Intermediaries in Information Economies - Communication, Culture ...

INTERMEDIARIES IN INFORMATION ECONOMIES
A Thesis
submitted to the Faculty of the
Graduate School of Arts and Sciences
of Georgetown University
in partial fulfillment of the requirements for the
degree of
Master of Arts
in Communication, Culture and Technology
By
Bethany L. Leickly, B.A.
Washington, DC
April 30, 2004

INTERMEDIARIES IN INFORMATION ECONOMIES
Bethany L. Leickly, B.A.
Thesis Advisor: D. Linda Garcia, PhD
Second Reader: Kathleen Wallman
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To Linda Garcia, this thesis would not have been possible without you. I cannot thank
you enough for your dedication. You continue to inspire me.
To Kathleen Wallman, thank you for encouragement and insight.
To Mom, Dad, Brandon and Eric, thank you for your constant love and support.
To Larry, thank you for always being there for me and believing in me.
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COPYRIGHT 2004 BY BETHANY L. LEICKLY
ALL RIGHTS RESERVED
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TABLE OF CONTENTS
Chapter 1. Introduction........................................................................................1
Chapter 2. Information and Uncertainty: A Conceptual Framework ....................9
Introduction........................................................................................9
Information and its role in the economy ...........................................10
i. Information defined.................................................................10
ii. Information: an uncertain commodity?....................................13
iii. Information asymmetry..........................................................14
Technology and information.............................................................16
Contending with uncertainty .............................................................18
i. Agency theory ..........................................................................19
ii. Transaction cost theory...........................................................20
Intermediation ..................................................................................24
Conclusion........................................................................................27
Chapter 3. Historical Analysis ............................................................................29
Introduction......................................................................................29
The traditional market.......................................................................30
The market expands..........................................................................32
Uncertainty in the Industrial Revolution ...........................................35
Conclusion........................................................................................41
Chapter 4. Technology and Uncertainties in the Digital Age ..............................45
Introduction......................................................................................45
Digital technology advances..............................................................46
New uncertainties .............................................................................49
i. Information overload ...............................................................50
ii. Information asymmetry...........................................................50
iii. Technology ............................................................................51
iv. Online strategy .......................................................................51
v. Mass customization.................................................................52
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vi. Asset specificity and networked firms.....................................53
vii. Information commodities......................................................53
viii. Personal information collection............................................54
ix. Privacy ...................................................................................55
x. Trust .......................................................................................58
New roles for intermediaries .............................................................59
i. Rules for success ......................................................................61
Conclusion........................................................................................63
Chapter 5. Infomediaries in e-Commerce: Case Studies.....................................65
Introduction......................................................................................65
Hagel and Singer’s infomediary model ..............................................66
Infomediaries in practice...................................................................68
i. Lumeria....................................................................................69
ii. AllAdvantage...........................................................................70
iii. Firefly/Passport .....................................................................72
Shortcomings of infomediaries..........................................................73
Alternatives.......................................................................................77
i. eBay .........................................................................................78
ii. Amazon.com...........................................................................81
Conclusion........................................................................................83
Chapter 6. Conclusion........................................................................................87
Suggested areas of research ...............................................................93
References..............................................................................................................95
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Chapter 1. Introduction
Information is an essential component of any market. In all transactions, buyers
and sellers must exchange information about the product, price, and settlement. Hence,
individuals must acquire information to make informed decisions in the purchase of both
goods and services (Kingma, 2001). Only recently has the economy has been labeled an
“information economy;” yet the market has always relied on the exchange of information.
In spite of the importance of information, neoclassical economics largely ignores
its role (Wolpert & Wolpert, 1986). The neoclassical model assumes that market
information is perfect, and thus transaction costs are low. In reality, perfect information
is impossible. Instead, actors have insufficient and asymmetric information, so they must
make decisions based on bounded rationality. This lack of perfect information results in
increased transaction costs for buyers and sellers alike.
Bringing buyers and sellers together, intermediaries have traditionally served to
reduce these information-related transaction costs. An intermediary works as an
economic agent who helps buyers and sellers find each other and execute a transaction.
Equally important, they help to sort, classify, and distribute market information and
goods. Not surprisingly, the role of intermediaries has continued to grow, and become
more specialized, as advances in communication and transportation technologies increase
the size and complexity of the marketplace (Beniger, 1986; Garcia, 2002; M. D. Smith,
Bailey, & Brynjolfsson, 2000; Spulber, 1998).
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Today, however, further advances in technology and communication threaten the
role of the traditional intermediary. Based on the Internet, these technologies transform
the locale of business transactions from the traditional marketplace to cyberspace.
Although the Internet exponentially expands the size and scope of the market for
businesses and consumers, it also gives them direct access to each other. Thus, for
example, using the Internet, businesses can advertise and market directly to customers,
while consumers can employ web technology to seek out the businesses that they want.
These technological capabilities facilitate “disintermediation,” or the elimination of the
middleman in the value chain.
This changing paradigm of business processes is shifting the focus on the Internet
from traditional goods to information goods and services, ushering in the true
“information economy”. The infrastructure of the Internet adds value to information by
enhancing the ability to store, retrieve, filter, repackage, and distribute it (C. Shapiro &
Varian, 1998). As a result, information can more easily be commodified—that is to say,
bought and sold for a price in the marketplace. Using the Internet, for example,
businesses can now access vast amounts of data from their customers, such as
information about credit cards, bank accounts, purchases, demographics and other
personal data (Larson, 1992). Even more important, businesses now have an incentive to
collect this customer data—they can sell it, trade it and use it for direct marketing. By
controlling consumer information, businesses can maximize profits and reduce transaction
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costs. Thus, information commodities include not only intangible goods, but also
commercial uses of personal information.
Because of the enhanced value of information, there is, however, a greater
potential for personal information to be misused by businesses. For, in capitalizing on
such consumer information, businesses subject consumers to a loss of property and
privacy rights (Frost, Dec. 1980). Moreover, consumers have no control over how their
personal information might be used or shared—to their detriment—with others. Not
surprisingly, there has been a growing concern about personal privacy and the need to
impose stricter controls over businesses’ use of personal information (Cavoukian &
Tapscott, 1997).
Clearly, a balance must be achieved that gives consumers greater control of their
information, while allowing businesses to capitalize on recent technology advances. One
way of resolving this tension is through a new kind of intermediary. With this potential in
mind, John Hagel III and Marc Singer put forth a new concept in the late 1990s—the so-
called “information intermediary”, or “infomediary”. The infomediary was intended to
help customers capture, manage and maximize the value of their private information.
Specifically, Hagel and Singer proposed that new businesses be established to act on
behalf of consumers by negotiating how their personal information would be made
available to businesses. Consequently, a relationship between the infomediary, the
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consumer and the business would presumably be developed based on trust and
transparency (Hagel & Singer, 1999; Rosenblatt, July 1999).
Although Hagel and Singer’s idea was touted as the panacea, sustainable
infomediaries have yet to materialize (Rosenblatt, July 1999). In 1999, several such
intermediaries were founded to help consumers handle their personal information. These
included Privaseek, Lumeria and AllAdvantage (Muller, 2000; Pomeroy, n.d.). The results
have hardly been successful. By 2004, Privaseek was non-existent; the AllAdvantage
website redirected users to a different website 1 ; and Lumeria’s website had been inactive
since 2000 2 .
The present dearth of infomediaries suggests that Hagel and Singer’s concept was
flawed in some fundamental way. The failure of the infomediary model raises a number
of related questions. In particular, what accounts for the lack of both supply of and
demand for infomediaries in today’s information-based economy? Is it a function of the
changing role of information in the economy, the advent of information technology, new
sources of transaction costs, or some combination of these factors? Are there any
circumstances under which an intermediary can succeed in the information economy?
Because new communications technologies provide a direct link between the
business and the consumer, the traditional role of an intermediary may no longer be viable
1 http://aia.plugusin4cash.com/
2 http://www.lumeria.com/
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in the digital age. Historically, intermediaries found a niche in markets where transaction
costs were high, and they served both the buyer and the seller in reducing these costs.
The middleman worked on behalf of both the business and the consumer, negotiating a
contract between them. As technology reduces transaction costs for both parties, thereby
undermining the role of the middleman, intermediaries must redefine their role and find
new ways to add value to business transactions.
This thesis hypothesizes that the infomediary model put forth by Hagel and Singer
failed because, in controlling private information, it sought to provide support for the
customer alone. In so doing, the model failed to create enough incentives for businesses
to buy into the solution. As history shows, the middleman must benefit both the buyer
and the seller, and the infomediary failed to do this.
A second hypothesis accounting for the failed model is that it did not adequately
take into account several key aspects of a networked economy. Most notably,
infomediaries are subject to extremely high fixed costs, network effects, bandwagon
effects and unraveling. These factors made it difficult for infomediaries to sustain
themselves in the digital marketplace.
Furthermore, the infomediary, in its effort to work on behalf of the customer to
protect personal information and privacy, had to first gain the confidence of the
consumer. However, in the unstable environment following the dot-com bust, the fate of
the infomediaries was highly uncertain. Hence, consumers were wary to trust an
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infomediary to control all of their personal information, not knowing if the company
would prosper or fold.
As a final hypothesis, this thesis suggests that there is a role for the infomediary in
the information economy. For while communication and technology advances promote
disintermediation in some markets, there are instances in which intermediaries can still
add value to business transactions. However, intermediaries can only succeed as
differentiated, specialized agents for commerce, not as watchdogs of consumer
information and privacy. Thus, the benefit will come from the intermediary’s ability to
reduce transaction costs by addressing the problems of the information overload
associated with the information economy. The solutions to the problems of privacy and
consumer information protection will require a new model for the relationship between
customers and business--a model that relies on trust, social and legal contracts, incentives,
and procedural fairness in handling personal information.
To test these hypotheses, this thesis will proceed as follows. Chapter Two will
conceptualize the role of information in the economy and how it gives rise to transaction
costs. In addition, it will describe and analyze the case of information impactedness and
information asymmetry, and how it affects economic activity and the relationships among
economic actors. The chapter will then lay out the relationship between trust and
transaction costs. Finally, the chapter will define the role of intermediaries and their
potential to reduce uncertainty and transaction costs.
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Building on this theoretical framework, Chapter Three will look from an historical
perspective at the role that intermediaries have played in reducing transaction costs.
Special attention will be given to the role that communication and technological advances
have played both in expanding markets and generating the need for the middleman in
business. It will show how, under various circumstances, these technologies generated
uncertainty and hence different types of intermediary roles. Understanding how these
factors led to the changing role of the intermediary over time, we will be better able to
anticipate the intermediary’s role in the networked economy.
Turning to the present, Chapter Four will lay out and discuss the emerging
information-related issues that businesses and consumers face in the digital age. The
chapter will begin with a brief characterization of today’s technology advances, and how
they are likely to affect transaction costs in a general sense. Next, the chapter will look
more specifically at the impact of new technologies on information asymmetry, the
potential for collecting consumer information, privacy concerns and information
overload. Having identified the sources of digitally-related uncertainties and risks, it will
suggest how intermediaries might play a useful role.
Chapter Five will analyze the role that intermediaries presently play in e-commerce
and the information economy. In particular, it will seek to determine why some
intermediaries have failed to capture the necessary critical mass of users, while others have
successfully stepped in to deal with information asymmetry and information overload. At
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the same time, it will identify and analyze under what circumstances businesses have
successfully eliminated the middleman from their value chain.
In conclusion, Chapter Six will summarize the lessons learned. Building on the
discussions in the previous chapter, this chapter will discuss the likelihood that consumers
and businesses will find an adequate incentive to support the role of an intermediary and
the circumstances under which they might be most likely to do so.
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Chapter 2. Information and Uncertainty: A Conceptual Framework
Introduction
To answer the question Are there any circumstances under which an intermediary can succeed
in the information economy?, the general function of an intermediary must be understood.
Also, before examining the role that intermediaries play in reducing uncertainties in the
digital age, it is necessary to lay out a conceptual framework, focusing on uncertainties of
information in any economic system. Only by understanding the fundamental role that
information plays in the economy can we examine the factors that give rise to the role of
the intermediary. This conceptualization will serve as a basis for the following chapters, in
which the intermediary is analyzed in both historical and present day markets.
Furthermore, by understanding the general principles underlying the function of the
intermediary, the viability of the “infomediary” model in the digital age can be analyzed.
To this end, the chapter first defines information and its role in the economy,
focusing on the uncertainties to which information gives rise. Particular emphasis is given
to information asymmetry and the commodification of information. Secondly, the
chapter identifies how technologies serve as catalysts for changing uncertainties related to
information. Considering all these factors, the next section presents two theories—agency
theory and transaction cost theory—each of which seek to explain the conditions of
uncertainty that are inherent in any economy. Next, the chapter defines the role of
