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Organizational Dynamics
Springer Text s in Business and Economics Elect ronic Commerce A Managerial and Social Net works P…
maidul islam
Int ernet business models and st rat egies: Text and cases
Aust in Yu
Organizational Dynamics, Vol. 33, No. 2, pp. 161–173, 2004 ISSN 0090-2616/$ – see frontmatter
ß 2004 Elsevier Inc. All rights reserved. doi:10.1016/j.orgdyn.2004.01.004
www.organizational-dynamics.com
Product-Related
Evaluation
Search Transaction
Service-Related
Problem-Solving
Exhibit 1
Eli Lilly: Virtually Seeking Solutions—Worldwide
In 2001, pharmaceutical giant Eli Lilly was anticipating a big drop in sales. That was the year the patent
expired on its blockbuster drug Prozac, which accounted for 34 percent of Lilly’s annual sales. But rather than
launch a new drug, Lilly launched an Internet business—InnoCentive, LLC.
InnoCentive, as the name implies, provides incentives for innovation. It does so by providing a platform for
scientists from around the world to work in virtual communities to solve complex problems. The effort does not
just benefit Lilly, but provides a virtual, open source research and development (R&D) organization that any
member company can use.
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Here’s how it works: Drug companies, called ‘‘Seekers,’’ put up ‘‘Wanted’’ posters describing problems
that need addressing. Bounty-hunting scientists, labeled ‘‘Solvers,’’ sign confidentiality agreements that gain
them admission to a secure project room where they can access data and product specifications related to the
problem. If they solve the problem, they get a reward—around $25,000–$30,000 depending on the problem.
According to InnoCentive president and chief executive officer (CEO) Darren J. Carroll, what Lilly has done is
unusual for two reasons. First, by creating a global community of scientists, ‘‘We’re punching a hole in the side of
the laboratory and exposing mission-critical problems to the outside world,’’ says Carroll, ‘‘It’s using the Net to
communicate, collaborate, and innovate.’’ Second, it makes it possible for scientists to essentially become
freelancers. According to Carroll, ‘‘Free agency has never been an option in the hard sciences—until now.’’
Eli Lilly & Company has used the Internet to the cost structures of certain industries, is a
form a virtual platform where top scientists key feature of the digital economy. Applica-
help drug companies solve complex pro- tions of Internet-based technologies have
blems. already had an enormous impact. Giga Infor-
Many products involve both a service mation Group, Inc. estimates that the cost
and a product component; therefore, both savings from business use of e-commerce
problem solving and evaluation may be will reach $1.25 trillion by the mid-2000s.
needed. Dell Computer’s Web site is an There are numerous examples of how the
example of a site that has combined the Internet is both lowering the cost of and
benefits of both. By creating a Web site that speeding up the transaction process. Auc-
allow for customization of individual com- tions of various sorts, from raw materials
puters, they address the unique concerns of used in manufacturing to collectibles sold
customers ‘‘one computer at a time.’’ But the on eBay, facilitate the process of arriving at
site also features a strong evaluative compo- mutually agreed-on prices. Services such as
nent because it allows users to compare the Paypal provide a third-party intermediary
costs and features of various options. Shop- that facilitates transactions between parties
pers can even compare their customized who have never met. Amazon’s One-Click
selection to refurbished Dell computers that technology, which allows for very rapid pur-
are available at a substantially lower cost. chases, and Amazon’s overall superiority in
managing order fulfillment has made its
transactions process rapid and reliable. In
Transaction Activities
fact, Amazon’s success today can be attrib-
Transaction refers to the process of complet- uted to a large extent to the fact they have
ing the sale, including negotiating and agree- sold this transaction capability to other com-
ing contractually, making payments, and panies such as Target Corp., Toys ‘‘R’’ Us
taking delivery. Numerous types of Inter- Inc., and Borders Books & Music.
net-enabled activities have contributed to These four factors are primary ways
lowering this aspect of overall transaction that organizations go about adding value.
