You are on page 1of 33

Strategies in the Internet Economy:

Value Creation and Mirages (*)

Bertrand MUNIER
Ecole Normale Supérieure de Cachan, Paris

Introductory Background

What has come to be designated as "the New Economy" is an incredibly

heteregeneous set of economic enterprises with its own style of new young
millionaires, with its uncertainty, its hopes and its actual and potential
desillusions. To some analysts, it spreads out of a new industrial revolution,
to others it merely supports a financial bubble. To the latter, it will at best
give way to a new handling of information for traditional businesses. To the
former, it opens a new world of business which we barely perceive today.
As a matter of fact, it is not even clear what the truly new features of the
New Economy are. In this paper, we shall ignore intranet issues as to how
traditional businesses might benefit from the new information technologies
to reorganize their internal structure and functioning. We shall also restrict
ourselves to the Internet market economy as the core of the new economy.

It also is seriously questioned whether financial markets can be efficient

when confronted to such a deep epistemic uncertainty. There is fear that
these markets, under the influence of the many gurus they let thrive, have
grossly overvalued some of the start-ups of this "New Economy", many of

(*) Professor, Ecole Normale Supérieure de Cachan (Paris), France, and Head of the research
Group on Risk, Information and Decision (GRID, UMR CNRS 8534). This paper has greatly
benefited from discussions with member of GRID, notably M-L. CABON, L. DEVEAUX,
B. LELOUP, C. PARASCHIV & J-CH. TAVANTI. Any remaining error would obviously be ours.
Financial Support from CNET (Research Contract Nr. 98 1B 460/ENS Cachan/France
Telecom/CNET) is gratefully acknowledged.

COMMUNICATIONS & STRATEGIES, no. 40, 4rd quarter 2000, p. 91.


which do not reap any profit and are barely expected to do so in a distant
future. Finally, doubt has arisen even about the appropriateness of this
"new economy": Does it create value? Many have also voiced a fear that
markets might not be as effective and legitimate in the new world of
business which we are witnessing.

The present paper aims at discussing several aspects of these

questions which, in fact, epitomize variations of the same theme: how to
discriminate between real value creation in the Internet Economy and the
mirages it might trigger, at the business level as well as at the collective
level. The first section will try to distinguish between the so many different
actors in the new economy and offer an interpretation of what can be
regarded as the most important activity of the internet economy and its
likely evolution. The second one will deal with some of the invoked mirages
of the Net economy, namely the "irrational" overvaluation of Internet
startups by investors and markets dysfunctioning under the new
technological conditions, in light of the discussion in the first section. Some
concluding comments are presented in the third section.

Actors and Value Creating Strategies in the Internet


A seemingly kaleidoscopic world

One can use many criteria to distinguish between actors in the New
Economy: technological status (access providers, portals, final sites),
access price charged (free sites versus pay sites), type of activity (products
online sellers, etc.), types of connections established (business to
consumers, business to business) are among the most quoted ones.

The main activities on the web are represented on figure 1.

• Free sites are the ones which can be accessed without paying a fee.
They are primarily financed through advertising fees or/and through
subscription in some limited cases. But one should sharply distinguish
between free final sites – mostly of an official or scientific nature – and the
free intermediate or finalized sites. The latter are dispensing information on
quality, performances, price, etc. of some good(s) to help consumers
choose between variants of a product or different products. Clearly, they

are often financially related to the corresponding online suppliers, but not
always. On the other hand, free finalized sites are among the most
important sites on the web. They provide information formatted in such a
way that it helps buying goods or services. Price comparisons are among
the most useful informations provided by such sites. In the analysis below,
we leave aside free final sites.

• Pay sites are only accessed through the payment of a fee. But they are
to be subdivided between the three same categories as the free finalized
sites: on line products and services suppliers (typically: booksellers online),
final information sellers (sites helping to compute a driver’s road itinerary,
etc.) and the category of "pure piloting" sites, which we define and
comment upon further down.

Figure 1 - An economic representation of activities on the web.

Solid lines divide actors into finer categories.
Arrows indicate the type of production of each category of sites.

Access provider

Free final sites

Pay sites
Free finalized sites

Final information
(experience good)
Products and
commercial services
Pure piloting sites: online sellers
- simple tips
- tips + inference
Information sellers - intelligent of meta-piloting sites

Intermediate Given goods

No matter which information and/or services in
goods and/or services (search) such or such sector

The impact of the new technology has to do with the way demand,
whether from final consumers or from businesses, is connected with supply.
In the "old" type of economy, consumers never consider to visit all possible
"brick and concrete" shops offering the good or service they look for in
order to compare prices and qualities in the most general sense. In the"
new economy", they can do so at negligible costs (BAKOS, 1997) . To
overcome the mentioned difficulty, it is customary in the old economy to use
"proxies" like brand, marketing devices (loyalty rewards, etc.), advertising,
etc. designed to "pilot" consumers amidst the forest of suppliers, products
types, products qualities, etc. But these proxies – we almost have forgotten
about it – have been designed to overcome the difficulty that consumers,
due to search costs, never will be able to visit all possible suppliers. This
postulate becomes if not obsolete at least way too strong in the Internet
economy. This does not mean that advertising and the other proxies
already mentioned become useless but that, under their current design and
as long as can be seen, they are considerably less effective and important
for at least part of the consumers. As soon as the consumer can check in a
minute a number of possible goods corresponding to his/her needs, their
prices and their features, why would he/she bother to try evoking the ads
he/she has seen, or trust more one brand than another? This might
represent a considerable change from the traditional situation as well as
from the usual array of management tools.

The true revolution, however, will have to do with what could be called
"pure piloting" sites. We define these sites as those for which the main
activity consists precisely in providing consumers with as complete and
refined a scheme of information as possible on the demand and supply
hinterland by suggesting, designating, showing, analyzing, comparing, etc.
products and/or services that might satisfy real or potential needs of theirs.
The word "piloting" is used here to mean that the activity does not only
consist in providing information to each side on the other, but entails indeed
a transformation process of demand as well as of supply. As a matter of
principle, piloting may be free (financing relies then purely on publicity) or
charged to the consumer (financing of the site relies then purely on a
percentage of the price paid by the consumer) or charged to the producer
(financing of the site relies then purely on a percentage of the price paid by
the producer) or mix any combination of these three possibilities. Piloting
costs are not zero, by any means, but may be essentially of a fixed type for
large ranges of number of clients served. One can intuitively feel that if
major competitive advantages can be found in the new economy with
respect to the old one, they should lie precisely in pure piloting. How can

such competitive advantages be analyzed? Should future activity

concentrate on piloting and thus reduce the web’s diversity of actors, and

Competitive advantage and the emergence of pure piloting

How should comparative advantages be assessed in the new economy

with respect to competitors? Three factors should be brought to attention
here: density, thinness, relevance.

• Density is measured by how many different products and their

suppliers and how many clients a site can connect together. Products or
services may be listed in the site or reachable through hyperlinks between
the site and its partner sites (online sellers in particular). Density is the most
obvious advantage a site can offer with respect to a traditional brick and
concrete business. For example, many people still see as a
books seller. But if Amazon has any value, it ows it probably more to the
undeterminateness of the boundaries of what it sells : books, toys, CDs,
and… whatever. Jeff Bezos keeps saying that it wants its business to be
the largest supermarket online in the world, featuring a number of products,
including the ones it does not have. As the latter may still be the largest
category, what other definition would make more of a pure
pilot than of a bookseller? Conversely, was once the largest
CDs seller in the US, but it lost that position (to Amazon)… because the
consumer doesn’t want to be limited to one single product: density was
overlooked, and clients turned away. Piloting is not simply marketing its
own products on the web !

