Key Concepts in E-commerce: Digital Markets and Digital Goods in a Global Marketplace

The location, timing, and revenue models of business are based in some part on the cost and distribution of information. The Internet has created a digital marketplace where millions of people all over the world can exchange massive amounts of information directly, instantly, and free. As a result, the Internet has changed the way companies conduct business and increased their global reach.

The Internet reduces information asymmetry. An information asymmetry exists when one party in a transaction has more information that is impor­tant for the transaction than the other party. That information helps determine their relative bargaining power. In digital markets, consumers and suppliers can see the prices being charged for goods, and in that sense, digital markets are said to be more transparent than traditional markets.

For example, before automobile retailing sites appeared on the web, there was significant information asymmetry between auto dealers and customers. Only the auto dealers knew the manufacturers’ prices, and it was difficult for consumers to shop around for the best price. Auto dealers’ profit margins de­pended on this asymmetry of information. Today’s consumers have access to a legion of websites providing competitive pricing information, and three-fourths of U.S. auto buyers use the Internet to shop around for the best deal. Thus, the web has reduced the information asymmetry surrounding an auto purchase. The Internet has also helped businesses seeking to purchase from other busi­nesses reduce information asymmetries and locate better prices and terms.

Digital markets are very flexible and efficient because they operate with reduced search and transaction costs, lower menu costs (merchants’ costs of changing prices), greater price discrimination, and the ability to change prices dynamically based on market conditions. In dynamic pricing, the price of a product varies depending on the demand characteristics of the cus­tomer or the supply situation of the seller. For instance, online retailers from Amazon to Walmart change prices on thousands of products based on time of day, demand for the product, and users’ prior visits to their sites. Using big data analytics, some online firms can adjust prices at the individual level based on behavioral targeting parameters such as whether the consumer is a price haggler (who will receive a lower price offer) versus a person who accepts offered prices and does not search for lower prices. Prices can also vary by zip code. Uber, along with other ride services, uses surge pricing to adjust prices of a ride based on demand (which always rises during storms and major conventions).

These new digital markets can either reduce or increase switching costs, de­pending on the nature of the product or service being sold, and they might cause some extra delay in gratification due to shipping times. Unlike a physical market, you can’t immediately consume a product such as clothing purchased over the web (although immediate consumption is possible with digital music downloads and other digital products).

Digital markets provide many opportunities to sell directly to the consumer, bypassing intermediaries such as distributors or retail outlets. Eliminating inter­mediaries in the distribution channel can significantly lower purchase transac­tion costs. To pay for all the steps in a traditional distribution channel, a product may have to be priced as high as 135 percent of its original cost to manufacture.

Figure 10.2 illustrates how much savings result from eliminating each of these layers in the distribution process. By selling directly to consumers or reducing the number of intermediaries, companies can raise profits while charging lower prices. The removal of organizations or business process layers responsible for intermediary steps in a value chain is called disintermediation. E-commerce has also given rise to a completely new set of new intermediaries such as Amazon, eBay, PayPal, and Blue Nile. Therefore, disintermediation differs from one industry to another.

Disintermediation is affecting the market for services. Airlines and hotels operating their own reservation sites online earn more per ticket because they have eliminated travel agents as intermediaries. Table 10.3 summarizes the dif­ferences between digital markets and traditional markets.

1. Digital Goods

The Internet digital marketplace has greatly expanded sales of digital goods— goods that can be delivered over a digital network. Music tracks, video, Hollywood movies, software, newspapers, magazines, and books can all be expressed, stored, delivered, and sold as purely digital products. For the most part, digital goods are intellectual property, which is defined as “works of the mind.” Intellectual prop­erty is protected from misappropriation by copyright, patent, trademark, and trade secret laws (see Chapter 4). Today, all these products are delivered as digital streams or downloads while their physical counterparts decline in sales.

In general, for digital goods, the marginal cost of producing another unit is about zero (it costs nothing to make a copy of a music file). However, the cost of producing the original first unit is relatively high—in fact, it is nearly the total cost of the product because there are few other costs of inventory and distribu­tion. Costs of delivery over the Internet are very low, marketing costs often remain the same, and pricing can be highly variable. On the Internet, the mer­chant can change prices as often as desired because of low menu costs.

The impact of the Internet on the market for these kinds of digital goods is nothing short of revolutionary, and we see the results around us every day. Businesses dependent on physical products for sales—such as bookstores, music stores, book publishers, music labels, and film studios—face the possibil­ity of declining sales and even destruction of their businesses. Newspaper and magazine subscriptions to hard copies are declining, while online readership and subscriptions are expanding.

Total record label industry revenues fell nearly 50 percent from $14 billion in 1999 to about $7.7 billion in 2016, due almost entirely to the rapid decline in CD album sales and the growth of digital music services (both legal and illegal music piracy). But revenues increased in 2017 by 16 percent to $8.7 billion pri­marily through the growth of paid subscriptions (RIAA.com, 2018). The Apple iTunes Store has sold more than 50 billion songs for 99 cents each since opening in 2003, providing a digital distribution model that has restored some of the rev­enues lost to digital music channels. Yet the download business is rapidly fading at Apple, down more than 25 percent in recent years, as streaming becomes the dominant consumer path to music. Since iTunes, illegal downloading has been cut in half, and legitimate online music sales (both downloads and streaming) amounted to $5.7 billion in 2017. As cloud streaming services expand, illegal downloading will decline further. Digital music sales, both digital download and streaming, account for more than 80 percent of all music revenues. The music labels make only about 32 cents from a single track download and only 0.5 cents for a streamed track. Although the record labels make revenue from ownership of the song (both words and music), the artists who perform the music make virtually nothing from streamed music. Artists’ earnings on a streamed song on an ad-supported platform like Spotify are pennies per million streams.

Hollywood has been less severely disrupted than the music industry by il­legal digital distribution platforms, because it is more difficult to download high-quality, pirated copies of full-length movies and because of the avail­ability of low-cost, high-quality legal movies. Hollywood has struck lucrative distribution deals with Netflix, Google, Hulu, Amazon, and Apple, making it convenient to download and pay for high-quality movies and television series.

These arrangements are not enough to compensate entirely for the loss in DVD sales, which fell 60 percent from 2006 to 2017. Digital format streaming and downloads grew by 20 percent in 2017 and, for the first time, consumers viewed more downloaded movies than DVDs or related physical products. As with tele­vision series, the demand for feature-length Hollywood movies appears to be expanding, in part because of the growth of smartphones, tablets, and smart TVs, making it easier to watch movies in more locations.

In 2019, about 258 million Internet users are expected to view movies, about 82 percent of the adult Internet population. There is little doubt that the Internet is becoming a major movie distribution and television channel that rivals cable television, and someday may replace cable television entirely (see the chapter-opening case).

Table 10.4 describes digital goods and how they differ from traditional physi­cal goods (eMarketer, 2018i)

Source: Laudon Kenneth C., Laudon Jane Price (2020), Management Information Systems: Managing the Digital Firm, Pearson; 16th edition.

8 thoughts on “Key Concepts in E-commerce: Digital Markets and Digital Goods in a Global Marketplace

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