News Release

Internet companies profit more from B2B e-commerce than brick and mortar firms, paper argues

Peer-Reviewed Publication

Institute for Operations Research and the Management Sciences

Collaborations in the marketplace allow Internet companies to profit more from business-to-business e-commerce than companies that originated as brick-and-mortar firms, according to a paper delivered earlier this month in Salt Lake City at a convention of the Institute for Operations Research and the Management Sciences (INFORMS®).

The authors find that the returns to Internet firms are almost double those of brick-and-mortar firms.

"Economic Returns to Firms from Business-to-Business Electronic Commerce Initiatives: An Empirical Examination," is by Dr. Mani Subramani and Eric A. Walden, a doctoral candidate, both at the Carlson School of Management, University of Minnesota.

The paper focuses on partnerships between firms.

"With the recent growth of the Internet and the coming of the XML standard, the costs associated with B2B data exchange will decrease dramatically. As current B2B relations migrate to less expensive Internet-based platforms, we expect to see increased profits for firms that partner in this way," say the authors. "We believe that investors understand the power of relational business and the potential of the market, and that they will incorporate this into their valuation of firms."

In their paper, the authors distinguish between two types of companies that engage in e-commerce: relatively new firms that do all their business on the Internet and older companies that add e-commerce to their already established brick-and-mortar business.

Internet firms like Amazon.com, eBay, and America Online exist only on the Internet in the sense that they have no physical stores or outlets. Because of their young age and focus on a single distribution channel -- the Internet -- a new partner is likely to be either the only partner in an area or one of a select few. This gives the partners more bargaining power and greater incentive to invest. The greater investment of the partner firms generates a more valuable output, and thus a larger pie.

In contrast to Internet firms, brick-and-mortar firms pursue business in two channels. Often these firms face both a traditional partner and an electronic-commerce partner. There is often confusion over which channel to emphasize because it is unclear whether the e-commerce partnership will be successful over the long run. Thus, this type of firm finds itself add new relationships in areas where they already have relationships. There is less incentive to invest in this type of relationship.

The authors conducted their research by observing public announcements about companies' e-commerce initiatives and resulting changes in stock price that reflected the new assessment of the firm's value.

The authors collected data from a full text search of company announcements related to e-commerce in the period between October 1, 1998 and December 31, 1998. The 1998 Christmas season was a special time in the development of e-commerce. It was the first time e-commerce was able to prove that it was a viable business model.

They examined two leading news sources, PR Newswire and Business Wire. Overall from the set of 536 announcements derived from the text search, they identified 190 B2B e-commerce events relating to publicly traded companies with enough trading history to be retained for analysis. Of the 190 events, 115 involved Internet firms and 75 involved brick-and-mortar firms.

The authors classified announcements by multiple firms of e-commerce products and services involving cooperative action between them to serve specific markets or special arrangements to make the products of one firm available to the customers of others as B2B.

The paper relies on a theory called incomplete contract theory, which argues that firms have a tendency to underinvest when they know they will have to share profits in the future.

The Institute for Operations Research and the Management Sciences (INFORMS®) is an international scientific society with 12,000 members, including Nobel Prize laureates, dedicated to applying scientific methods to help improve decision-making, management, and operations. Members of INFORMS work in business, government, and academia. They are represented in fields as diverse as airlines, health care, law enforcement, the military, the stock market, and telecommunications. The INFORMS website is at http://www.informs.org.

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