intermediaries, how they function, and how they reduce uncertainty and transaction costs.
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Based on this analysis, this chapter identifies the key conditions under which
intermediaries can be viable economic actors.
Information and its role in the economy
i. Information defined
Information is a “fuzzy” concept, which has become the subject of economic
analysis only in the past 100 years (Rose, 1999, 6). Economists differ in their definitions
of information. 3 However, given the focus of this thesis on the role of intermediaries, a
definition that relates to uncertainty is most appropriate. Thus for the purpose of this
thesis, the following definition will take precedence. Information is that which can be
exploited to reduce uncertainty in decision-making (Rose, 1999, 10). Uncertainty is
defined as “the dispersion of individuals’ subjective probability (or belief) distributions
over possible states of the world,” (Hirshleifer, 1973, 31). Thus, information is a message
that an individual receives that reduces uncertainty in his or her environment. In
economics, this refers to the knowledge of prices, agents, and supply and demand of
products.
3 Some definitions of information include “knowledge is power,” (Stigler, 1971, 61); “the negative measure
of uncertainty…and an economically interesting category of goods,” (Arrow, 1984, 138); and “anything that
can be digitized,” (C. Shapiro & Varian, 1998, 3).
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In some cases, uncertainty also creates a market for information. When agents are
uncertain about future events—the quality of products, or the honesty of others—they
look to purchase information to reduce uncertainty (Kingma, 2001). In this sense,
information decreases the risk involved in complex transactions. Risk is “the potential for
loss when uncertain future events may cause economic harm,” (Kingma, 2001, 89). To
understand how agents can exploit information, it is first necessary to operationalize these
uncertainties.
All information can be described by common properties. For one, information is
an intangible resource and an immaterial good (Rose, 1999). Second, information is a
highly fungible resource (Sampler, 1998). In this sense, it can be exchanged or
interchanged with other information. Yet, information varies in its degree of fungibility or
alternative uses (Sampler, 1998). 4 Thus, the nature and value of information change
according to its use. In addition, the production of information goods involves high fixed
costs and low marginal costs (C. Shapiro & Varian, 1998). There are also high sunk costs
in creating information, but it is relatively cheap to replicate. Thus, “information is costly
to produce but cheap to reproduce,” (C. Shapiro & Varian, 1998, 3). Unlike tangible
4 Sampler gives an example of using customer demographic data to explain the varying fungibility of
information: “customer demographic data may be highly applicable to a wide variety of consumer goods
firms, but information regarding the quantity of a particular product…would be less fungible, i.e., it would
have fewer alternative uses or be applicable in fewer situations,” (Sampler, 1998, 346).
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goods, information is subject to perfectly increasing returns. Once the initial investment
is made, information can be reused at no additional cost. Likewise, information can be
replicated at zero cost and without limit, and it will never wear out or deteriorate, unlike
tangible goods. However, information may become obsolete or untrue with time, and its
value may decrease the more it is replicated (Evans & Wurster, 2000).
Information is a non-exclusive good, a feature that generates uncertainties in
markets where information is sold (Kingma, 2001, 7). For example, when information
transfers between a producer and user, usually only a copy of the information is sold. The
producer keeps the actual information. Likewise, the seller retains the information even
once it is sold. Thus that same piece of information can be enjoyed by more than one
consumer simultaneously (Kingma, 2001, 7). The buyer can also copy and distribute the
information without the seller’s knowledge. Thus, the seller risks loss of compensation
for the information’s future uses. The non-exclusive nature of information also induces a
disclosure problem for agents selling it, because its use by one agent may reveal the
information to others. Moreover, when agents hesitate to reveal information additional
market uncertainty is created. As a result, agents are likely to under-invest in the
production of knowledge and information (Rose, 1999, 18).
Market uncertainties also arise because the true value of information cannot be
predicted ex ante (Rose, 1999, 18-19). More specifically, a consumer cannot know the
value and worth of a piece of information before buying it. If the seller exhibits the
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information before selling it, it has in effect been given away. Thus, the buyer is at risk,
never knowing the exact nature of the information being purchased. As in the case of
non-exclusivities, these uncertainties may also lead to an underdeveloped market for
information.
Given these unique characteristics, information does not easily fit in the traditional
neoclassical economic model. As Boisot has pointed out, “Neoclassical economics has
addressed the problem of information goods somewhat schizophrenically,” (Boisot, 1998,
76). On one hand, economic theory treats information as a free good that is not subject
to trading and is instantaneously available to all economic agents. In this respect, it
functions as a support to exchange and “to foster the perfect foresight so essential to
efficient markets,” (Boisot, 1998, 76). Conversely, neoclassical economics also treats
information as a good that, through artificial means, can be made subject to the same
scrutiny of physical goods and thus also to the normal rules of trading. In the first case,
information has utility, but because it is in abundance, it has no value. In the second case,
it has both utility and scarcity, and therefore has value (Boisot, 1998).
ii. Information: an uncertain commodity?
Because information is different from tangible goods, questions arise as to
whether it can function as a true commodity in the marketplace. An economic
commodity is an item that can be traded for a price (Allen, 1990, 268). To be classified as
a commodity, goods must directly or indirectly satisfy a human need, they must be limited,
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and their production must compete with other commodities for scarce resources (Rose,
1999, 36). Furthermore, buyers and sellers must be able to judge whether the properties of
a good satisfies their needs. As well, they must be secure in the property rights of the
commodity, so they can use the resource, retain the returns, alter the resource, and
alienate the resource (Tietzel, 1981, as cited by Rose, 1999, 37). Lastly, the commodities
must possess an exchange value (Rose, 1999, 36).
According to these criteria, information possesses some characteristics of a
commodity. The fit, however, is problematic, which is the source of additional market
uncertainties. As we have seen, information is non-rivalrous insofar as the use of
information by one person does not exclude its use by others. Moreover, because of its
low marginal costs, it does not compete for scarce resources, and it is easily reproduced.
Equally problematic, maintaining property rights in intangible resources, such as
information, is very difficult because such commodities are non-exclusive. Thus, the
question as to who owns the information arises. Both the buyer and the seller can
simultaneously possess the information, and use it as they chose.
iii. Information asymmetry
The problematic nature of information as a commodity exacerbates the problems
of information asymmetry and imperfect information, which are features of any economy.
Asymmetries are associated with the uneven distribution of information in the
marketplace (Phlips, 1988, 4). When information is commoditized and exchanged for
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value in the marketplace, certain agents will invariably have more information than other
agents. For example, a buyer may have more complete information than the seller, and
visa versa.
Information asymmetries may occur for a number of reasons. For example, in
some markets, information is available but producers are not willing to reveal it to
consumers. A producer will get a better price if he can hide information from consumers.
These uniformed or misinformed consumers make poor decisions about a product’s
value. Thus, they are reluctant to buy goods and services, thereby reducing the number of
transactions in a market (Kingma, 2001).
Information asymmetry also causes information impactedness. Defined by Oliver
Williamson, information impactedness is the condition that occurs when the buyer and
the seller have knowledge of different and essentially private information when they take
part in complex contracting (Williamson, 1985, 51). This condition is costly to overcome
and gives rise to a trading hazard, occasionally resulting in market failure (Akerlof, 1970,
cited by Williamson, 1985, 212).
Asymmetrical information negatively affects market transactions. At a minimum,
asymmetries make the market operate less efficiently insofar as prices will not represent
real costs and benefits (Kingma, 2001, 92). In the worse case, if parties are discouraged
from transacting, asymmetries can undermine the market all together. Economist George
Akerlof (1970) provides the classic example of such a case in his article, “The Market for
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Lemons.” As he describes, the seller has an incentive to misrepresent the car’s quality,
and the buyer has little incentive to believe what the seller says. This uncertainty prevents
transactions between high quality buyers and sellers (Akerlof, 1970).
To overcome the problems of imperfect information and information asymmetry,
a third party can mediate between the buyer and the seller. One solution is the creation of
an agent who will act in both the user’s and producer’s interest (Steinmueller, 1992). “An
agent’s incentives to compromise the producer’s information by revealing it to [the] user
can be offset by contracts and the incentives to continue to gain economic returns
through repeat dealing with producers,” (Steinmueller, 1992, 191). Repeat dealing and
reputation effects would discourage misrepresentation of information to the buyer. This
solution aligns incentives between producers and users (Steinmueller, 1992, 191). Thus, a
third party –an intermediary—reduces information asymmetry.
Technology and information
Technology is intrinsically tied to information in an economy because technology
advances affect how information is produced and transmitted. In the past, major
technological advances improved communication techniques, which affected both the use
of information and physical transport. “Information technologies related to
communication and transports have a common property, namely to be very general
(generic) in application, and contributing to the coordination and filtering processes of the
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economy…they exercise leverage effects on the entire economic system,” (Gunnar,
Folster, Lindberg, Pousette, & Taymaz, 1990, 18).
Examples of technologies that have changed the distribution and control of
information include the printed word, the steam engine, electricity, standardization,
automobile transport, financial institutions, electronics based information technology, and
general education. The printed word was a “path-breaking production technology…(that)
made it possible to pass on large volumes of knowledge in the abstract form of written
information, a technology in itself,” (Gunnar et al., 1990, 19). With the advent of the
printing press, barriers to the spread of information and knowledge were removed. The
advances in transportation systems (notably steam engines and automobiles) also changed
communication methods, increased the transport of goods, and thus increased the flow
and exchange of information (Gunnar et al., 1990).
As technology advances, certain uncertainties are resolved. But, at the same time,
new uncertainties emerge as relationships are restructured (Garcia, 2002, 51).
“Although…technologies can reduce transaction costs and improve economic
performance, their usage will generate a whole range of new uncertainties and transaction
costs,”(Garcia, 2001, 3). To contend with these new uncertainties, new means of control
must be established. “For, while reducing information-related costs in one part of the
transaction chain, these solutions serve simultaneously to generate new transaction costs
elsewhere in the chain, thereby creating anew the need for organizational and
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technological innovations,”(Garcia, 2002, 47). Information and communications
technologies serve to control economic activities of production, distribution and
consumption of goods and services (Beniger, 1986, 16). “A society’s ability to maintain
control—at all levels from interpersonal to international relations—will be directly
proportional to the development of its information technologies,”(Beniger, 1986, 8-9).
Technology also affects the commoditization of information in the economy.
Because technologies offer increased scope and reach in communication across the globe,
information has a greater ability to be valued and exchanged in the marketplace. “The
increased availability and capacity of communication networks stresses the basic
characteristics of interdependence, inappropriablilty and externality of information as a
commodity. At the same time it makes information an evergrowing strategic input in
decision making, in production and consumption,” (Stiglitz, 1989, 198). Thus,
technology increases both the flow and value of information in an economic system.
Contending with uncertainty
Neoclassical economics fails to take into consideration the uncertainty of
information, requiring alternate theories to explain the organization of markets. In this
section, two of these theories are examined: agency theory and transaction cost theory.
Both offer explanations of and solutions for dealing with uncertainty, and thus help to
explain the role of the intermediary.
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i. Agency theory
One relatively new theory that accounts for uncertainty is agency theory. This
theory, first developed in 1976, examines the contractual relationships in an organization
(Karake-Shalhoub, 2002, 103). Agency theory assumes that human beings are rational,
risk-averse, and motivated by self interest (Karake-Shalhoub, 2002, 10). The theory aims
to develop efficient organizational and contractual structures that can overcome problems
of uncertainty arising in economic relationships. The main sources of these problems are
the asymmetric distribution of information between actors, and uncertainty about the
future states of the environment and actions taken by the agents (Rose, 1999, 27).
In agency theory, there is a defined relationship between the “principal” and the
“agent.” The agent (provider of the service) acts on behalf of the principal (user of the
service). Information asymmetry affects the principal-agent relationship. Because both
the principal and the agent are individuals who act in their own self-interest, a conflict can
occur when both parties attempt to maximize their individual self-interest (Karake-
Shalhoub, 2002, 105). Uncertainty occurs when the agent’s action is not directly
observable by the principal (Rose, 1999, 27). Without the ability to monitor the agent, the
principal may assume that the agent is hiding information, which is a problem of moral
hazard.
Agency costs incur from uncertainty in principal-agent relationships. Agency costs
are the losses resulting from imperfect information, and they can result directly from the
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conflict between agent and principal. Moreover, agency costs can reduce the value of an
organization. Thus, agency theory sets out to explain how to best coordinate relationships
to reduce these costs (Karake-Shalhoub, 2002, 109).
Agency theory offers solutions to help economic actors reduce agency costs and
mitigate problems of uncertainty, moral hazard and adverse selection in the market. For
example, signaling, which reveals private information to the buyer, prevents adverse
selection. Risk sharing--wherein the principal bears a portion of the risk to minimize
opportunism--can overcome the problem of moral hazard. Furthermore, uncertainty can
be diminished by using incentive schemes and control mechanisms in contracts (Karake-
Shalhoub, 2002).
ii. Transaction cost theory
Another valuable theory for contending with uncertainty is transaction cost
theory. Transaction cost theory originated in the early twentieth century, and, like agency
theory, it only recently came into focus in economics. Transaction cost theory is
concerned with how firms might best be organized to reduce information related costs.
Transaction costs, as originally defined by Ronald Coase in 1937 in his article “The Nature
of the Firm,” add inefficiencies to the market (Coase, 1937, 390). Both Kenneth Arrow
and Oliver Williamson played a seminal role in expanding on Coase’s postulations in the
1970’s and 1980’s. Williamson defines transaction costs as the “costs of running the
economic system,”(Williamson, 1985, 18).
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Transaction costs add to the price of a good or service, and involve search costs,
information costs, bargaining costs, decision costs, policing costs and enforcement costs
(Downes & Mui, 1998). In business transactions, transaction costs also include the
negotiating, monitoring and enforcement costs associated with the transfer of goods and
services between the firm and the customer (G. R. Jones & Butler, 1988, 204).
Transaction costs can apply to both the firm and the consumer, yet it is often the
consumer that faces higher transaction costs, leading to information asymmetry in the
market. Economic agents seek to reduce transaction costs, making the market more
efficient (Downes and Mui, 1998, 38).
Transaction cost economics characterizes economic agents as having several
determining features: bounded rationality, opportunism, and asset specificity (Williamson,
1985, 30). Agents are subject to bounded rationality when making decisions, “whence
behavior is intendedly rational, but only limitedly so,” (Simon, 1961, as cited by
Williamson, 1985, 30). In this respect, transaction cost economics differs from agency
theory, which assumes that economic agents are rational. In transaction cost economics,
environmental and social factors limit an agent’s rationality.
Opportunism often involves blatant and subtle forms of deceit (Williamson, 1985,
47). This refers to the incomplete or distorted disclosure of information, especially the
effort to mislead, distort, disguise, obfuscate, or otherwise confuse other agents
(Williamson, 1985, 47). Opportunism is responsible for conditions of information
21