costs. Managing costs, and even changing Exhibit 2 describes several examples of how
Exhibit 2
Value Adding in the Auto Industry
The auto industry jumped on the Internet bandwagon in a big way. One of the early successes was
Autobytel, and many on-line auto sales Web sites quickly followed. The majority of them have now fizzled
away. The big auto makers also made huge investments in the Internet. Ford was especially aggressive and
the automobile industry and car buyers have detailed and attractive content. But the
used each of these four activities to benefit expense did not generate sales. Content only
their own value-adding efforts. adds value if it contributes to the overall
value proposition. As a result Garden.com
failed in early 2001 (but the name is still being
Content as a Source of
used by the Burpee company, a 125-year-old
Competitive Advantage
supplier of garden products who bought
There are other factors that can be important rights to the name).
sources of competitive advantage. One of the Three types of content can improve the
most important of these is content. The Inter- value proposition of a Web site—customer
net makes it possible to capture vast amounts feedback, expertise, and entertainment pro-
of content at a very low cost. REI.com, for gramming:
example, a provider of recreational equip- Customer feedback: Buyers often trust
ment and apparel, has over 78,000 items what other buyers say more than a com-
described on its 45,000-page Web site. But pany’s promises. One type of content that
firms have not always managed content in can enhance a Web site is customer testimo-
ways that add value. Garden.com, a site that nials. Remember the leather sofa in the exam-
started strongly in 1999 and raised enormous ple above? Even though individuals can’t
venture capital, spent millions on creating feel and smell a sofa on-line, the unbiased
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testimonials of other buyers can build con- sharing expert knowledge help build commu-
fidence and add to the chances that the pur- nity in industry or professional groups.
chaser will buy on-line ‘‘sight unseen.’’ This Entertainment programming: The Inter-
is one way that content can be a source of net is being used by more and more people
competitive advantage. Being able to interact as an entertainment medium. With technol-
with like-minded customers with shared ogies such as streaming media, which
interests by reading their experiences or allows the Internet to send television-like
hearing how they have responded to a new images and sound, computers can provide
product builds a sense of belonging that is everything from breaking news to video
otherwise hard to create. games to on-line movies. In fact, a study
Expertise: The Internet has emerged as a by the Pew Internet & American Life Project
tremendously important learning tool. Fifty- indicates that among people using high-
one percent of users compare the Internet to a speed broadband service, TV viewing is
library. The prime reason many users go to the down, and on-line activity has increased.
Web is to gain expertise. Web sites that pro- One reason is because the technology is
vide new knowledge or unbiased information interactive which means that viewers don’t
are highly valuable. Additionally, the pro- just passively watch but use the Web to
blem-solving function often involves educat- create art or play on-line games. Businesses
ing consumers regarding options and have noticed this trend, of course, and are
implications of various choices. For example, creating Web content that is not just infor-
LendingTree.com, the on-line loan company, mative but entertaining. Exhibit 3 tells how
provides a Help Center that includes ex- on-line game developer Skyworks Technol-
tensive information and resources about ogies is using games to increase product
obtaining loans, maintaining good credit, sales.
Exhibit 3
‘‘Advergaming’’: Making Advertisements Interactive and Fun
Video games were popular well before the Web came along. But new digital technologies have made it
possible to feature some of the best games on-line. Combine this with advertisers’ need to use the Net’s
interactivity to make on-line ads more interesting and what do you get: Advergaming—on-line games that
weave advertisements into the experience. Here are some examples:
A game designed for Pepsi involves an auto race in which the goal is to recover a stolen shipment of
Mountain Dew Code Red. The top 100 gamers received a free case of the soft drink.
Some games make you buy something to play. To play the Pebbles Big Barney Chase game, players
must answer a question; to learn the answer, you have to purchase a box of Post Cereal.
Candystand.com, a Web site developed by Skyworks to promote Life Savers for Kraft Foods, features
dozens of card, racing, and arcade games and ranks as the sixth most popular gaming destination on the Web.
