Graduate School of Business
The University of Texas at Austin
Graduate School of Business The University of Texas at Austin |
Electronic Payments and the Future of Electronic Commerce
by
Soon-Yong Choi
Center for Electronic Commerce
The University of Texas at Austin
Dale O. Stahl
Department of Economics
The University of Texas at Austin
and
Andrew B. Whinston
Graduate School of Business,Department of Economics,and Department of Computer Science
The University of Texas at Austin
Abstract: We discuss market implications of adopting electronic payment systems and digital currencies in electronic commerce. The key to understanding and exploiting electronic commerce is to recognize it as a market mechanism where all components of a market interact and must be analyzed collectively. For example, electronic payment systems bring more than lowered transaction costs, affecting product choices, pricing and competition. We examine economic implications of electronic payment systems and especially micropayments enabled by digital currencies in terms of size advantage, the lemons problem, digital product pricing, product differentiation, the commoditization of consumer information and advertisements, and copyrights. In short, electronic payment systems are one of the critical factors which allow process innovations via electronic commerce. These process innovations may either promote competitive and efficient markets or worsen the trend toward the vertical integration and monopolization in the globalized economy. We discuss these two scenarios relating them to electronic payments and digital currencies.
"I think there is a world market for maybe five computers."-Thomas Watson, chairman of IBM in 1943.
"Incomprehension is the night of the mind, but a night without moon or star."-Confucius.
1. Introduction
In just a few short years, the Internet has expanded from a limited access academic and research network into a pervasive, multipurpose electronic medium. In addition to educational and research uses, it has become a popular medium of choice for communicating, advertising and, with the advent of the World Wide Web, for doing business.
Going far beyond simply "doing business electronically," electronic commerce enables businesses to innovate the whole processes from production to customer service, not in stages, but by integrating them in a seamless whole. Consumers can search and order products online, exchange product information, learn about product quality from other online users, and negotiate with sellers for lower prices and better quality. Governments are developing electronic commerce platforms to collect taxes, disseminate information, monitor market processes and interact with citizens via personalized, up-to-date communications networks.
With these far-reaching implications for the future economy, today's heightened interest among businesses, researchers and government policy makers is quite encouraging for those who are staking out their future on this new ground. So far, journalists and magazine columnists are making more money on the Internet than are many businesses. But the increased attention in the popular press has its own drawback, fanning more hypes than focused analyses. What we endeavor to do in this paper is to shed some light on the future of electronic commerce in the globalized economy. Drawing from our book, "The Economics of Electronic Commerce," and adding some pertinent observations, we begin by defining electronic commerce as a market system, and then examine effects of electronic commerce on market performance and structure, primarily focusing on electronic payment systems such as digital currency and micropayments. We conclude with some observations on business strategies and government policy options for the future.
2. Electronic Commerce as a Market
Electronic commerce is a very versatile phrase that describes a wide range of activities. To begin, it commonly denotes:
- searching for product information
- ordering products
- paying for goods and services
- providing online customer service
In addition to these business-to-consumer interactions, within-business and business-to-business activities in electronic commerce include:
- internal electronic mail and messaging
- online publishing of corporate documents
- online searches for documents, projects and peer knowledge
- distributing critical and timely information to employees
- managing corporate finance and personnel systems
- manufacturing logistics management
- supply chain management for inventory, distribution and warehousing
- sending order processing information/reports to suppliers and customers
- tracking orders and shipments
These online activities are possible because of the enabling technologies which include computer hardware, software, telecommunications networks, and innovative products and processes such as network protocols, encryption programs, real-time applications, digital currency, cybercommunities as well as digitized contents available online. Many consider these enabling technologies to be the essence of electronic commerce. They are certainly the building blocks of electronic commerce and the information society of the future. However, this focus on technology often neglects the on-going innovations in products and processes, which will come to define a new market, the virtual economy if you will, that is fundamentally different from physical markets.
