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Find this article at: http://www.business2.com/content/magazine/indepth/2000/03/01/20681

Making New Markets

From the March 01, 2000 issue

Mohanbir Sawhney

The limitations of space have long dictated the economics of exchange transactions. Buyers must be physically close to sellers for exchanges to be efficient. As sellers grew in size and buyers became geographically distant from sellers in the Industrial Economy, direct buyer-seller exchanges became impossible. This spatial separation gave rise to middlemen who facilitated exchanges between firms and customers. Intermediaries added value by providing spatial utility, assortment utility, and temporal utility to customers. They provided customers with the right products at the right place and at the right time. The value of intermediation derived from the geographical fragmentation of demand and the transportation costs of customers.

In the Network Economy, the limitations of space no longer apply. Firms can reach their customers directly without regard to their physical location. In a world where everyone and everything is connected, the shortest distance between a customer and a firm is one mouse click. This "death of distance" is a defining feature of the New Economy. If the pundits are to be believed, middlemen would become the roadkill on the information superhighway.

But a funny thing happened on the path to frictionless capitalism. The economics of distance died, but the economics of attention took its place. Firms indeed did set up shop to market directly to their customers, and direct-to-customer models have been successful in books, software, investing, and toys. But in many markets, customers find themselves overwhelmed with vendors clamoring for their attention, and vendors find themselves in a desperate battle to acquire customers. Customers still need to search, evaluate, negotiate, and configure products on their own. What customers gained in reduced transportation costs, they seem to have lost in increased search costs. These search and evaluation costs continue to create significant friction in commerce. So is frictionless commerce a mirage? How can we address the problem of attention poverty if every marketer wants to reach customers directly? And what is the future of middlemen in networked commerce? Will we see fewer middlemen, as the proponents of disintermediation suggest? Or will we see more middlemen, as the proponents of infomediation argue?

The answers to these questions depend on understanding a new breed of intermediary called metamediaries, who will operate in new kinds of markets called metamarkets. Metamediaries have no parallel in the analog world and have little or no physical presence. They are the "switches" and the "routers" of networked commerce. To appreciate the concept of metamediaries, we must progress through three levels of understanding about the influence of the Internet on exchange transactions. Taken together, they paint a clear picture of the future of intermediation in the network economy.

Communities of commerce
The Internet is revolutionary because it connects firms with firms, firms with customers, and people with people. And it connects them without regard to time, space, and hardware/software platforms. Firms can connect with their trading partners through the Internet at far lower costs and with far more flexibility than proprietary EDI (electronic data interchange) links. General Electric's Trading Process Network allows GE to connect with its suppliers, dramatically reducing the cost and time of purchase transactions, while raising their quality. Ingram Micro, a computer wholesaler, electronically manages the inventory of computer resellers such as CompUSA. Its customers can connect with firms to gather information, evaluate products, configure products, place orders, and get technical support. Dell Computer has become a leader in ecommerce by using the Web to connect with its customers for configuring, ordering, and supporting its products. Cisco Systems handles 90 percent of its software upgrades and 70 percent of its customer support queries over the Internet. Intel claims a run rate of $1 billion per month from ecommerce. People can connect with people to form communities of commerce. These communities may bring buyers together (examples include the GroceryNetwork, Manufacturing Marketplace, OilOnline, and VerticalNet), or bring buyers and sellers together for negotiated-price transactions (examples include FastParts.com, FairMarket, Onsale, eBay, and the Virtual Garment Center).

Improved connectivity dramatically reduces the cost of communication and coordination in exchange transactions. In a networked economy, firms can bypass intermediaries who have traditionally facilitated the flow of information and goods between firms and their customers. This phenomenon, called disintermediation, is beginning to take hold in many industry sectors. Firms such as Travelocity (travel), InsWeb (Insurance), Wells Fargo (retail banking), Charles Schwab (investments), and Amazon.com (book sales) are reaching out directly to their customers, eliminating retailers and other channel intermediaries. Disintermediation threatens a variety of middlemen such as travel agents, stockbrokers, insurance agents, retail banks, bookstores, and automobile retailers. These middlemen will need to find new ways of adding value if they are to continue to be relevant.
Deconstruction: Shift of space, time
If we think deeply about disintermediation, it becomes obvious that for every intermediary that is eliminated, several additional intermediaries are created. Amazon.com sells books directly to customers, but uses Ingram Book as an intermediate supplier, United Parcel Service and DHL Worldwide Express for delivery, and America Online for customer acquisition. Autobytel.com takes purchase requests for automobiles over the Internet, but the orders are fulfilled by traditional dealers. In each of these cases, however, the Internet enables the separation of information (bits) from the physical product (atoms), and the core product from complementary products. Most products consist of a physical component and an information component. When consumers buy cameras, cars, or books, they buy information about the products along with the products. And most complex products are bought along with complementary products and services. Computers require software, cameras require lenses, and cars are sold with a warranty, financing, and accessories.