asymmetry and uncertainty, which, according to Williamson, “vastly complicates problems
of economic organization,” (Williamson, 1985, 48).
The most critical element in transaction cost economics is asset specificity
(Williamson, 1985, 30). Transactions that are supported by investments in transaction-
specific assets experience “lock-in” effects (Williamson, 1985, 53). Assets that are specific
to the transaction include cost advantage, such as a unique location or learning, or task-
specific labor skills (Williamson, 1985, 54). There are four types of asset specificity: site,
physical, human asset, and dedicated assets (Williamson, 1985, 55). 5
Transaction cost economics thus seeks to explain how uncertainties in the market
might be reduced. Williamson proposes that an agent should “organize transactions so as
to economize on bounded rationality while simultaneously safeguarding them against the
hazards of opportunism,”(1985, 32). Williamson also argues that uncertainty would
disappear if individuals were either fully open and honest in their efforts to realize
5 According to Williamson, “asset specificity refers to durable investments that are undertaken in support of
particular transactions, the opportunity cost of which investments is much lower in best alternative uses or
by alternative users should the original transaction be prematurely terminated, and the specific identity of the
parties to a transaction plainly matters in these circumstances, which is to say that continuity of the
relationship is valued, whence contractual and organization safeguards arise in support of transactions of
this kind, which safeguards are unneeded (would be the source of avoidable costs) for transactions of the
more familiar neo-classical (nonspecific) variety,” (1985, 55).
22