According to Skyworks Technologies founder Garry Kitchen, advergaming can leave a deeper and more
positive impression than television commercials. The idea is catching on—in a recent year, Skyworks made
$4.3 million in revenues. Industry analyst Kent Allen of the Aberdeen Group expects the trend to continue,
especially among consumer packaged-goods marketers. ‘‘The consumer guys are starting to understand
advergaming,’’ says Allen. ‘‘They’re realizing it’s a great way to connect with people.’’
and so forth. Further, the expertise function These three types of content—customer
is not limited to consumer sites. In the case feedback, expertise and entertainment
of B2B businesses, Web sites that facilitate programming—are potential sources of
166 ORGANIZATIONAL DYNAMICS
competitive advantage. That is, they create for putting buyers and sellers together, eBay
advantages by making the value-creation earns a commission. Reverse auctions run by
process even stronger. Or, if they are companies such as FreeMarket.com have
handled poorly, they diminish perfor- also gained importance by generating sub-
mance. Quality content that is strategically stantial savings in procurement costs for
deployed provides companies with a way to business-to-business users.
effectively differentiate their product or ser- Advertising-based models are used by
vice offerings. This can be especially impor- companies that provide content and/or ser-
tant in an on-line environment where the vices to visitors and sell advertising to busi-
opportunities to differentiate may be con- nesses that want to reach those visitors. It is
strained compared with the opportunities similar to the broadcast television model in
to compete on the basis of low costs. which viewers watch shows produced with
Next, we turn to the topic of Internet advertising dollars. A key difference is that
business models. How the Internet creates on-line visitors can interact with both the ads
value depends to a great extent on how a and the content. Large portals such as yahoo.-
value proposition is enacted. Business mod- com are in this category as well as specialty
els provide a guide to the effectiveness of the portals such as iNest.com, a portal that pro-
value-adding process. vides services for buyers of newly constructed
homes. ePinions.com, a recommender system,
is just one example of the many types of
content that are often available.
INTERNET BUSINESS MODELS
Markup-based models are used by busi-
The Internet provides a unique platform or nesses that add value in marketing and sales
staging area for business activity which has (rather than production) by acquiring pro-
become, in some ways, like a new market- ducts, marking up the price, and reselling
place. How do firms conduct business in this them at a profit. Also known as the merchant
new arena? One way of addressing this ques- model, it applies to both wholesalers and
tion is by describing various Internet busi- retailers. Amazon.com is the most well-
ness models. A business model is a method known example in this category. It also
and a set of assumptions that explains how a includes bricks and mortar companies such
business creates value and earns profits in a as Wal-Mart Stores, which has a very suc-
competitive environment. Some of these cessful on-line operation, and vendors whose
models are quite simple and traditional even products are purely digital, such as fonts.-
when applied in an Internet context. Others com, which sells downloadable fonts and
have features that are unique to the digitally photographs.
networked, on-line environment. In this sec- Production-based models are used by
tion, we discuss seven Internet business companies that add value in the production
models that account for the vast majority process by converting raw materials into
of business conducted on-line. value-added products. Thus, it is also
Commission-based models are used by referred to as the manufacturing model.
businesses that provide services for a fee. The The Internet adds value to this model in
business is usually a third-party intermedi- two key ways: first, it lowers marketing costs
ary and the commission charged is often by enabling direct contact with end users.
based on the size of the transaction. There Second, such direct contact facilitates custo-
are many different types of commission- mization and problem-solving. Dell’s on-line
based businesses. The most common type ordering system is supported by a state-of-
is a brokerage service such as a stockbroker the-art customized manufacturing process.
(e.g., ameritrade.com) or real estate broker Travelocity uses its rich database of travel
(e.g., remax.com). This category also includes options and customer profiles to identify,
auction companies such as eBay. In exchange produce, and deliver unique solutions.