In the offline world, information typically is bundled with the physical product, and the core product is often sold along with complementary products. Vertically integrated intermediaries provided bundled flows and bundled offerings. For instance, automobile buyers rely on automobile dealers for information, negotiation, financing, parts, warranties, and delivery of automobiles. The bundling of functions and offerings provides one-stop-shop convenience for consumers, who would otherwise have to deal with several product and service providers. But bundling also involves significant compromises, because vertically integrated middlemen are often not the best or lowest-cost providers of specific flows or specific complementary products. Auto dealers, for instance, often use new car sales as a loss leader to sell higher-margin accessories, financing, and extended warranties.

In the Network Economy, the flow of information can be shifted away in both time and space from the physical flows in a distribution channel. Customers can search, evaluate, negotiate, pay for, and take delivery of products at different points in time, and from different providers. Just as the VCR allowed consumers to shift the transmission time of TV programs from the viewing of the programs, the Internet allows customers to shift the time and space of channel flows in exchanges. Hence, integrated intermediaries can be replaced by a combination of specialized marketspace intermediaries who manage information flows (the bits), and a set of specialized marketplace intermediaries who manage physical flows (the atoms). For instance, automobile dealers are coming under attack from specialized providers of automobile information, auto insurance, extended warranties, financing, negotiation services, and used cars. This market deconstruction offers significant advantages to consumers because they can mix and match best-of-breed providers of channel flows, instead of being forced to buy a bundle of channel flows from vertically integrated middlemen. But deconstruction flies in the face of the economics of attention. The separation of flows and the proliferation of middlemen place unreasonable demands on a customer's time. Instead of dealing with one middleman, consumers now must deal with a whole host of specialized intermediaries. They must search, evaluate, and assemble information from a variety of providers. And they must perform this search process on the Internet, where information is poorly organized and of uncertain quality. So, while consumers gain by finding lower-cost and specialized service providers on the Internet, they lose in terms of higher search and evaluation costs. Higher search costs translate into higher marketing and customer acquisition costs for service providers. Deconstruction is an incomplete view of intermediation, because it makes customers' lives less efficient.

A new breed
To achieve the promise of frictionless commerce, deconstructed channel flows and offerings must be reassembled in ways that reduce the search and evaluation costs for customers. A new breed of intermediate institutions is emerging to inform and advise customers, and to simplify their dealings with product and service providers. These metamediaries dramatically improve the efficiency and effectiveness of transactions in the Networked Economy. Metamediaries also redraw the boundaries of markets by creating metamarkets, which have no parallel in the physical world.

The concept of metamarkets stems from a simple, yet profound insight: Customers think about products and markets very differently from the way products and markets are bundled and sold in the physical marketplace. Customers think in terms of activities, while firms think in terms of products. Activities that are logically related in cognitive space may be spread across very diverse providers in the marketplace. ("The Automobile Metamarket" (left) illustrates this gap between the cognitive space and the marketplace in the context of the automobile metamarket.) Metamarkets, then, are clusters of cognitively related activities that customers engage in to satisfy a distinct set of needs. They are markets in the minds of customers. Their boundaries are derived from activities that are closely related in the minds of customers, and not from the fact that they are created or marketed by related firms in related industries.

Consider the activities associated with home ownership. From an activity perspective, customers view home buying, home financing, home maintenance, home repair, and home improvement all to be logically related. This activity cluster can be viewed as the "home ownership metamarket." In the marketplace, however, homeowners must deal with real estate agents, banks, mortgage firms, newspapers, plumbers, electricians, lawn care services, maid services, home improvement stores, home remodeling contractors, architects, and interior designers to perform this set of activities, and to satisfy this set of related needs. In doing so, customers must search, evaluate, and negotiate with a large number of service and product providers.
Looking for metamarkets
In business-to-consumer markets, metamarkets can be constructed around major life events and major assets. Life events that can be used to construct metamarkets include weddings, childbirth, education, career changes, and retirement. Also providing fertile ground for metamarkets are home ownership, automobile ownership, and financial assets.

The conditions essential for constructing a viable metamarket include:

A broad set of cognitively related activities. These activities should be important in terms of customer time and economic impact.
To perform these activities, customers should need to deal with a diverse set of product and service providers spanning a number of industries.
Significant "mind share" in terms of consumer time and money.

