In search of the perfect market

SURVEY: ELECTRONIC COMMERCE

In search of the perfect market

May 8th 1997
From The Economist print edition

The Internet, for all the miracles it has wrought in communications, is still a horrible way to buy a shirt. But it will get better, much better, says Christopher Anderson

AN ARMOURED cable as thick as a sewer pipe runs up the wall around the back of the headquarters of Netscape, the world’s best-known Internet software firm, in Sunnyvale, California. Embedded in four inches of steel is a finger-width bunch of thin, flexible fibre-optic cables. Within the cables flash bursts of laser light, carrying half a billion digital bits of information each second to and from Netscape’s central computers. Many of the bits coming in are orders from around the world for Netscape’s software, complete with credit-card numbers, amounting to more than a thousand sales a day. And many of the bits going out are electronic deliveries of that software. Employees pat the armoured pipe lovingly: “That’s where the money comes in.” Thanks in large part to these online sales, Netscape has become the fastest-growing software firm in history.

This is the dream of electronic commerce. The Internet has already connected 50m-60m of the world’s people through a seamless digital network. Where they live and what time zone they are in makes no difference. Place a store on the Internet anywhere and it is, in effect, everywhere. If, like Netscape, that store sells digital products—from software to information—all the better: it can deliver the products as easily as handing them over a counter. Cisco Systems, a network-equipment maker, is already selling products from its Web site at the rate of $1 billion a year. General Electric is saving a fortune by buying $1 billion-worth of goods from its suppliers online. Dell Computer is selling $1m-worth of PCs a day on the Web.

“We have waited a long time for broad-based electronic commerce, and it looks like 1997 will be the year that the market gains legitimacy,” says Bill Gurley, an analyst with Deutsche Morgan Grenfell, an investment bank. No wonder industry titans such as Bill Gates, the boss of Microsoft, regale the world’s leaders with the promise of “friction-free capitalism”: the idea that ubiquitous and equal access to information will create the closest thing yet to Adam Smith’s perfect market.

The statistics look promising. In a survey published earlier this year by CommerceNet, an industry consortium, and Nielsen, a media-research firm, 73% of Internet users had used the Web for shopping in one way or another in the past month. According to projections by International Data, a Massachusetts consultancy, by 2000 46m consumers in America alone will be buying online, spending an average of $350 a year each.

The cold light of cyberdawn

Now log on to the real world, where consumers are faced with a bewildering choice of thousands of online stores, each one inadequate in its own way. Just finding something to buy is a triumph, never mind comparing prices and paying for it. Between the endless lists of online merchants and the delays as each graphics-heavy shopfront downloads, you can spend an hour just finding a product. No wonder analysts reckon that consumer Internet transactions in 1996 were worth a total of only around $500m-600m, about the same as was spent on computer publications full of glowing articles on Internet commerce. In the three years since the Internet has taken off, the slow growth of electronic commerce has been one of its greatest disappointments.

The software bugs, baffling interfaces and limited selections of the average online shop make even the corner grocery look like a miracle of organisation and choice. And most online stores are losing a fortune: even MarketplaceMCI, the glossy online mall set up two years ago by MCI, an American telephone giant, has since shut its doors. For most consumers today’s Internet, far from being a perfect market, is the high street from hell.

So why devote a whole survey to it? Because it will get better—much better—and in ways that today’s fitful efforts only hint at. The ultimate promise of electronic commerce is undiminished, but the road from here to there is taking some surprising turns. Indeed, practically everything that was predicted about electronic commerce three years ago has turned out to be wrong.

For starters, the big money is not in consumer shopping but in business-to-business commerce. This should not have been a surprise—it mirrors the physical world, where business transactions are worth about ten times as much as consumer sales—but few realised how quickly apparently stodgy firms would convert. The reason: most business transactions were already done at a distance, whether by fax, telephone, post, or private electronic links. Moving that process to the Internet makes it cheaper, faster and easier.

Second, the industry has defined electronic commerce too narrowly. Most analysts include only transactions actually carried out on the Internet; but many consumers research their purchases online and then buy in some other way. No wonder the analysts’ forecasts are so widely spread (see chart 1). Only 3% of business-to-business Web sites are designed for direct sales, rather than for marketing and customer service, says Forrester Research, a Massachusetts consultancy. Even for consumer businesses, only 9% of sites offer online transactions. A CommerceNet/Nielsen survey in March found that whereas 53% of Internet users in the United States and Canada had used the Internet to reach a decision on a purchase, just 15% carried out the final transaction on the Web. Yet it is just that last bit that is usually measured.

ecsurgrapgics

Third, the online leaders are not the traditional commercial giants of the physical world, but outsiders who often knew next to nothing about the markets they chose to enter. They succeeded because they understood the Internet and how it could be harnessed to commerce of any sort.