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Referral-based models are used by a third-party intermediary and earns fees by
firms that steer customers to another com- referring viewers to other sites through its
pany for a fee. One type is the affiliate model affiliate programs. As noted earlier, Ama-
in which a vendor pays an affiliate a fee each zon.com not only earns revenues by reselling
time a visitor clicks through the affiliate’s marked-up merchandise but also has gener-
Web site and makes a purchase from the ated income by charging fees for providing
vendor. Many name brand companies use expertise based on its transaction capabil-
affiliate programs. For example, Wedding- ities. Major manufacturers such as Ford
Channel.com, which provides a bridal reg- Motor Co. and Dell Computer not only use
istry where wedding guests can buy gifts their sites to manage procurement with sup-
from companies such as Tiffany’s, Macy’s pliers, but also to advertise their services and
or Crate & Barrel, receives a fee each time provide consumers with information that is
a sale is made through its Web site. Another used to order customized products.
referral-based example is Yesmail.com, Table 1 summarizes the key feature of
which generates leads using e-mail market- each Internet business model, suggests what
ing. role content may play in the model, and
Subscription-based models are used by addresses how the four value-adding activ-
businesses that charge a flat fee for providing ities—search, evaluation, problem-solving,
either a service or proprietary content. Inter- and transaction—can become sources of
net service providers are one example of this competitive advantage.
model. Companies such as America On-line Clearly, Table 1 provides a framework
and Earthlink supply Internet connections for exploring means by which a company can
for fees that are charged whether buyers enhance its sources of competitive advan-
use the service or not. Subscription-based tage. By using Internet-specific value-adding
models are also used by content creators such activities in the context of viable business
as The Economist or New York Times. Although models, many new avenues for using the
these recognizable brands often provide free Internet to add value may come to light.
content, only a small portion is available free. Firms seeking to add value by using Internet
The Economist, for example, advertises that 70 capabilities might ask:
percent of its content is available only to How has the Internet affected our
subscribers. value-adding processes? Is there some
Fee-for-service-based models are used aspect of our value chain that needs to
by companies that provide ongoing services be reevaluated or realigned? Are we
similar to a utility company. Unlike the com- relatively strong in our use of the
mission-based model, the fee-for-service Internet, or has it exposed new weak-
model involves a pay-as-you-go system. That nesses that are making us vulnerable?
is, activities are metered, and companies pay How might our firm make better use
only for the amount of service used. Applica- of search, problem-solving, evalua-
tion service providers fall in this category. tion, or transaction capabilities to
For example, eProject.com provides virtual improve its value proposition or save
work space where people in different physi- costs internally?
cal locations can collaborate on-line. Users How can we enhance the content of
essentially rent Internet space, and a host of our Web site with testimonials, exper-
tools that make it easy to interact, for a fee tise, or entertainment programming in
based on their usage. order to strengthen the usefulness of
It is important to keep in mind that many the Internet?
companies combine these models to achieve Has the digital economy created new
competitive advantages. For example, a com- opportunities that our firm can seize
pany such as LendingTree not only sells by deploying its unique competencies
advertising but also earns a commission as and capabilities? Conversely, do we
168 ORGANIZATIONAL DYNAMICS
TABLE 1 INTERNET BUSINESS MODELS
SOURCES OF COMPETITIVE
TYPE FEATURES AND CONTENT ADVANTAGE
Commission-based Commissions charged for brokerage or intermediary Search
services. Adds value by providing expertise and/or Evaluation
access to a wide network of alternatives. Problem-solving
Transaction
Advertising-based Web content paid for by advertisers. Adds value by Search
providing free or low cost content—including Evaluation
customer feedback, expertise, and entertainment
programming—to audiences that range from very
broad (general content) to highly targeted
(specialized content).
Markup-based Reselling marked-up merchandise. Adds value Search
through selection, distribution efficiencies, and by Transaction
leveraging brand image and reputation. May use
entertainment programming to enhance sales.
Production-based Selling manufactured goods and custom services. Search
Adds value by increasing production efficiencies, Problem-solving
capturing customer preferences, and improving
customer service.
Referral-based Fees charged for referring customers. Adds value by Search
enhancing a company’s product or service offering, Problem-solving
tracking referrals electronically, and generating Transaction
demographic data. Expertise and customer feedback
are often included with referral information.
Subscription-based Fees charged for unlimited use of service or content. Evaluation
Adds value by leveraging strong brand name, Problem-solving
providing high quality information to specialized
markets or access to essential services. May consist
entirely of entertainment programming.
