongly branded, advertising revenue is constant, and the distribution value chain (based upon a hard-fought and reliable network) is effective all over the world. But with the advent of the Internet, "frictionless" e-magazines are popping up everywhere. The issue for the brick-and-mortar company is how to leverage this new medium without cannibalizing its own healthy print product.

An aggressive strategy could be to cut the losses now, forget about print, and start "e-versions" of the current print product. This may seem a bit drastic, particularly since the major revenue source for print is advertising, and "e-advertising" models are still maturing. But any losses in revenue could be recouped by cutting costs in resource acquisition (paper, ink, etc.), printing, and distribution. Writers and editors could simply publish directly online, cutting out the middleman. At the same time, new advertising models could be experimented with and refined.

A less aggressive approach would be to simply do both. Leave the print product as is and simply establish e-versions. This may sound simpler, but is actually more complex. Although a magazine is essentially the same product in print or electronic format, a print version and an e-version will have two entirely different business models. The most obvious drawback is that if an e-version exists, why would anybody pay for the print version?

In my opinion, the basic flaw in this argument is that for some reason, people assume that "e-products" are meant to replace brick-and-mortar products. In some cases it may happen, but certainly not across the board. There is a certain "stickiness" to some brick-and-mortar items that illusory e-products simply can't match. In short, you may not be able to read an "e-zine" as comfortably as its print counterpart in bed or in the bathroom. You can't leave one on your coffee table so guests can enjoy your unquestionably good taste. Interestingly, the difference between an e-company and a brick-and-mortar company is not that the products themselves are radically different, but the distribution of these products and their information, or more exactly the distribution value chains, are different!

The magazine publisher is selling not just magazines, but the content, or information contained within. That's what interests people. The print form is just a means of distributing that content. The more ways an organization can find to distribute its content, the more value it adds to the content. The key concept for our theoretical publisher to grasp is that the core value of its content, or product for a manufacturer, has not changed in regard to its market. Only the means of distribution has changed. But changing these means will inevitably change the business relationships of the traditional distribution channels. This is the real challenge our publisher and any mass-production manufacturer must face in the next millennium: the idea of value-chain unbundling.

For instance, a shoe manufacturing concern finds it can order and track leather supplies via the Internet, therefore abandoning its costly, high-maintenance procurement system. This produces increased efficiency now that ordering can be "tuned" to fit projected capacities. These projections become increasingly accurate because, day-to-day, even minute-to-minute, the manufacturer can track inventories at some or even all of its geographic distributors in real time. In conjunction, each distribution center maintains its own inventory control by meeting the demands of retail customers via internal intranet and shipping merchandise directly to customers using an e-commerce web site. Amazon.com, for example, maintains massive warehouses that are constantly in touch with both suppliers and consumers. B2B and B2C commerce engines are only the tip of the Internet's growing role in how supply chain economics are evolving.

Frictionless Commerce

Although this producer-consumer economy still relies heavily on digital networks, the producer need only be concerned with producing its goods and content and maintaining whatever software is required to create and transport information up and down the value chain. The real advantage is that the supplier, the distributor, and the consumer don't need to erect these units and support a costly digital network themselves. The network is frictionless. Via frictionless commerce, network economies of scale arise when individual business units are no longer dependent solely on internal networks that may or may not be well-defined and supported. Each business unit can act independently, knowing that the information it has available at any given time is up-to-date and accurate.

Businesses that broker information, make markets, or set standards are all taking advantage of a self-reinforcing dynamic. This dynamic is eventually measured in productivity gains, lower operating costs, and, most importantly, higher net profits. Unfortunately, although the idea is common-sense, handing over this responsibility to the Internet is still a radical idea. Not only are the security issues daunting, but so is the relative immaturity of the software and even the hardware that would have to support this type of infrastructure. Developers and vendors of the required software are relatively inexperienced as well.

Redistributing the Value-Chain Concept to the Net

Let's take a look at a theoretical but very possible example of using current business principles to redistribute a value-chain concept to the Internet. Every autumn across tens of thousands of college campuses in America and throughout the world, hundreds of thousands of college students begin new classes. Each class has required textbooks for particular courses. Publisher A will probably publish a good proportion of those textbooks. Traditionally, each student has to make a trip to the college bookstore, find the required text, and buy it. Even if used, these textbooks are generally expensive and have very limited use. In terms of information economy, these texts are rich information items. Yes, some of these books will become reference material for years to come, but most reach the end of their utility at the end of the semester. They will then be sold, traded, or eventually thrown away. The distribution chains between Publisher A and the bookstores determine reach. This value chain comprises a static but very viable network.

Now, what would happen if Publisher A made every textbook that was published and distributed to the bookstores on its distribution lists available via the Internet? The distribution network would change overnight. The business economics of each college student, and of college education itself, would change overnight. Instead of having to purchase a $65 tome they may or may not need six months later, students could simply browse all pertinent passages on their PCs or on computers in the campus library—for a nominal fee, of course. But would that fee be equal to the price of a bound and edited version? In either case, there would be economic advantage to both student and publisher. The student would no longer have an overwhelming collection of books to store and maintain (unless she wanted to do so). The publisher could now extensively scale down or do away with the costly expense of printing, binding, and shipping. And none of the economic value of the information would be lost. In fact, the economic value would be enhanced by actually removing the bookstore from the value chain and substituting a web browser. Reach has been increased and richness maintained, while expenses have been considerably decreased!

Bookstores may not like being excluded from this scenario, but as they provide no added richness to the process, the advantages to producer and consumer are very clear. So why doesn't Publisher A, or any other major publishing company, leap at the chance to do this? Because, like most hierarchically managed, traditional businesses, no one wants to be a pioneer.

Traditionally (and tradition goes back only five years or so), Internet business has been defined as fast, flexible entrants taking on dominant incumbents: Netscape versus Microsoft, Amazon.com versus Barnes & Noble, Schwab.com versus Wall Street. Some businesses are merely looking for additional profit, not for a war, but although defining a web-based approach to business doesn't have to be a war, it can be a struggle that some businesses aren't quite ready to take on.

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