Clearly, Internet offers the possibility of almost infinitely multiply density

with respect to traditional retailers. Amazon has more goods for sale than
any of the American supermarkets hold. This is because density in itself is
largely independent of any physical storage.

• Thinness is the degree with which detailed and accurate information is

being offered by e-commerce to consumer’s choice. It is also a domain in
which the Internet economy can provide consumers with unparalleled
performance at very affordable costs. Moreover, whereas traditional
physical commerce has always had to face some quite constraining trade-
off between density and thinness on grounds of costs in storage,
description support, memory storage, extraction capabilities, etc., electronic

connections allow for an entirely different course. E-commerce can

technically provide its clientele with density and thinness without enormous
costs. Shopbot’s quality is in this respect a decisive technical and economic
tool of strategy in the new economy.

• Relevance is best epitomized by the ability of the traditional

connoisseur-bookseller. Having read extensively, titles of books evoke in
his mind knots of a network upon which the art of writing is arrayed. As a
man of deep and broad background, he quickly forms not only appropriate
models of his clients taste and aims, but also models of how characteristics
of literature works will interplay with these tastes, goals and values. In this
respect, he is ablest among all to determine the best set of books to
present to a specific person in his clientele. In an even more complex
interaction, he guesses what interesting changes in his clients tastes or
values might be triggered by reading some given piece of writing. In short,
he is the ablest pilot between individual demand and the whole supply from
the art and science of writing.

Clearly, e-commerce will ever lack this connoisseur-seller, whether in

books, wines or anything else, because too complex a system would be
needed here to perform such a sophisticated activity. But it can try to
mimick him as closely as possible. Intelligent agents do already a pretty
good job in this respect. Learning about the set of books to offer to a
relatively stable clientele is not insuperable for them. Learning about tastes
of such a clientele is feasible, although it could be improved. Present
models look at individuals having bought a given number of similar books
and at which other books these individuals have also bought. The idea is
that an overlap of preferences between two individuals leads to conjecture
that the overlap is larger than what has been observed (ex :
or: The rule is far from the sophistication a human mind as
described above can perform, but it has the advantage to instantaneously
provide the client with suggestions, even though the latter are only vaguely
likely to seduce him or her. And it can be complemented by other
informations also instantaneously brought to the client like written opinions
(by any reader rather than by established critics, i.e. a very quick
information, although of ambiguous value) etc. Clearly, it is not difficult to
imagine that one can do much better in the present state of the technology,
even though one cannot dream of getting anywhere close to the ideal
picture given above.

The new technologies allow to go quite a way towards relevance without

being able to match the connoisseur’s role in this respect. This constitutes in
fact one of the biggest challenges they bump into (1).

Internet piloting will however work in this respect like an (unintended in

our example, intended in cases like forum sites, etc.) self-organizing system:
it will let networks of somehow similar individuals emerge, with a sociological
ambiguous statute around the ones of a fans club, of a political party, of an
ideological group, of a society with given goals, of a sect, etc. Belonging to it
can sooner or later become conscious to the individual (in forums or in sites
explicitly providing individuals with "self-defining items" like military or
military-like equipment or clothing of a given type). In other cases, the
individual will be largely unaware of it (like in the example above of books
preferences) or perhaps even completely unaware for ever (in the virtually
infinite market segmentation allowed to intelligent agents actually learning on
tastes of the individuals in the clientele). Whether conscious or unconscious,
aware or unaware, the individual in such virtual networks is deprived of the
benefit to personality forming which the complexity of actual human contact
and exchange provides. Virtual networks of individuals will never be groups
of individuals on Athen’s Agora. They will be only substitutes, sometimes
useful, sometimes poor and misleading, sometimes detrimental. Here is a
side-effect of Internet that society will nilly willy have to cope with sometimes.

Whereas density and thinness call in electronic commerce for little trade-
off, as has been argued above, relevance clearly implies somewhere a trade-
off with the two other factors of specific competitive advange in the Internet
economy. In some specific domains "which necessitate a very complete
personal adaptation" of preferences, whether on physical goods (restaurants,
elegant clothing) or on experience services (art pieces, personal working
tools, etc.), it even makes density and thinness poor competitive advantages
of internet commerce (MUNIER, 1985). Generally speaking, relevance is to
some extent antagonistic to density and thinness and softens the competitive
advantage of virtual commerce with respect to brick and concrete

(2) Relevance is yet the most important factor of the three, while density and thinness are
fairly obvious and easy to acquire advantages. EVANS & WURSTER (1999) use related
concepts, but fail to identify the third and most important internal factor of competitive
advantage, as well as the external factors. Moreover, density and thinness should relate, in
our view, to preferences transformation by Internet. SAVAGE (1972) already discussed the
importance of being fine and tight for a preference relation. Morgenstern wrote in the Sixties
on similar ideas. This motivates our terminology, which sets the course to more formalized
models of the Net economy.

Degrees of density, thinness, relevance together with external factors of

the chosen strategy and technology of the site help also specificy what
economists would call the production function of a site, which relate the
maximum state of attainable outputs given a combination of inputs and
hence the cost-structure of the site. In building its site’s software, an
e-commerce firm should pay closest attention to such characteristics (along
others). Competitive advantage in e-commerce largely lays in these.

An asymptotically common pattern of activity?

Why should numerous entrepreneurs with innovative ideas (types of

services that the new economy gives way to and which were excluded in
the old economy) and many entrants into the new competitive scene realize
that they should give priority to pure piloting?

Incumbent producers have little choice: if they want to survive, they have
to create the conditions of it, by entering online business and/or
establishing partnerships with pure pilots. We show hereunder why. Of
course, small publishers (or entrants) do not mind Amazon selling online:
this gives them a chance to have their books sold and read, without having
to make the enormous investment of buying a well located window (or
renting space in it) in the largest shopping mall of the city. But incumbents
do mind Amazon. Due to internet pilots, their brands will not bring them in
the future as large an advantage over entrants or small little known
producers as it used to do, for the books of the latter will appear on Amazon
the same way as theirs will. Small almost anonymous producers won’t
suffer anymore the disadvantage to have neither a pretty maid, nor a
learned connoisseur serving books in the lavish bookstore that great and
established publishers may afford to own or to be associated with. Internet
puts producers pretty much on the same starting line when it comes to sell
or buy their products.

So, what to do for incumbents? One strategy seems to refuse entering

the web business, i.e. refrain from having its books sold online (say, by
Amazon) and advertise that they are sold "only in real good bookshops" (3),

(3) This might not be easy to do. Again, Amazon offers a good example: when it came to
France, having failed to buy one similar online company in the country, it offered to buy
catalogs or database on French books. But no one accepted to sell any database. So,
Amazon bought one copy of every French book on (brick and concrete) publishers’ catalogs
(publishers may not refuse that on legal grounds) and recorded them. Another close example
is Cdnow’s effort to block out BargainFinder browsing for best prices, which failed (DE LONG
& FROOMKIN, 1998). Such a blocking strategy is therefore mentioned here only for
completeness’ sake.

another one seems to enter the new economy and go online. This is a
gametheoretic situation. Which outcome can we guess?

