Disintermed1iation Concept

The concept of shortening the supply chain or "disintermediation"

caused by electronic commerce is a relatively new concept. Typing
disintermediation into Yahoos search engine, results in over 1800
document matches. According to one author, the word has only
been around for three or four years. In its widest sense,
disintermediation means the elimination of intermediaries such as
distributors and retailers.
There is a natural evolution in the ways organizations provide value
to the supply system. The value system (Porter & Millar 1985), as
Porter terms it, is in a period of change given advances in
information technology2. What is it that fuels the interest in
information technology towards value chains? Transaction cost
theory provides some insight. Wigand and Benjamin have
summarized that there are two mechanisms for coordinating the
flow of materials and services through adjacent steps in the value
chain: markets and hierarchies.
COORDINATION COSTS

What are the costs that support coordination between multiple

buyers and sellers, i.e., market transactions, and those supporting
coordination within the firm, as well as industry value chain, i.e.,
hierarchy transactions?3 In the most basic sense, we can think of
these costs as the costs of channel inventory procurement and
internal general & administrative costs. In a larger sense, we can
consider the cost of accessing customers and managing customer
relationships. Economic theory and practice shows that firms will
seek to minimize the costs. Evidence in this regard comes
from I2 Technology's VP of Logistics Operations. Jon Kirkegaard
remarks "It used to be Company X competing with Company Y, Now
it's supply chains competing with supply chains."4 Recently,
Forrester Research performed an analysis of the costs of inventory
procurement for tangible goods manufacturer. They found that
manufacturers spent 14% of their revenues on procurement (see
Exhibit 1 for typical supply chain costs in the shirt industry).

1 http://web.mit.edu/ecom/www/Project98/G11/15_963.html

We can see why companies such as I2 and GE that link the

distributors inventory management systems with the
manufacturers and suppliers electronically, are growing so rapidly.
The opportunity costs of inefficient overhead and working capital
are enormous. Even if we view the opportunity costs as the costs of
distributor inventory and order processing the savings are very
tempting. For example, Doug Tuttle National Director of High
Tech Practice Deloitte & Touch Consulting said (on Dell versus
Compaq), "Dell has a 10% - 12% cost advantage over someone like
Compaq mainly because of the lack of inventory."5Thus, its not
surprising that Dell has been able to maintain competitively
advantageous prices. On March 9th, 1998, Compaq warned
investors of disappointing results for among other things, falling
prices and demand. On the same day, Dell said, that not only is
demand firm, but they are "not feeling price pressures and continue
to price to our (Dells) cost structure". Many people have
speculated that Compaqs resistance to setting up an on-line direct
channel forced them to consider acquisitions of higher margin
computer companies such as Digital Equipment Corporation.
SAP has recently placed it stake in the e-commerce market with an
equity investment in CommerceOne. The agreement is to integrate
SAPs world leading enterprise resource planning application, SAP
R/3 into Commerce Ones Chain Suite for cooperate purchasing on
the World Wide Web. Chuck Donchess, VP of marketing and
business development at Commerce-One stated, "suppliers are
brought into the equation as if they were departments inside the
companyit will allow companies to check a suppliers inventory,
place the order, and reconcile order problems."
DIRECT MODEL SHIFT

So why arent traditional tangible goods industries shifting to a

customer-direct model? First, to dump your intermediaries would
suggest that the manufacturer could take over privileged customer
relationships efficiently. In fact, that is not the case. A 14" computer
screen with dazzling graphics cannot replace the power of human
relationship. Plantronics Incs. (maker of telecommunication
headsets), CEO recently noted that demand in the call center
industry for headsets has recently begun a strong return as people
demand human interaction for service. Also, distributors are willing