A market consists of (1) market agents including sellers, buyers, intermediaries and other third parties, (2) commodities and services to be exchanged and (3) market processes such as product selection, consumer searches, competition, marketing and market research, advertising, distribution, payments and consumption. In physical markets, consumers visit physical stores, examine products, negotiate, pay and consume physical products. Sellers send out advertisements, collect demand information through focus groups and opinion surveys, and distribute their products through wholesalers and retail stores.
In the electronic marketplace, the same market players are engaged in the same economic activities. However, they assume online identities, set up virtual firms and Web stores, communicate, search, advertise and settle payments electronically. Processes of tracking sales, collecting customer information and engineering product specifications not only occur simultaneously but integrated so as to allow real-time feedback. Going beyond obvious efficiency gains in transactions, this innovative market setting allows market agents to behave differently. For example, interactions between buyers and sellers result in customized products, which benefits consumers but lowers product substitutability opening up the possibility for first-degree price discrimination (see Choi, Stahl and Whinston, 1997, Chapter 8). To target advertisements, sellers are no longer limited to using crude demographic data. Instead, cybercommunities and online interest groups segment consumers into finer groups than ever before (see ibid., Chapter 7). Microproducts and micropayments allow consumers to try out products before paying for a long-term subscription or a large bundle (see ibid., Chapter 10). Online usage monitoring along with micropayments enable not only selling a news report or a magazine column individually but also distributing copyright payments equitably and efficiently (see ibid., Chapter 5). The electronic marketplace is deceptively similar to physical markets in terms of the economic functions they carry out, but these market innovations will affect the structure of the market and its competitiveness.
Being a market, the electronic marketplace is a suitable candidate for economic analysis. The economics of electronic commerce aims at applying standard economic analyses to this new market in order to provide a coherent framework for evaluating electronic commerce issues, formulating radically new business models and advancing economic policy recommendations. Instead of focusing on technical and legal aspects of electronic commerce, for example, "The Economics of Electronic Commerce" examines the major issues in electronic commerce from an economics perspective, including quality and the role of intermediaries, digital copyrights, advertising, consumer searches for product information, product selection and pricing strategies, electronic financial and payment services, online taxation, regulatory and global economic policies. As electronic commerce progresses towards a full-fledged marketplace, economic analysis will take on an increasingly greater importance. In the remaining sections of this paper, we examine some implications of electronic market processes in terms of market efficiency and competitive structure, and evaluate how they will affect the economy of the future.
3. Electronic Commerce Issues and Payment Methods
The key to understanding and exploiting electronic commerce is to recognize it as a market mechanism where all components of a market interact and must be analyzed collectively. With this understanding, we examine a number of issues that are frequently discussed in the popular press in order to highlight market aspects which are consistently ignored in current debates, with special emphasis on electronic payment systems.
3.1. The Size and Reputation of a Firm
In physical markets, large firms often have advantages over smaller firms in many ways.. For example, large firms and corporations often have better access to the capital market than do small firms. Economies of scale often result in increased profits for large companies. And the widespread name recognition of large established firms is a valuable asset in itself. Such advantages, for example of General Motors over small-scale car manufacturers, translate into a dominance in physical markets.
In electronic commerce, however, it is difficult to distinguish virtual firms or Web stores by their size. From this observation, the electronic marketplace is said to be the great equalizer which accommodates big and small firms on equal terms. A popular cartoon claimed that "no one knows your are a dog on the Internet." To witness, small firms have successfully dominated the Internet in this early stage of market growth. For example, Amazon.com (http://www.amazon.com) has no physical stores or distribution channels, but is the largest and most successful online bookstores. Netscape (http://www.netscape.com) dominates the Web browser market. VeriSign (http://www.verisign.com) is the leader in certification services where U.S. Postal Service (http://www.usps.gov) is a potential competitor.
Despite the success and dominance of these nimble and innovative firms on the Internet, large firms in physical markets are entering the online market with a force to beckon with. For example, Amazon.com faces competition from established booksellers such as Barnes and Noble and Borders (http://www.borders.com); Netscape from Microsoft's Internet Explorer; and VeriSign from U.S. Postal Service.