Let us look at the type of game which arises in such conditions. If the
incumbent refuses to enter e-commerce and if all other publishers,
including entrants, were to do the same, the payments could be stylized by
(1,1), i.e. 1 for the incumbent, 1 for each other publisher, where "1" means
that the corresponding player gets its usual result (presumably more for the
incumbent than for each small publisher or entrant, but that plays no role
here). If some incumbent refuses, but other publishers go online, this
incumbent will lose a large part of its clientele to others and entrants, who
will be in a much better situation. The converse will be true if other
publishers and entrants refuse the web, whereas the incumbent goes
online alone. Finally, if everyone goes online, competition will become
sharper and everyone might face a partial loss in its usual surplus.

Table 1 - Incumbent producer’s entrance game to the Internet

Small Publisher or Entrant

Refuse the web Go online

Incumbent Refuse the web (1 ; 1) (-0,5 ; 2)

Go online (2 ; -0,5) (0,5 ; 0,5)

Such a game configuration is well known and has been extensively

studied: it is a "prisoner’s dilemma" type of game. Two different types of
"equilibria" appear:
- one yields the (1; 1) outcome and is supported by a substantial degree
of cooperation between players (either through effective agreement
between them (4) or after a number of repetitions of the game).
- the other one reflects, to the contrary, an ‘isolated rational’ behavior
from each of the players (5), yielding the (0,5; 0,5) outcome.

The second equilibrium however is much more likely to occur, for the
corresponding strategies are dominating ones for each player respectively.
This simple gametheoretic analysis suggests therefore that it will be very

(4) This kind of outcome refers to what has been called "Cooperative Game Theory", but
repetition leads to a similar result in "Non cooperative Game theory". Needless to say, such
agreements are forbidden by Law.
(5) In gametheoretic terminology, a Nash equilibrium.

unlikely that any incumbent producer stays out of the Web, even if it had
the capacity to keep its own products out of the online business.

Once online, however, a second challenge will be encountered by the

producer. Will it sell online only its own products, or should it go beyond
that stage and either mandate a "pure pilot" to sell its products along with
all others or become itself a "pure pilot", and establish its own site to sell
not only its own products but also the ones of other producers including
competitors, so that its main activity online will be to pilot consumers
between demand and supply?

We use the same framework to reflect on such an issue. This time,

however, valuing the outcomes of some strategic couples will require some
more discussion than above. In the online game, online producer I is
assumed to be a competitor of online producer II. Each one of them has
two possible strategies: sell only its own products or let also the products of
its competitor be sold alongside its own ones, either on its own site or on a
"pure pilot’s" site with which it can enter into a partnership.

Table 2 - Online producers’ game

Online producer II

Own products All products

Online producer I Own products (1; 1) (-0,5; X)
All products (X; -0,5) (0,5; 0,5)

If each one of them sells only its own products - and assuming
temporarily here that no one else enters the market online -, little will be
changed with respect to the physical situation: piloting the consumers will
still depend primarily on publicity, brand image, loyalty rewards and all the
usual marketing actions. We set this outcome as (1; 1). If both sell or let sell
both products (and, presumably, all their close substitutes), competition will
be harsher because online consumers will be made more clearly aware of
existence of and differences between the different products and brands.
Economic theory predicts that, in general situations, more of the global
surplus will flow to consumers rather than to producers, hence the (0,5; 0,5)
stylized outcome. But what will happen if player I sells only its own products
whereas player II chooses to let both products (and all substitutes) be sold
on the same site? Clearly, competition will be increased, as before, but
density as defined above will play its role and most online consumers will
presumably go over to player II, who should then receive X>1. The
outcome will be of the (0,5; 2) type, as in the previous game. But thinness

and relevance play here in the other direction (after all, who could, better
than the producer itself, give detailed, well-documented, and relevant,
information on its own product?). Thus, some compensation, indeed even
overcompensation, might occur. One might as well have X<1, and the
outcome might be of the (0,5, 0,75) or of the (0,5 ; 0,25) type.

Predicting an issue to this game seems therefore more difficult than to

the previous one.

If X>1, two different "equilibria" will exist as above and, again, the most
likely will be the isolated rational one (All products sold by or on behalf of
each producer).

If X<1, two equilibria will still exist, but both will be isolated rational ones
(Nash equilibria) and it is impossible to decide from a gametheoretic point
of view which one will be more likely to be preferred, for no strategy will
dominate the other for any player.

However, from a business psychology point of view, one might expect

that every producer will think that there is a way to get around that difficulty
and to restore X>2: sell online all products, but develop its own site to
introduce an unfavorable bias in information against the competitor’s
products! Producer 1 will perceive game structure 1, whereas producer 2
will perceive game structure 2 as represented on table 3.

Table 3 - Asymmetrically perceived game by online producers

Game structure 1 (perception of producer 1)

(1; 1) (-0,5; 0,25)

(2; -0,5) (0; 0)

Game structure 2 (perception of producer 2)

(1; 1) (-0,5; 2)

(0,25; -0,5) (0; 0)

Clearly then, each producer perceives a dominating strategy from his

own point of view (6), and the outcome (0; 0) will in fact be most likely as in
table 1 game, but for reasons that are different from the situation in table 1.

(6) Of course, such a strategic equilibrium would not be sustainable for a long time, as argued
further down. But it will anyway not be tested, as the (0,0) equilibrium will ensue, as shown here.

Whatever the reasons (7), this basic and quick game theory analysis
suggests that online producers won’t confine online sales to their own
brand’s products. If they were to do it, the market would threaten to exclude
them. Markets may be sometimes accused of being a relatively poor tool to
produce value creative firms, but they are a very performing tool to exclude
lower value creating businesses!

Physical producers – or group of producers – will therefore enter Internet

commerce, and let Internet activity be open to other’s goods and services.
This is not to say that they will abandon their physical activity, obviously,
but that it is in their interest to help generate portals to offer their goods
and those of others. This is true, whether in the business to consumers
activity – in which we have taken our examples up to here – as in the
business to business trade. This is true not only in trading outputs, but also
in trading inputs. Thus, the case could similarly be made that it is in the
interest of producers to create portals to trade in their inputs and in those of
others. An example is provided by the recent portal of subcontractors
opened by four major automobile firms (General Motors, Ford, Daimler-
Chrysler and Renault-Nissan). In each case, it is important to note that
those portals do not aim simply at selling – or buying – some goods or
services, but at piloting firms between demand and supply. Some kind of
negotiation and of re-framing (of preferences, etc.) will enter the picture at
some point (like in traditional procurement, e;g.).

Physical distributors (as opposed to producers) have not been explicitly

considered in the above analysis. But is not difficult to see that they will
have to face the same two dilemmas. It is not difficult either to check that
the same reasoning holds for them in both cases like it held for physical
producers. There is however one major difference here. Indeed, virtual
distribution should cannibalize quite a large part of traditional distribution
(about 25% according to some authors) (LANGDON, 2000) , whereas
physical producers will, as such, continue to exist the same way as before.
This represents a serious threat, not only to traditional distribution, but also
to urban life and development, with the exception of some specific
domains" which necessitate a very complete personal adaptation "of
preferences (relevance), whether on physical goods like restaurants, formal
or luxury clothing (the bankruptcy of in the summer of 2000 is one

(7) If both producers hesitate between both game structure perceptions, whatever their
beliefs, the outcome will the same, i.e. (0, 0). This is why game theorists might prefer to more
subtly view the situation as one leading to a Bayesian Nash equilibrium with two supports of
beliefs. The basic idea is quite close to the interpretation given here above.

possible illustration, other sites like might have difficulties

also, etc.), or on experience services like art pieces, personal worktools,
etc. (MUNIER,1985). Most American cities might not suffer too much from
this phenomenon (8), but some serious changes might affect European and
Asian urban life (9) .