to accept lower net profit margins on the order of 5%-10% which

manufacturer/developers are not willing to invest in (20+% ROI
requirements).
This is not to say that electronic commerce business systems will
not replace the role of human interaction. On the contrary, given
the nonlinear growth of business to business net-based
transactions ($200B by 20016 Also see Exhibit 2) the market of
electronic opportunities will be large. It is closer to say that many
people erroneously jump to the net as the end-to-end solution for
cutting costs. Yet they forget the strategic implications of their
decision. This, in fact, is the first reason we havent seen a
tremendous shift to opening electronic direct channels by existing
manufacturers in traditional tangible goods industries. Instead,
major investments in the VC community are being targeted at
building the new digital middlemen.7 Startups such as Ariba
Technologies, CommerceOne and Actra Business Systems are
automating business produces that support electronically linked
business value systems. The VC community believes that their
investments in ORM (operating resource management) companies
will lead to the emergence of the new value chains.
The second reason we havent seen a major shift to the electronic
channels is the complications caused by this new arrangement.
Consider the sources of value in the traditional supply chain at the
distribution level. Wholesalers provide a major inventory and
distribution location to warehouse and distribute product to
hundred and maybe thousands of local retail outlets. The local
retail outlets, then provide local sales, service and support for the
products they sell. Wholesalers provide value mainly in the
efficiency of their distribution and make money on their ability to
minimize inventory and stimulate demand at the retail level.
Retailers, provide value mainly through their availability of
product, information dissemination, service and local
administration. With the advent of ORM software coupled with
highly efficient distribution networks a significant portion of the
traditional value at the wholesaler and retailer levels is made
unnecessary. What is necessary are the client lists, relationships
and marketing information at the local level that is so crucial to the
manufacturer.

So what has happened when the manufacturer has tried to move to

the direct model? Consider Ciscos Pat Frey, Manager of Supply
Chain Operations on sharing information between supply chain
partners. "Weve run into quite a bit of resistance," says Ciscos
Frey. "Lots of people just arent ready to start sharing information
on this level."7 Frey probably isnt surprised in reality. If the
distribution channel doesnt trust the intentions of the
manufacturer you can bet they will resist sharing their most
valuable assets, i.e. customer intelligence.
This is not an isolated case. Based upon our research, we have not
identified even one public company in an existing traditional
tangible goods supply chain that has opted to open an electronic
channel directly to its end users. We see the largest untapped
opportunity in electronic commerce going to the value chains that
adopt the electronic business model that aligns the strategic
sources of value of the distributor/retailer with the manufacturer
and supplier while eliminating the inefficient transaction costs.
Until that occurs, we will continue to see merely shavings of costs
coming out of supply chains versus order of magnitude strategic
improvements.
Business Model : Direct to Consumer
With more than 31 million connections to access the Web, users
spread around the world are truly starting to believe in the Internet
as a viable emerging channel for purchasing both products and
services. Many companies have opted for starting from stage 1 to
develop a business plan for this purpose. They have emerged in
well-known industries like computer sales, book, investing, home
delivery, etc. With innovative business models, they have managed
to take market share away of traditional marketing channels. Dell
and Amazon.com are considered to be innovators in the adoption of
this model and in the following section we will discuss the
advantage of a channel strategy like theirs.
History

AMAZON.COM

Amazon was founded in 1994 by CEO Jeff Bezos, when he was

looking for a Web service that would offer e-commerce advantages
unavailable at traditional retail stores. Books came to the top of his
list of viable products to sell because of the unlimited amount of
titles and the easiness to develop search and retrieval interfaces.
Backed by approximately $10 million in venture capital money from
John Doerr, the company incorporated in July 1994. In July 1995
Amazon sold its first book on line. Since then, it has gained
significant sales momentum and developed a number of vendor
relationships. It is one of the most widely known, used and cited
commerce sites in the Web with daily hits to its site averaging over
80,000, which translates into 30 million hits per year. Sales have
increased significantly from $875,000 in the first quarter of 1996 to
$66MM in Q4 1997. It presently has more than 940,000 customer
accounts in 160 countries. 8
Electronic Advantages of on-line store
Some years ago, bookstores began building bigger stores in efforts
to meet demand and more efficiently manage inventories. Barnes &
Noble and Borders led this superstore trend. These business
models typically require significant investments in both real estate
and inventories. Average booksellers carry around 130,000 titles,
with some of the biggest ones carrying 170,000.9 Amazon.com has
significant advantages over these traditional retail bookstores
including:
Direct customer advantages
24 hours a day, 7 days a week availability
Unlimited shelf-space that provides potential customers with
accessibility to more than 2.5 million titles, 14 times more
than traditional bookstore superstores.
Access to search and retrieval systems that ease the customer
search job.
Value added content as text excerpts and title
recommendations, which can be provided to aid the customer
in their purchase decision.

