Disintermediation and Reintermediation by E-business

By David Steele, December 2009


Abstract/Summary

Disintermediation or ‘cutting out the middle man’ as it is also known is, at first glance, an attractive concept for manufacturers with its cost-saving incentives. Competitive advantage can potentially be achieved by cutting the payments made to intermediaries, not to mention the valuable information that can be collected through direct contact with customers. However, after a more detailed study of the critical issues involved such as market conditions, core competencies and the value added to products by intermediaries, it is clear that some significant barriers to the success of disintermediation exist in many industries. This report concludes that complete disintermediation is not something that can be expected in the near future. Rather, since e-business is changing the ways in which consumers search for and buy products and often intermediaries are in the best position to provide the desired services, it is possible that the introduction of more intermediaries (reintermediation) would be more beneficial to manufacturers at this time, freeing them to concentrate on their core competencies. However, firms will have to carefully evaluate the suitability of their particular industry for either business model.

Introduction

In his book ‘E-business and e-commerce management’ (2009), Dave Chaffey defines ‘Electronic business (e-business)’ as “All electronically mediated information exchanges, both within an organisation and with external stakeholders supporting the range of business processes”. Chaffey (2009) defines Disintermediation as “The removal of intermediaries such as distributors or brokers that formerly linked a company to its customers” and Reintermediation as “The creation of new intermediaries between customers and suppliers providing services such as supplier search and product evaluation”. Despite early predictions that the use of the internet by manufacturers to sell directly to consumers would result in high levels of disintermediation (Agrawal et al, 2006; Rosenbloom, 2007), reality is now telling a different story (Agrawal et al, 2006). By discussing the critical issues surrounding manufacturers selling directly to consumers and its effects on competitive advantage, this study aims to determine whether or not complete disintermediation by e-business is something that can be expected in the near future.

The consumer distribution channel (CDC)

The widespread use of the internet and e-business applications for online selling has given manufacturers the option of cutting out intermediaries from the original CDC (see part (a) of fig. 1) in order to sell directly to consumers, resulting in a CDC made up of only the producer and the consumer (as illustrated in part (c) of fig. 1) (Chaffey, 2009).

Fig. 1 – Disintermediation of a Consumer Distribution Channel (CDC)
Showing (a) the original situation, (b) disintermediation omitting the wholesaler, and (c) disintermediation omitting both wholesaler and retailer. Source: Chaffey, 2009.

The importance of this study

The CDC and its ability to generate profit for any manufacturer of goods is at the core of its business model and is therefore absolutely vital in determining the success or failure of that manufacturer’s operations. Changes in the CDC such as ‘cutting out the middle-man’ (disintermediation) or the introduction of new ‘middle-men’ (reintermediation) can have significant effects on a firm’s competitive advantage and ultimately, its future. Therefore it is of high importance to manufacturers that they understand the critical issues involved so that they can utilise the opportunities created by e-business to their advantage.

Disintermediation: An attractive concept?

The concept of doing away with the ‘middle-men’ in the CDC certainly has its incentives. King (1999) suggests that higher profit margins and access to valuable customer information are the main drivers for disintermediation. It has also been suggested that pressures to reduce costs in highly competitive industries are forcing companies to find ways to reduce payments to intermediaries (McCubbrey & Taylor, 2005) whereas complete disintermediation would cause payments to intermediaries to disappear altogether. Also, manufacturers could benefit greatly from direct access to customer information, potentially enabling them to better meet customer requirements and improve customer satisfaction. These two factors alone (cost saving and access to customer information) have the potential to significantly improve a firm’s competitive advantage. Furthermore, success stories such as Dell’s (Kraemer, 2000) build confidence that such a business model can bring high levels of success.

Dell has discovered that it can better meet customer needs through direct contact with customers and even offers customers the option of customising their products during the order process (Kraemer et al, 2000). This is a step further than simply obtaining customer information. In fact, Dell’s customers are able to actually dictate a product’s specifications prior to its assembly. This would be a very expensive and complicated service to offer if intermediaries were involved. Using this model, Dell has differentiated itself from the competition and become a clear market leader in the PC industry.

Disintermediation in reality

Despite disintermediation being an attractive concept at first glance, King (1999) and Rosenbloom (2007) both suggest that the advantages are ‘theoretical’ and argue that they are not often realised in reality. This is in line with Palvia(et al)’s (1999) findings that although many theories that promote disintermediation exist, very little empirical data exists to support them and general practice does not confirm that it works as well as the theories might claim. It seems that the critical issues surrounding disintermediation are a strong enough deterrent for manufacturers at this time. Failed attempts such as that of clothes manufacturer Levi Strauss to bypass intermediaries and sell its clothes directly to consumers online (King, 1999) may also act as a warning for other manufacturers.

The critical issues

Costs: Although disintermediation has the potential to reduce a firm’s costs, Van der Heijden (1996) suggests that the ‘economies of intermediation’ are often overlooked. Companies need to carefully consider the financial impact of cutting out intermediaries before doing so. Rosenbloom (2004) states that although large manufacturers enjoy economies of scale in production, it is unlikely that they will benefit from such economies of scale when it comes to providing services such as distribution. The result could be that it costs the manufacturer more to fulfil the role of the intermediary than the intermediary was charging in the first place. Furthermore, even if a manufacturer is able to carry out a service at lower cost, it is unlikely that the service will be equal or higher in quality than that offered by a company who specialises in that particular service (Gigalis et al, 2002). Therefore, it could be argued that the success of disintermediation is dependent on the manufacturer being able to provide at least the same standard of service as the intermediaries and at the same or a lower cost.