Fee-for-service-based Fees charged for metered services. Adds value by Problem-solving
providing service efficiencies, expertise, and Transaction
practical outsourcing solutions.
face new threats because of the adop- field, referred to more broadly as customer
tion of Internet technologies by our relationship management (CRM). But sales-
competitors? force.com has taken a slightly different
In addition to what we are now doing approach. Instead of installing software on
with our Web site, how might we each user’s PC, salesforce.com rents out its
utilize other business models and/or service for $65 to $125 per user. Users access
combine complementary activities to the software by going on-line; accounts are
add greater value? managed and maintained on the Internet.
Questions such as these can help man- According to Marc Benioff, CEO of salesfor-
agers evaluate new avenues for adding value ce.com, ‘‘We’re a utility . . . We’re like elec-
from using digital and Internet technologies. tricity. You only pay us if you use us.’’ Thus,
Additionally, there are a number of illustra- salesforce.com has utilized a fee-for-service
tive examples of firms that have used these business model to create a business system
value-adding techniques in unique ways. that is seriously challenging Oracle and Sie-
An interesting example is the fast-grow- bel Systems, its close competitors. With other
ing company salesforce.com, a provider of enterprise software, there is typically a large
sales management services. Many companies upfront expense and additional training and
have jumped into the sales management consulting is required to get it working. This
169
makes the salesforce.com solution especially Thus, the Internet is having a strong
attractive to small and young firms that are impact on many business sectors. In some,
trying to hang on to their cash. The company it is clearly creating opportunities to attract
has become successful by developing a sim- customers and generate new revenues. But
ple business model which provides a solu- successfully creating wealth requires that
tion that is both differentiated and relatively companies identify which technologies and
low cost to the longstanding problem of sales solutions can be enacted to add value. Mon-
management. It is creative combinations itoring the effect of these technologies and
such as this that are helping Internet compa- the changes that they stimulate will become
nies develop strong new value propositions. an increasingly important task for strategic
There is a contrasting view, however, to managers as firms adjust to the new practices
the perception that enlightened applications and possibilities of the Internet-enabled digi-
of Internet technologies are creating value. At tal economy.
the industry level, what may be good for a
few companies has been devastating for
others. That is, there are whole industries
CONCLUSION
that have lost value because of adopting
Internet solutions. The Internet and digital technologies have
Consider the following example: Makers created new opportunities for firms to create
of color-printed cardboard boxes such as value. This paper has examined ways in
those used to package frozen dinners and which companies are using the Internet to
breakfast cereals have been forced, in add value. Four value-adding activities that
essence, to participate in reverse auctions have been enhanced by Internet capabilities
in order to make sales. Reverse auctions were addressed—search, evaluation, prob-
get their name from flipping the traditional lem-solving, and transaction. Search activities
‘‘one-seller, many-buyers’’ model to create include processes for gathering information
auction systems where many sellers bid for and identifying purchase options. Evaluation
the business of one buyer. With traditional activities refers to the process of considering
auctions, the bidding drives prices up; but alternatives and comparing the costs and ben-
with reverse auctions bidding drives prices efits of various options. Problem-solving
down. In many industries, including the activities include identifying problems or
printed cardboard box industry, this bidding needs and generating ideas and action plans
process has driven prices down to levels that to address those needs. Transaction activities
were unthinkable prior to the advent of Inter- involve the process of completing a sale,
net-based auction processes. Some Internet including negotiating and agreeing contrac-
observers claim that Internet-enabled reverse tually, making payments, and taking delivery.
auctions not only create economies, but also These four activities are supported by three
allow small suppliers who would not other- different types of content that Internet busi-
wise have a chance to participate to be nesses often use—customer feedback, exper-
included in the bidding. But cardboard box tise, and entertainment programming.
companies and manufacturers of many other Internet business models provide a con-
industrial products claim that these Internet text for enacting value-adding activities.