There are at least two factors that favor large firms in electronic commerce. First, many digital products such as computer software have large fixed costs. Due to this economies of scale, a larger firm which can invest more on quality will command a higher share of the market, and if products have the same price, a firm with higher quality will dominate the market since consumers learn about quality and repeat purchases. Second, reputation built in physical markets can be transferred to the electronic marketplace. As a result, the company with reputation as a dominant and large firm in physical markets enjoys a form of size advantage in electronic commerce as well.
In this vein, SET, the electronic payment system for credit cards favored by Visa (http://www.visa.com) and MasterCard, has the advantages of these firms' reputation and size in physical markets. Likewise, the success of a digital currency payment system will depend on consumers' faith and trust in the firms providing the service. As a currency is as good as its backer, the governments, a large financial institution or a software giant is in a position to dominate the digital currency market due to their size and reputation. If digital currency providers can appropriate only a small portion of the government's seigniorage, the potential profit in this market may amount to billions of U.S. dollars. Competitive digital currency markets will of course pass this seigniorage to consumers in the form of convenience and quality for payments. To guarantee consumer benefits, however, banking regulations and monetary policies must adapt to the possible free-for-all market competition.
3.2. Quality Uncertainty and Micropayments
The quality of an experience good is learned only after consumption. For this reason, markets for experience goods such as used cars often fail to exist or only support low-quality products. This lemons problem (Akerlof 1970) due to quality uncertainty is prominent in electronic commerce. For example, most information goods are experience goods. Furthermore, reading a detailed description of an information good amounts to actually consuming it. Therefore, sellers must be careful in providing product information and may require payments prior to purchase. But uncertain about quality, consumers will be reluctant to pay up-front without a mechanism to resolve the problem.
In our book (see Choi, Stahl and Whinston 1997), we examine several market mechanisms to resolve the lemons problem in electronic commerce. One method is to use intermediaries who guarantee quality of their products using incomplete contracts (Bernheim and Whinston, forthcoming in AER). Another is to allow consumers to try out a product based on microproducts and short-term options contracts. Payment systems that support micropayments such as Mark Twain Bank's E-cash (http://www.marktwain.com) or Mondex International (http://www.mondex.com) are essential in implementing consumer try-outs since, under this method, only a small portion is sold on a short-term basis, often at a fraction of a dollar or a yen.
The quality uncertainty problem is also present in the Internet infrastructure pricing. For example, the quality of timely information delivered via the Internet is affected by network congestion. Various Internet pricing mechanisms have been proposed to resolve the congestion problem and allocate the infrastructure resources more efficiently-for example, smart markets (MacKie-Mason and Varian 1995) and dynamic optimal pricing schemes (Gupta, Stahl and Whinston 1996). Contrary to subscription plans based on a flat monthly fee, optimal infrastructure prices must reflect usage patterns and valuations placed on transported messages. In turn, flexible payment systems that include micropayments are necessary to price both small and large messages as well as intense and occasional needs for the infrastructure.
3.3. Digital Product Pricing and Payment Systems
Already, there seem to be multiple, often contradictory theories of how digital products should be distributed, sold and priced. Some would argue for bundling (a sort of flat fee) while others argue for micropayments (a sort of usage-based pricing), each having some evidence for justification and mathematical as well as economic proofs, which we discuss in Chapter 8 of our book in more detail. Those who see electronic commerce simply as an alternative marketing channel find some spurious similarities between digital products and their physical counterparts, and argue that electronic commerce pricing will be no different from physical markets where vendors prefer bundling and subscription. While some products and services will indeed be better served by bundling and subscription, this practice will be only a small part of how digital products will be sold in electronic commerce. Instead, the changing nature of information goods and market processes will demand more flexible distribution and pricing schemes such as microproducts and micropayments.
In the physical world, information products are often bundled and sold on a subscription basis. For example, a newspaper is delivered with all sorts of news and information in one-fits-all package. Cable services are priced as a group of channels (tiers) instead of a-la-carte options. Bundles of this type are convenient since precise information about consumer demand for each component or between components is not required; consumers can also average out the fluctuation in product quality and their own demand; and billing and payment are simplified. Bundling therefore appears to be an appropriate product selection strategy for many digital products, at least for digital information products, since many similarities are found in two forms of information products-i.e. between digital versions (e.g. online magazines) and physical versions (e.g. paper-based magazines).