 Global accessibility from all over the world, on-line stores like
Amazon.com can exploit the advantages of selling and
distributing worldwide.
Cost advantages
Centralized and largely automated operations instead of
inventory management in a complicated supply chain. This
directly impacts cost structure and allows for rapid inventory
turns. Demand forecasting is simplified and channel
management is eliminated.
Low investments in real assets and real estate.
Analyst Miles D. Russ expects that the company, which is still
working at a loss, will reach profitability by the end of 1999, after
critical sales volume is reached. This expected growth is based on a
number of key advantages:
Amazon.com has positioned itself as the leading on-line
retailer and by owing and retaining the advantages of a first
mover.
Brand extension: Amazon can leverage its strong brand name
by selling other products like CDs and videotapes. Already
they have begun selling a limited number and will slowly
expand their product breadth. Customers interested in various
products will be able to eliminate most acquisition (shipping)
costs.
Books and music sales already generate $150 million online
revenues. This category is expected to grow significantly in
the following years.
Amazon.com has developed strategic alliances with five out of
the six most visited sites in the Internet, including Excite,
Geocities, AOL, Netscape and Yahoo!, ensuring that the
company has the maximum exposure to online subscribers.

 Amazon.com continues to build a database of customers

information and purchasing patterns, enabling true direct
marketing to pump sales.
Business Model : Traditional with Transitional Baby Steps
Some companies have been assuming a more visionary attitude
towards the utilization of the Internet as an important business-tobusiness communications means. (see Exhibit 3). Instead of
selling directly to its customers, the auto industry is an example of
an industry that has taken small steps by rolling out Extranets and
other services to link the different components of the value chain,
suppliers, manufacturers, dealers, etc. In the following paragraphs
we will outline the steps one of the "Big three" auto manufacturers
has taken.
Ford Motor Company
Ford Motor Companys FocalPt Extranet was rolled out in 1997
with the intention of providing customer support worldwide
through its network of 15,000 dealers.10 Repair records of
individual vehicles are available online for throughout the
dealership chain, along with inventory, pricing, financing, and
promotional information to help salespeople close a deal.
An Extranet in this sense is no more than a network comprising
elements of both Intranet and Internet, establishing secure
communications and data exchange between internal and external
users. Below are some of the pros and cons of an Extranet like the
one Ford has launched:
PROS

Cost Savings associated with typical channels in terms of

time, travel, phone, and fax calls.
Faster and cheaper online publishing and distribution of
manuals and other documentation is faster and cheaper than
printed materials.

 Enhanced inter-company collaboration and routine processes

like purchasing, order fulfillment, and inventory control.
Affordable information transportation and prices made
available by the Internet.
Low training costs since the browser is the functional users
tool.
CONS

Concern for data security. The fear still exists that the
Extranet will provide a direct channel into the companys
databases and information resources.
This problem has been addressed by a number of ways such as
password protection, secure server technologies. Other options
include placing the shared data outside the boundaries of the
Intranet or firewall, or contract hosting services to ISP that provide
virtual private data networks with special encapsulations and
security transfer protocols.
Business Model : Combining Traditional and Direct
Some companies have opted for a middle approach in the adoption
of the Internet as a viable and profitable way to commercialize its
products. Any industry in general where dissemination of
information is of additional value to consumers is likely to be
shaken by the Internet sales trend. Among these are auto sales,
financial services, travel, insurance, etc. The software industry is a
clear example of such companies that have been slow and cautious
in implementing a double distribution channel.
INTUIT & MICROSOFT
Companies like Intuit and Microsoft are developing business
models consisting of a mix of the old supply chain model and a new
direct sales approach.12 Intuit has been reluctant to push electronic
commerce because they dont want to upset the traditional sales
channel. However, they are now selling products both on the Web
and in regular retail stores. Although one of the main advantages of

selling on the Web should be a lower price due to a lower cost

structure, Intuits prices on the Web are actually slightly higher
because of large discounts offered in the retailing channel. Alan
Gleicher of Intuit said, "We don't want to disrupt the channel so
[retailers] feel that we are competing with them."
Nevertheless, several retailers with both traditional and online
sales dont believe that the Internet will cannibalize their regular
store sales. They believe that the main goal is to increase sales and
acquire momentum, whatever the sales channel. Despite the
increased online sales, it will still take a long time before any
software manufacturers see the majority of their revenues coming
from the Web.
Microsoft is also following the same lines. The software gorilla said
it is planning to launch an Internet store in August, which will be
use "Buy Now" buttons spread around those Web pages that
contain Microsofts product information. The actual site offers
information of its products and refers to its resellers whenever a
purchase is to be consumed. With the new approach, Microsoft
attempts to close transactions before buyers have the chance to go
somewhere else. Once they have decided to buy the product,
customers are given the possibility of choosing if they would prefer
to go through a software reseller that offers a discount on retail
prices. If they choose "yes", they will be given a menu of resellers
from which to choose from.
"Microsoft.com gets 170 million hits a day, but only 12,000 of those
go to shop," said Neil Farnsworth, General Manager for Business
Development at Microsofts end user customer unit. "Hopefully," he
adds, "well be able to have an influence on people who are
implementing online commerce sites in all industries but are afraid
of irritating resellers."

