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New Rules Electronic Economy.

Online commerce is changing the mechanics of the entire economy. Businesses are having to change their own mechanics just to keep up. Steve James of Andersen Consulting offers advice to companies on how to adapt to:

The financial services marketplace is going through major changes Factors like globalization, deregulation, consolidation, increasing customer choice and power, excess capital, and the emergence of new roles and entrants are making marketing sessions increasingly critical and complex. The state of the stock market and the fundamental shifts in measures and rewards that are occurring further complicate the matter. Every single organization with which Andersen Consulting in works wonders how to ensure its future success and how to respond to the possibilities and threats created by this "new order."

The problem is not simply a technology issue, even though technology is driving most of the change. This shift to the future is not merely faster electronic transactions, "e-commerce," or "e-business," but the trend is the "electronic economy."

Industrial Economy

The current shift to the electronic economy is not dissimilar to the shift to the industrial economy that occurred some 100 years ago (although the shift 100 years ago was at a slower pace than the current shift). Then, revolutionary capabilities converged to fuel the changes that are now known as the Industrial Revolution. This convergence led to new industries and changed the way people worked, where they lived, and the skills they needed. These changes set the scene for fundamentally new ways of creating value.

Electronic Economy

We are now going through another historic convergence--that of the merging of computing, communications, and knowledge, which creates the new e-economy. The absolute pervasiveness of computing, the speed and capacity of telecommunications, and the power of knowledge and insight have merged to create fundamental changes in the economic landscape.

However, are these changes really representative of a fundamental shift in the rules of our economy? Granted, all of us have witnessed significant change and market upsets with other technologies. The cycle is the same--rapid creation of businesses, followed by rapid consolidation. Disproportionately large market caps come and, sometimes, they go just as fast. But, the present changes to the underlying fabric of business and society have never been more pervasive. The change affects every industry from communications and high-tech to financial services, government, and retail.

The Internet and e-commerce technologies have made several inventive business models possible. As these business models have emerged, they have upset many of our 'ingrained' economic assumptions, as well as many of our market value expectations.

The Internet and e-commerce is a new economy with a new basis for competition. Investors reward both new organizations that build their business models according to the new rules and established organizations that have unlearned many of the "old" assumptions and have reshaped their businesses. There are five "new rules" of the electronic economy that every organization must apply to ensure long-term, ongoing success in this emerging business context:

1. Vertical disintegration and the role of value networks and alliances

2. Value of information assets and how they change the returns that companies can demand

3. Increasing returns to scale on investments in new business models

4. Power of the customer and the impact of the ease of accessing information

5. Speed to change

These five new economic rules have forever changed market dynamics. E-commerce pioneers have helped establish these rules and are redefining how companies will operate in the future.

Degrees of Vertical Integration

1. Vertical Disintegration

Old Assumption:

It was common practice to build large, vertically-integrated businesses to achieve savings across the value chain, thus reducing costs and squeezing as much profit out of a product as possible. Now, because of global communications and the Internet, collaboration and interaction are easy, allowing anyone to "plug in" and "unplug" business partners as needed. The value chain is now best viewed as a value network.

New Rule:

By assembling a network of "best of breed" partners that specialize and excel in the links of the value chain and perform only those functions that the customer values most, it is possible for organizations to achieve rapid growth with new levels of quality, flexibility, and cost savings. This assembly creates both an extraordinary opportunity and a challenge to intermediaries. Unless a company is able to move with its customers' changing needs around access and cost in a way that increases its value as an advisor, the company leaves segments of its business open to the threat of disintermediation.

2. Return on Intangible Assets

Old Assumption:

In the industrial world, firms were measured on the value of the means of production. Thus, market returns were derived primarily from productive capacity, such as property, plants, and equipment. However, as mass markets become more and more segmented, these assets become commodities--which does not imply that physical products are going away, but that the market today places more value on intangibles that can create a one-to-one customer experience, with things like brand equity, knowledge capital, and the relationship with the seller.