Such outward similarities, however, have more to do with the characteristics of today's sellers and products than with the nature of digital products and the electronic marketplace. As long as sellers see electronic commerce only as a simple extension of their physical products, they may sell digitized versions of existing contents under the same payment methods. However, tomorrow's electronic commerce, with numerous micro-producers and information-based products, will certainly demand different economic models to guide business decisions. For example, today's expensive personal service providers-e.g. personal investment advisers, accountants and lawyers-may offer their services on a short-term basis; four-year colleges may offer need-based education and skill-oriented short courses online. Consumers will be able to enroll in a specific course to get a certificate of completion. As these examples illustrate, electronic commerce is indeed a new way of delivering products and services, which requires a more flexible pricing scheme than the familiar flat-fee subscription.
An important prerequisite of unbundling and mixed bundling is the designing of a micropayment system suitable for pricing the resulting microproducts and microbundles. Fees for bundled products often are large enough to be paid by credit cards and checks, and some economists argue that microproducts and micropayments discussed in connection with electronic currency will become largely unimportant. If transaction costs can be made low enough to handle even sub-dollar payments, why should digital product sellers be limited to accepting credit card payments and other large-scale payment methods? To justify a large bill, consumers are often require to purchase multiple products or a bundle with unwanted products. Micropayments are as essential to electronic commerce as product customization.
3.4. Product Differentiation
Micropayments and unbundling will be a natural response to a growing abundance of customized microproducts. We see the potential sources and applications of microproducts in all different areas. Take, for example, the traditional media world. Newspapers, magazines and TV programs are intermediary services that collect, edit, and distribute materials from various sources, often packaged in a bundled program or newspaper. However, there is no reason why information should be distributed only via a centralized distribution system. In other words, the New York Times or CNN may not be the sole gatekeepers of news, ideas, information and knowledge. The Internet is a natural dispersed information channel for small, occasional sales. Its unique interactive capability also makes everyone a potential guest columnist on the net. These microproducts will be paid for not by subscription but by micropayments.
3.5. Consumer Information and Advertising
New types of information goods are generated by interactions among market agents. For example, each interaction between a consumer and a Web page results in information about agents (e.g. consumer information), which has more refined information about consumer preferences than today's data collected off-line, which nevertheless retailers sell to direct marketing firms at $2-3 per name and telephone number. Numerous free email and Internet service providers-e.g. Juno (http://www.juno.com)-are indeed intermediaries who deal with consumer information. Most operate like TV networks who convert audience into advertising revenues.
Both consumer information and advertisements can be fully commoditized so as to let the market determine their prices. CyberGold (http://www.cybergold.com), for example, proposes to sell advertisements directly to consumers, who are paid money for reading messages from advertisers. Similarly, consumers may offer their identifiable information at a price. An efficient market for such a snippet of information will require payment methods suitable for low-value transactions. Even product descriptions can be broken down into smaller components and sold individually. In addition, new commodities exchanged in the electronic marketplace will include many physical products made smart by applying intelligence and technology: smart automobiles, smart furniture, smart appliances, and so on. Just as we buy a can of motor oil or a replacement light bulb, consumers will want to purchase a new control routine for smart automobiles, an improved temperature diagnostic subroutine for smart boilers, etc. If these smart products use open and interoperable standards, there will be no need to rely on proprietary, expensive, all-in-one software to install and update them. Instead, small shareware products will be readily available over the Internet. Microproducts and micropayments are essential in achieving such a vision.
3.6. Digital Copyrights and Micropayments
Micropayments also play an important role in calculating equitable payments to component owners of a bundled product. In the physical world, the music industry has developed what is probably the most sophisticated copyright payment scheme through ASCAP and BMI, as we discuss in Chapter 5 of our book. However, their payment schedule still depends on the estimated popularity of each copyrighted material played on radio and other media, which cannot be measured accurately. Some popular artists may be under-paid while others are over-paid. A bundled sale of digital products faces similar problems. Consumers may not actually view or use some components, while other portions or features are heavily used. If the seller charges a flat fee for the bundle, how would it distribute the revenue to the various copyright owners of a bundled product? Without actual usage data, a precise allocation will be difficult or inequitable. However, since the electronic marketplace has the technology to monitor usage, a more efficient revenue distribution will be based on individual sales-for which micropayments are needed.
