The Thing with Feathers

The key to a successful transition lies in continued innovation. And innovative technological advancement thrives on hope. When hopes soar, imagination accepts few boundaries, what was once unimaginable becomes suddenly mundane, and technology advances in leaps and bounds.

Every technological transformation has expanded opportunities and incentives and improved the overall human condition. Refrigeration, indoor plumbing, heating, air conditioning, medicine, food safety, and many other modern “necessities” began as luxurious hallmarks of wealth. They worked their way throughout society, reaching more and more people every year and every generation. At times, we even felt that these one-time luxuries had become so important that we accepted societal responsibility to make them universal. “Trickle down” theories are inevitable for long-term technology, if not for short-term economics. Recent scientific advances in the medical, agricultural, and information sciences may still cluster among the wealthiest societies’ wealthiest members. But they’ll eventually work their way downstream. The only question is at what speed. That’s the true beauty of network economics. There’s more than enough to go around. Expand opportunities and raise the floor. Expand incentives and raise the ceiling. They are emphatically not contradictory goals—at least not in the long-term. The broader our concept of societal responsibility, the higher we raise the floor, and the fewer constraints we put on the ceiling, the richer we all will become.

But these advances can flourish only in an environment of hope. Some work will be necessary to restore that hope, and the information sector is a fine place to look for guidance. As it broadens its reach, we must wonder how it will reshape society, beginning with industry and com­merce, where its impact has been most pronounced. Though we know that the information sector reduces transaction costs, we’ve only seen those reductions in a few high-profile places. We need to consider what happens as increasing numbers of industries avail themselves of this new infrastructure channel. We must revisit the Internet to understand the New Channel paradigm. Because as New Channel thinking works its way throughout the economy, transaction costs will fall, we’ll become a bit richer one transaction at a time, and we’ll realize that there is plenty of cause for hope. The information sector can help us raise the floor, raise the ceiling, and let the luxuries of the ceiling become the necessi­ties of the floor. And if we’re lucky, they’ll even trickle down on Inter­net time.

The key message of New Channel thinking is that the Internet changes the economics of information. Information that once was hard to find and expensive to collect became so cheap that it created the contempo­rary problem of information overload. The timeless challenge of col­lecting desirable information morphed almost overnight into the chore of discarding useless information. In the Internet-enabled world, collec­tion is often (though not always) trivial, but finding a coherent story amidst a flood of data is trickier. Filtering has replaced collection as the key activity of information professionals.

By reducing information costs, the Internet provides a new way for firms to communicate with each other, with their customers, and with potential new customers—in short, a new channel important to com­merce. Any other benefits of the Internet derive from this single enabling mechanism. Because information costs are a form of transaction costs, the Internet moves us closer to a transaction cost-free world.

As a result, we’re unlikely to see a rapid, rampant restructuring of the industrial terrain. We are likely, however, to see intellectual ferment among normally staid managers in mature industries. Because the Inter­net changes the economics of information, they’ll be forced to reassess a number of transaction types that once appeared unprofitable. For some, the lack of profitability may have arisen from the expense of collecting and/or disseminating information—in other words, a cost imposed by the limitations of information technology. In those instances, the Internet is likely to generate cost-saving efficiencies that render these transactions both viable and profitable. This change, in turn, will have a ripple effect on all other mechanisms that companies have long used to transact the business in question. Relative efficiencies, price/quality trade-offs, turnaround times, and the degree of customization may all come into play. Some existing channels may disappear, some may reduce their prices, some may integrate the Internet to form hybrid “brick-and- click” channels, and some may remain unchanged.

Changes in the economics of information change the relative merits of various types of transactions. Different industries will feel this effect in different ways.¹¹ In any industry, some companies may choose to rely exclusively on the Internet, others may ignore it, and still others will fall somewhere between these extremes. Each level of Internet usage will allow competing companies to offer a distinct level of service under a different cost structure. Consumers will then be free to choose among them. And that, in a nutshell, is the New Channel paradigm.

To apply this paradigm, we must realign the questions that we ask about the Internet. Bob Litan and Alice Rivlin got us started by chairing a two-day conference in September 2000 featuring early New Channel thinkers. Now, they probably didn’t know that they were New Channel thinkers; the significance of the paradigm shift may not yet have been clear. But whether or not they realized that their analyses were a radical departure from virtually everything that preceded them, they laid out many foundational questions of New Channel analysis:

^• Is the [Inter]net just a new way to communicate—an alternative to phone or fax or airmail—and thus not likely to have a fundamental impact on the func­tioning of the economy?

^• What does it mean for the importance of the Internet that investors were willing to pour billions into Internet companies with dubious earnings in the late 1990s only to find many of them virtually worthless by the end of 2000?

^• Will the Internet prove to be a major economic phenomenon, significantly increasing productivity and enhancing the prosperity of average wage earners?

^• Will the net alter the structure of industries and the size of companies, while enriching the variety of products and services available to consumers and their ease in obtaining them?¹²

Litan and Rivlin’s study addressed the Internet’s impact on the economy as a whole. But the key to that impact lies in understanding the behav­ior of people and companies that combine to generate that overall effect.

