DisinteREmediation: Longer, Not Shorter, Value Chains Are Coming

From 1998 Ten-Year Forecast

Beware of conventional wisdom, for it is nearly always wrong.

Barely five years ago, the notion of commerce over the Internet was anathema. Later, Internet commerce became the hottest thing in cyberspace. Once Net-commerce became real, conventional wisdom held that the Internet would spell the death of advertising.

In fact, the Internet has turned out to be a huge new advertising frontier. (For more on the Net and advertising, see the article “Advertising Adapts to the Digital Age.”)

Now a much more dangerous bit of conventional wisdom is on the loose. It is the notion that information technologies will bring about disintermediation (1)‹that is, networks and information systems will allow buyer and seller to interact directly, thereby eliminating intermediaries and radically shortening value chains.

There’s only one problem with this theory. It’s directly at odds with what is actually happening. Rather than eliminate intermediaries, information systems do quite the opposite. Information systems are powerful commercial tools because they lower transaction costs. Lower transaction costs enable new kinds of transactions, which lead to new market niches and, overall, make the market environment more complex. In short, information systems create openings for new intermediaries to discover and occupy.

Meanwhile, old intermediaries are disappearing, but that is only part of the picture. What seems to be disintermediation is really a mirage, one static piece of a larger process in which the introduction of new information systems perturbs market environments, creating slots for new intermediaries whose presence threatens older established intermediaries who either disappear or adapt to new market realities. What looks like disintermediation is but one frame of a larger dynamic of “disinteremediation.”

What Is DisinteREmediation?

Disinteremediation is not new. It isn’t even always a consequence of digital technologies. Even before the advent of computers, information innovations triggered disinteremediary processes. For example, the advent of movable type and subsequent invention of the printing press set loose disinteremediary forces in the hill towns of Northern Italy, where the advent of the printing press led to a quickening and complexification of commercial life. By the early 1500s, this transformation led to the birth of modern mercantile capitalism complete with a host of utterly novel financial instruments, and novel terms to describe them, terms that form the basis of commercial language today. (2)

The Airline Industry: DisinteREmediation in Action

More recent instances of disinteremediation illustrate the forces afoot in our brave new commercial cyberspace. Consider the recent history of the airline reservation business. In the late 1950s, if you wanted a plane ticket, chances are you went directly to the airline to make your purchase (Figure 1). In theory, travel agents could help you, but working through them was slower and more uncertain.

Figure 1. Traditional Plane Ticket Purchasing Chain

Phase I: SABRE

Meanwhile, the airlines had a serious problem. Their business was growing more quickly than their primitive in-house reservations systems could handle. They were desperate for anything that might automate the reservation process and thus increase the efficiency of scarce reservation-taking employees. As it happened, in 1953 the President of American Airlines was sitting next to an IBM executive on a flight across the country. (3) He mentioned his company’s unique problem, and the IBM executive suggested they create an automated reservation system. IBM had just finished the SAGE (Semi-Automatic Ground Environment) system for detecting enemy bombers over North America; he figured that solving American’s problem would be a snap by comparison.

It wasn’t. After nearly a decade of effort, by 1962 IBM had built SABRE,4 a time-shared system that allowed American’s ticket agents to automate the reservation process. The problem was that by the time SABRE was a reality, merely automating American’s system was not enough to meet burgeoning traveler demands. So American eventually took a radical step, offering the SABRE system for use by outside travel agents in off-peak hours.

This step firmly brought travel agents into the airline reservation process. American enjoyed early competitive advantage over other airlines, as the information quality and convenience of SABRE caused agents to direct a disproportionate share of travelers onto American flights. But this advantage came at a price, for travelers quickly learned to turn to local agents and not American for tickets.

Worse, American’s competitors took note of the advantage of SABRE. Little matter that they had declined participation in SABRE when American approached them in the early stages of its development. Now that it was a success, some wanted in, while others elected to build competing reservation systems. And they prevailed upon the U.S. Department of Justice to open SABRE up to them, and open up the travel agent desks to competing systems. Suddenly, what had been a unique source of competitive advantage for American became a mere commodity shared by all the airlines.

