Disintermediation

The Production Chain and Disintermediation

What problems might arise from shifting sales to the Internet? To understand the issues in EC, particularly B2C, you need to think about the role of retailers. In a traditional model, manufacturers produce products and then sell them to wholesale dealers. These dealers then handle any export-import issues including shipping and customs. Eventually the products are delivered to retailers who sell to customers. Companies at each step in the process increase the price—sometimes by doubling it. Three or four steps removed from the manufacturer, a retail price for an item might be four or even eight times higher. For instance, a Chinese manufacturer might sell a tool to a wholesaler for $6 but when it hits the retail shelf at an American store, it might sell for over $35 or more.

This large price difference gives incentive to the manufacturer to sell directly to consumers. This disintermediation of the wholesaler and retailer becomes possible with e-commerce because consumers can easily find the manufacturer. Some companies do make a point of “cutting out the middleman to sell directly to consumers. With EC and global shipping, it is possible to take individual orders and ship directly to the consumer. However, what purpose is served by retailers?

The current system of manufacturers, wholesalers, and retailers came about for more reasons than just distance and searching. In particular, a key reason for manufacturers selling to wholesalers is because they produce items in bulk and wholesalers purchase the items on contract as they are made. Selling to consumers means waiting for individual sales to trickle in, which also requires storing products.

Additionally, many manufacturers do not want to deal with thousands (or millions) of individual customers. It is easier to specialize in manufacturing and let large retailers handle the details of payment methods, returns, and customers who cannot make up their minds.

The situation is more complex for service industries. Consider the situation of airlines. In the 1960s and 1970s, airlines created giant reservation systems to handle flight bookings. The system consisted of the airlines’ massive central computers and databases and travel agent terminals connected by a custom network. It was too expensive for customers to connect directly. Also, the systems were hard to use and travel agents needed special training. Agents were paid a commission based on the value of the flights booked through the reservation system paid by the airlines.

With the advent of frequent-flyer miles, airlines encouraged consumers to book flights with the airline itself, bypassing the travel agent and saving the cost of the commission. But it is difficult to search for flights using the telephone. The Internet changed everything. Several travel sites and the airline sites themselves make it easy to find flights, compare prices, and purchase a ticket any time of day without the assistance of an overworked travel agent or salesperson. Tickets are merely electronic reservation numbers, where you simply show appropriate identification at the airport.

For a few years, most of the airline industry relied on a few companies to provide data and reservation services to various Web sites. These companies were the same reservation systems originally created by the airlines, including Sabre created by American Airlines, and spun off. In 2010, the disintermediation extended further when American Airlines, in a dispute with the reservation companies (including Sabre), pulled all of their data from the online systems and required customers to book online directly with the airline.

Southwest Airline had long followed a similar practice—to avoid the fees paid to the reservation companies. One effect of this change is that it is more difficult for consumers to find and compare flight costs. If all airlines require individuals to connect directly, a search would require checking every airline separately. Eventually, a consolidator might be able to search and display data from multiple sites, but the airlines will be reluctant to pay the fees, so the consolidator would have to find another way to make money. Eventually, American Airlines relisted its flights on the major booking systems, but the issue of fees is likely to arise again.

One significant challenge with disintermediation is the risk of cutting off the existing sales channel. Removing an intermediary can increase profits and can be used to reduce prices to capture more market share. But is the intermediary a critical component? Will sales remain if the channel is removed? Are customers ready to switch to direct purchases? Some firms attempt to do both: keep sales through traditional channels and also provide direct e-commerce sales through a Web site. But they minimize competition and appease the retailers by charging the suggested retail price on the Web site. So, consumers can often find the product cheaper at a local store—which is willing to offer a discount on the list price.