^• The potential of the Internet to enhance productivity growth over the next few years is real.

^• Much of the impact of the Internet may not be felt in e-commerce per se, but in lower costs for quite mundane transactions that involve informa­tion flows—ordering, invoicing, filing claims, and making payments—across a wide range of existing “old economy” sectors, including health care and government.

^• The Internet produces considerable scope for management efficiencies in product development, supply chain management, and a variety of other aspects of business performance.

^• The Internet will enhance competition, both increasing efficiency and reducing profit margins throughout the economy, but the profit squeeze itself should not be counted as a productivity enhancement.

^• The Internet is improving consumer convenience, increasing choices, and leading to other benefits that may not be readily measured, or if they are, may show up as productivity gains in industries or sectors other than those in which the savings may be initially generated.¹³

In other words, they only were able to measure some of the Internet’s benefits.

The key message is that balance-sheet analyses don’t apply to critical infrastructure. Yet even with that general caveat in place, Litan and Rivlin’s teams still were able to find significant savings. The Internet may not generate a New World of inevitable monopolists, but it should gen­erate enough savings and enough winners to reignite our hope in the future. Those winners are well worth looking for, and New Channel analysis will help us find them. And when we do, we’re likely to find— as Litan and Rivlin did—that “[our] conclusions rest on a far firmer foundation than... the many (now defunct) dot.com firms that so pop­ulated the business landscape and garnered so much attention from the media only a short time ago.”¹⁴

We’re also likely to find ourselves back where we started, by noting that if you want to start a profitable company, you’d better be able to answer three questions: What’s your product? What makes your product special? How are you going to use that “special quality” to generate profits? The first time we hit these questions, Tom Friedman heralded Lyle Bowlin as the David who would slay Goliath Amazon. Back when we thought of the Internet as a New World, it was just a cute story. Now that we see the Internet as a New Channel, we’re going to have to come up with answers. Due diligence is back in style.

Of perhaps even greater importance than due diligence, however, is honest reflection. If we want the future to be better than the past, we must understand why the past unfolded as it did. The Internet invest­ment bubble is an interesting story, but without a focus on the future it’s just that: a story. It’s easy to dismiss it as irrationality, exuberance, mania, alchemy, or simply a Ponzi scheme. All of those things may be true, but they’re also incomplete. I’d hate to dismiss two years that changed the world as a case of America getting excited, greedy, and ultimately silly. I prefer to believe that it contained some important lessons about this still-new and intriguing medium known as the Internet.

The bubble built the Internet. We held a lottery using Web sites as tickets. While a few lucky winners became billionaires, we as a society emerged with a functioning commercial information infrastructure. We may have endured a roller coaster ride to get it, but in the long run we accomplished something long considered impossible: we developed infra­structure with minimal governmental input. In all fairness, of course, without the government, we would have had nothing upon which to build. R&D investments in twenty-plus years of the ARPANET provided the framework for the commercial Internet. Ascribing the Internet to “pure” capital markets and entrepreneurship would be highly disingen­uous. It is fair to say, though, that the government provided both a prac­tical and a legal framework within which investors and entrepreneurs could interact. The private sector then built around it a full-fledged medium for communication and commerce. Would that we could find a comparable formula for improving our other infrastructures.

Perhaps the most important lessons of the bubble, though, are those that take the greatest effort to extract. Thanks to the nationwide (or global) quest for Internet gold, we’ve been able to accumulate volumi­nous empirical data about the Internet. Every Internet venture launched during the bubble had a business model based on little more than a hunch. While entrepreneurs and venture capitalists (VCs) prided them­selves on their ability to predict likely successes and failures, they turned out not to be very good at it after all. Their poor performance is hardly surprising. They made all of their decisions in an experiential vacuum. At best, they reasoned by weak analogy to other technologies that bore some cosmetic similarity to the Internet. The Internet community’s famed laissez faire attitude was a matter of practical necessity. None of them knew what they were doing because they had no reliable data on which to base their decisions.

The bubble changed all that. We’ve been privy to the inner workings of more Internet approaches to more sectors of commerce than we pos­sibly could have imagined. We now know a lot about what works, what doesn’t—and if we’re willing to think about it, why. We’ve gained sig­nificant insights into the nature of positive feedback, the need for com­mitment, the challenge of maintaining customer loyalty, the value of branding, the ease of entry, and above all the importance of viable busi­ness plans outlining credible paths to profitability. The amount that we now know about e-commerce—a phenomenon still less than ten years old—is truly remarkable. Now we must apply that knowledge.

The New Channel paradigm provides the framework for that appli­cation. And perhaps the single most important key to appreciating the New Channel view of the world lies in remembering that incumbents don’t like losing their customers. As soon as they see a new entrant— Internet-based or otherwise—beginning to make inroads into their markets, they’re likely to come out fighting. This reaction always has occurred in competitive markets, and it always will. It’s simply the nature of the beast—and the essence of competition. That competition, in turn, will necessarily rest upon the infrastructure that we build for it.