individual advantage, or if full subordination, self-denial, and obedience could be
presumed in the transaction (Williamson, 1985, 49).
Trust plays an important role in transaction cost economics. Karake-Shalhoub
defines trust as “a social lubricant that allows consumers to transact with merchants who
are not part of their immediate network,” (2002, 38). By placing trust in a merchant, the
consumer alleviates the perception of risk in a transaction. High levels of perceived risk
correspond with a high level of trust needed to execute a transaction. Thus, “when risk is
present, trust is needed to make transactions possible,” (Karake-Shalhoub, 2002, 38).
Distrust is an uncertainty that increases transaction costs. When opportunism is
present, trustworthiness is rarely transparent (Williamson, 1985). Relationships are easily
invaded and exploited by agents who do not possess trustworthiness. In other words, a
lack of trust on the part of some actors decreases trustworthiness in all relationships,
because an agent cannot be sure whom to trust. If one party trusts in another, it is making
itself vulnerable to the other party’s behavior (Karake-Shalhoub, 2002). To overcome
this, agents must make concessions to the effects of opportunism (Williamson, 1985).
There are several ways to build trust in economic relationships. First, competence
can be a source of trust in asymmetric relationships. Competence means that parties
display a level of professionalism, that they have the capability to follow through on
promises, that they can realistically judge a situation, and they have strong interpersonal
skills (Karake-Shalhoub, 2002, 31). Other factors for establishing consumer trust in a
23

seller organization are reputation and size (Karake-Shalhoub, 2002, 39). Reputation is the
extent to which buyers believe that the selling organization is honest and concerned about
its customers. “The better the seller’s reputation, the more the seller has presumably
committed resources to build that reputation, the higher the penalty from violating the
consumer’s trust, and hence the more trustworthy the seller is perceived to be,” (Karake-
Shalhoub, 2002, 39). Size matters because a large organization signals to the consumer
that the business has invested significant resources in the organization. Thus, the
organization stands to lose a great deal if it acts in an untrustworthy way. Thus, the larger
the firm, the greater the perception that it is acting in the customer’s best interest (Karake-
Shalhoub, 2002).
Again, George Akerloff’s market for lemons exemplifies the importance of trust in
transactions (1970). Trust plays a large role in the market for lemons. The presence of
dishonest agents in the market who offer inferior goods tend to drive the market out of
existence, because inferior products drive out the legitimate business (Akerlof, 1970).
“The cost of dishonesty lies not only in the amount by which the purchaser is cheated; the
cost also must include the loss incurred from driving legitimate business out of existence,”
(Akerlof, 1970, 495).
Intermediation
Having presented two theories to explain uncertainty and information asymmetry
in a market, several questions are raised: what role do intermediaries play in this framework? Can
24

intermediaries step in to reduce uncertainties? Intermediation is a possible solution to the
problems of uncertainty in the economy. An intermediary steps in to overcome
information asymmetry, information impactedness, distrust, and high transaction costs
associated with information (Rose, 1999). An intermediary functions by seeking out
suppliers, finding and encouraging buyers, selecting the buy and sell prices, defining the
terms of transactions, managing the payments and keeping records of transactions, and
holding inventories to provide liquidity or availability of goods and services (Spulber,
1996). Intermediaries provide utility by increasing the chances of a successful match
between buyers and sellers, thus the need for an intermediary will come about because of
frictions in the market (Cosimano, 1996).
Intermediaries relieve both agency costs and transaction costs. Intermediaries
emerge in markets where transaction costs are high. As Coase and William purport, firms
are organized to minimize the role of transaction costs (Coase, 1937; Williamson, 1985).
Thus, the intermediary can be interpreted as a firm that acts to reduce transaction costs
(Cosimano, 1996). The intermediary can also be interpreted as a mechanism for
controlling uncertainty and sharing risk to reduce agency costs.
The roles available to an intermediary are determined by the types of uncertainties
present in the market (Spulber, 1996). The occurrence of uncertainty is a prerequisite for
the existence and the justification of intermediaries (Gumbel, 1985, as cited by Rose, 1999,
58). In markets where uncertainty is present, intermediaries coordinate transactions with
25

okering activities. When opportunism is present, intermediaries create market
information and provide guarantees for quality. Likewise, when it is costly to observe the
actions of agents, intermediaries provide monitoring and contracting support.
There is something intrinsic in intermediation which solves the problems of moral
hazard and appropriability which tend to inhibit the production of information (Leland
and Pyle, 1977, as cited by T. S. Campbell & Kracaw, 1980, 863). To eliminate
information asymmetries regarding the qualities of assets, the market must perceive
information to be reliable. Reliability can only be achieved with the resolution of any
uncertainty and moral hazards which inhibit the production of information or diminish its
integrity (Leland and Pyle, 1977, as cited by T. S. Campbell & Kracaw, 1980, 879).
Intermediaries also emerge as information producers because the production of
information, the protection of confidentiality, the provision of transactions services, as
well as other intermediary services, are naturally complementary activities (T. S. Campbell
& Kracaw, 1980). The moral hazard problem is resolved when the intermediary has a
large enough position in the market to be trustworthy. Intermediaries are profitable when
they can jointly produce information and other services valued by investors. Thus,
intermediaries do not emerge only when there are difficulties created by asymmetric and
costly information. They can profitably emerge when they can jointly produce
information as well as other products or services valued by buyers and seller (T. S.
Campbell & Kracaw, 1980).
26

The insertion of an intermediary in the value chain can have negative impacts in
certain situations. “Intermediation introduces a further step of transaction in the value
chain and therewith causes additional transaction costs. So intermediation can only be
advantageous if the increase of value added through intermediation overcompensates the
transaction costs additionally incurred,” (Rose, 1999, 46). Thus, to be viable,
intermediaries must add value to transactions.
Conclusion
An intermediary seeks to reduce uncertainties for agents in markets that manifest
information asymmetry and rising transaction costs. But the specific nature of these
uncertainties changes with each successive generation. The intermediary functions by
producing information, decreasing information asymmetry and reducing transaction costs.
Thus, at any particular point in time, the function of intermediaries will depend on
information asymmetry, information impactedness, the commodification of information,
and transaction costs. It is clear that for an intermediary to succeed, it must add value for
both the buyer and the seller. In any economy—the age of mercantilism, the Industrial
Revolution, or the Digital Age—intermediaries emerge when uncertainties are present in
the market. As these uncertainties change, the role of the intermediary changes as well.
With this conceptual framework laid out, further consideration can be given to the
role of intermediaries in history and in present markets. Having identified the
uncertainties that give rise to intermediaries in an economy, the next step is to analyze
27

how these factors affected the role of intermediaries in historical markets, from the
traditional town square market to the Industrial Revolution. What uncertainties and
transaction costs in these markets gave rise to the first intermediaries? What roles did
intermediaries play in these markets?
28

Introduction
Chapter 3. Historical Analysis
To assess the need for intermediaries in the digital age, it is first necessary to
understand the role that they have played historically in reducing transaction costs and
uncertainty. By identifying the factors that determined the intermediary’s role in the past,
we can consider how these might apply in a digitally networked economy. Likewise, how
intermediaries’ responded previously to technological changes can help us anticipate how
intermediaries might react to today’s rapidly changing digital environment. The following
historical account builds on the conceptual framework laid out in the previous chapter.
This chapter first describes the traditional market, when trade took place in the
town square. The focus is on the role that information played in the exchange of tangible
goods and how buyers and sellers contended with uncertainties. Secondly, the chapter
looks at how communications and technological advances expanded these markets, and
thus gave rise to the intermediary. Particular consideration is given to growing market
uncertainties and how intermediaries stepped in to resolve them. The chapter then
considers the Industrial Revolution, focusing on the new uncertainties to which the
railroads, telegraph, and telephone gave rise. In keeping with the previous chapter,
transaction cost theory and agency theory provide the basis for explaining these new
uncertainties. Building on this analysis, the chapter examines the changing role of the
29

intermediary in this new context. In conclusion, the chapter discusses how intermediaries
must reinvent their roles to remain viable in new technological contexts.
The traditional market
Before the development of national markets supported and sustained by advanced
transport and communications networks, economic exchanges took place in traditional
town markets, where transactions were confined to the local town square (Garcia, 2001).
At these markets, buyers and sellers directly exchanged commodities such as food, grains,
and wares; goods were sold immediately and on sight. Social life revolved around the
market. “It was at the market that the townspeople met, made deals, quarreled, perhaps
came to blows,”(Braudel, 1982b, 30).
Transactions in the traditional market relied, therefore, on personal relationships.
In this type of barter economy, the producer dealt directly with the consumer, so
middlemen played little part in executing transactions. Economic roles, moreover, were
somewhat diffuse; the producer also served as the retailer who sold his or her goods
directly to consumers. Furthermore, where coordination beyond the immediate
marketplace was required, family partnerships, rather than intermediaries, were employed
(Beniger, 1986; Shaw, 1912).
As discussed in chapter two, information exchange is inherent in any economy.
Thus, traditional markets relied on the exchange of information, even though most gains
came from the exchange of tangible goods. In a traditional local market, the flow of
30

