This is a fascinating blog post I’ve reposted, written by Brian Carpizo at Digital Orchid. It discusses how transaction cost theory and scalability of those costs are the foundation for understanding the impact of eCommerce on channel structure. Also discussed is the gap between the B2B online revenue when compared to predictions from past years.
“B2B firms considering a significant investment in eCommerce capabilities often struggle to understand the impact on their existing channels and as a result, delay implementation. Despite mounting evidence that customers throughout their channel increasingly prefer searching and transacting online over traditional methods of doing business, B2B firms slow to develop a strong eCommerce channel may find that they are missing an opportunity to reshape channels in their favor or worse – give existing and future competitors a chance to fill the gap.
In this article Brian discusses how transaction cost theory and scalability of those costs are the foundation for understanding the impact of eCommerce on channel structure. “Before tackling this, let’s calibrate on what B2B eCommerce is and how it compares to B2C.
B2B eCommerce is a “Liger”
Like the Liger, the magical Lion/Tiger crossbreed (and Napoleon Dynamite’s favorite animal), B2B eCommerce is a hybrid of B2C and B2B functionality. B2B eCommerce borrows heavily from its B2C eCommerce cousin for several reasons but the one that B2B executives should take heed is that their customers are also consumers heavily trained using typical B2C eCommerce work flows (research & transacting) in their everyday lives.
Let’s review some of the system functionality found in a well-presented B2C eCommerce site:
- Multiple-level category catalogs with filtering by multiple attributes.
- High quality images with multiple view settings, 360 degree views, zoom.
- Product relationships – cross sell, up sell, replacements, parts, accessories, warranty, etc.
- Bundling, product sets, kits, and assortments.
- Product availability information, shipping options.
- Search – search synonyms, auto-suggest, relevance ranking,
- SEO – rich snippets, static URLs, on-page SEO.
- Promotions – buy/get 1 free, X% over $Y amount, promotion codes, etc.
- Display support for multiple formats: 1920px wide desktop, smartphone, tablet.
- Account information – invoices, payments, order history, shipping status.
- Shopping cart – save for later, email cart, stored credit cards.
Most B2C eCommerce functionality is directly applicable to B2B. However, there are many distinct B2B eCommerce features not required for B2C that without, render an eCommerce system to be ineffective or useless for B2B. Some of these include:
- Catalog – multiple catalog views depending on the customer segment.
- Pricing – multiple price lists per customer segment, qty price breaks, dynamic pricing.
- Business account support – business entity as an account with multiple users per account.
- Order approval workflows with buyer authorization limits.
- Quoting – submit for quote, reject, counteroffer.
- User defined order templates for easy reordering.
- Expanded payments – on account, EFT, Level 2 and Level 3 processing.
- Catalog syndication and integration to eProcurement systems, support for punchout.
- Quick order and support for CSV order uploads.
- Guided selling and product configuration.
- Multiple sites & hosting storefronts on behalf of distribution partners.
Lower Transaction Costs and Improved Scalability
There are many benefits to B2B companies from an implementation of a high quality eCommerce system; however two characteristics are especially important when analyzing channel strategies: 1) lower transaction costs and 2) improved scalability.
Lower Transaction Costs
In economic theory, transaction costs are a broad concept encompassing the aggregate internal and external effort required to make a transaction in the marketplace. Classically speaking, it consists of 1) search and information costs 2) bargaining and decision costs and 3) policing and enforcement costs. These costs are much more expansive then accounting forms of transaction costs (landed costs, overhead cost per order, etc). And these costs occur on both the buy and sell side.
In B2B, the area of biggest impact from eCommerce is the ability to dramatically lower search and information costs. Let’s examine one area in particular from the list of eCommerce functions above:
- Product relationships – cross sell, up sell, replacements, parts, accessories, warranty, bundling, kits, services, “others who looked at this item bought XYX””.
Unless you are in the business of selling one or two products, the complex web of your product relationships is an important reason why your customers buy from you. It institutionalizes solution selling vs. product selling. These sorts of relationships are commonplace in B2C eCommerce but are not present in most of today’s B2B eCommerce systems.
