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MANAGING THE DIGITAL
ENTERPRISE

PROFESSOR MICHAEL
RAPPA

BUSINESS MODELS ON THE
WEB

Business models are perhaps the most
discussed and least understood aspect of the web. There is so much talk about
how the web changes traditional business models. But there is little clear-cut
evidence of exactly what this means.

In the most basic sense, a business model is the
method of doing business by which a company can sustain itself -- that is,
generate revenue. The business model spells-out how a company makes money by
specifying where it is positioned in the value chain.

Some models are quite simple. A company
produces a good or service and sells it to customers. If all goes well, the
revenues from sales exceed the cost of operation and the company realizes a
profit. Other models can be more intricately woven. Radio and television
broadcasting is a good example. With all the talk about "free" business models
on the web, it is easy to forget that radio, and later television, programming
has been broadcast over the airwaves free to anyone with a receiver for much of
the past century. The broadcaster is part of a complex network of distributors,
content creators, advertisers (and their agencies), and listeners or viewers.
Who makes money and how much is not always clear at the outset. The bottom line
depends on many competing factors.

E-commerce will give rise to new kinds of
business models. That much is certain. But the web is also likely to reinvent
tried-and-true models. Auctions are a perfect example. One of the oldest
business models, auctions have been widely used throughout the world to set
prices for such items as agricultural commodities, financial instruments, and
unique items like fine art and antiquities. Companies like eBay have
popularized the auction model and broadened its application on the web to a wide
array of goods and services (we will have more to say about auctions in the next
section of the course).

Reading the literature you will find
business models categorized in different ways. Presently, there is no single,
comprehensive and cogent taxonomy of web business models one can point to. So I
am offering my own take on some of the generic forms of business models
observable on the web. They include:

Brokerage

Advertising

Infomediary

Merchant

Manufacturer

Affiliate

Community

Subscription

Utility

These models are implemented in a variety of
ways. Moreover, any given firm may combine different models as part of its web
business strategy. Thus, an advertising model may be blended with a subscription
model to yield an overall strategy that is profitable. The taxonomy I propose is
not meant to be exhaustive or definitive. Business models on the web evolve
rapidly. New and interesting variations can be expected in the
future.

One last point that is critical to remember: the
term "business model" has taken on new meaning and greater importance in the
last few years in the realm of intellectual property
protection. Within the legal community, business models are defined within the
context of patent law. Recently a number of patents have been granted for
business models (see Patent
Protection for E-Commerce Business Models). While the definition of "new and
novel" may be specified precisely to determine what is patentable, what counts
as a business model is less clear. In many cases, patented web
business models will need to withstand court challenges before we can say
for certain.

Type of Model:

Description:

Brokerage
Model

Brokers are market-makers: they
bring buyers and sellers together and facilitate transactions. Those
can be business-to-business (B2B), business-to-consumer (B2C), or
consumer-to-consumer (C2C) markets. A broker makes its money by
charging a fee for each transaction it enables. Brokerage models can
take a number of forms, such as:

Buy/Sell
Fulfillment
-- This can be an online financial brokerage, like eTrade,
where customers place buy and sell orders for transacting financial
instruments. Also, travel agents fit into this category. In this the
broker charges the buyer and/or seller a transaction fee. Some
models work on volume and low overhead to deliver the best
negotiated prices, for example, CarsDirect.

Market
Exchange --
increasingly common model in B2B markets. Good examples are MetalSite
or ChemConnect's
World Chemical
Exchange. In the exchange model, the broker typically charges
the seller a transaction fee based on the value of the sale. The
pricing mechanism can be a simple offer/buy, offer/negotiated buy,
or an auction offer/bid approach.

Business Trading
Community
-- or "vertical web community," a concept pioneered by VerticalNet.
It is as a site that acts as an "essential, comprehensive source of
information and dialogue for a particular vertical market."
VerticalNet's communities contain product information in buyers'
guides, supplier and product directories, daily industry news and
articles, job listings and classifieds. In addition, VerticalNet's
sites enable B2B exchanges of information, supplementing existing
trade shows and trade association activities. [see also: Buzzsaw.com]

Buyer
Aggregator -- Model pioneered by Accompany,
which describes buyer aggregation as the process of bringing
together individual purchasers from across the Internet to transact
as a group so they can receive the same values traditionally
afforded to organizations who purchase in volume. Sellers pay a
small percentage of each sale on a per-transaction basis. [see also:
Mobshop,
Volumebuy,
Etrana]