information was very dense. Even in the case of distant trade, most communication took
place by word of mouth; for the written word (letters, chronicles, and official documents)
was limited in its usage and dissemination (Reyerson, 2002, 145).
Producers depended on getting quality information. Retailers were mainly
concerned with supply and demand in local and distant markets, wars, politics,
import/export regulations, monetary changes, climate, and agricultural conditions. To
help obtain this information, notaries, innkeepers and brokers acted as simple
intermediaries, discovering business opportunities and bringing buyers and sellers
together. Yet the role of these intermediaries was undeveloped, and they took little part in
market (Garcia, 2001; F. M. Jones, 1937; Reyerson, 2002).
Transaction costs and agency costs, therefore, were relatively low in traditional
markets. Proximity helped to reduce uncertainty, as buyers and sellers knew one another.
In the town market, and buyers could easily monitor the producer’s behavior, protecting
against moral hazard. Tight-knit social relations deterred producers from acting in self-
interest, and thus agency costs from adverse selection were negligible. Furthermore,
because the market was confined to a specific locale, search costs were also low, and
opportunism was minimal (Garcia, 2002).
However, there were still some uncertainties. Because the market was limited in
scale and scope, and buyers and sellers were immobile, they had few options and there
was little competition (Williamson, 1985, 95). Moreover, once buyers and sellers became
31

linked in tight-knit social relationships, they could easily become locked in, generating
greater opportunity for one party to take advantage of the other. Under such
circumstances, the cost of seeking alternatives could be very high.
Uncertainty also arose due to information asymmetries. Buyers and sellers faced
the problem of seeking out their options, and the lack of transportation and
communications infrastructures made this difficult. As Geertz characterizes the
traditional market, information was:
...poor, scarce, maldistributed, inefficiently communicated, and intensely valued.
The level of ignorance about everything from product quality and going prices to
market possibilities and production costs (was) very high, and much of the way in
which the (market functioned) can be interpreted as an attempt to reduce such
ignorance for someone, increase it for someone, or defend someone against it.
(Geertz, 1978, as cited by McMillan, 2002, 41)
The inability of principals to monitor agents generated uncertainty about product quality
and market prices, increased agency costs, moral hazard and information asymmetry. Yet,
rather than relying on intermediaries to solve problems of uncertainty and reduce
transaction costs, people relied on trust and shared cultural norms (Garcia, 2001).
The market expands
In the 1600’s, improvements in transportation, especially shipping, led to an
expansion of trade. As traditional markets were dislocated and circumvented, Europe
developed a commercial economy (Braudel, 1982b). This increased market gave rise to
greater uncertainty. The result was a greater division of labor; merchants emerged to
32

organize the market, and the producer’s role became more circumscribed and specialized.
Instead of selling his own goods directly, producers sold their finished products to
merchants who—acting as middlemen—sold them to consumers. Thus, the merchant
made his money by incurring the transaction costs that increased along with the
complexity and scope of trade (Reyerson, 2002; Shaw, 1912).
Nonetheless, as trade expanded, new uncertainties arose. Trust and shared
cultural norms could no longer resolve problems of market uncertainty, so information
asymmetries between producers, merchants and consumers grew (Garcia, 2001, 5).
Furthermore, the task of bringing buyers and sellers together became more problematic,
especially in the late 1700s when commercially organized markets gave way to nationally
organized markets. Merchant middlemen could no longer maintain control of the market,
so, once again, new types of intermediaries stepped in to reduce uncertainties. In
particular, intermediaries contended with rising transaction costs and reduced search and
bargaining costs, protecting against opportunism for buyers and sellers (Braudel, 1982b;
Reyerson, 2002; W. D. Smith, 1984).
Given the ever-increasing size of the American market, it is not surprising that
intermediaries eventually came to flourish and prosper in the New World. At first,
however, American producers contended with uncertainty by resisting specialization.
Primitive communication facilities rendered it difficult for merchants to maintain control
33

at great distances, so they diversified their investments and functions and reduced their
risks (Beniger, 1986).
The first American intermediaries specialized in agricultural trade, the
predominant form of trade in the US until the mid-1800’s. To reduce the uncertainties
associated with agricultural goods, intermediaries classified and graded them. As Beniger
describes with respect to the cotton market:
Because its value varied markedly according to quality and grade, an error in
classification would either prove costly to a seller or land him in litigation. This
problem of preprocessing bales into their essential market information came to be
resolved by yet another specialized middleman and information worker: the cotton
broker. In larger ports where trade volume permitted, individual brokers served as
intermediaries between buyers and sellers, helping them to find one another for a
commission and to agree on a shipment’s quality and grade. (1986, 139-140)
To trade in distant markets, businessmen and markets needed specialized
information. Lacking a high-quality communication infrastructure, American
businessmen and farmers depended on a large chain of middlemen to gather information.
Thus, for example, commissioned middlemen stepped in to furnish information to
businessmen and farmers about market prices, potential buyers in other locales and
product quality. In exchange for this information, merchants paid the middlemen a fixed
percentage of the profits. Two other types of middlemen in the early American market
included the merchant middlemen and agent middlemen. Merchant middlemen, such as
shipping merchants and importers, took title to the commodities that they handled. On
34

the other hand, agent middlemen, such as factors, brokers, and auctioneers, acted for a
principal and did not acquire title (Beniger, 1986; F. M. Jones, 1937).
Uncertainty in the Industrial Revolution
The boom in technological advances and the expansion of national markets fueled
the Industrial Revolution. Originating in Great Britain in the years between 1750 and
1830, and spreading thereafter to the US and other European countries, the Industrial
Revolution transformed national economies and completely restructured economic
activities. Not only was there a major shift from agricultural production to manufacturing;
equally important, firms completely reorganized themselves in order to deal with growing
uncertainties associated with industrialization. Large-scale vertically integrated firms soon
replaced decentralized horizontal firms. As firms gained control over their uncertain
environments, the intermediary’s role radically changed.
Technological innovations in transportation and communication revolutionized
the way business was carried out. The new transport technologies developed during the
Industrial Revolution allowed producers, distributors and merchants to communicate
much more easily and increase the scope of their markets, thereby reducing uncertainties
in distribution. Included were advances in coastal shipping, railways, and turnpikes, all of
which eased transport in both Europe and the United States (Braudel, 1982a). Advances
in transport technologies coincided with advances in communication technologies. In the
United States, the first federal postage stamp was introduced in 1847, ushering a national
35

system of distribution and easing communication across great distances. In the mid-
1800s, Samuel F. B. Morse invented the telegraph system, making it possible for firms to
communicate instantaneously at great distances. The commercialization of the telephone
in the 1800’s was likewise critical to the development of a national communication
infrastructure (Beniger, 1986).
As technologies advanced, the role of the intermediary evolved. The greater
expansion of trade created new uncertainties in distribution and sales as businesses sought
new ways to control the markets at greater distances. Thus, the need for even greater
coordination and control of information grew (Garcia, 2001, 11). Businesses that still
relied on traditional middlemen to process market information were at a disadvantage.
Middlemen that controlled the flow of information became bottlenecks, exerting pressure
upon businesses and narrowing the margin of profit—in effect, raising transaction costs
(Garcia, 2001, 7) To avoid these added costs, and to reduce uncertainties, stronger
producers sought to go around the middleman (Shaw, 1912, 728). For instance, firms
reduced their dependency on middlemen by vertically integrating the transportation of
their goods into their organizational hierarchy.
Vertical integration began to take place at higher levels of the economic system,
thus marginalizing the role of the middleman further (Beniger, 1986, 159). With this
reorganization, there was a decrease in the steps of production and thus a decline in the
number of middlemen (Shaw, 1912, 728). These firms absorbed many of the functions
36

normally divided between several intermediaries, such as transportation, distribution and
sales. The functions once held by middlemen become integrated into businesses that
bought directly from manufacturers and sold to specialized retailers, eliminating many
functions of traditional middlemen (Beniger, 1986). 6
Yet the Industrial Revolution did not bring about a total extinction of middlemen.
Intermediaries were still viable in cases where control was difficult and uncertainties were
high. For new technologies introduced new transaction costs into the economy. As the
distance between transactions grew, buyers and sellers had less knowledge about each
other, so the possibility of opportunism and moral hazard increased. Consumers and
businesses also faced a problem of information asymmetry. Moreover, as businesses
sought to specialize, they had to deal with problems of greater asset specificity. New types
of intermediaries appeared to reduce these transaction and agency costs. Whereas before,
the intermediary was often a lone middleman, the Industrial Revolution saw the
conception of firms acting as intermediaries.
One example of a new type of intermediary was the factor, or wholesaler
middleman. Wholesalers and the wholesale market emerged in early 1800s to buffer
6 Beniger give an example of this: “in textiles…jobbers supplied store that sold retail to consumers who, in
turn, either mad either made their own clothing or took the cloth to tailors. By the 1840s, however, the
demand for ready-made clothing had been well enough established for manufacturer to integrate to a single
firm,” (Beniger, 1986, 159).
37

sellers from the overproduction of goods associated with the use of new factory
machinery (F. M. Jones, 1937, 10). Because it was difficult to establish a presence in
distant markets, merchants used several types of specialized wholesale intermediaries, such
as commission agents, factors, and brokers, to work on their behalf. These middlemen
resolved uncertainties concerning the location of buyers and sellers, their credit standing,
the market price, places and rate of storage, and transportation facilities (F. M. Jones,
1937, 65-66). The wholesalers benefited consumers by expanding the range of
commodities on the market and reducing the search costs for finding the goods.
Another modification on the traditional intermediary was the auction. Auctions
rose in popularity early in the nineteenth century, peaking in the United States, between
1825-1836 (Beniger, 1986, 147). Bringing buyers and sellers together in a central locale,
the auction reduced uncertainty by facilitating the sorting and distribution of imported
goods with uncertain values (Beniger, 1986). The efficiency of the auction undermined
the role of traditional middlemen. In order to re-insert themselves into the value chain,
middlemen began to purchase directly from domestic and foreign manufacturing agents
for resale to local consumers. Because technology made communications between
merchants and middlemen across long distances easier, many middlemen changed their
role by becoming importers (Beniger, 1986). By controlling communication, this new type
of intermediary was able to gain predominance in international trade. Importers found a
niche in international markets where communication between distributors and
38