The conclusion of the above analysis is that most actors in Internet

economics will end up doing pretty much the same sort of thing, i.e. piloting
consumers between demand and supply. Of course, some actors might
better succeed than others. Competitive advantage is also enhanced by
external factors.

External strategic factors in Internet pure piloting

Piloting might be financed in different ways and happen with different

denominations yielding as many ‘window services’, as will be explained
further down. It should be also noticed that, as long as they distribute a
large scope of products, Internet pilots should as a matter of principle be
less linked to any producer than to consumers. Exceptions do not represent
any stable business model. To the contrary, promising business models
should rely on financing from consumers, offer services which hardly can
find a counterpart in the brick and concrete economy, all this in cost
conditions that also differentiate them from the traditional economy. In such
a way, the Internet economy should be able to sell services and hence
deliver value to the economy as a whole.

Financing strategy of piloting sites

Some pilots will be dependent on one producer (or on a group of

producers) because they will have been created by some producer(s) in the
first place (we have examined the producer’s entrance game into Internet
above). It has been even mentioned that some producers might have the
idea to bias the information they provide consumers with against their
competitors products or services. Some other pilots will rely on publicity and
might be induced to bias their informations and suggestions as well. But

(8) Some authors argue that they might indeed profit of it, for hyper- and super-markets would
be more affected than shops and urban centers might correlatively be revived. See LANGDON
(9) Can we imagine what would become of Paris without any other shops than restaurants,
chic clothing and touristical trash ones? What about Vienna, London without Harrod’s? They
certainly would not be turned into ghost cities, but they might be substantially affected.

what pilots sell is an experience service – creative adaptation of demand

and supply – and clientele can be maintained only if confidence is
established and renewed. Should consumers discover that some goods are
systematically over recommended with respect to others, they would
change to another pilot.

Pay pilots might emerge to help consumers hedge against such

potential a misfortune, like pay TV has emerged from the low quality of free
TV programs. Other pilots will discover quickly that advertising not only
arise suspicion from consumers but does not pay much if it has to be
shared between too many actors on the net, all the more because marginal
income from ads for the company advertised is decreasing with marginal
product, i.e. with total quantity (10). Finally, many pilots should discover also
that royalties on sold products bring a safer income than publicity and
constitue a more distinctive way to make money with respect to the
consumer (who might be fed up by publicity at some point and decrease
loyalty). They might end up being the successful model of value creation.

This is all the more true, because such an income source is compatible
with another very important source of income, which exploits the value of
the data base generated by piloting. Such a data base will have all the
more value, the more density, the more thinness and, to some extent, the
more relevance, because the pilot will have built into its site a learning
process on preferences, purchasing history, etc. This shows how such
finalized or intermediary free sites sit at the interface of the traditional and
of the virtual commerce.

Finally, density, thinness and relevance should be acquired at low costs

to make e-business profitable. In this respect, partnerships with suppliers
and other pilots are of a particular interest. They save advertising expenses
– one major source of failure of e-business startups – while being most of
the time more effective incomewise (a hyperlink to one’s site at many
partners and conversely might bring in many more clients than costly
continued advertising). They also save running huge storage facilities by
drawing on existing physical suppliers and simply deriving commissions
from the sales they will give way to. Such arrangements can be combined
with loyalty programs on behalf of the physical suppliers, though pure pilots
should be here careful not to be the fool of some physical producer.

(10) Analysts extrapolating over long periods the present upward tendency in total quantity of
advertising will go wrong at some point. It is already common to read statements by site
owners to the effect that people do not click on advertising stripes on top of screens.

In other words, strategic rules on Internet have to cope with (i) offering
services which the traditional economy does not offer, at least in terms of
the density, thinness and relevance it can afford and (ii) to avoid the costs
the traditional economy has to incur in terms of massive transactional
marketing, in terms of inventory holding, in terms of logistics and correlative

Recent bankruptcies or strategic reorientations illustrate one or several

of these points. For example, Altavista has recently abandoned its efforts to
produce editorial contents and fired 25% of its total employment to
concentrate on density through substantial improvements of its shopbots. lacked in density and had underestimated the sunk costs
of development, advertising and marketing. As a result, Lastminute has not
been until now profitable. This is why – having been lucky enough to raise
huge funds at a time where this was possible – it recently bought its
competitor Degriftours. The latter is profitable because it works as an
Internet pilot which has been able to avoid the massive costs Lastminute
did not. We have already mentioned the bankruptcy of, but we
mention it here again, for it epitomizes what should never be done on
Internet : replicate an activity which the brick and concrete economy
performs quite well, underestimate costs in salary charges, walls, logistics,
which have to be added to the inevitable development costs of a site. One
can predict without too much risk of being wrong that quite a few such
bankruptcies will happen in a near future for similar reasons.

In contrast to these negative examples, pilots doing well and already

piling up value correspond to the model we have analyzed above, like price
comparison sites which sell their database for targeted advertising, of which
Kelkoo and Budgetelecom are examples. A similar strategy is followed by, which not only sell ads, but also questions directed at its
database. Auction sites are perfect examples of why pilots do well and
online sites with similar activity but endowed with walls, logistics, salaries,
etc. do not. The only ones of such sites which are profitable follow the business model, where income flows in when an object is offered
to online auction and again when the object is sold, but where i) advertising
stripes do not represent any dominant part of revenues and ii) no logistics,
no walls, no massive advertising bear on revenues. If profitable firms are
the ones following the "pure piloting" model, one can predict that sooner or
later, most surviving sites will belong to the same category.

Window services for piloting activity

If many actors can be expected to end up doing more or less the same
thing on Internet – which decidedly deserves the name of shopbots
economy – they will nevertheless do it under different denominations, each
of these denominations relating to a specific service on which the site is
focusing. Of course, this service will be delivered to the clientele, but it will
not be the one effectively sold on the market and yielding money to its
supplier. To that extent, we call here this service a "window denomination"
or a "window service". This does not mean that it is indifferent whether such
or such window service is offered to determine how much value creation
happens. The fact that this service is bundled together with another one or
other ones may determine the clientele to visit the site. Hence, choice of the
window service partly determines value creation whether or not explicitly or
directly paid for by clients.

The less a market for a window service exists in the traditional economy,
the more real will be value creation by the site offering it. An example of a
window service which does not exist and cannot exist in the traditional
economy (due to something economists subsume under "transaction
costs") is the wishlist service. It amounts to making immediately available to
those interested the list of presents someone would love receiving, with an
immediate connection to online sellers: you can have your carefully
updated list on some site and make it accessible to the persons you
determine. Conversely, you might see whether such or such person has a
list on the site that you might use to honor her with a present. In the brick
and concrete economy, such a service would be very hard to offer, because
it would have to be in a shop having a huge number of potential gifts.
Storage costs would immediately be prohibitive if a special brick and
concrete shop were to exist, except when presents to be offered belong to
a given specific category, like in the case of wedding presents, where a few
specialized shops exist. Alternatively, transaction costs would be prohibitive
for the client ready to offer something, if lists were to exist in many different
shops for a same person.