Enabling Technologies
Many software vendors have created a market by helping
companies enable their supply chains via the web or to create
entirely new business models. Their products range from specific
solutions that can automate an already established process using

web technology to totally new systems designed around a business

model where the manufacturer can sell direct to the consumer.
Essentially there are three different approaches to the
"intermediation" problem. First, there are many software
companies that build "Convergence Applications."13 This is a
generic term that is defined as applications focused on solving
problems and processes external to a company. For example, an
Extranet solution would be a type of "Convergence Application."
Convergence applications are also defined as systems that use open
standards, usually object-oriented, and purchased from an outside
vendor rather than developed in-house. Second, other companies
have taken an end-to-end approach by providing turnkey or "Total
Solution" systems where a companys entire operation can be
compressed into one package. This model best facilitates direct
sales since it gives the manufacturer or distributor an immediate
presence with the customer while also providing the back end
business logic for the entire sales operation. While these turnkey
solutions can bring a companys sales presence to the web rapidly,
many of the most successful solutions have been created by inhouse development. This is the case for Amazon, Cisco, and Dell,
who have each invested millions of dollars building custom webbased systems supporting their new business models.
Enabler Type I : Convergence Applications
Convergence applications typically allow a company to improve its
existing supply chain by optimizing certain segments of
communication or reducing lead times and errors. Usually these
solutions serve to reinforce existing distribution models rather than
developing entirely new scenarios.
Enabler Company : CrossRoute Software
Product : Alliance
Price : $250,000 to $1 Million
Customers : Adaptec
Key Technology : Java, Windows NT

CrossRoutes product "Alliance" is targeted at linking customers,

distributors, and suppliers via an Extranet. The business processes
supported include inventory replenishment, distributor order
management, and logistics operations. A key advantage is
Alliances integration with back-end ERP (Enterprise Resource
Planning) systems. The system allows a manufacturer to instantly
distribute design documents in addition to sales forecast info, WIP
data, and quality reports to its channel. The result is reduced lead
times as a competitive advantage to its competitors. An added
benefit is a logistics extension that allows a manufacturer to
monitor inventory in warehouses operated by third parties. They
can also send orders to the logistics providers and receive shipping
confirmations.
On the other side of the equation, distributors can directly enter
orders into a manufacturers system with up to the minute pricing
information. Plus the system only allows correctly configured
orders (in the case of a configurable product). After orders are
placed the distributor receives order confirmation and shipping
details.
Enabler Company : Ariba Technologies
Product : Ariba ORMS (Operating Resource Management System)
Price : $750,000 and up
Customers : AMD, Cisco, Octel, Visa
Key Technology : Java
Similar to CrossRoutes system, Ariba has developed Extranet
applications focused on the purchasing side of the supply chain.
However, Aribas focus on the ORM market is somewhat different
from CrossRoutes. ORM systems handle purchasing of industrial
supplies, office supplies, capital equipment, services, and other
non-production items that an enterprise acquires to support its dayto-day operations. However, Ariba provides additional functions
internal to the company such as HR information for purchase
approvals that make it very different from CrossRoute.