The hard part is articulating those product relationships. Sure, ERP systems have categories and families but most of those relationships are defined by how they are internally managed rather than how they are externally valued. Catalogs impose a structure but the taxonomy is a rigid, logical grouping convenient for categorization rather than use case.
Take the following three items from the fictional ACME catalog from the old “Road Runner” cartoon:
An Anvil, Hi-Speed Tonic, and a Tornado Kit – totally unrelated items with different value propositions. However, to the smart marketers at ACME who know their frequent customer Wile E. Coyote, they are all defined as replacements for each other (for the purpose of “Road Runner extermination”). Also, the hypothetical system returns all three products whenever the phrase “Road Runner” or “Roadrunner” is searched. (ACME also sells roller skates. The cross sell? Rockets.)
For many B2B companies, this web of relationships may be known internally – it may be written down but often it is tribal knowledge and not in the format for customers. If the web of relationships is not known internally it has to be generated over and over again, creating non-scalable transaction costs. If the web of relationships is known and documented, there is a cost of communication. Often it is left to the actors in the distribution channel to learn and then disseminate the information about these relationships to customers in a painfully inefficient one-to-one verbal or written communication process that often does not occur when the customer wants or needs it to happen. (It goes without saying that paper/PDF catalogs are not ideal for communicating this web of relationships.)
For a product based B2B firm, nothing beats an a best-in-class eCommerce system with a robust PIM (Product Information Manager) to institutionalize this web of relationships and present it to a customer when they need it, not when you can give it to them.
There are many additional ways to lower search and information costs through eCommerce – product reviews, related articles, instructional videos, high quality images, full product specifications, search capability, automated quoting, guided selling – your ability to consistently deliver this information 24×7 creates significant value in your customer relationships.
TAKEAWAY: Transaction costs are anything that comes between a customer’s needs and your ability to fulfill those needs through your product and service offerings. Lower them and you create value completely outside of the price paid for the product.
eCommerce implementation costs are characterized by upfront costs and comparatively low ongoing operating costs. The marginal cost of adding an eCommerce customer is negligible; the cost of setting up the system and feeding it the proper information is high but it is one time for as many customers as you can attract to your site.
If your eCommerce system is built to scale, then your ability to lower your operating cost per unit shipped as your business grows is assured (all other things being equal). An eCommerce system allows you to collect, package, and disseminate information in a repeatable fashion with low marginal costs.
Another issue when considering scale is the concept of reach – how does my capital investment create more reach for my products and services. eCommerce is the definitive high reach investment – it potentially turns anyone in the world with an Internet connection into a customer. And with the increased capability of third party fulfillment services and the historically low cost of money available to finance inventories, a whole new frontier of possibilities exist.
TAKEAWAY: Well functioning B2B Commerce systems unequivocally improve scalability and reach. Improved scalability increases margins. Improved reach makes the pie bigger.
Transaction Costs and the Nature of Channels
Why does your industry’s distribution channel structure exist the way it does today? There are many reasons but one primary force shaping channels is the relative levels of transaction costs that exist throughout the chain.
University of Chicago economist and Nobel laureate Ronald Coase laid out the case for how transaction costs shape markets and firms in his influential 1937 essay “The Nature of the Firm”.
Coase attempted to explain why we have any firms at all – why can’t everything be contracted through the market rather than through firms made up of employees? The answer is the presence of transaction costs: the more transaction costs the more it makes sense to have employee, firms – and things like defined channels.
In a distribution channel structure for a given industry, all players provide essentially three main functions between the product/service provider and the end user (consumer or business):
- Disseminate information (marketing)
- Transact (sales)
- Deliver (fulfillment)
Coase states that the relative levels of transaction costs in all three areas influence the size and structure of firms an industry. If the inside and outside forces are stable, things fall into a equilibrium, forming the industry’s channel structure.
But equilibriums are disrupted by things such as technology – and everyone is familiar with industries known to be transformed by eCommerce, such as the distribution of retail travel in say, 1994 compared to today.