manufacturers was deficient. They were thus able to reduce the rising transaction costs of
doing business at great distances.
Innovations in distribution and sales also reduced uncertainty, thereby eliminating
certain types of traditional middlemen. To control distribution costs, producers reduced
the amount of information necessary to process information about commodities (Beniger,
1986, 331). To this end, they developed standards in packaging, sizes, weights, inspecting,
sorting and prices (Beniger, 1986, 331). These innovations benefited consumers by
reducing uncertainty in product quality and facilitating market transactions. Standards also
reduced asymmetric information and adverse selection for consumers by acting as a
signaling mechanism for quality. Consumers no longer needed middlemen to monitor the
producer and control these uncertainties.
In order to re-insert themselves into the value chain, middlemen entered the field
of standards and patents. They became specialized intermediaries—patent agents and
lawyers—working on behalf of inventors to distribute and license patents. These
intermediaries stepped in during a time of technological boom when uncertainties existed
in the patent system, thereby reducing transaction costs by bringing buyers and sellers of
patents together (Lamoreaux & Sokoloff, 2003).
Along with these changes, the role of the intermediary as a distributor began to
evolve. Technology advances allowed manufacturers to produce goods at an increasingly
higher rate, so they needed to expand their sales outlets and increase the speed of
39

distribution (Beniger, 1986, 160). But once again, reduction in some uncertainties and
their associated transaction costs gave rise to others. Even as businesses vertically
integrated their distribution functions, they produced goods at faster and faster speeds;
thus, to regain control, they looked for middlemen to help speed up the distribution
process. To meet this need, a new type of intermediary appeared on the scene: mass
retailers, including department stores, chains stores and mail-order services (Beniger, 1986,
160). Making note of this development in 1912, Shaw wrote: “the enormous growth of
the mail order business in recent years gives evidence that in some lines of distribution
there are economies in this system,” (730). Like wholesalers, these intermediary retail
firms also served the consumer by expanding the selection of goods offered, and easing
acquisition of commodities.
Technology advances altered the function of intermediaries by improving
communication. Enhanced communication allowed producers to reach consumers more
efficiently and effectively. Some firms vertically integrated this function, but most sought
the help of an intermediary. Thus, a new type of intermediary firm—media and
advertising—developed. In particular, by using the point-to-multipoint media such as
catalogs, magazines and newspapers, producers could not only design their own messages,
they could also reach a greater number of customers at much lower costs. It was more
economical for a business to rely on an intermediary firm to distribute the message, rather
than face high fixed costs to produce the media themselves. Thus, intermediaries
40

specializing in mass media and advertising replaced traditional middlemen to convey
information to consumers. This form of intermediary reduced information asymmetry
and search costs for consumers, while at the same time raising profits for businesses.
Conclusion
The Industrial Revolution transformed the function of intermediaries. Before the
Industrial Revolution, intermediaries transported goods from producers to consumers,
distributed goods, and provided communication links. New technologies reduced these
uncertainties in market transactions and thus eliminated the functions of traditional
middlemen. Yet, as the technological innovations introduced new uncertainties,
middlemen stepped in to reduce them, reinventing themselves to retain their value in the
market.
The continual expansion from a town-centered market, to a commercial market
and finally to an international economy caused middlemen to evolve from simple store
merchants into intermediary firms. As the market widened, industries such as banking,
stocks, insurance, advertising and marketing grew. Middlemen found new positions in
these service-oriented and information-rich industries. Thus, intermediary firms helped to
control the flow and transfer of increasingly commodified information. In addition,
intermediaries found new opportunities when unforeseen economic conditions gave rise
41

to new uncertainties (Shaw, 1912) 7 . In these roles, their functions changed from that of a
single distributor and communicator to an information broker and trusted source, working
on behalf of the buyer and the seller to reduce transaction costs.
For a seller to solicit an intermediary, the services needed to provide value. If an
intermediary could not add value to the business, nor decrease transaction costs,
businesses simply vertically integrated the intermediary functions into their own
organizations. As new technologies decreased uncertainties for businesses, the challenge
to the intermediary in the Industrial Revolution was to create new services for businesses
that they could not do on their own. Most businesses found that intermediaries provided
an efficient solution because they shared the risk involved in entering a new market, and
they could absorb high sunk costs, especially those associated with advertising and retail
sales.
Technology helped businesses to expand their markets and increase sales, but, at
the same time, consumers faced greater uncertainties. The expansion of the market
introduced new goods and services into the economy and left consumers with the difficult
job of sorting through their new options. Businesses grew in size and power, and
7 “Suppose, for instance, that the protective tariff system of the United States were to be swept away and
free trade instituted. The middleman could then draw upon the foreign producer for supplies of unbranded
staple goods, which might serve to increase his importance as a link in our system of distribution,” (Shaw,
1912, 730)
42

consumers faced rising problems of information asymmetry and search costs. To gain
information about the market, which they could not gather on their own, consumers
turned to intermediaries. Consumers found that the services offered by an intermediary
helped to reduce their rising transaction costs in an international market.
Intermediaries did best when they met both consumers’ and businesses’ needs.
Thus, intermediaries that reduced transaction costs for both parties were most likely to
succeed. Take, for example, the role of the intermediary as a mass retailer. Although
businesses could have vertically integrated this function and developed their own retail
outlets, instead they relied on the intermediary to do this for them. Intermediaries thrived
in this role because they created value for both businesses and consumers. The prevalence
of modern-day equivalents such as grocery stores and department stores proves that this is
a viable role for intermediaries.
Historical analysis of market transactions shows that, as markets became
increasingly complex, the tendency to eliminate intermediaries from transactions grew.
Businesses vertically integrated and marginalized the role of the intermediary. As
communications increased in reach and scope, businesses accessed their customers more
directly than ever before. When technology changed the business processes of the
economy, intermediaries reinvented themselves to add value for both the buyer and the
seller. Thus, there was a continual cycle of intermediation—disintermediation—re-
intermediation as the economy changed (Chircu & Kauffman, 1998). The same is true for
43

present day markets. What uncertainties have been resolved with new digital
communications, and what new ones have arisen? How are new communications
technologies changing the role of the intermediary in the digital age?
44

Chapter 4. Technology and Uncertainties in the Digital Age
Introduction
As we have seen during the Industrial Revolution, the function of the intermediary
evolved in relation to the advent of new technologies and the corresponding rise and shift
in the loci of uncertainties. A similar phenomenon is occurring today. Building on the
lessons of the previous chapter, we can now turn our attention to the present. To this
end, this chapter defines the emerging uncertainties that businesses and consumers face in
the digital age. In addition, it considers how present-day intermediaries must change their
roles if they want to remain viable economic actors in the new digital business
environment.
The chapter begins by briefly characterizing today’s technology advances,
specifically computers, the Internet and e-commerce, and describing how they reduce
some uncertainties while generating others. Next, and more specifically, the chapter looks
at the growing collection of consumer information in the digital economy and the
associated uncertainties relating to issues of privacy and trust. Finally, the chapter
proposes the roles that intermediaries might play to help resolve these related
uncertainties and risks.
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Digital technology advances
Just as communication and transportation innovations drastically changed the
industrial economy, so too advances in telecommunications and information technology
are transforming today’s economy. The term “digital revolution” characterizes these
technological innovations. Digital technology and advances in processing powers of
computers increase the scope, speed, reliability and efficiency of communications systems,
changing the way in which economic actors process and transfer information. Computers
translate data into digitized bits and then send them via telephone wires, coaxial cables
and fiber-optic cables to other computers across the globe. With sufficient speed and
memory, computers can become an actual telecommunications medium. These systems
process information at high speeds and capacity, greatly reducing communication
expenses and transaction costs (Antonelli, 1992; Evans & Wurster, 2000; Gandy, 1993;
National Research Council (U.S.) NII 2000 Steering Committee., 1996; Neuman,
McKnight, & Solomon, 1997).
Providing a platform for digital communication, the Internet and the World Wide
Web constitute the most fundamental innovations of the era. According to Jonscher, for
example, the Internet ranks along with the printing press in terms of its wide-reaching
ramifications (1999, 159). Originating during the Cold War within the defense community
as a decentralized communication network that could withstand attack, the Internet (then
the ARPANET) was further developed and promoted within the academic community. It
46

developed into a global network, managed by NSFNET (National Science Foundation
Network), providing a general data transfer service used for applications such as e-mail
and file transfer (Blumenthal & Clark, 2001; Harris & Hansen, n.d.; Jonscher, 1999).
The Internet, a virtual network, connects users across the world. “The Internet
has undone what Columbus discovered 500 years ago: it has made the earth flat once
again,” (National Research Council (U.S.) NII 2000 Steering Committee., 1996, 149). It is
a decentralized “network of networks” defined by interface protocols, which do not rely
on corporate structure, physical routes or boundaries. The interconnectivity, flexibility,
extensibility, and internetworking of the Internet enable it to change as new technologies
and service requirements emerge (National Research Council (U.S.) NII 2000 Steering
Committee., 1996; Neuman et al., 1997; Srinagesh & Gong, 1996).
In the 1990’s, after the development of the World Wide Web, the Internet
diffused beyond universities and the government. Anticipating greater participation from
the private sector, the government replaced the NSFNET infrastructure with commercial
networks. This commercialization promoted further development of browser applications
for the World Wide Web. Supported by HTML standards for encoding information, the
World Wide Web is a user-interface application that allows content providers to format
information for use on the Internet (Bailey & Bakos, 1997; Harris & Hansen, n.d.;
Jonscher, 1999; National Research Council (U.S.) NII 2000 Steering Committee., 1996).
47