4. The Virtual Economy of the Future
Innovations in electronic payment systems are examples of how electronic commerce will change our lives in the future. That is, the future online world is not the extreme cyber version of a world that is described in movies and television programs, where machines and electronic agents fight virtual wars. Rather, the future information superhighway is the platform where a wide range of processes become interactive and interoperable, enabling more efficient and integrated activities in production, distribution, consumption as well as education, entertainment and government operations.
For example, consider today's media and network technologies for communications, information and entertainment. For these activities, we have a telephone, a fax machine, a TV, a VCR and a camcorder, a stereo set, a personal computer and other devices used for each specific purpose. The information superhighway interconnects these devices, availing them wherever or whenever they are needed. Imagine that all these devices are interoperable via the Internet. In addition, smart appliances in your smart house and other worldly possessions can be operated, monitored and controlled via the Internet. This networked virtual environment will change our lives significantly.
For example, suppose that Alice is away vacationing in Hong Kong from her Austin, Texas, home. If anything is out of order, her house alerts her instantly, reporting the problem and what it did to correct the problem within the parameters allowed, or asking for actions. Alice acknowledges-or sends instructions-and goes on vacationing.
One evening, Alice receives an email message from Bob, who wants to use her empty house for two nights. Since her house uses a digital key, Alice sends the digital file-the house key-over the network, which Bob stores on his personal card. He goes to Alice's house, enters using the downloaded key, and accesses the central computer. By inputting into Alice's computer a file that stores all his preferences about light, temperature, net news, radio and TV stations-out of the hundreds of channels available-Bob makes himself at home. At the same time, Bob's intelligent agent, which connects itself with Alice's computer, begins notifying others of his whereabouts so that messages can reach him without delay over the net.
The house key sent by Alice, however, will expire in two days, at which time the computer will remove Bob's settings and restore Alice's. The key self-destructs by the same mechanism that old computer hackers used to detonate computer viruses. If Bob refuses to vacate the house in two days, Alice can override his control of the house. (Perhaps, she can send an email message to her furnace to raise room temperature to 100 degrees.)
There is nothing extraordinary in this scenario. In fact, the relevant technologies already exist. The futuristic aspect in this scenario is in making all these technologies work in a seamless, interoperable system. Therefore, when developing a component technology, businesses need to have a long-term perspective. For example, the analog HDTV standard has been abandoned by the Japanese government and corporations who introduced it early in the 1980s. Analog HDTVs will not operate with digital HDTVs and thus unable to participate in the digital revolution. Going against such a trend will be a disaster. Likewise, smart products should adopt standard communications protocols so that they can be controlled remotely via the Internet or other prevailing networks. Proprietary software will isolate the product and diminish its usefulness in the virtual economy. By visualizing how consumers use their products in the future, businesses can gain an insight into what features their products must offer as well.
The above example is decidedly not one of a market transaction involving sellers and buyers. However, electronic commerce will be conducted in the same manner as Alice and Bob made contacts, exchanged their messages, and went about their everyday lives, but with added technologies and features of an economic system-payment mechanisms, product specifications, intermediation and negotiation processes for trade, contracts and delivery. The most manifest lesson for product sellers in the above example should be the need for interoperability that enables an integrated and seamless consumption process. As for payment systems, this interoperability amounts to integrating various payment methods and processing systems. More importantly, however, payment systems need to be versatile enough to support various transaction needs, which include long-term subscriptions, large bundles, micro-bundles and microproducts. As we reviewed in the previous section, market efficiencies critically depend on the availability of these alternative payment methods, and in a global scale.