In 1994 you could only get price information for airline tickets by speaking to the airline directly or working with a travel agent. Only a travel agent had access to a system (Apollo or SABRE) they used to price airfares from different (but not all) airlines. You needed to pay cash or present a credit card in person to pay for the ticket, which was sent to the travel agent or to your address through the mail. In 1994 information about hotels, rental, cars, and destinations was not readily available and for this a travel agent was indispensable.
Today, all airfare information is available to anyone with a web browser 24×7. You transact by purchasing online an e-ticket with your credit or debit card. An almost limitless amount of information about hotels, rental cars and destinations is available 24×7.
People still buy airline tickets, stay at hotels, and rent cars. And the level of transaction costs in the channel changed from the introduction of the Internet and eCommerce. This had a huge impact on the structure of the retail travel industry.
Tens of thousands of travel agencies disappeared. A whole slew of online travel sites appeared. Then they consolidated. It didn’t happen overnight but once the technology became standard a new equilibrium was reached (perhaps about 10 years ago when Orbitz became well established) and now the channel structure is fairly stable. Of course travel agents still exist but now they must focus on more value added services.
How B2B eCommerce Changes Your Channel Structure
The state of B2B eCommerce has been receiving a lot of attention in recent years. Last year Forrester Research sized the market for B2B eCommerce at $559B in 2013. A recent report from leading B2B software provider Intershop found that 81% of companies surveyed stated that B2B eCommerce changes are driven by “customer demand and expectations”.
But outside of certain industries (like MRO dominated by Grainger), by many measures B2B eCommerce is lagging behind what many see as its potential. It is telling that a recent report by Modern Distribution Management stated that:
“Companies are generally considered to have a mature e-commerce channel when 10 percent or more of their total revenue comes from e-commerce…e-commerce within distribution is still young with just above 20 percent of the companies in 2013 at the point of maturity, according to a joint MDM online survey with Real Results Marketing conducted in the first quarter of 2014.”
10 percent is “mature”? And only 20 percent of the companies have more than 10 percent of their sales through eCommerce? That means 80 percent of companies are selling less than 10 percent through online channels. That’s just one survey but I’d say that there is a lot of room for major disruption.
One theory why there is this adoption gap is that existing channels are tough to change. Why the inertia? Simple – your existing channels are bringing in the revenue you have now. That’s pretty damn important. And one of the channels that will inevitably be impacted is a B2B firm’s own internal direct sales channel, the source of significant political power in the organization. Channel partners understandably have much to protect. For these reasons, there is a strong incentive to stay status quo – despite knowing that customers strongly prefer good eCommerce systems to search and transact. As Lawrence J. Peter (of the Peter Principle) said:
“Bureaucracy defends the status quo long past the time when the quo has lost its status.”
For many B2B firms, it is a just a matter of time before eCommerce drives significant structural changes in their distribution channel – it is question of “when” it happens and “who” will benefit (besides the end customer). For some B2B industries, that “who” may be someone new like Amazon Supply. “How” it changes is depends on many factors but in the end because of lower transaction costs there will be an inevitable, unmovable march toward higher value and greater profitability for some; and a punishing blow for others who deal in commodity items competing on price alone.
In the next article of the series we’ll discuss more in-depth ways B2B channel structure changes with the introduction of significant eCommerce capability – here are some:
- Adding a channel direct to the end customer (including B2C)
- Adding a channel partner branded site
- Routing certain channels to online only
- Re-drawing channel boundaries (geographic, industry, size)
- Restructuring channel margins and/or prices
- Change a segment of channel partners to “fulfillment only”
- Prune the channel structure – feed the strong who add value, eliminate the weak who don’t
For high performing B2B firms, investments in eCommerce capability that strongly support the B2C/B2B multi-channel “Liger” are absolutely required to create customer value and earn the right to shape channels for their benefit. Just like the example of newly reduced transaction costs in the retail travel industry – products will still be sold but the channel structure will change.”