With the government’s new privatization and commercialization policy, e-
commerce exploded. The use of electronic networks for business transactions actually
began in the 1970’s in the financial sector, when money was first transferred between
economic institutions via telecommunications networks (Barnes & Hunt, 2001). The
World Wide Web provided a new platform for electronic commerce by introducing a new
way to communicate and distribute and trade goods and services. Taking advantage of
technology advances, innovative entrepreneurs set out to create a new market (Bailey &
Bakos, 1997). They developed mechanisms to carry out virtual transactions between
buyers and sellers that entailed the sale of products, services and information in
cyberspace (Turban et al., 2000, as cited by Barnes & Hunt, 2001, 1).
One advantage of e-commerce is that it can expedite transactions and reduce
transaction costs. In fact, as Shapiro and Varian note, e-commerce allows for a “friction-
free” market, where search costs are minimized (1998, 127). The Internet facilitates e-
commerce by allowing businesses to reach consumers directly. At the same time, the
Internet provides consumers with expanded choices and search capabilities. Using
automated search engines that seek out and sort information, consumers can do their own
searching on the World Wide Web. Thus, the Internet serves both businesses’ and
consumers’ needs, reducing the cost, time, and effort required to acquire market
information. These benefits are, moreover, synergistic, giving rise to network externalities
48