Web sites are becoming de rigueur. By the end of last year, 80% of America’s Fortune 500 firms had a Web site, compared with only 34% a year earlier; but only 5% were conducting transactions on the Web, according to Forrester Research. Instead, their main reasons for setting up Web sites are to market their wares and help their customers, saving themselves money in the process (see chart 2).

ecsurgrapgics

The most important lesson would-be traders on the Internet must learn is that it rarely works like the physical world. For example, the “virtual malls” that have sprung up in their thousands over the past two years have been an abject failure. In real life, where driving to the store can take as long as shopping itself, putting many unrelated stores under one roof is a good way to attract a critical mass of customers. Online, where no store is more than a mouse click from any other, the hope was that the reputation of the mall itself would draw the dazed punters in from the chaos online. But big firms chose to stand alone, confident that their well-known brand names would be enough to attract customers. Smaller stores, rather than rent space in one of a hundred obscure malls, are increasingly grouping themselves by theme, joining or creating consumer communities with shared interests. Some have taken to advertising in stores selling related goods, which is rarely done in the real world.

No feel-good factor

Virtual stores have also found that the hard goods traditionally sold through consumer catalogues and retail stores often sell poorly online, where they cannot be held and examined. Instead, online commerce seems best suited to services—such as finance, travel and cars—where in the past their physical counterparts have benefited from the general public’s limited access to information.

The Internet allows such service firms to undercut their competitors in the physical world by a wide margin, but prices for hard goods, surprisingly, are not much lower than in bricks-and-mortar shops. Instead, they are proving that better information about products, particularly in the form of other customers’ views, can be a greater draw than deep discounts.

A year ago, retailers blamed their minuscule online sales on consumers’ fears that hackers would steal their credit-card numbers as they passed over the wild, unprotected Internet. Never mind that there is no evidence that this has ever happened, and that most stores now use software that encrypts order information. Credit-card companies (with which the buck stops in case of fraud) still claim that consumers are frightened to shop online, but clued-up consumers know that breaking Internet security, originally designed for military secrets, is much harder than stealing credit-card numbers in the real world.

Consumers are also learning that the promise of a seamless global market has yet to be fulfilled. Geography has wormed its way into cyberspace, using tools such as sales tax, credit-card restrictions and shipping. Indeed, the main justification for online malls today is to group stores within a country to spare locals such irritations.

Information goods, from software to news, can travel on the Internet itself, where customs agents have not yet ventured. For money, the leap into the virtual world seemed more hazardous, so a whole new set of Internet currencies (digital cash) was prepared to resist every conceivable attack by hackers. Alas, the experts failed to anticipate the biggest threat of all: consumer apathy. Now the firms pushing such payment systems are struggling, whereas the familiar payment systems of the physical world—credit cards, subscriptions, advertising— have moved online with surprising ease.

The idea of a robotic market, too, where software scours the virtual world looking for the best and cheapest goods, even haggling on behalf of its masters, now looks naive. So far “intelligent agents” have proved nothing of the sort, and automated online auctions have succeeded only in the narrowest of categories.

Wait for it

However painful these lessons have been for the firms that lost millions identifying dead ends in electronic commerce, their bloodstained maps will be the guides to tomorrow’s online marketplace. These are still early days. Consumers caught the Internet bug a mere four years ago, with the release of Mosaic, the first graphical Web browser. The extraordinary growth in the underlying network remains as strong as ever, with the number of users still nearly doubling each year. Worldwide, some 23m households are now connected to the Internet (see chart 3), which translates into around 55m users. Some estimates, taking a broad definition of Internet use, say that by 2000 the number could grow to 550m, or 10% of the world’s population.

ecsurgrapgics

True, few companies are as yet making any money online, but plenty are trying. This survey will argue that it is only a matter of time before they succeed in a big way. Andy Grove, the boss of Intel, the world’s biggest chipmaker, recently summed up the online pioneers’ attitude when asked about the return on investment from his firm’s Internet ventures: “What’s my ROI on e-commerce? Are you crazy? This is Columbus in the New World. What was his ROI?”