Interestingly, ORM software like Aribas does not give a company

any new ability to manage its customers, rather it has an opposite
effect. It allows suppliers to be more integrated with customers
who use ORM software. For instance, a paper-clip manufacturer
might supply a company using ORM software. With the enhanced
ability to communicate order information with this customer, the
paper-clip supplier could change its distribution model to
communicate directly with its customers and eliminate some excess
costs in managing a supply channel.
Enabler Type II: Total Solutions
While "Total Solutions" packages could broadly be defined under
the category of convergence applications, they are different in the
sense that they enable entirely new business models to be
implemented. Their key advantage is of course faster time to
market and lower development costs since the software is
purchased from a specialized vendor.
Enabler Company : Open Market
Product : Transact, LiveCommerce
Price : $125,000 and up
Customers : AT&T, Barclay Square, Disney Store, BuyDirect.com,
OpenMarkets product Transact, originally developed in 1995, has
matured to become the premiere electronic commerce storefront
solution. It integrates the customer ordering and payment process
along with back end logic to support the business operation.
LiveCommerce, a web-based industrial catalog product,
compliments Transact by providing the link to a companys
suppliers. Manufacturing companies could find it an easy tool to
use to develop a web direct sales channel for tangible goods, but
digital product companies have already taken it to the next level.
For example, BuyDirect.com uses OpenMarkets products to sell
software directly over the Internet. This new model totally
eliminates distribution and provides instant delivery to the
customer.
Enabler Company : BroadVision

Product : One-to-one commerce

Price : $100,000 and up
Customers : Kodak, Hewlett-Packard, Phillips Electronics,
BroadVisions One-to-one commerce system provides similar
capabilities to that of Open Market. It also provides capabilities to
cross-sell products to customers and handles digital coupons and
other incentives. In addition to the digital storefront application,
One-to-one handles order management and fulfillment.
Enabler Type III: Home Grown Systems
Home grown systems are by far the most flexible of all solutions
since the only requirements are a set of development tools and a
large investment from the company. It is interesting to note that the
companies that have made the largest internal investments in
developing their web business models are also the companies that
are leading the world in e-commerce. In fact, in a 1997 year end
summary by C/NET, Cisco, Dell, and Amazon were identified as the
leaders in e-commerce and described as " credible, making lots of
money, everyone wants to be them, and it seems to be a sustainable
business model on the Web."

Conclusion
A short list of priorities such as adopting a standard for domain
names, ensuring privacy and security, and establishing commercial
practices will shape and determine e-commerces future.
Increasingly companies and individuals are going online for basic
commerce and ways to save money. The industry must commit itself
to producing unified and workable solutions to the challenges of
self-regulated business.

Exhibit 1 : Value Chains in the Shirt Industry

Exhibit 2 : Projected Retail Internet Transactions

Exhibit 3 : Major Companies E-Commerce Strategies

Vendor

Digital
Equipment

Strategy

What they say

Offer multi-vendor
services as well as
Digital products;
leverage Alta Vista
search technology

"Business to business Ecommerce is the biggest

market. Its three to 10
times bigger than the
consumer market."
Laura Franham, VP of
marketing for Internet
solutions

HewlettPackard

Sell hardware-software
packages for the Web,
security and payment

"E-business is helping
corporations take
advantage of the Internet

IBM

systems, and the HP

Changengine
framework for process
and workflow
applications

to improve relations with

customers and suppliers."

Sell systems that

handle customer care,
electronic payments,
and supply-chain
management; Apply ebusiness solutions to
vertical industries

"If you are going to

transform a company, you
need to master three
disciplines; technology
deployment, reengineering,
and change management.

Ann Livermore, VP and

general manager, software
and services group.

Doug Sweeny, VP of
strategic development.
Microsoft

Promote the value

chain initiative, an
effort to integrate
disparate supply-chain
applications using
Microsoft tools and
applications

"We want to leverage our

existing base of
technologies, injecting
commerce into Windows,
and commerce enabling
our Backoffice products."
Jonathan Weinstein, Lead
product Manager of Site
Server commerce
marketing.

Novell

Promote Netware as
an open platform for
distributed, Web based
applications, in a joint
venture with Netscape.

"E-business from our

perspective means
integrating ERP software
on our platform and
managing these
applications"
Chris Stone, Senior VP of
corporate strategy

Oracle

Reposition database
and application
products for e-

"We have a very substantial

business built around Ebusiness."

commerce in an
environment based on
thin clients and Java
SAP

Sun
Microsystems

Beatriz Infante, senior VP

of application servers.

Help Web middleware

and E-commerce
vendors develop links
to R/3 over the Net;
invest in startups
Crossroads Software
and CommerceOne

"We want to participate in

business to business Ecommerce both by product
development and
investments."

Supply the hardware

for network computing
while promoting Java
as a platform for
electronic business

"E-business is a marketing
wrapper around a whole
bunch of separate but
related activities around
the enterprise."

Howard Lau, executive VP

of venture capital funding

Anil Gadre, VP of
marketing.