Justifying higher costs: Manufacturers who are not able to offer the same quality of services at a better cost will have to decide whether or not there are other benefits of disintermediation that outweigh these two factors. In Dell’s case for example, higher costs may be incurred by not using intermediaries but the information that is collected by selling directly to consumers may be valuable enough to justify this. Firms will need to discover which approach will most improve their competitive advantage.

Market conditions: Kraemer (2000) suggests that market conditions are a key factor to be considered, i.e. what works for Dell may not work under conditions different to that of the PC industry. Research also suggests that the likelihood of a manufacturer being able to provide a particular service depends on the nature of the service itself and the complexity of the product that the service is related to (Agrawal et al, 2006). It is understandable that intermediaries such as high street clothes retailers in which customers can see the clothes and try them on before buying, might be essential to the CDC. However, suppliers of electronic goods (e.g. computer software) that expect customers to leave their houses and purchase from a high street retailer are likely to lose business to competitors who offer their product as an instant download from their website. It is therefore vital that firms carefully consider whether or not the industry they are operating in is suitable for disintermediation to be viable. Factors such as these may begin to explain why companies such as Dell can succeed by cutting out the middle man but Levi Strauss, for example, failed miserably even after investing several million dollars in its attempt to sell directly to consumers online (King, 1999).

The value of the product: Benjamin & Wigand (1995) suggest that the arguments for disintermediation focus primarily on costs and do not take into consideration the value that intermediaries bring to the value chain. The value chain (see fig. 2) consists of all the elements that add value to a product before it finally reaches the customer. Intermediaries often fulfil the ‘primary activities’ in the value chain and it has been recognised for many years that their role is critical to adding value to the product (Butler, 1917). Furthermore, Porter & Millar (1985) suggest that the value chain is vital in attaining competitive advantage.


Fig. 2 - The Value Chain (Porter & Millar, 1985)

If the value of the final product is significantly increased by the services of intermediaries as Porter (1985) argues, manufacturers that are unable to replicate those services will find themselves with a product of less value. It could even be argued that the manufacturer would be selling a different product altogether which could have significant effects on demand.

Core competencies: Porter (1985) suggests that organisations should re-evaluate their value chain and concentrate on the operations that they can do best. A manufacturer that attempts to offer marketing/distribution/logistics services is no longer operating out of its core competencies. Such attempts could be a distraction from its core task of manufacturing. This would also mean competing in areas of non-expertise. The result could be a serious competitive disadvantage. Intermediaries themselves are possibly in a much better position to make the most of new technologies relating to their particular service, since that is where their core competencies lie. Also, the threat of disintermediation may put pressure on intermediaries to ‘earn their place’ in the value chain by either lowering their prices or providing even better services. If so, manufacturers could potentially benefit even more from advances in e-business by continuing to use intermediaries. A manufacturer that outsources those essential parts of the CDC that it does not specialise in, is free to concentrate and continually improve on its core competencies which are arguably its main source of competitive advantage.

Reintermediation: A more attractive concept?

E-business has created many opportunities for new intermediaries, as well as enabling existing intermediaries to become better-managed and more efficient (Rosenbloom, 2007). Services such as supplier search, product evaluation (Chaffey, 2009) and price comparison websites are proving very attractive to customers therefore firms whose products are not included on these sites or on the sites of leading online retailers such as Amazon are at a disadvantage.

Amazon (originally an online book retailer) has used e-business to quickly develop a customer base which far exceeds that of any book publisher. This is because consumers were (and still are) drawn by the value-adding services provided by Amazon. Nowadays, Amazon sells a huge variety of products and any manufacturer who opts not to sell its products through intermediaries such as Amazon will considerably limit their sales opportunities. Using such intermediaries enables manufacturers to reach a much wider audience with their products and offer customers a ‘value-added’ experience.

Manufacturers can also take advantage of the marketing opportunities created by e-business. For example, they can set up ‘affiliate marketing’ programs online which enable their products to be promoted and sold by almost anyone for a commission. This way products can be widely marketed, only costing the manufacturer when a sale is made. This model of inviting an unlimited number of intermediaries to sell a product is attractive because it means that money is not wasted on marketing that does not bring sales.

If the use of intermediaries is the most cost-effective and efficient way to take advantage of all that e-business has to offer, it could be argued that now is the time to introduce more intermediaries than ever before. Any intermediary that adds more value to a product than it charges for the service is worth considering and so too are those intermediaries that will enable a product to be more widely marketed or efficiently distributed than it is currently being. Rosenbloom (2007), Agrawal (2006), Gigalis (et al, 2002) and King (1999) all suggest that reintermediation has just as much, if not more potential to create competitive advantage which may explain Palvia(et al)’s (1999) findings that it is the more popular model in reality.

Conclusions

The critical issues surrounding disintermediation reveal that ‘cutting out the middle man’ is not something to be rushed into. A lack of consideration of more than its cost-saving potential was the likely cause of early expectations that it would widely adopted. When considering factors such as market conditions, core competencies and the value added to products by intermediaries, it is clear to see that major obstacles stand in the way of complete disintermediation taking place in many industries. In fact, firms that attempt to gain competitive advantage by disintermediation could find themselves at a serious disadvantage. Therefore it can be concluded that complete disintermediation is not something that can be expected in the near future. In fact, the opportunities that e-business has created for reintermediation have emerged as very attractive and perhaps unavoidable if manufacturers want to succeed in a market where consumers expect high quality, value-adding services, particularly in their online shopping experience. However, unforeseen advances in Information Technology that better enable manufacturers to replicate the services offered by intermediaries could change this, as could an unforeseen re-shaping of the way people search for and purchase products online.

 


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