MD253 / MK252 Electronic Commerce Feb. 15, 2006 Channel flux: channel pressure, digital music network effects, CEIs, and auction systems

Issues Covered Channel Pressure –Power & partners, pressure & innovation limits New Channels & Media Industry Disruption Network Effects –the secret sauce of tech markets New Intermediaries –examples, impact, threats, market creation Auction Models –markets of first choice and last resort

Channel Conflict customersuppliercustomer Traditional Retailers (small) Distributors customer Internet Retailers customer Traditional Retailers (big box)

“We recognize that a vendor has the right to sell through whatever distribution channels it desires. However, we too have the right to be selective in regard to the vendors we select and we trust that you can understand that a company may be hesitant to do business with its competitors.” HomeDepot memo to suppliers

Major Labels in Crisis 3 Years: 26% Sales Drop Online piracy CD piracy Shrinking retail space Competition from other media Music Quality

Traditional Client/Server vs. BitTorrent More Computers Require More Bandwidth Customers Distribute Content

Innovation effect Lowers competition with established standard Increases innovation within standard buyers sellers Users (Windows, PS2) Developers (programs, game titles) members Understanding Network Effects (a.k.a. Network Externalities, Metcalfe’s Law) When present, product or services become more valuable as its installed base expands. Why? Users crave… Exchange opportunities Stability Extrinsic Benefits Characteristics: Early competition, bandwagons, monopolistic tendencies ‘Best’ products don’t always win.

Channel Extending Intermediaries suppliercustomer CEI supplier customer Search for opportunities to add value: e.g. high customer search costs, switching costs, low customer satisfaction Wield new power by consolidating traditional buyers & customers. Become the first-line interface with consumers.

Auction Formats Liquidation Auctions: (e.g. Priceline) supplierscustomers auction Market Efficiency Auctions: (e.g. eBay) Seek lowest price on widely available goods and services auction disincentives to use auction shrink supply over time Seek first to maximize existing channels & reduce inventory supplierscustomers Seek access to unique / rare products or services incentives to use auction increase supply over time Auction format is favored over the inefficiency of existing channels

Leading Global Retailers

Shop, Buy/Transact, Communicate Search, Be Entertained

Dependent on paid & natural search

IPO Inefficiencies The Firm small Investors $45/share Underwriting syndicate pays a 7% fee $27/share Institutions & large investors

CompanyDate Shares Underwritt en Underwritin g Share Price First Day Close Share PriceDifference Percent Undervalu ed JetBlue4/12/20025,500,000$27$45 $ 99,000,00067% PayPal2/15/20025,400,000$13$20 $ 37,854,00054% NetScreen Technologies12/11/200110,000,000$16$24 $ 77,200,00048% Magma Design Automation11/19/20014,850,000$13$19 $ 29,051,50046% Global Power Equipment5/17/20017,350,000$20$31 $ 84,157,50057% Simplex Solutions5/1/20014,000,000$12$21 $ 36,800,00077% Transmeta11/7/200013,000,000$21$45 $ 315,250,000115% CoSine9/26/200010,000,000$23$63 $ 400,600,000174% Active Power8/8/20208,000,000$17$53 $ 286,000,000210% StorageNetworks6/30/20009,000,000$27$90 $ 569,250,000234% VA Linux12/9/19994,400,000$ /4 $ 920,700,000698% Red Hat8/11/19996,000,000$14$52 $ 228,375,000272% mp3.com7/20/199912,300,000$28$63 $ 434,343,750126% Efficient Networks7/15/19994,000,000$15$53 $ 152,000,000253% Tibco Software7/14/19997,300,000$15$40 $ 182,500,000167% China.com7/13/19994,200,000$20$67 $ 197,862,000236% CommTouch7/13/19993,000,000$16$24 $ 24,000,00050% eToys5/19/19998,300,000$20$77 $ 473,100,000285% iVillage3/18/19993,500,000$24$56 $ 112,000,000133% AutoWeb3/23/19995,000,000$14$28 $ 71,250,000102% Auto-by-Tel3/24/19993,500,000$23$40 $ 60,375,00075% Prodigy2/11/19998,000,000$15$28 $ 105,040,00088% VerticalNet2/11/19993,500,000$16$45 $ 102,830,000184% Healtheon2/11/19995,000,000$8$31 $ 116,900,000292% Pacific Internet2/5/19993,000,000$17$48 $ 93,000,000182% Theglobe.com11/13/19983,100,000$9$64 $ 168,950,000606%