5. Globalization and Electronic Commerce
Not many of the issues are local in electronic commerce. A Web store operates worldwide, accepting orders from and shipping products to every corner of the world. Opportunities and pitfalls for electronic payment service providers and digital currency issuers lie in the internationalization of the Internet, which goes far beyond the expansion we witnessed in the last century. For most of the 20th century, corporations have operated as multinational entities "knowing no national boundaries." Literally, now we see free trade zones springing up in North America, Europe, and around the Pacific Rim. While these large economic blocks of countries represent the most recent achievement in fostering the free movement of goods, the Internet was created from its inception without borders. For the goods and services that can be ordered and delivered over the network, the Internet is truly a global marketplace.
It is easy enough to say that electronic commerce is global. The difficulty lies in identifying the effects of globalization on the economy-income levels, jobs, domestic prices, capital flows and foreign exchange rates, etc. An interesting exercise in international trade and finance economics is to see how two previously closed economies are affected by subsequent interactions in human resources, materials, and capital. Even though the soundness of trade is well-known through the theory of comparative advantages and trade makes sense even when one country has absolute advantages in all sectors, the advocates and opponents of free trade continue to debate other issues. Specifically, does international trade have an impact on domestic economies? And how would border-less electronic commerce change that?
By definition, a closed economy would not be affected by the international movements of goods and capital. The United States, for example, was considered to be relatively closed until the 1970s as its trade accounted for less than 10% of its gross national product. With the share increasing to over 15%, opinions vary as to the impact of trade on the U.S. economy.
On the one side, the flux of cheap imports into the U.S. is viewed as the equivalent to a huge supply of cheap labor, which depresses low-skilled workers' income and increases income inequality. Exporting jobs overseas further creates an over-supply of unskilled labor and affects their income adversely. On the other side, competition from foreign labor is greatly discounted as a factor in the worsening of income inequality. Rather, the blame is put to domestic policies, especially the introduction of high-technology, which raises the income level of skilled workers while non-technical workers do not gain. The argument is that the flight of corporations abroad for cheap labor will not have a long-term effect since wages in those countries will eventually be driven up. Low productivity due to the low skill level of domestic workers is cited as the primary reason why the income gap is worsening. For both sides, creating more jobs domestically will help to narrow the income gap. However, opponents to free trade argue that expanding job opportunities for low-skilled workers and perhaps encouraging more domestic investments by multinational corporations will raise wages for low-skilled workers. Advocates of free trade, on the other hand, argue that such policies will have no effect. Rather, the skill level and the productivity of low-wage earners have to be raised, perhaps through more job training and education, but not by restricting job exports by corporations.
The growth of global information infrastructure and its commercial use cuts through both of these arguments. Through electronic commerce, high-wage jobs-not just low-wage jobs-are being exported, i.e. high-value products are being imported. For example, software engineers in India work on projects via satellite networks linking directly with U.S. companies. High-skilled researchers and scientists in Eastern Europe can be linked via Internet for research purposes. This will depress wages for high-skilled laborers and should narrow income inequality. At the same time, education and training will become cheaper through electronic education services on the Internet, and technological skill and productivity in the electronic marketplace will level off among workers because the difference between high-tech and low-tech laborers is smaller than in physical markets. For these reasons, the income gap is expected to narrow as electronic commerce grows.
The global nature of electronic commerce will also change how corporations operate globally, making these corporations more mobile. Shifting manufacturing abroad is justified when wages are sufficiently different to account for the cost of relocation. With electronic commerce, that cost will be smaller, enabling corporations to exploit even small differences in wages. In essence, this will result in more open economies worldwide and a possible convergence in income levels.
Globalization, however, will not break down all market boundaries since customers still have different tastes. While spatial convergence removes geographical market boundaries, virtual communities will act as distinct and coherent groups just as physical markets and nations do today. These cybercommunities or cybernations are a natural outgrowth of today's Internet societies, where the process of word-of-mouth dissemination of information is greatly facilitated by personal email, mailing lists, chat lines, newsgroups, and other discussion forums, which can occur almost concurrently and reach every corner of the globe. Sellers will want to know who participates in such virtual communities and how they interact.