Distributor -- A catalog-type operation that
connects a large number of product manufacturers with volume and
retail buyers. B2B models are increasingly common. Broker
facilitates business transactions between franchised distributors
and their trading partners. For buyers, it enables faster time to
market and time to volume as well as reducing the cost of
procurement. By providing the buyer with a means of retrieving
quotes from preferred distributors -- showing buyer-specific prices,
lead-time, and recommended substitutions -- transaction are more
efficient. For distributors, it decreases the cost of sales by
performing quoting, order processing, tracking order status, and
changes more quickly and with less labor. [ex: NECX]

Virtual
Mall -- A site that hosts many online merchants. The Mall
typically charges setup, monthly listing, and/or per transaction
fees [see, for example Yahoo!
Store's terms. The virtual mall model may be most effectively
realized when combined with a generalized portal. Also, more
sophisticated malls will provide automated transaction services and
relationship marketing opportunities [ex: Yahoo!
Stores, ChoiceMall,
iMall,
Women.com's Shopping
Network]

Metamediary -- a business that brings buyers
and online merchants together and provides transaction services such
as financial settlement and quality assurance. It is a virtual mall,
but one that will process the transaction, track orders, and provide
billing and collection services. The metamediary protects consumers
by assuring satisfaction with merchants. The metamediary charges a
setup fee and a fee per transaction. Expect to see virtual malls
move more in this direction. [ex: HotDispatch,
Amazon 's zShops].

Auction
Broker -- A
site that conducts auctions for sellers (individuals or merchants).
Broker charges the seller a fee, which is typically scaled with the
value of the transaction. Seller takes highest bid(s) from buyers
above a minimum. Auctions can vary in terms of the offering and
bidding rules. [ex: eBay,
AuctionNet,
Onsale]

Reverse
Auction -- The "name-your-price" business model, also called
"demand collection" and "shopping by request". Prospective buyer
makes a final (sometimes binding) bid for a specified good or
service, and the broker seeks fulfillment. In some models, the
broker's fee is the spread between the bid and fulfillment price and
perhaps a processing charge. Frequently aimed at high-priced items
like automobiles or airline tickets. [ex: Priceline,
Respond.com,
eWanted,
MyGeek.com]

Classifieds -- A listing of items for sale
or wanted for purchase, typically run by local news content
providers. Price may or may not be specified. Listing charges are
incurred regardless of whether a transaction occurs.

Search
Agent -- An agent (i.e., an intelligent software agent or
"robot") used to search-out the best price for a good or service
specified by the buyer, or to locate hard to find information. [DealTime,
MySimon,
RoboShopper,
R
U Sure, ShopFind]
An employment agency can act as a search agent broker, finding work
for job-seekers or finding people to fill open positions listed by
an employer. [CareerCentral]

Advertising
Model

The web advertising model is an
extension of the traditional media broadcasting model. The
broadcaster, in this case, a web site, provides content (usually,
but not necessarily, for free) and services (like e-mail, chat,
forums) mixed with advertising messages in the form of banner ads.
The banner ads may be the major or sole source of revenue for the
broadcaster. The broadcaster may be a content creator or a
distributor of content created elsewhere. The advertising model only
works when the volume of viewer traffic is large or highly
specialized.

Generalized
Portal --
high-volume traffic -- typically tens of millions of visits per
month (see chart at right) -- driven by generic or diversified
content or services (ex: search engines and directories like Excite,
AltaVista
and Yahoo!
or content driven sites like AOL).
The high volume makes advertising profitable and permits further
diversification of site services. Competition for volume has led to
the packaging of free content and services, such as e-mail, stock
portfolio, message boards, chat, news, and local
information.

Personalized
Portal --
The generic nature of a generalized portal undermines user loyalty.
This has led to the creation of portals (ex: My.Yahoo!,
My.Netscape)
that allow customization of the interface and content. This
increases loyalty through the user's own time investment in
personalizing the site. The profitability of this portal in based on
volume and possibly the value of information derived from user
choices. Personalization can support a "specialized portal"
model.

Specialized
Portal --
Also called a "vortal" (i.e., vertical portal). Here volume
is less important than a well-defined user base (perhaps 0.5-5
million visits per month). For example, a site that attracts only
golfers, or home buyers, or new parents, can be highly sought after
as a venue for certain advertisers who are willing to pay a premium
to reach that particular audience. Prediction: expect to see a
proliferation of specialized portals in the near future.

Attention /
Incentive Marketing -- the "pay for attention" model -- pays visitors for
viewing content and completing forms, or sweepstakes, or frequent
flyer-type point schemes. The attention marketing approach has the
most appeal to companies with very complex product messages, which
might otherwise find it hard to sustain customer interest. The
concept was pioneered by CyberGold,
with its "earn and spend community" that brings together advertisers
interested in incentives-based marketing with consumers looking to
save. To facilitate transactions, the company developed and patented
a micropayment system. Other loyalty-based relationship marketing
approaches are Netcentives,
or MyPoints.