Such a service may therefore be a good candidate to what can be

termed a "window service", hiding a "pure pilot" and hence potential value
creation, but from other sources in effect than from the window-service
directly. Accordingly, if some sites in this category meet the other conditions
mentioned above, they should be good examples of value creation.
Examples are wishlist in the US and millemercis in Europe. Such wishlists
services are obviously window services. This window service provides, in

itself, a service that cannot be served in the traditional economy, as has

been argued. In addition, it helps customers make up their preferences and
make these preferences thinner and thinner, which adds also to surplus
forming and thus to value creation. It brings income under the form of
commissions from online producers and/or online sellers and to some
extent from correlative "targeted" advertising. Moreover, the main part of
value it can generate is an incredible data base for direct marketing and
targeted publicity of high value. Such database producing activities are
specific aspects of the value creation "hidden behind the window" of the
wishlist service. More generally speaking, the true source of value creation
lies here in a set of engineering tools to foster and make thinner demand
and supply interplay, i.e. pure piloting.

Of course, financial strategies remain decisive tools for success. If such

entrepreneurs think of massive transactional publicity to attract clients, they
have a good chance of being soon bankrupts. If they insist on running their
own inventory and logistics, the same might very well hold true. If, on the
other hand, they avoid these basic mistakes and work hard on partnerships,
they are likely to meet with success.

Simple gametheoretic tools appear as useful to predict some aspects of

the future industrial organisation of the net economy, as has been shown in
this section. It can therefore be only surprising that so many different types
of Internet business models have been given a chance to raise as much
money as they have. One possible explanation is that standard tools of
microeconomic theory have glaringly led investors to misinterpret value
creation in the Internet economy.

Mirages in the Net Economy? A Microeconomic


Fluctuations of financial markets regarding Internet stocks support the

opinion that startups of the Internet economy had been, at least in a first
period, overvalued. Such an overvaluation has to be meant with respect to
some benchmark of "rational" valuation of firms. But one can wonder why
rational rules used to evaluate stocks on technological markets would be
different from the rules usually put forward on other markets. Biased
expectations on costs, as has already been argued, help to explain the
overvaluation. In this respect, overvaluation can be termed irrational. But

these expectations are only part of the story. Techniques used in Internet
business culture together with investors risk psychology, as experimental
economics has taught it to us in the last twenty years, explain the other
part. In this respect, overvaluation can be regarded as indeed rational. We
explain why in this section. Let us first recall the frame of analysis which
investors quite rationally can rely upon.

Real option theory and "rational" valuation of Internet startups

Using real option theory to decide whether or not to invest in a firm

requires some assumptions which are open to discussion (11) . But it
nevertheless gives some interesting clues as to the factors which should
influence the evaluation of a startup by an investor. In a continuous time
model (SCHWARTZ & M. MOON, 2000), the value of the firm is the discounted
value (under the risk-neutral interest rate) of the anticipated cash-flow
available at a given date where the firm could be liquidated and all cash-
flows distributed. Under the hypotheses usually used in financial option
theory (revenues are assumed to follow a Wiener stochastic process) and
some more specific assumptions (the process is assumed to converge after
the starting time to its long term average, costs and taxes are assumed to
be an affine function of revenues), it turns out that the value of the firm is a

V= V(R, µ, L, X, t) [1]

where R stands for (intensity of) sales revenues, µ for the anticipated rate
of growth of R, L for the (instantaneous) loss carry-forward (12), X for the
amount of cash available, t the dates at which each of the former variables
can be estimated. These variables are not independent of each other, as
can be easily seen. If (each variable being indexed in t) Y = (R- COGS –
SG&A – other costs) (1-τ), where t stands for rate of profit taxation (13),
then, either dL = -Ydt (L>0) or dL = max (-Ydt, 0), while dX = Y dt. Applying
Ito’s lemma to the V(·,·,·,·) formula leads to the dynamics of the value and of

(11) The basic idea is to consider investing in the company. The value of the ‘underlying’
stock depends then on the inflow of revenues (net of costs) which can be obtained from
exercising the option, i.e. from investing.
(12) If the loss carry-forward is positive at some time t, the tax rate in t is zero.
(13) For readers not familiar with American accounting, COGS stand for costs of goods sold
and SG&A stands for selling, general and administrative expenses. In the case of Amazon,
the latter seem to have developed substantially above the linear tendency observed in 1996-
1998 starting early 1999.

the volatility of the company, the latter depending on the volatility of R, of µ

and of their mutual correlation. A discrete version of such a model allows to
use Monte-Carlo simulation and to solve for the value of the company on
the basis of initial values (observable from published company’s accounts
or other sources, or based on argued for estimates), and of a value of T.

The authors fed such a model with figures drawn from the Amazon case,
with T=25, and ran a Monte Carlo simulation of the model alluded to above
on that basis (SCHWARTZ & MOON, 2000). They show that the two sets of
parameters which have the largest impact on the value of the firm are costs
parameters and parameters affecting the future growth rate in revenues.
This is in line with standard expectations.

One first reason for overvaluation of internet startups (and of high-tech

startups in general) can then immediately be seen. Estimates of costs
parameters of net businesses are downward biased. What has been said
above shows that, like in every new industry, costs structures are badly
known. Besides, in the special case of the net economy, global costs
dynamics are generally undervalued because investors do not realize that
combining the exceptional levels of density-thinness performance of the Net
economy with physical costs of inventory and general logistics means
reaching not only skyrocketing levels of investments, but – which is worse –
deteriorating general and operations expenses. In the case of Amazon,
SG&A have increased by 200% while sales were increasing by 50%
(between december 98 and september 99). More recent data confirm the
tendency. Operating profit before taxes reached a negative peak of
–190.106 US $ in the last quarter of 1999 (the last figure incorporated in
SCHWARTZ & MOON’s paper), but went way below -300.106 US $ for each
of the first three quarters of 2000. One may venture to say that at least part
of the costs incurred had not been anticipated.

As for the volatility of future growth rate of revenues, economic

psychology has more to say than invoking simple biases in estimates.

Risk psychology as a rational explanation for "overvaluation"

The authors of the article mentioned rely on expected utility theory, i.e.
use probabilities to form expectations of means and variances in play
(using risk neutral probabilities boils down to a special case). All we know
from experimental economics does not validate that rationality assumption.
Moreover, "business angels" and other investors in internet startups seem

to have a specifically "agressive" psychology profile, to the extent that they

lay value in "thick" positive tails, even if such distributions also have thick
negative tails and hence mediocre expectations. Such a profile is
impossible to interpret in traditional expected utility theory, but can be
modeled in the framework of the new rationality models which have
emerged on grounds of experiments in risk theory.

We recall here briefly the "rank dependent model", by now the most
popular of these models. In this risk appraisal model, financial prospects
are not evaluated as an expectation. Rather, the individual looks for the
minimal outcome first, and then add outcome increments weighted by non
linear transforms of the decumulative probability distribution attached to
them. As a result, the psychological volatility σ * is sensibly larger than the
volatility σ computed on the basis of straight probabilities.

Let us take a simple example based on three scenarios:

- "Blue" (like Heaven) is the very favorable scenario (positive tail of the
distribution), leading to a µ3 value of µ
- "Red" (like Hell) is the unfavorable scenario (negative tail, including
bankruptcy), leading to a µ1 value of µ
- "Grey" (like difficult life on Earth) is the intermediate and most likely
scenario, leading to a µ 2 value of µ at a given horizon. Assume, for
simplicity’s sake, E(µ) = µ 2. The standard valuation of the probability
distribution is:
p1 µ1 + p2 µ2 + p3 µ3 [2]
or, equivalently: µ1 + (µ2 - µ1).(p2 + p3) + (µ3 - µ2).(p3)
where the investors realize that µ1 is certain, the increment (µ2 - µ1) has
only probability to come about and increment only probability (p2 + p3) to
come about and increment (µ3 - µ2) only probability to obtain.