And therein lies a pattern. A new information technology arrives on the business horizon. Innovative players get in early and use the new technology for unique competitive advantage that affords them a brief period in which they can charge a premium for their products or enjoy disproportionate profits. But soon — too soon — competitors emulate their strategy, and what was once a unique feature becomes a mere commodity shared by everyone. When SABRE linked agents only to American flights, American benefited uniquely. But when SABRE and copycat systems allowed agents to surf prices and schedules of multiple airlines, American lost its unique edge.

The playing field was leveled, but the destabilizing technology did not go away. It stuck around, making the playing field more complex than ever. And in the case of SABRE, it produced a playing field with a new intermediary — the travel agents — who by virtue of owning the SABRE terminals, were now calling the competitive shots. The net consequence of American’s SABRE innovation was to distance the airline from air travelers by firmly intermediating travel agents in the travel value chain (Figure 2).

Figure 2. Phase I: SABRE: Beginning Disinteremediation

Phase II: AAdvantage

But the disinteremediation of the reservation process did not stop there, for American’s executives promptly began looking for a new competitive advantage. Advances in information technology worked in their favor, lowering the cost of computing cycles to a point where they could do something previously unthinkable — track the travel miles and habits of frequent flyers. Thus was born “AAdvantage,” the first frequent flyer program, brainchild of an American executive eager to find ways to capture the hearts and minds of travelers now firmly in thrall of third-party travel agents. The AAdvantage program caught on like wildfire, with the desired effect: Mileage-conscious travelers were instructing their agents to book them on American flights regardless of what prices the competition might be offering (Figure 3).

Figure 3. Phase II: Rewards Programs Increase Disinteremediation

But the competitive landscape is not solid ground. Rather, it is an undulating landscape on which the competition wasted no time in copying American’s frequent flyer program. (5)

But the playing field wasn’t the same as before. For starters, the thing being sold — airline tickets — had become subtly but profoundly different. Back in more innocent times, travelers based their airline choices on very simple criteria — who would get them to their destination fastest, for the least cost. With the advent of frequent flyer programs, a subtle secondary metric crept in. Perhaps a stopover was not all that terrible an inconvenience, provided that it added extra miles to the traveler’s account. What was once a clearly defined product started down a slippery slope to becoming an unpredictable abstraction.

Phase III: “Tied” Credit Cards

Meanwhile, American’s executives once again looked for something to differentiate their new-commodity offerings. One executive had a bright idea: Create a link with a major credit card company to offer a card tied to American’s frequent flyer program. Thus armed, travelers were able to gain miles without ever leaving the ground, simply by concentrating their purchases on the AAdvantage card. And the more miles added, the more likely travelers once again would become happy captives of the American system, instructing their agents to book them exclusively on American’s flights.

There is an interesting footnote here. American first asked American Express to be its credit card partner. AmEx declined, explaining that their brand was the most valuable thing they owned, and that they could not possibly share it. So American went to MasterCard, which happily co-branded with the airline. MasterCard thus enjoyed enormous lift from the link, while stodgy AmEx was left on the ground, a bystander as “tied” cards took off.

Once again, American enjoyed an early competitive advantage, but its competitors — and MasterCard’s — quickly caught up. What was once a unique offering became a commodity offered by everyone on a yet more complex competitive terrain (Figure 4). And what was once a clearly defined product became a yet-more-metaphysical offering. At the extreme, travelers were tempted into buying products they didn’t really need in order to generate frequent flyer miles to be applied to destinations they really didn’t want to visit.

Figure 4. Phase III: Credit Cards Intensify Disinteremediation

And of course, the competition didn’t stop with credit cards, for this is an endless process of competitive infinite regression on an undulating competitive landscape. As it happens, American Airlines has been obsessed not only with its competition, but also with disinteremediating the travel agents it brought into the process in the first place several decades ago. Along with other airlines, it has sought to use Web pages as a means of drawing its customers ever closer into the American orbit. And of course, all the airlines have sought ways to cut out the pesky travel agents, from offering special “travel cards” — charge cards that can be used only with the airline directly — to more overt efforts to cut the commissions of travel agents, now under scrutiny by the courts and the Justice Department.

The Lesson of DisinteREmediation

The lesson of three decades of computer-enabled innovations in airline reservation systems is that information systems create new niches, and the first players to exploit these niches are likely to be the winners in the new order to follow. Even if the new order is transitory, the transitory advantages to being the innovator are vastly better than those of being the laggard.