Free
Model --
Give users something for free: site hosting [ex: FreeMerchant],
web services, Internet access, free hardware, electronic greeting
cards [BlueMountain].
Freebies create a high volume site for advertising opportunities.
Viability is hardest when based purely on advertising revenue.
Opportunity to blend with infomediary model.

Bargain
Discounter
-- the most notable example is Buy.com,
which sells its goods typically at or below cost, and seeks to make
a profit largely through advertising.

Infomediary
Model

Data about consumers and their
buying habits are extremely valuable. Especially when that
information is carefully analyzed and used to target marketing
campaigns. Some firms are able to function as infomediaries by
collecting and selling information to other businesses. An
infomediary may offer users free Internet access [NetZero]
or free hardware [eMachines.com]
in exchange for detailed information about their surfing and
purchasing habits. This is more likely to succeed than the pure
advertising model.

The infomediary model
can also work in the other direction: providing consumers with
useful information about the web sites in a market segment that
compete for their dollar. One such example is Gomez.

Recommender
System --
is a site that allows users to exchange information with each other
about the quality of products and services -- or the sellers with
whom they have had a purchase experience (good or bad) [See: Deja.com,
ePinions].
ClickTheButton
takes the concept a step further by integrating the recommender
system into the web browser. Such agents monitor a user's habits,
thereby increasing the relevance of its recommendations to the users
needs -- and the value of the data to the collector. Recommender
systems can take advantage of the affiliate model offered by
merchants to augment revenue from the sale of consumer
information.

Registration
Model --
Content-based sites that are free to view but require users simply
to register (other information may or may not be collected).
Registration allows inter-session tracking of users' site usage
patterns and thereby generates data of greater potential value in
targeted advertising campaigns. This is the most basic form of
infomediary model. [ex: NYTimes.com]

return
to top

Merchant
Model

Classic wholesalers and
retailers of goods and services (increasingly referred to as
"e-tailers"). Sales may be made based on list prices or through
auction. In some cases, the goods and services may be unique to the
web and not have a traditional "brick-and-mortar" storefront.

Virtual
Merchant --
a business that operates only over the web and offers either
traditional or web-specific goods or services (a.k.a., pure-play
e-tailers). The method of selling may be list price or auction. An
example of a service merchant is Facetime,
which calls itself an "application service provider". It offers live
customer support for e-commerce web sites. [ex: Amazon,
eToys,
OnSale]

Catalog
Merchant --
the migration of mail-order to a web-based order business. [ex: Levenger]

Surf-and-Turf -- traditional brick-and-mortar
establishment with web storefront. The model has the potential for
channel conflict. [ex: Gap,
Lands
End, B&N]

Bit
Vendor -- a
merchant that deals strictly in digital products and services and,
in its purest form, conducts both sales and distribution over the
web. [ex: Eyewire]

Manufacturer
Model

This model is predicated on the
power of the web to allow manufacturers to reach buyers directly and
thereby compress the distribution channel (i.e., eliminate
wholesalers and retailers). The manufacturer model can be based on
efficiency (cost-savings that may or may not be passed on to
consumers), improved customer service, and a better understanding of
customer preferences. Perishable products that benefit from fast
distribution, like fresh flowers [ex: Flowerbud],
may prove advantageous by eliminating middlemen. The model has the
potential for channel conflict with a manufacturer's established
supply chain. [ex: Intel,
Apple]

Affiliate
Model

In contrast to the generalized
portal, which seeks to drive a high volume of traffic to one site,
the affiliate model, provides purchase opportunities wherever people
may be surfing. It does this by offering financial incentives (in
the form of a percentage of revenue) to affiliated partner sites.
The affiliates provide purchase-point click-through to the merchant.
It is a pay-for-performance model -- if an affiliate does not
generate sales, it represents no cost to the merchant. The affiliate
model is inherently well-suited to the web, which explains its
popularity. Variations include, banner exchange, pay-per-click, and
revenue sharing programs. Potential problems loom ahead that may
inhibit the diffusion of the affiliate model due to the granting of
a broad patent to Amazon.com. [ex: BeFree,
and while there, read about
affiliate marketing; also see i-revenue.net,
a guide to affiliate programs on the web, or AffiliateWorld.]

Community
Model

The viability of the community
model is based on user loyalty (as opposed to high traffic volume).
Users have a high investment in both time and emotion in the site.
In some cases, users are regular contributors of content and/or
money. Having users who visit continually offers advertising,
infomediary or specialized portal opportunities. The community model
may also run on a subscription fee for premium services.