Experiments show that the psychology of risk is more subtle and calls
for a representation which can be better approximated by:
µ1 + (µ2 - µ1).θ (p2 + p3) + (µ3 - µ2).θ (p3) [3]
where θ (.) is a non linear monotonically increasing function ((θ: R R),
with θ (0) = 0, θ (1) = 1, and, ∀p, θ '(p)> 0. The typical profile of an
"agressive" investor looks like the curve on figure 2.

The θ (.) function in this simple discrete case has as a graph the
piecewise linear curve OABO’. The standard probabilities are the three
segments on the abscissa (determined by the abscissa values of A and B).

The h1, h2, h3 segments which are the images through θ (.) of the p1, p2, p3
segments respectively have an immediate interpretation. It can indeed
immediately be seen that equation (3) above can be rewritten as:
µ1 [θ (1) - θ (p2 +p3)] + µ2 [θ (p2 +p3) - θ (p3)] + µ3 [θ (p3) - θ (0)] [4]
µ1 .h1 + µ2 .h2 + µ3 .h3 [5]
3 3
with, ∀i,hi = θ ( ∑ pi) − θ (
∑ pi ).
i +1

In other words, probabilities pi are being replaced psychologically by

coefficients hi in equation [2] above. The volatility computed in a standard
way, as SCHWARTZ & MOON do, would be:
σ * ( µ̃) = p1 .(µ1 - µ2)2 + p3.(µ3 - µ2)2
whereas the psychological value of the volatility would be:
σ ** ( µ̃) = h1 .(µ1 - µ2)2 + h3.(µ3 - µ2)2

But, in the relevant case of an "agressive" psychology - which we

presume characterizes investors in Internet start-ups - experiments show
(see figure 2) that:
h1 >> p1 and h3 >> p3

Clearly: σ ** ( µ̃) >> σ * ( µ̃).

Figure 2 - Probability transformation curve in the rank dependent psychology





p3 p2 p1

Let us look at the relationship between volatility and share price

(obtained under some hypotheses which we disregard here for the time
being) obtained by SCHWARTZ & MOON (2000) on their figures 7 and 8,
which we adapt here as our figure 3. The observed share price volatility at
the end of 1999 was close to 100%, implying a σ * (µ) ( slightly above .03,
and a share price of 12.42 US $, according to SCHWARTZ & MOON (2000).
The market value of the share meanwhile was 76 US $ approximately,
representing a dramatic overvaluation with respect to model findings, and
implying an almost double volatility of the growth rate of sales and also of
the share price, above 180% in the latter case. If σ ** (µ) had been used, it
might have got close to .05 and, instead of a 12.42 US $, it might have
implied a share price close to the 30-40 US $ bracket.

Fig. 3 - Share price and share price volatility as functions of the volatility
of sales growth rate
(adapted from SCHWARTZ & MOON, 2000, pp.72-73)

Shared price Shared price volatility

US $



200 200
100 Price
100 volatility
Price observed
observed end 1999
end 1999

0.01 0.02 0.04 0.06 0.08 σ (µ)

The observed share price had been around 100 US $ in the spring of
1999, and it went down to 27.7/8 US $ during the summer of the same year.
During the first part of 2000, it recovered and reached 40 US $. The share
price volatility seems also to have slightly decreased, while the σ ** (µ)
volatility might have increased (the relationships between share price and
σ ** (µ) have probably been slightly altered). Assuming nevertheless that

figure 3 has not undergone any too dramatic change in a few months, a
share price of 40 US $ implies a σ ** (µ) slightly above .05, which seems
only slightly outside the interval identified above.

We therefore would argue that, had the model taken economic risk
psychology into consideration, the overvaluation of the share might not
have completely disappeared, but at least would have looked much less
dramatic as in SCHWARTZ & M. MOON’s (2000) paper. Internet stocks might
not be as overvalued as analysts seem to believe, if account is taken of
investors psychology.

Some economists would of course claim that the investors pictured here
are "irrational". I do not want to take up this issue here, but no logically
compelling argument forces us to believe that it is so (MACHINA, 1995;
McCLENNEN, 1988; QUIGGIN, 1993; etc.) and most experimental results give
evidence that it isn’t so. Such investors are, indeed, consistent and thus
‘rational’ in the economic sense.

Internet financial culture and value creation

Internet companies focus on growth of revenues, as was made clear

enough in the preceding paragraph. They consistently call for innovation,
human performance and hence incentives. At the same time, they have to
emphasize the capability to raise funds with only a long term profitability
perspective. All these factors are essential to the success of Internet
startups. To meet the challenge of assembling these factors together, a
new business culture is needed. Such a business culture will consistently
question some of the most current accounting practices, although such a
questioning refers to larger issues than Internet’s (JOHNSON & KAPLAN,

To take a few examples, let’s mention first the fact that employee
training and research and development are in standard GAAP "current
operating expenses". In a long term perspective, however, they also are
investments in Human capital as well as new technology development and
should be considered that way. Second, considering all the funds used one
way or the other to generate long term cash is a very strong incentive to
foster firm’s value. To consider cash brought in excess of the needed
compensation of those who brought the funds means taking care of the
interests of those persons. These are two of the reasons why "Economic
Value Added"-type of practices (or "Economic Profit" concepts) and thinking

have pervaded the Internet economy and more generally high tech firms,
especially in the US (14).

Value creation is therefore not just happening on different grounds in the

Internet economy, as shown in the first part of this article, it is also
measured differently. Table 1 gives some insight in the differences between
NOPAT in the usual sense and Economic Profit. These differences are very
often forgotten about in discussions about economic profitability, which use
the terme "funds employed" and "cost of capital" in the same sense as
usual. Yet, these differences are important in at least two respects:
1. They clearly show that economic profit has important implications
relating to the praise of long term growth of profitability (Human training is
not only a current cost), of profitable innovation, of strong and proper
human incentives in everyday operations (awareness that changes in
stocks have to be valued, for instance, when evaluating a decision). Of
course, as has already been mentioned, economic profit reinforces
managers awareness of stockholders interests. Growth is not sufficient to
insure firm’s value as long as the profitability of all funds employed does not
match their financial compensation.
2. One even less noted feature of economic profit is its volatility. It is yet
an interesting feature, to the extent that it triggers a proper feedback effect
on firms evaluation. Indeed, economic profit is a more volatile measure than
NOPAT, as table 4 suggests: Most items to be added to the standard
NOPAT computation are either positively correlated with NOPAT or result
of such complex causal chains that they may be regarded as close to
random "noises". The wider use on the "technological" stock markets
(NASDAQ, etc.) of EVA considerations rather than ROI or other standard
measures of profitability contribute to explain why these markets are more
volatile than more conventional ones.

But greater volatility implies higher valuation, as has been emphasized

in the preceding paragraph. Larger volatility estimates by investors referring
to EVA or economic profit measures rather than to traditional analysis go
therefore another part of the way in destroying the idea that "overvaluation"
of Internet stocks is necessarily "irrational".