techniques have increased the bargaining Seven business models have been identified
power of buyers to such a degree that their that are proving successful for use by Internet
industry has been seriously compromised. firms. These include commission, advertising,
The long-term impact of this intense price mark-up, production, referral, subscription,
competition is uncertain, but to the extent and fee-for-service based models. Strategic
that it damages whole industries, it is doubt- use of value-adding activities, as well as the
ful whether the net effect will be to create seven business models, can help firms build
value across the whole economy. competitive advantages and contribute to
170 ORGANIZATIONAL DYNAMICS
profitability. Firms have also found that com- the practices and models that will enhance
binations of the Internet business models can and not detract from a firm’s value proposi-
contribute to greater success. tion is central to using the Internet to create
Firms that want to benefit from these wealth.
new value-adding approaches need to ask
how the Internet is affecting their current
operations and how they might effectively
implement Internet capabilities. Identifying
171
SELECTED BIBLIOGRAPHY
Michael E. Porter popularized the concept of 2nd ed. (Burr Ridge, IL: McGraw-Hill, 2003).
the ‘‘value chain’’ in his seminal book, Com- Table 1 draws on insights from these authors
petitive Advantage (New York: Free Press, as well as the work of Paul Timmers, Electro-
1985). Here, he described two different cate- nic Commerce (New York: John Wiley & Sons,
gories of activities: primary activities Ltd., 1999) and Michael Rappa, ‘‘Business
(inbound logistics; operations; outbound Models on the Web,’’ http://digitalenterpri-
logistics; marketing and sales; and service) se.org/models/.
and support activities (procurement, technol- For more information about Lilly’s Inno-
ogy development, human resource manage- Centive program, refer to: B. Breen, ‘‘Lilly’s
ment, and firm infrastructure). By exploring R&D Prescription,’’ Fast Company, 2002; and
relationships among activities within a firm as www.innocentive.com. Information about
well as between the firm and a more encom- ‘‘advergaming’’ can be found in M. Athitakis,
passing value chain that includes suppliers, ‘‘The Entertainer,’’ Business 2.0, May, 2003; P.
customers, and alliance partners, a greater Suciu, ‘‘Mobility Takes the Forum,’’ GameSpy,
understanding of how value is created and May 2, 2003; and, www.skyworkstech.com.
competitive advantage is achieved is possible. Information about how the auto industry uses
Charles Stabell and Oystein Fjeldstad, in Stra- the Internet to add value was drawn from V.
tegic Management Journal (May 1998) built on Postrell, ‘‘How Much is that Civic On-Line?’’
Porter’s seminal work by describing value New York Times, April 24, 2003; M. Stepanek,
shops, value chains, and value networks to M ‘‘New Routes in the Internet Car Business,’’
broaden Porter’s framework beyond manu- CIO Insight, January 23, 2003; and N. Wing-
facturing firms and include organizations that field and K. Lundegaard, ‘‘eBay is Emerging
predominantly use intensive technologies as Unlikely Giant in Used-Car Sales,’’ Wall
(e.g., hospitals) and mediating technologies Street Journal, February 7, 2003.
(e.g., real estate brokerages). Fig. 1 draws on Some of the other articles and/or Web
the work of Stabell and Fjeldstad, as well as sites that we have drawn on include: ‘‘B2B
insights from Ming Zeng and Werner Rein- E-Commerce Headed for Trillions.’’ CyberA-
artz, in California Management Review (Winter tlas, March 6, 2002 (www.cyberatlas.com);
2003) who addressed the role of the Internet in www.shop.org.; P. Evans and T. S. Wurster,
the value-adding process. Michael Porter also Blown to Bits (Cambridge, MA: Harvard Busi-
addressed how the Internet influences the five ness School Press, 2000); Q. Hardy, ‘‘All Eyes
competitive forces in ‘‘Strategy and the Inter- on Google,’’ Forbes, May 26, 2003 (www.for-
net,’’ Harvard Business Review (March 2001). bes.com); C. Bayers, ‘‘The Last Laugh,’’ Busi-
For a fuller discussion of the seven busi- ness 2.0, September 2002; A. Weintraub, ‘‘E-
ness models that are addressed in this paper, Assets for Sale —Dirt Cheap,’’ BusinessWeek
refer to Allan Afuah and Christopher L. e.biz, May 14, 2001; and L. Tischler, ‘‘Vote of
Tucci, Internet Business Models and Strategies, Confidence,’’ Fast Company, December 2002.
173