Voluntary
Contributor Model -- similar to the traditional public broadcasting model --
the listener or viewer contributor method used in not-for-profit
radio and television broadcasting. The model is predicated on the
creation of a community of users who support the site through
voluntary donations. Not-for-profit organizations may also seek
funding from charitable foundations and corporate sponsors that
support the organization's mission. The web holds great potential as
a contributor based model because the user base is more readily
apparent. [Ex: National
Public Radio]

Knowledge
Networks --
or expert sites, that provide a source of information based on
professional expertise or the experience of other users. Sites are
typically run like a forum where persons seeking information can
pose questions and receive answers from (presumably) someone
knowledgeable about the subject. The experts may be employed staff,
a regular cadre of volunteers, or in some cases, simply anyone on
the web who wishes to respond. [Deja,
ExpertCentral,
KnowPost,
Xpertsite,
Abuzz]
Also fee-based model [Ex: Guru,
Exp]

Subscription
Model

Users pay for access to the
site. High value-added content is essential [ex: Wall St.
Journal,
Consumer Reports]. Generic news content, viable on the newsstand, has proven
less successful as a subscription model on the web [ex: Slate].
A 1999 survey by Jupiter Communications found that 46 percent of
Internet users would not pay to view content on the web. Some
businesses have combined free content (to drive volume and ad
revenue) with premium content or services for subscribers
only.

Utility
Model

The utility model is a metered
usage or pay as you go approach. Its success may depend on the
ability to charge by the byte, including micropayments (that is,
those too small to pay by credit card due to processing fees). [ex:
FatBrain,
SoftLock,
Authentica]

Learning
Objectives:

Define a business
model;

Determine the nine
major kinds of business models and how they work;

Examine the numerous
variations in each of the nine models observed on the web;

Look at some
examples of models used in practice.

Question to
ponder:

Discuss how conventional business
models are changed by the web...in the Forum.

Things to read:

Product
or Service? The
Internet Infrastructure's Battling Business Models
Lawrence M.
Fisher
PDF
| 192K

The
Truth about Internet Business Models
Jeffrey F. Rayport, Harvard
University
PDF
| 60K

Let's Get Vertical
Mohanbir Sawhney and Steven Kaplan

Barriers
to Electronic Commerce
CommerceNet

In the news:

The
New York Times: Five Years on the Web
Interview with the Editors | Jan.
20, 2001

As
Boldest E-Commerce Ventures Fall, Modest Dreamers Fly On
Saul Hansell |
Dec. 13, 2000

Will
GM's Internet direct-sales model catch on?
Rachel Konrad | Dec. 05,
2000

This
Web Site Rocks! (It's Turning a Profit.)
Susan Stellin | Dec. 03,
2000

Content
in Search of Profits
Jennifer Greenstein | Dec. 01, 2000

E-Tailers
Fine-Tune Affiliate Sales
Bob Tedeschi | Nov. 06, 2000

Internet
Companies Learn How to Personalize Service
Susan Stellin | Aug. 28,
2000

Internet
Changes the Economics of Information Industries
Hal Varian | Jul. 27,
2000

On the airwaves:

__/ 01-04-00 Web
Advertisers Rethink Strategy
Nancy Marshall, National Public Radio |
01.04.01

Online
Classified Ads Spell Trouble for Newspapers
Jim Zarroli, National
Public Radio | 01.01.01

Data sources:

Top-50
Rankings of Unique
Visitors
MediaMetrix

Top
Monthly Web
Sites
PC
Data Online

Top
Monthly Web
Properties
PC
Data Online

Daily
Buying Meter
PC Data Online

Ground
Zero 25
NetMarketMakers

Web
Advertising Data
AdRelevance Intelligence Center

Hungry
minds:

Models
made "e"
Pete Martinez, IBM Global Services
PDF
| 397K

B2B E-Commerce Hubs
Steven Kaplan and Mohanbir Sawhney
PDF
| 60K

The Economics of
Surfing
Eytan Adar and Bernardo
Huberman, Xerox PARC
PDF |
72K

Intermediaries and
Cybermediaries
Mitra
Sarkar, et al., Michigan State Univ.

Making New Markets
Mohanbir Sawhney, Northwestern
Univ.

Business
Models for Electronic Markets
Paul Timmers
PDF
| 116K

A Taxonomy of Internet
Commerce
Paul
Bambury

Patent Protection for E-Commerce Business
Models
and
Internet
Business Model Patents
Jones & Askew, LLP

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topic:

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Markets

© 2001 Michael Rappa