Econometric studies reveal a much better correlation of economic profit

approaches with capital market returns on the US stock market than on the

(14) EVA was first defined and promoted by Stern Stewart & Co.

German one (WEIMER, 1988, reported in GÜNTHER, LANDROCK & MUCHE,

2000). This might result from the larger number of high-tech and Internet
related firms on the US stock market than on the German one.

Table 4 : Measuring Value Creation through Economic Profit

"Standard" Items from GAAP Corrective Items

Cost of Good Sold
Gross Profit
Sales, General and Administrative costs
Net Operating Profit
Net Operating Profit After Tax
LIFO Reserve Increase
Interest expense, net of taxes
Loss on sales of assets, net of taxes
Net Adjusted Operating Profit After Tax
Training costs, R&D Costs, net of taxes
Less : Amortization of R&D
Readjusted NOPAT

Capital Charge in Operating Perspective:

Accounts Receivable
Inventory (net of LIFO Reserve) LIFO Reserve

Accounts Payable LIFO Reserve

Current Assets Non amortized Cumulative R&D Investmt
Current Liabilities
Net Fixed Assets
Non amortized Cumulative R&D Investmt
Total Capital Employed
Capital-Employed Charge

Readjusted NOPAT
Capital Employed charge
Economic Profit

In any case, one can see that the impact on markets of the Internet
economy might be quite differentiated. The way markets function in the Net
economy deserves therefore some comments here before we can

Internet markets and economic welfare

The new technological conditions for exchange may worry economists

about the effectiveness and the legitimacy (due to efficiency) of markets. As
we have argued that Internet is essentially about piloting consumers and
producers between supply and demand, we might as well examine step by
step these two aspects.

The supply side: pricing and shopbotting

Internet opens the way to two characteristics of pricing: one is an

incredible dynamics of price adjustments capacity, notably because of
LATOURRETTE, 2000). But the latter are not only of use to consumers, they
also provide a way for sellers to immediately observe competitor’s prices.
The other characteristics is a virtually infinite possibility of price
differentiation, which might be turned into price discrimination. Both
characteristics can therefore be a threat to market functioning and

• Price setting and adjustment

There is some evidence that dynamic price adjustments occur between
online sellers or between online sellers and physical sellers. For instance,
between two sellers, if one seller raises its price, the other one does the
same by some equivalent or similar amount. Conversely, when one seller
cuts its price, so does the other. This type of market behavior, called "price
matching", is well-known in the traditional economy and there is an already
old example in the informational economy, namely the one of the SABRE
information system, which allows airline reservations. Airlines have made
an extensive use of price matching and it is difficult to hinder such behavior,
be it only because when it happens downward, nobody (except airlines)
complain. Can this be more harmful on Internet markets than on airlines
ones? The two major differences are the number of incumbents, on one
hand, and the type of entry costs on the other one. Between two cities, the
number of airlines competing is sometimes low (2 or 3 airlines only), even if
monopoly cases are not fequent. The number of competitors on Internet is
likely to be much higher, and this will make price matching more difficult
without an explicit cooperation which would be openly against the law.
Besides, entry costs into the Internet economy are less substantial than
they are for airlines, although they are in part sunk costs, i.e. costs which
cannot be compensated for if the entrant fails. The relative importance of

sunk costs in total entry costs is here one real issue. The bulk of these sunk
costs mostly consists in advertising and marketing, which can be huge
when the incumbent is well-known. We have nevertheless argued in the
first part of this paper that a large part of such costs can be avoided,
notably through partnerships. Barriers to entry are thus not larger – to say
the least – on Internet than in the traditional economy.

Finally, the real issue here is a of a different kind: who will prove to react
quicker, sellers or buyers? If buyers are quicker, there will be a very strong
tendency for sellers to stick to low prices, for the sellers raising their prices
will be punished by losing immediately clients to their competitors. The
converse is true if sellers are quicker than buyers, and this might be a real
source of concern. Hope lies in the fact that not all sellers will be as quick
as the technology allows them to be online, be it only because some of the
physical economy sellers, will find it difficult to follow the game and will thus
temper online sellers to raise their prices too much or too often. Hope lies
also in the fact that buyers learn more quickly than many theorists believe
(even when they are smart buyers themselves).

• Price differentiation
Price differentiation or discrimination reaches unheard of possibilities
within the Internet economy. That might thus moves us far away from the
homogeneity-anonymity postulate of perfect markets.

Possibilities of discrimination are much higher on Internet than in the

traditional economy because identification of buyers is immediate and
because information on the personality of buyers – in particular on their
purchase history – is easier to acquire, as was pointed out in the first part of
this article. Loyalty programs adds weight to these technical possibilities in
a way which only too obvious. Such informations allow sellers to guess the
willingness to pay of the consumer by attempting some correlation with one
of its characteristics and offer therefore a basis to effective discrimination.

But possibilities of discrimination are also much higher than in the

traditional economy because technology offers unlimited possibilities to
"degrade" products to deter higher willingness to pay consumers from
buying the cheaper product: cheaper versions of softwares let users wait an
awful amount of time, low-priced information packages will be more
inconvenient to use, messages will be delivered with annoying delay, etc.
(VARIAN, 1995). This sounds shocking to most of us. But should one forbid
such moves? We know that "bundling" (selling products only in packages)
is even easier on Internet than in the physical economy, at least for some

categories of goods, and it has results similar to those of product

degradation. Should we then also forbid bundling? How could we? In effect,
prices may vary more easily in the Net economy than in the traditional
economy according to the identity of the purchaser and according to the
quality of the good. But how harmful is it in the end?

The surprising answer is not only that such discrimination is not always
harmful in terms of common welfare, but also that it is often very useful to
increase consumers welfare – and hence global welfare, as the seller’s
surplus can only be higher. ARMSTRONG & VICKERS (1999) show that, as
long as markets are competitive enough and a few hypotheses can be
made, price discrimination increases welfare. The supply side is thus not
too much of concern on the whole. Clearly, however, more research on a
general methodology regarding price differentiation/discrimination would be

Effectiveness of the consumption side

The consumption side of the Internet economy can only benefit of being
closer than ever to the perfect information postulate of idealized markets.
We have argued above that consumers would not be kept away from the
possibilities of information which the new technologies offer them. Attempts
to do so have failed, as the example of some online CD sellers in the US –
trying to lock out the shopbot Bargainfinder – has shown. And we may
argue that consumers look effectively for information. A recent poll
conducted in fifteen European countries by some of the major Internet
companies (Altavista, Microsoft, Real Media, Yahoo and maybe a few
others (EXERTIER, 2000) showed that many Internet users in these
countries (15) essentially look for information, and not look for physical
supply. This suggest that they use the old strategy of going to the best
shops (today the best sites online), asking for information and then look for
the good somewhere else. There is every likelihood that, once the majority
of European websurfers discover the shopbots, they will use them to see
where they can buy online the product in many cases.

(15) Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, Norway, Portugal,
Spain, Sweden, Switzerland, The Netherlands, The United Kingdom.

Table 5 - What European Websurfers use Internet for

Most regularly: Men Women

Work 70% n.a.

Write to friends n.a.(*) 68%
Look for information 70% 59%

Read the press 41% n.a.
Send greetings 34% 39%

Buy books or records (CDs, etc.) 66% 79%
Send greetings 45% n.a.
Read the press n.a. 43%

* n.a.: figure non available. Source : from (EXERTIER, 2000)

One may additionally count on learning by the consumers about the real
nature of their preferences, on their risk attitudes, on the the quality of the
suppliers, on the reliability of pure pilots. But what about prices?