Enter the metamediary
Once we have understood the concept of metamarkets, it becomes easy to understand what metamediaries do. Metamediaries are neutral third parties that operate in the marketspace to realign the marketplace with cognitive space. Metamediaries make metamarkets possible by assembling the products and services in a metamarket into a seamless, integrated bundle. They serve as a single point of contact between buyers and sellers in a metamarket, and greatly improve the efficiency and effectiveness of exchanges. At their heart, metamediaries are providers of trusted advice and information that customers need to make better decisions for a cluster of activities. Unlike channel intermediaries, metamediaries do not represent the providers of products and services. They facilitate exchanges, but do not participate in the actual exchange transactions. They do not make money by advertising, subscription, or transaction fees. They recapture value by collecting a referral fee from partners for every connection they make between a customer and a product/service provider.

Finally, metamediaries are not product-centric aggregators like InsWeb (for insurance providers), Quicken.com (for financial services), or Autobytel (for automobile dealers). They are activity-centric aggregators. For instance, InsWeb might aggregate home, life, and automobile insurance. But customers might think about home insurance as part of the home metamarket, life insurance as part of the wedding or parenting metamarket, and auto insurance as part of the automobile metamarket. How much friction can a metamediary eliminate? According to the National Automobile Dealers Association, new cars sold for an average of $23,600 in 1998. Industry analysts say that 30 percent of this sum, or $7,080, was spent in distribution. About 15.6 million new cars were sold last year - that's $110 billion of friction! Of course, a significant proportion of these distribution expenditures are essential, but a 10 percent reduction in the nonproduction expenses for new cars alone would create $11 billion of value. And a metamediary that captured just 1 percent of this value created would be a $110 million business! Add used cars, spares, insurance, financing, repair, servicing, and the total value creation potential becomes astounding.

A good example of a metamediary in the automobile market is Edmund's, which has created a valuable data franchise by giving away information about new and used auto pricing, dealer cost and holdbacks, reliability, auto-buying advice, and auto reviews. Edmund's generates tremendous traffic on its site, which has been ranked as one of the most heavily trafficked as well as one of the most usable Websites. Over time, Edmund's has channeled this traffic to a number of specialized partners that provide specific channel flows:

Autobytel for negotiation and dealer search
CarFinance.com for financing
Price Auto Outlet for off-lease used cars
JC Whitney for auto spare parts
Geico for insurance
Warranty Gold for extended warranties

Customers can now visit the Edmund's site to gather information, negotiate, evaluate, finance, purchase, insure, and buy spare parts from a single place. Isn't this one-stop shopping? Yes, it is, but from the customer's activity perspective, not the producer's product perspective. That is why I do not consider producer-centric aggregators such as Intuit to be metamediaries. Metamediaries such as Edmund's allow channel flows to be disaggregated, distributed across a number of specialized providers in the marketplace as well as in the marketspace, and reassembled seamlessly and frictionlessly as an integrated offering. Notice that these steps involve aspects of disintermediation as well as reintermediation. But this happens at the functional level, not at the aggregate product level. Note that metamediaries need to make no money from subscriptions, no money from advertising, and no money from transactions. They create and capture value by facilitating exchanges between customers and suppliers. Where are metamediaries most likely to emerge? Fertile hunting ground includes product categories that:

are big-ticket items that require complex decision-making;
have a high information content;
require customers to collect information from a variety of fragmented sources;
consist of a large number of complementary products and services;
are characterized by inefficient retailer channels and an unpleasant retail buying experience.

But don't customers still need to kick the tires? Indeed, not all of the channel flows can be informationalized and performed in cyberspace. Automobile customers will still need to test drive vehicles and get their automobiles serviced. But these reduced number of flows no longer require the full-service dealerships, complete with potted plants and overpaid salespeople. This will spur the creation of another set of specialized providers in the marketplace, such as dedicated test-drive outlets, and multibrand repair outlets. Existing full-service retailers will need to adapt by stripping out channel functions that are better performed in the marketspace (such as financing and insurance), and will need to compete with specialized marketplace providers on a narrower set of marketplace functions. So disintermediation will indeed occur, but will be accompanied by the creation of a large number of specialized providers both in the marketplace and in the marketspace. And all of this will be enabled by metamediaries. Metamediaries represent the death of friction, and the birth of frictionless commerce.

Mohanbir Sawhney ([email-masked]) [http://www.business2.com/content/magazine/indepth/2000/03/01/www.mohansawhney.com] is the McCormick Tribune Professor of Electronic Commerce & Technology at the Kellogg Graduate School of Management. He is a contributing editor and a member of the advisory board for Business 2.0.

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