In the virtual marketplace, consumers will learn about product quality from each other, while sellers observe consumers' reactions to their products and marketing strategies. What will be the implications of such learning by agents in a market? For one thing, unlike today's emphasis on strategic interactions between firms and nations, the electronic marketplace will make apparent the importance of firms' interacting with consumers and consumers' interacting with other consumers and firms. Specifically, consumers will not be myopic but will become strategic players in the market. Cybernations and cybercommunities will become powerful instruments in influencing prices, product quality, and competitive behaviors.
To counter this trend, firms will develop market strategies based on their interaction with consumers. Indeed, demand preferences can be manipulated, quality information (advertising) can be controlled, and reputation or brand loyalty can be cultivated, all by actively participating in virtual communities. Firefly (http://www.ffly.com) is an example where intelligent software agents observe, record, and process online data logged by users of various Firefly communities in an attempt to learn more about consumers. Processed or mined data results are then offered to producers who use Firefly communities as avenues for targeted advertising. Software agents may even offer a review of a new product using their knowledge about the preference of each community.
To succeed in this business venture, Firefly faithfully duplicates Internet communities. For example, there are newsgroups and chat areas for movie buffs, country music fans, or cartoonists. Such areas may be subdivided more finely by using a hierarchy of, for example, books, and then fiction vs. non-fiction, etc. It is also possible to group them based on different characteristics, e.g. by authors or writing style. A list of one's membership, and the intensity of participation, etc., will provide a detailed preference profile of the person. A book seller may find such a market segment and post a review himself or through Firefly's software agent acting like a member of the group. By observing the message exchange and downloading pattern, and by correlating this with sales and other data, the seller may modify the product, change its advertising strategy, or find another target group. Knowing that, consumers may also engage in strategic behaviors to influence the decisions of the seller.
The potential value of cybercommunities will be tempered by technical problems regarding the accuracy and usefulness of data gathered by software agents in cybercommunities. The window of time over which data is used to calibrate the preference profile of each community is an important consideration in a rapidly changing environment such as the Internet. Software agents need a substantial period of time to learn and match the preference of a group. In a rapidly changing market, however, the learning speed of agents may be inadequately slow to be helpful. The group may change its composition and membership, or the group as a whole may undergo a shift in preferences. Such dynamic changes may be eliminated by requiring a strict guideline to join a group. But if there is such a guideline in the first place, there will be no need to 'learn' about the consumers. On the other hand, too short a window may yield very unreliable estimates about the preferences.
Despite these potential issues, marketing differentiated and customized products will depend on information gathered in cybercommunities. Mass market products are well suited for mass media advertising. On the other hand, niche market products often are too costly to advertise on such a scale, although the initial lack of people knowing about and trying out the product will be detrimental to future sales (McFadden and Train 1996). For niche products and experience goods that consumers are weary of trying out, a discussion group composed of people with similar tastes would become a major source of product information. If someone tries out a new product and posts the result about its quality, all other members will value the information since they share the same tastes. And as we have seen earlier, the seller, as a business member or acting as a consumer, may offer its own review to influence the opinion or promote its product in order to induce some consumers to try it out.
6. Competition or Monopolization?
The globalization is one of many converging forces in the virtual economy. In addition to this market space convergence, products, through digitization, become indistinguishable by physical attributes alone. For example, newspapers, musical CDs, television programs, advertisements, stocks, bonds and monies all appear as ones and zeros in the digital world. What distinguish them is the way we use them. However, the flexibility of digital files and converging communications networks bring new characteristics to these products as well as the way we produce and consume them. In this world of convergence, traditional boundaries among products and industries are vanishing as fast as are spatial borders for markets. The opportunity arises for a firm to dominate many industries with related products, raising prices, reducing output and limiting consumer choices. Equally likely is an economy where firms become fierce competitors in all markets, lowering prices and raising quality and market efficiencies. Both consumers and governments must be vigilant and involved in the shaping of our future economy in order to assure the best possible outcome from the electronic commerce revolution.
Suppose that a firm is a dominant player in computer operating system and many application program markets. It may also extend its dominance in the last mile from the computer to the information infrastructure through networking software and access services. By constructing the network itself, it can integrate all aspects of the infrastructure necessary for virtual processes. It can establish itself as a significant player in content provision as well by cooperating with other content providers. Virtual contents consist of more than information products and services. For example, online payment services, online banking and digital currency services are necessary for the virtual market. Indeed, this computer and software giant may become the network provider, the issuer of international currency and the international banker.