New Rule:

Intellectual property and customer relationships-that can be easily and cheaply leveraged across a global customer base--have become a freestanding source of revenue and value. Some businesses have even separated the customer relationship and intellectual property using a networked business model, allowing these components to be valued individually by the markets.

3. Increasing Returns to Scale

Old Assumption:

There were (and still are) decreasing returns to scale for investments in plants and equipment--that make up the majority of the fixed costs for production. Increased competition means squeezing margins for physical products, while more value can be created from intangibles (when you sell things that are not physical, the "production costs" are minimal after the initial investments in development).

New Rule:

By focusing on virtual assets (intellectual property, information, and customer relationships), you can achieve increasing returns to scale. Theoretically, an organization can grow without limit, incremental unit costs can approach zero, and unit value to the customer can increase exponentially.

4. Near-Perfect Information

Old Assumption:

Because of restricted access to information, sellers could garner a market premium on products or services. A good example is automobile sales; there are still pricing differences in Europe, based upon where a particular car is purchased. But, the Internet and global telecommunications have made much more information available, giving buyers much more purchasing power. At the same time, through the same interactive means, sellers can gain more information about current and potential customers. By collecting these data, products and services can be formulated or tailored to individual needs at the time of a transaction. If these data are not collected and processed by a company, the company's competitors will; they know who the best and most profitable customers are.

New Rule:

Because of customers' expanded choices and access to better comparison data, companies will create higher value only by using customer information to create interactive, innovative, and need-focused offerings.

5. Time to Market Can Be as Short as Overnight

Old Assumption:

Developing new markets created automatic barriers to entry for small players. Companies could easily detect market entry by monitoring the major activities that needed to take place, like manufacturing and logistics coordination. But, communications technologies make channel and alliance development more possible and more effective, which means a large physical presence is not necessary for market entry.

New Rule:

New markets and global virtual channels can be opened overnight to source, promote, sell, deliver, and support goods and services. To protect market share, companies must continually monitor and adjust their customer value proposition.

Thus, the five updated rules are:

1. Vertical disintegration can achieve flexibility and scalability.

2. Intangible assets can provide a significant source of revenues and value.

3. Intangibles can produce increasing returns to scale.

4. A near-perfect information market compels organizations to use customer data to create need-focused offerings.

5. Because new channels can be developed overnight, firms must continually monitor and adjust their value proposition to protect their revenues and customer bases.

Why Must These Rules Be Applied for Success?

Because a fundamental economic shift is underway, these rules have implications for both established and new organizations:

* Most incumbents have built their entire organizations around traditional economic rules and assumptions. Today, incumbents must learn to react to new competitors and compete on a stronger basis than price or, even better, take on new opportunities before fast movers take away the opportunities. The key is to hold onto and expand one's leadership position while taking steps to leverage one's strengths to create growth opportunities, even when those opportunities po-tentially cannibalize segments of one's core business. The biggest management challenge is to achieve change quickly (as one of Andersen Consulting's print advertisements says, "the dinosaurs never saw it coming").

* New organizations must recognize that while rules change, there are, in fact, new rules. These organizations must be able to scale fast, remain nimble, and use their market capitalization to establish longer-term value for shareholders. Otherwise, incumbents or newer startups that can better exploit these rules will take over the organizations. Two of the more interesting newer organizations to watch include:


This Internet company invested in seven warehouses and moved from a purely disintegrated, networked business model to a hybrid. While's investment is still much less capital-intensive than a traditional retailer, it will begin to vertically integrate and become a "clicks and mortar" company. If one delivers to market the "consumer appliances" that obviate books, CDs, and videotapes, will the "mortar" portion of's business model be a competitive disadvantage to yet another new entrant?