As was said above, there is every reason to think that this will become
with learning a standard habit of European websurfers as it is becoming
slowly one of the American ones.

And if by some reason, information on prices were not perfectly

collected by Websurfers? It still would be way above the level it can reach
in the traditional economy, and would insure strongly competitive markets
between sellers. And when strength of competition reaches such a high
level, as in the Net economy, while the price system is somehow distorted,
that strength can become the major source of welfare, the price system
playing only a role of the second order. Such a view has been maintained
by some authors, in a different framework than the neoclassical one
(ALLAIS, 1989, p. 125-126).

Concluding remarks

Like in all drastic changes in economic development, the way value has
begun to be created on the Internet has been awkward. Adaptations of
business plans to the new technological environment have not drawn all
necessary conclusions from this radical change. At the same time, illusions

have misled quite a few of the first generation of new entrepreneurs, as is

the case when the course of affairs undergo such a substantial change. It is
not necessary to refer to a new industrial revolution (though the situation
has quite a few of the needed features). It is sufficient to think about what
happened in European businesses when the foreign exchange system
jumped from the adjustable peg structure to completely floating rates: it
took a few years and a long series of substantial losses until industrial
management lost its excessive enthusiasm of the beginning

As a consequence, some important corrections on the stock market had

to occur. Some bankruptcies of the new businesses had to happen, and life
has been made less glorious to the ones starting now than to those who
started five or ten years ago. More important Schumpeterian destructions
might as a matter of fact happen also in the traditional economy in the
years ahead. Value creation has its price to be paid.

But there is no need to ignore the value already created and to be

created by innovations grounded on the new technologies. There is no
need to invoke some ill-defined "irrationality" beyond the simply excessive
confidence of the first years already mentioned.

At the same time, business strategy as a teachable discipline has to be

reevaluated in the new environment, as we have tried to show above, the
ensuing shifts in economic power have to be more accurately determined.
Clearly also, some rules of the game – property rights among others –
might have to be adjusted, a topic which has not been dealt with in this
paper, as has also been left aside the desirable type of pricing on Internet
(MACKIE-MASON & VARIAN, 1994; DESMETS, 1999). More research is also
needed in industrial organization.

Yet, there are many reasons to believe that the new markets will
function if anything more stringently than the traditional ones. Life might be
more difficult to producers and to sellers in general. The consumers should
learn on their part and seize the opportunity to extend their welfare, without
necessarily having a larger share of the global surplus. This can happen
only when net value is finally being created.


ALLAIS M. (1989): La Théorie générale des surplus, Grenoble, Presses

Universitaires de Grenoble (1st edition: 1981, in Economies et Sociétés, Cahiers 1 à
5, Paris, ISMEA).

ARMSTRONG M. & VICKERS J. (1999): "Competitive Price Discrimination",

Technical Report, Nuffield College, Oxford.

BAKOS J.Y. (1997): "Reducing Buyer Search Costs: Implications for Electronic
Marketplaces", Management Science, vol. 48, n° 12, 1676-1692.

DE LONG J.B. & FROOMKIN A.M. (1998): "The Next Economy?" in: Hurley D.,
Kahn B. & Varian H., eds., Internet Publishing and Beyond: the Economics of Digital
Information and Intellectual Property, MIT Press, Cambridge, Massachussetts.

DESMETS P. (1999): Politiques de prix sur Internet, Mimeo, University of Paris-



Negotiation Strategy on an Internet Agent-Based Market, Note de Recherche GRID
00-15, Mimeo.

ECONOMIDES N. (1996): "The Economics of Networks", International Journal of

Industrial Organization, 16 (4), pp. 673-699.

EXERTIER S. (2000): "La Toile européenne à la loupe", Le Figaro, 23 août, p. 30.

EVANS Ph.E. & WURSTER T.S. (1999): "Getting Real About Virtual Commerce",
Harvard Business Review, November-December, 85-94.

GENSOLLEN M. (2000): "La création de valeur sur Internet", Réseaux


GÜNTHER T., LANDROCK B. & MUCHE T. (2000): Profit Versus Value-Based

Performance Measures – An Empirical Investigation Based on the Correlation With
Capital Market Returns for German DAX-100 Companies, text available at:

JACQUET D. (1997): "Rentabilité et Valeur : EVA et MVA", Analyse Financière,

septembre, n°112, pp. 52-61.

JOHNSON H.T. & KAPLAN R.S. (1987): Relevance Lost, The Rise and Fall of
Management Accounting, Boston, Mass., Harvard Business School Press.

KEPHART J.O. & GREENWALD A. (1998): Shopbots Economics, Technical Report,

IBM Institute for Advanced Commerce. Mimeo. Available on:

LANGDON Ph. (2000): "The Evolution of Shopping", The American Enterprise,


MACHINA M. J . (1995): "On Maurice Allais’ and Ole Hagen’s Expected Utility
Hypotheses and the Allais Paradox, Contemporary Discussions of Decision under
Uncertainty with Allais’Rejoinder: "Rational" Decision Making versus "Rational"
Decision Modelling?", in Bertrand MUNIER, ed., Markets, Risk and Money,
Boston/Dordrecht, Kluwer Academic Publishers.

McCLENNEN E. F. (1988): "Dynamic choice and Rationality", in Bertrand MUNIER,

ed., Risk, Decision and Rationality, Dordrecht/Boston, D.Reidel Publishing

McKNIGHT L.W. & BAILEY J.P., eds. (1997): Internet Economics, Cambridge,
Massachussets, The MIT Press.

MUNIER B. (1985): Les nouvelles technologies de la communication : impact sur

l’organisation des entreprises, leur capacité à s’informer et les comportements dans
les relations professionnelles, Mimeo, University of Aix-Marseille, November.

PARASCHIV C. (2000): "An Internet Agent-Based Market Model with Search Cost
for Buying Agents", Note de Recherche GRID, 00-10, ENS de Cachan.

PARASCHIV C., DEVEAUX L. & LATOURRETTE M. ( 2000): "Buyer Search Costs

and Seller’s Strategies on Internet Agent-Based Markets", Note de Recherche
GRID, 00-16, ENS de Cachan.

QUIGGIN J. (1993): Generalized Expected Utility Theory,The Rank-Dependent

Model, Boston/Dordrecht, Kluwer Academic Publishers.

SAVAGE L.J. (1972): The Foundations of Statistics, New York, Dover (1st ed. New
York, Wiley, 1954).

SCHWARTZ E.S. & MOON M. (2000): "Rational Pricing of Internet Companies",

Financial Analysts Journal, May-June, 62-75.

SPICKERMANN S. & PARASCHIV C. (2000): "Drivers and Impediments of

Consumer Interaction in B2C Environments: A Marketer’s Dilemma", Third
International Conference on Telecommunications and Electronic Commerce, Dallas,
Texas, November 17-20.

STEPHENS K.R. & BARTUNEK R.R. (1997): "What is Economic Value Added? A
Practioner’s View", Business Credit, April, pp. 39-42.

VARIAN H. (1995): Pricing Information Goods, Mimeo, University of Michigan,

Department of Economics.

WEIMER R. (1998): Wertorientierte Unternehmenskennziffern und Ihre Korrelation

mit Aktienrenditen im Vergleich zwischen dem U.S.-amerikanischen und dem
deutschen Kapitalmarkt, unpublished dissertation, University of Augsburg.