[IS Theory]Electronic Markets and Electronic Hierarchies

Malone, T. W., Yates, J. & Benjamin, R. I.. 1987. Communications of the ACM. 30(6). pp. 484-497

Electronic Markets and Electronic Hierarchies: Effects of Information Technology on Market Structure and Corporate Strategies

 

[Definitions of Markets and Hierarchies]

 

1) Markets coordinate the flow through supply and demand forces and external transactions between different individuals and firms.

- Market forces determine the design, price, quantity, and target delivery schedule for a given product that will serve as an input into another process:

 2) Hierarchies, on the other hand, coordinate the flow of materials through adjacent steps by controlling and directing it at a higher level in the managerial hierarchy.

- Managerial decisions, not the interaction of market forces, determine design, price (if relevant), quantity, and delivery schedules at which products from one step on the value-added chain are procured for the next step

 

[Factors Favoring Markets or Hierarchies]

 

 - These coordination costs take into account the costs of gathering information, negotiating contracts, and protecting against the risks of “opportunistic” bargaining.

 1) Production costs include the physical or other primary processes necessary to create and distribute the goods or services being produced.

2) Coordination costs include the transaction (or governance) costs of all the information processing necessary to coordinate the work of people and machines that perform the primary processes

 

 

1) In a pure market, with many buyers and sellers, the buyer can compare different possible suppliers and select the one that provides the best combination of characteristics (such as design and price), thus presumably minimizing production costs for the desired product.

- The market coordination costs associated with this wide latitude of choice, however, are relatively high, because the buyer must gather and analyze information from a variety of possible suppliers.

 

2) Hierarchies, restrict the procurer’s choice of suppliers to one predetermined supplier, production costs are, in general, higher than in the market arrangement.

- The hierarchical arrangement, however, reduces coordination costs over those incurred in a market by eliminating the buyer’s need to gather and analyze a great deal of information about different suppliers.

- more specific, factors that can be changed by information technology are also important in determining which coordination structures are desirable: asset specificity and complexity of product description.

 

[Asset Specificity & Complexity of Production Description]

 

1) Asset Specificity

- An input used by a firm (or individual consumer) is highly asset specific, if it cannot readily be used by other firms because of site specificity, physical asset specificity, or human asset specificity.

- An asset is time specific if its value is highly dependent on its reaching the user within a specified, relatively limited period of time.

- There are several reasons why a highly specific asset is more likely to be acquired through hierarchical coordination than through market coordination

- Transactions involving asset-specific products often involve a long process of development and adjustments for the supplier to meet the needs of the procurer, a process that favors the continuity of relationships found in a hierarchy.

 

2) Complexity of Product Description.

- the amount of information needed to specify the attributes of a product in enough detail to allow potential buyers (whether producers acquiring production inputs or consumers acquiring goods) to make a selection.

 

 

[CONTEMPORARY CHANGES IN MARKET STRUCTURES]

 

1) Electronic communication effect.

(1) allow more information to be communicated in the same amount of time (or the same amount in less time),

(2) decrease the costs of this communication dramatically.

 

2) electronic brokerage effect

- of benefit primarily in the case of computer-based markets.

(1) increase the number of alternatives that can be considered

(2) increase the quality of the alternative eventually selected, and

(3) decrease the cost of the entire product selection process.

 

3) electronic integration effect.

 - the time saved and the errors avoided by the fact that data need only be entered once

 - Captured most easily in electronic hierarchies, but they are sometimes apparent in electronic markets as well.

 

[The Shift from Hierarchies toward Markets]

 

1) General Argument Favoring Shift toward Markets.

- The first is the assumption that the widespread use of information technology is likely to decrease the “unit costs” of coordination. As

- markets have certain production cost advantages over hierarchies as a means of coordinating economic activity.

 

2) Changes in Factors Favoring Electronic Markets versus Electronic Hierarchies.

- some of the new, computer-based information technologies have affected both of our key dimensions so as to create an overall shift from hierarchies to markets.

 

[Motives for Establishing Electronic Markets: Possible Market Maker]

 

 

[Stages in the Evolution of Electronic Markets]

 

 1) From Biased to unbiased markets

- the benefits of the electronic communication effect to capture customers in a system biased toward a particular supplier.

- the significant additional benefits to buyers possible from the electronic brokerage effect will drive almost all electronic markets toward being unbiased channels for products from many suppliers

- our model leads us to predict that this system (or its competitors) will move toward including products from many different suppliers.

 

2) From Unbiased to Personalized markets

- One of the potential problems with unbiased electronic markets of the sort we have described is that buyers might be overwhelmed with more alternatives than they can possibly consider.

- a final stage may be the development of electronic markets that provide personalized decision aids to help individual buyers select from the alternatives available, what we call “personalized markets.”

 

[Motives for Establishing Electronic Hierarchies]