The Internet company is facing new competitors, as well as other sites developing competing auction markets. A new company,, provides a way to search across several auction sites simultaneously to show users the companies that sell what the consumer wants. This process, called "deep linking," bypasses layers of the Web site to retrieve the content the consumer really wants. may lose advertising revenues as a result and has threatened legal action against However, the question is whether and how will continue to pursue the network effect and protect its leading market share.

How to Apply the New Rules

Companies will continue to face management challenges posed by the new rules:

* Tapping into real customer intentions and value propositions, which is the opposite of determining which customers will purchase a product/service and which means more than just buying customers through acquisitions.

* Continuously evaluating/redefining one's value propositions to stay in touch with customer needs and to address a continuing stream of new entrants--continuous differentiation at a fast pace--to protect against price erosion and to defend market share.

* Ongoing development and management of alliances with networked business partners and adjustments of strategy as one redefines value propositions.

* Unleashing a company's assets to grow the top line--look for new streams of value from existing assets that can be leveraged in new models: the brand, the customer base, the processes, and other intangibles.

* And, perhaps, the toughest challenge for incumbents, changing the management mindset within the company--the need to "un-learn" entrenched thinking, including "long-range strategic planning," "focus on core competencies," and "near-term SVA results"--while increasing the organization's speed and responsiveness.

Successful players tend to focus on three things simultaneously:

1. Leveraging technology to reduce their costs is necessary as the Internet continues to change the benchmarks for cost and speed. Applying Internet technologies to a business is becoming the minimum price to compete. However, this evaluation must be continuous, since new, innovative business models will continue to raise the benchmarks in this area.

2. "Entangling" themselves with their customers, finding ways to play a role in customers' lives and communities, tying themselves to their customers by bundling offerings that address key value propositions (time is the ultimate value proposition element; time is scarce), and focusing on maintaining and growing these relationships. A recent study by Andersen Consulting found that for communications companies, raising customer relationship management performance from "average" to "top-tier" can increase return on sales by 16 percent. To translate, for a $2 billion business unit, that is an improvement of more than $320 million. Over half of those gains can be attributed to just four things:

a. Better pricing models,

b. Sharing customer information (within the organization and with strategic partners),

c. Developing effective strategic partnerships and alliances, and

d. Executing (not just developing, but executing) marketing plans and programs.

3. As an intermediary, developing and delivering high-quality content and advice to customers when they need it and how they want it. If these actions are coupled with low-cost, high-value-added transaction capabilities and the courage to act decisively, technical knowledge and relationships can be effectively leveraged to maintain competitiveness and market position.

The electronic economy is our new reality. While the challenges seem steep, the up side of this opportunity is enormous: 50 million more Internet users in the next 2-4 years--100 million people spending more time online. Business-to-business commerce is on the rise. Strong endorsements keep coming from capital markets. Success will be achieved by those organizations that have courage--courage to challenge existing management assumptions, courage to rethink their entire business model and sources of value, and, most of all, courage to play by the new rules.

Stephan A. James joined Anderson Consulting in 1968 and has consulted primarily in the Financial Services industries, with an emphasis on strategy planning, change management, and the implementation of large-scale, networked computer systems. He has worked throughout the United States, Europe, and Asia. In 2000, he assumed his current position, where he is responsible for two executive roles. He is the Global Market Unit Managing Partner for Resources, which includes the Energy, Chemicals, and Utilities industries and is also in charge of Global Markets Operations, which encompasses Finance, Human Resources, Marketing, and various firmwide Strategic Initiatives. These functions support the operations of all Global Market Units.

Mr. James has been an elected member of Andersen's Worldwide Board of Partners for the last nine years and sits on several Andersen Consulting management committees, including the Andersen Consulting Executive Committee.

Mr. James graduated from the University of Texas in 1968, with degrees in Industrial Management and Labor Relations. He is a member of the University of Texas Business School Advisory Board.
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Author:James, Steve
Publication:Business Perspectives
Geographic Code:1USA
Date:Mar 22, 2000
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