A dominant player in the world digital currency market will provide the functions of the World Bank, IMF, international commercial banks, national governments issuing currencies, foreign exchange markets, and international wire and payment clearing services in addition to its roles as the international communications carrier and content provider. Such a firm must possess the reputation and capital necessary to convince consumers to hold its currency, just as the wealth and credibility of the U.S. government is the sole guarantee to those who hold dollars. The seigniorage associated with national currencies becomes a powerful magnet for potential profits. The process of vertical integration and monopolization in all these sectors of the worldwide economy has been unimaginable, but is becoming a reality driven by the convergence in markets and the relaxation in-or the lack of-regulatory market interventions.
Certainly, potential profits will also draw more competitors, resulting in an alternative scenario of an efficient, competitive economy where markets support many players and allocate resources efficiently. Decentralization or disintegration, for example, often eliminate inefficient mechanisms for resource allocation, induce better quality for products and services, and guarantee a level playing field for all players. An upstream monopolist such as local telephone companies benefits from increased demands by long-distance carriers in the downstream market since more long-distance calls result in more access charges. Similarly, efficient network services will increase demands for access devices such as modems, network software and computers. But if these two markets are integrated, the upstream monopolist has an incentive to raise its competitors' costs to access the upstream market in order to increase its market share in the downstream market. The economy suffers collectively from higher prices, lowered quality and inefficient resource allocation. A decentralized and competitive upstream market, on the other hand, will ferment active and efficient downstream markets. A competitive market for digital currency issuers, for example, will avail consumers with convenient payment options at lower prices and promote more online transactions.
Electronic commerce, by its own efficiencies, will also be able to provide competitive and effective marketplaces for products and services which are often monopolized in physical markets. For example, differentiated and customized products will offer more choices than a mass produced good, for which a firm with sufficient economies of scale has the cost advantage. Microproducts, applets and microbundles enable short-term contracts between suppliers and intermediaries and between retailers and consumers. Short-term contracts, in turn, reduce inefficiencies caused by quality uncertainty as we discuss in Chapter 4 of our book. Electronic payment systems based on micropayments and digital currency will facilitate selling microproducts in addition to bundling and subscription, for which existing payment mechanisms are adequate. Micropayments will also support a usage-based copyright payment system, enabling content sellers to meter and bill for small and large uses of their products. In short, electronic commerce enhances competition by its relentless drive toward efficiencies and open markets. The converging factors in electronic commerce are a two-edged sword. They open all markets for a single, powerful firm to dominate or for all firms to compete in each other's market.
7. Concluding Remarks
Whether you believe the future economy will be a conventional, monopolized world or a vibrant, competitive economy, various market forces are already in place to influence our economic lives in the next century. The virtual world on the surface parallels our physical world in many respects. The most important change it will bring lies in the way we will interact with each other and with products-i.e. virtual processes. Technological developments in the next twenty years will be substantial, but the seeds of the virtual world-virtual players, products, and processes-are already here. The virtual world that knows no physical boundaries turns out to be cybercommunities and cybernations. While these interest groups exist only virtually, in one sense they are an extension of today's segmented markets. The difference, of course, will be that these groups will have the means and reasons to be more coherent and will become a force to reckon with in the marketplace and in politics as well.
Unlike today's national currencies and payment methods which operate in spatially-delineated markets, digital currencies and payment systems will be customized for specific products or services and for online communities and markets concerning them. Monetary policies and regulations based on territorial boundaries have little meaning in this worldwide virtual economy. As with any digital product, the future of digital currency will be determined by the market demand and supply. Being a commodity market, then, economic researches should focus on the cost structure and pricing models for digital currencies as well as product differentiation and customization of money in order to present an effective framework for businesses and policy makers.
References
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Bernheim, B.D., and M.D. Whinston, forthcoming. "Incomplete contracts and strategic ambiguity." Forthcoming in American Economic Review.
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