And now the innovative center of gravity has shifted from simple computer systems to the Internet in general, and the World Wide Web in particular. Amidst all the changes are a few constants. One is what happens when you lower transaction costs — you have more intermediaries than ever, not fewer. We are seeing new intermediaries springing up all over the Net. A particularly good example is the bookseller Amazon.com, which emerged out of nowhere to exploit a new electronic niche which has allowed it to directly threaten traditional booksellers like B. Dalton, which is now struggling to launch a Net offering of its own. A key to Amazon’s strategy is leveraging the new efficiencies of the Net-based environment to keep its costs far below that of a traditional bookseller.

A second example of lowered costs leading to new complexification is that of “microcash,” a hot new concept on the Net whose essence is that in cyberspace, one is able to conduct transactions involving a fraction of the amounts required to conduct transactions in the physical world. This new capability to conduct micro-transactions will be exploited by a host of new players offering countless new products.

Disinteremediation’s bottom line is quite simple, namely that computers and information systems make the commercial environment more complex, creating new niches for new kinds of intermediaries who recognize opportunities that did not previously exist. In other words, following each information innovation, we will have more intermediaries, not fewer, BUT these may not be the same old intermediaries, for new players will first occupy niches overlooked by old. And if the old aren’t careful and adaptive, they will be first displaced and eventually replaced by new innovators.

Implications

Disinteremediation generates a host of implications. Here are a few from a longer list to consider:

• From value chain to value web. The notion of a value chain is as much an optical illusion as the notion of disintermediation. One doesn’t have a single-transaction relationship with a seller, but rather, the relationship arises out of multiple interactions. And these quickly evolve into a web of interactions, not a chain. Some interactions are immediate and direct, while others are highly indirect, transmitted through intermediaries serving the interests of both buyer and seller.
• Get closer to the customer at your peril. If one views transactions as a static process, value chains are, in single transactions, getting shorter. But if viewed as part of an overall relationship between buyer and seller, they are getting longer than ever. Indeed, they are becoming value webs, as explained in the previous bullet. The trick in a world of disinteremediation is not to blindly get closer to the customer, but to get farther from the customer in the right way by interposing intermediaries who can effectively deliver your message in ways you can’t accomplish directly. The world in which disin-teremediation operates is a world not unlike the old board game of Chutes and Ladders, in which you are willing to head in the opposite direction of your goal in order to get to the top of a chute that will drop you off exactly where you want to be. The essence is not blind efficiency, but effectiveness in accomplishing the ultimate goal.
• Net pricing is weird. A world of disinteremediation is a world full of surprises. For example, net pricing is truly weird. Classical economics suggests that a single item bought on a per-item basis will be more expensive than the single item bought in a batch. But next time you’re on an airline flight, look around and consider who paid what for their ticket. Chances are that the grandmother who flies once a year paid less than the business traveler who flies over 100,000 miles per year. The lesson is that there is a premium on occasional but utterly reliable users who must use the product in some form or other. And the more you use something — the more you must use it — the greater the premium may become. Net pricing isn’t weird; it is utterly logical, but only in cyberspace.
• Advantage goes to small players. The lesson of the last several decades is that systems scale up badly. That is, they deliver useful benefits to small players first, and larger players later. Consider the PC: It delivered clear benefits to individual players almost the moment it was introduced. But benefits to teams didn’t emerge until the desktop revolution of the mid-80s. And the benefit of PCs to enterprises was elusive until the early 1990s. This has profound implications, for it means that when new information technologies are introduced, the playing field is not level. Advantage adheres not to large players, but to small. All things being equal, you are at an advantage if you are small, novel, and flexible. All other factors being equal, larger players will have a much harder time using new information tools in innovative ways.

Sharing: A Competitive Strategy?

Disinteremediation creates an interesting market situation that on the face of it seems counterintuitive — in the longer run, companies can do better by sharing their competitive advantage. Compare the fortunes of Apple and Microsoft. Both had a unique crown jewel — their operating systems. But Apple kept its crown jewel locked up in its hardware, while Microsoft happily rented its crown jewel to third-party manufacturers to bundle in their operating systems. At first, Microsoft’s crown jewel was vastly inferior to Apple’s, but by virtue of its cooperative strategy, Microsoft ended up the long-term winner. The lesson? Don’t lock up your assets in a castle.