and increasing returns. The more consumers and businesses participate in the system, the
greater the benefits for all (Bakos, 1991; Karake-Shalhoub, 2002; McMillan, 2002).
Insofar as the benefits of e-commerce are related information costs, they affect the
role of the intermediary. Thus, early on, observers predicted that disintermediation would
take place, given the ability of businesses and consumers to reach each other directly via
the World Wide Web (Chircu & Kauffman, 2001, 50). Observers anticipated that
disintermediation would be greatest in information intense industries such as finance,
insurance, travel and book sellers (Downes & Mui, 1998; Scott, 2000, 5). The changing
role of travel agencies provides a good example. On the World Wide Web, customers can
find the best deal and make travel arrangements themselves (Standing & Vasudavan,
2001). Likewise, in financial markets, investors can bypass traditional brokers and find
investment information on the Web (Downes & Mui, 1998).
New uncertainties
As seen in chapter three, although technologies reduce some uncertainties and
transaction costs, they simultaneously engender others. Thus, it should not be surprising
that, contrary to initial predictions, e-commerce is not a “friction free” market. Certainly,
the shift to a cyber marketplace has affected the organization of economic relationships,
markets and firms (Evans & Wurster, 2000). However, uncertainties and transaction costs
continue to confound businesses and consumers alike. The myriad sources of these
uncertainties are discussed briefly below.
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i. Information overload
E-commerce increases the amount of information exchanged between buyers and
sellers, resulting in information overload. Even when customers use an automated search
engine to seek out sellers, they still are confronted by vast amounts of information. Given
all the options available to them, consumers find it hard to differentiate between
trustworthy or opportunistic businesses. As a result of these transaction costs, they are
increasingly bounded in their ability to make ‘rational’ choices (Ba, Whinston, & Zhang,
2000, 190).
ii. Information asymmetry
The inability of consumers to process all the information available to them in an e-
commerce environment exacerbates information asymmetry. Online, it is much harder to
ensure product quality, or verify the reputation of a business. Hence, in a virtual
environment, businesses have an advantage to the extent that they have more and better
information than buyers. For example, on e-commerce websites, information can be
counterfeited, forged or misrepresented. As a result, a ‘lemon market’ ensues, leading to
inefficient transactions and market failures. Uncertainties, transaction costs and agency
costs for both buyers and sellers increase (Ba et al., 2000).
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iii. Technology
Technology itself creates new forms of uncertainty. For example, consumers may
be weary of technical malfunctions, failures or hackers. Consumers may be unwilling to
provide their credit card information online or personal information, fearful that it will
end up in the wrong hands, or that the business will overcharge them or misuse their
information. They may also hesitate to order goods or services online because they are
uncertain that the transaction will go through. This unfamiliarity of technology causes
greater moral hazard and risk for consumers. If there is a problem, businesses can escape
responsibility by blaming technical glitches (Karake-Shalhoub, 2002).
iv. Online strategy
New uncertainties also arise from the need of businesses to redefine themselves
for e-commerce. E-commerce is so new that traditional businesses have a hard time
finding the best strategy to capitalize on it. Caught by the legacy of their own success,
established firms hesitate to tread into the uncertain territory of e-commerce. Many
businesses continue to employ current business models, treating their website as a static
entity, such as a catalogue or a publishing medium. They do not capitalize on the
opportunities provided by the enhanced communication channels to their consumers. By
not taking full advantage of the dynamic capabilities that the Web has to offer, businesses
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isk stagnation and competitive disadvantage as new, web-only entrants surpass them
(Karake-Shalhoub, 2002).
v. Mass customization
Given the global scope of e-commerce, businesses now face intense competition,
a major source of new uncertainties. In a global environment, businesses must be more
responsive and adaptive to consumers than ever before. For example, new manufacturing
technologies, the increased speed of technological change and a shortened product life
cycle, as well as the shifting nature of customer demand, necessitate that businesses
change their strategies. Firms can no longer compete by offering standardized products;
rather, they must meet consumer demand for greater product variety and higher quality
products and services. To this end, firms are adopting mass customization strategies,
which allow them to personalize products and provide greater variety while still benefiting
from economies of scale and scope. To these ends, businesses rely on ‘just-in-time’
manufacturing, quality control, and ‘customer-facing’ business plans that strengthen
existing customer relations. More and more, businesses take notice of their customers,
listening to them and applying their feedback (Dutta & Segev, 2001; Kotha, 1995; Wolters
& Hoogeweegen, 2001).
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vi. Asset specificity and networked firms
As firms begin specializing and customizing, they face asset specificity, resulting in
uncertainty and rising transaction costs. These specialized firms experience lock-in once
they have made a significant investment in a specific asset. One strategy that businesses
are adopting to address these new uncertainties is vertical disintegration. Although
vertical integration served well to reduce transaction costs in the industrial era, it is
unsuitable for the digital age. Instead, firms specialize in a certain part of the value chain
and build alliances and partners, thus outsourcing unessential activities. Networked firms
enter into contracts and hold joint assets to share the risks of operating in a rapidly
changing technological landscape (Downes & Mui, 1998; Sarkar, Butler, & Steinfield,
1995; C. Shapiro & Varian, 1998).
vii. Information commodities
Many networked firms profit not from tangible goods, but intangible information
assets, resulting in increased uncertainty. For example, by exploiting the unique features
of the Internet, information producers can trade information for a price in the market
(Gandy, 1993; C. Shapiro & Varian, 1998). To maximize their profits, these producers
control access and distribution of information by enforcing patents and copyrights,
making information scarce. Information asymmetry increases as a result. Yet, at the same
time, producers are also experiencing greater uncertainties. For maintaining intellectual
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property rights is increasingly problematic, given digital technologies that allow individuals
to access, reproduce, and retransmit information without permission of the producer.
Thus, as intangible goods become increasingly profitable, their value is increasingly
difficult to protect. As the Electronic Frontier Foundation’s John Perry Barlow said,
“information wants to be free,” (Downes & Mui, 1998, 49-50). Perhaps he should have
said, “consumers want information to be free.” For information producers to make a
profit, information must retain economic value as a commodity. Without a financial
incentive for producers to create information, the production of information will slacken.
Uncertainty arises from the conflicting demands to commodify information and to
distribute it for free over the Internet (Evans & Wurster, 2000; Loebbecke, 2001).
viii. Personal information collection
To maintain control and develop information-based strategies, businesses must
find new ways to create value from their intangible assets through customer relations,
reputation and consumer information. In fact, to employ a mass customization strategy,
businesses must gain a deeper understanding of their customers. Today’s technologies
allow businesses to do so. Thus, when consumers search the Internet, browser
applications place ‘cookies” inside their computer to track their activities, recording the
websites they visit and the information they provide. Profiled in huge databases, this
information is used to target advertisements and messages to customers based on their
demographics and behavioral profiles that factor in race, gender, age, class, education,
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health, sexuality, and consumptive behavior (J. E. Campbell & Carlson, 2002). This
personal information is itself commodified, and bought and sold, often without the
knowledge of or permission from the consumer (J. E. Campbell & Carlson, 2002; Evans
& Wurster, 2000). In this sense, consumers are themselves commodified.
Consumers, likewise, play a role in this process. Convinced that the gains from e-
commerce are greater than the privacy costs that they incur, many consumers willingly
provide their personal information. Others may be unaware of this asymmetrical
exchange because the surveillance is often not made explicit. As Campbell and Carlson
have pointed out, consumers engage in self-disclosure, even though the terms are rarely
negotiable, because they do not want to be excluded from participating in the
marketplace 8 (J. E. Campbell & Carlson, 2002).
ix. Privacy
Given businesses’ greater access to personal information, consumers face greater
moral hazard and risk. Thus, privacy concerns are becoming a major source of
8 Campbell and Carlson refer to this phenomenon as a “Consumerist Panopticon,” alluding to Michel
Foucault’s conceptualization of the Panopticon as a function of surveillance in modern institutions, notably
prisons, workplaces, clinics, educational institutions and governments. Their model implies that if you do
not engage in self-disclosure of information, you will be punished by being excluded from the rewards of the
marketplace. Transactions are inequitable as producers or suppliers set the terms of a contract, which a
consumer can only accept or decline (2002).
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uncertainty for today’s consumers, and the consumers bear the additional transaction and
agency costs. Consumers have no information privacy, and are uncertain of how their
information will be handled by businesses, so they are less likely to engage in e-commerce
transactions (Cavoukian, 2002, 40-41) 9 . A series of surveys conducted by Harris and
Associates show that consumers are increasingly concerned about their privacy online.
They feel that businesses collect too much personal information, over which consumers
have little control. At the same time, however, consumers do not equate customer
profiles with a loss of privacy, and thus they are willing to provide personal information to
companies in exchange for specialized services and products (Leickly, 2003). 10
9 Information privacy is the ability of an individual to control the access, use and disclosure of one’s
personal information(Cavoukian, 2002)
10 An analysis of two Harris and Associates surveys, originally collected in 1990 and 1998.
For my purposes, I focused on six questions:
(1) How concerned are you about threat to your personal privacy in America today?
(2) How confident are you that businesses use personal and confidential information in a proper manner?
(3) How strongly do you agree or disagree with the following statement? Consumers have lost all control
over how personal information is circulated and used by companies.
(4) How strongly do you agree or disagree with the following statement? Business organizations generally
ask for too much personal information from consumers.
(5) How acceptable would it be for businesses you deal with to use information from your customer profile
to inform you of existing and new products and services that these businesses provide, and that they think
would be of interest to you?
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Nonetheless, without greater privacy guarantees, consumers may be less willing to
engage in e-commerce. It is important to note in this regard that consumers are less likely
to perceive information practices as privacy infringement under the following
circumstances:
1. Information is collected in the context of an existing relationship;
2. They perceive that they have the ability to control future use of the information;
(6) During the past year, have you or has a member of your household purchased goods or services through
the Internet, or not?
Results show that concerns for privacy were greater in 1998 than in 1990, before the commercialization of
the Internet and the World Wide Web (significant at the .0005 level). The analysis concluded that as the
feeling of a loss of control over personal information and a feeling that businesses ask for too much
information increases, the concern for threats to privacy increase as well. Individuals who had purchased
goods on the Internet over the past year were not more or less likely to feel an increasing concern to
privacy.
These findings confirm that consumers have a greater concern for personal privacy in the digital age. They
feel that businesses are collecting too much personal information, that there is a loss of control of personal
information, and there is less confidence in businesses’ use of personal information. Interestingly, the
results showed that most consumers did not equate customer profiles with a loss of privacy. Consumers are
willing to provide personal information to companies if, in return, the companies provide specialized
services and products. Nonetheless, these findings suggest that businesses will need to rethink their use and
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3. The information collected or used is relevant to the transaction; and
4. They believe the information will be used to draw reliable and valid inferences
about them. (Culnan, 1993, 345)
x. Trust
Not surprisingly, given high transaction costs, e-commerce requires a high level of
trust. 11 For trust to exist, consumers must believe that businesses will deliver goods and
services of high quality and in the manner promised. Ironically, as communication costs
decrease, the costs of building trust and reputation increase (Karake-Shalhoub, 2002, 29).
Trust is developed over time, and through repeated interactions. However, in online
markets, such relationships are hard to establish and foster. Paradoxically, a new business
can only succeed if it builds strong relationships with customers; yet, customers are less
likely to trust and interact with an unknown business.
To protect against uncertainty and generate trust in online transactions, businesses
can employ conventional agency methods. For example, standards and contracts generate
application of consumer information in the 21st century, so that both the business and the consumer benefit
(Leickly, 2003).
11 “Trust is the essential lubricant of Web business; without trust, business grinds to a halt,” (Karake-
Shalhoub, 2002, 157).
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trust and protect against opportunism and moral hazard (Palmer, Bailey, & Faraj, 2000, 5-
6). Also, to foster repeat transactions, businesses can build a positive reputation through
branding. If these methods fail, a trusted third party can intervene, vouching for the
business. Third parties can capitalize on their own reputation to encourage repeat service
and trust for their clients, preserving the integrity of e-commerce markets (Karake-
Shalhoub, 2002; Palmer et al., 2000; Scott, 2000, 8).
New roles for intermediaries
New types of specialized intermediaries are emerging to contend with the new
uncertainties of the digital age. Digital intermediaries support the interaction of buyers
and sellers, stepping in to facilitate the organization of e-commerce (Sarkar et al., 1995).
These intermediaries help consumers deal with information overload and information
asymmetry by sorting, routing and filtering, comparing prices and vouching for worthiness
of products and firms (Kelly, 1998, 101). For example, search engines on the Internet
turn up thousands of results, causing an individual to invest time in sorting through and
filtering the information. An intermediary adds value to the consumer by sorting through
the information, helping to find the best match (M. D. Smith et al., 2000, 122).
Intermediaries reduce the uncertainties that arise from recently restructured
business organizations in a networked economy. When a networked firm vertically
disintegrates and out-sources its non-essential services, new intermediaries appear on the
scene. The nodes that connect firms in a networked economy are intermediaries, and the
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more connections a firm has, the more roles there are for an intermediary (Kelly, 1998).
To add value for businesses, intermediaries reduce the transaction costs in nearly every
activity for functions outside of the firm. They find niches in vertically disintegrated
markets, offer specialized services and assume a portion of the risks involved (Chircu &
Kauffman, 2001; Downes & Mui, 1998; Sarkar et al., 1995).
The uncertainties in specialized digital information markets signal a new
opportunity for intermediaries as well. Intermediaries help information producers
maintain control of their intangible assets by facilitating information transactions, giving
producers incentive to create new information goods. Because distribution of information
on digital networks costs nearly nothing, intermediaries can step in to bundle and
distribute large amounts of information goods in a more efficient manner than if each
piece of information were sold or distributed separately, acting as an information broker
or ‘infomediary’ (Bailey & Bakos, 1997, 9). As Grover and Teng so aptly put it:
“infomediaries are to information markets in the electronic marketspace what
intermediaries, such as wholesalers and retailers, are to physical markets in more
traditional marketspaces,” (Grover & Teng, 2001, 79). To gain competitive advantage,
infomediaries become experts in one particular area or a limited number of areas,
benefiting consumers with expert advise (Evans & Wurster, 2000, 96). Furthermore,
infomediaries can serve consumers by helping them to protect, manage and control the
use of their personal information, thus alleviating privacy concerns.
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Network effects determine the success or failure of an infomediary. Infomediaries
require large investments in system development and maintenance costs, but they reap
economies of scale by disseminating information to a large population, and the
incremental costs for adding users is low. Thus, infomediaries must obtain a first-mover
advantage, and create a critical mass to sustain a competitive edge. When critical mass is
achieved, the high sunk costs necessary for creating the service are leveraged over all the
users. The main incentive for infomediaries is profit, determined by the value the services
can create for potential clients—both businesses and consumers (Bakos, 1991; Loebbecke,
2001; Rose, 1999; C. Shapiro & Varian, 1998).
i. Rules for success
Like intermediaries in historical markets, intermediaries in the digital age must
provide value for both consumers and businesses. For consumers, the Internet provides
complete and objective information about products. Consumers’ access to complete
information is at odds with businesses’ interests, because ideally, the best market would be
one that provides biased information about their products to influence the consumer.
Thus, an intermediary must determine the balance between the consumer’s needs for
information and a producer’s needs for influence, while at the same time creating
economic value for itself. Any intermediary that does not successfully balance these needs
will ultimately fail (Bailey & Bakos, 1997; Sarkar et al., 1995, 11).
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The success of digital intermediaries also depends on whether or not they can
promote trust in e-commerce. Many customers hesitate to make purchases online because
the intermediaries involved in the transaction are unfamiliar and hence untrustworthy,
increasing the perceived level of risk. A study performed in 2002 by the Georgia Institute
of Technology found that all intermediaries—banks, credit card companies, e-commerce
portals, and third parties—are not perceived as equally trustworthy. Incumbents such as
eBay and Amazon.com tend to be more trusted than lesser-known online retailers
(Ghosen, 2002). Moreover, consumers are more likely to trust intermediaries that
represent many producers, because this implies that they will be less biased (Sarkar et al.,
1995, 15). For example, trusted intermediaries sort through different news media outlets
to find correct information and news. For this type of intermediary to be successful, the
consumer must be assured that they are receiving unbiased news accounts (A. L. Shapiro,
1999, 190).
Digital-age intermediaries: The seven rules for success
1. Provide value for businesses and consumers.
2. Promote trust in online transactions.
3. Become experts in specialized industries.
4. Respect information privacy.
5. Achieve critical mass.
6. Gain first-mover advantage.
7. Take advantage of information commodities.
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Conclusion
Contrary to enthusiasts’ claims, the Internet is not a “friction free” market. The
reduction of transaction costs in the digital age does not eliminate all uncertainties.
Rather, as search costs and communication costs decrease, new uncertainties arise.
Businesses and consumers face new transaction costs, particularly in establishing trust in
e-commerce. Technology allows businesses to offer consumers increasingly customized
and personalized services, but there is a trade-off, as consumers must contend with
growing privacy concerns. Furthermore, competition is fierce in the global networked
economy, and businesses that do not change their strategies face collapse.
Predictions of a “frictionless” market threatened to make traditional intermediaries
irrelevant. But similar to intermediaries in the Industrial Revolution, intermediaries in the
digital age find value in other functions by exploiting the new uncertainties. Once again, it
is a case of the intermediation-disintermediation-reintermediation cycle (Chircu &
Kauffman, 1998).
Intermediaries have viable roles to play in the digital age. They succeed in
specialized markets by offering expertise on products and services. They reduce
information overload by simplifying search processes for consumers. Most importantly,
they help to establish trust in e-commerce markets. Trust is a vital part of online
transacting for businesses, consumers and intermediaries. With any abuse of trust, a firm
or intermediary is likely to fail.
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Another possible role for intermediaries in the digital age is the “infomediary”: an
intermediary specializing in the brokering of information for consumers and businesses.
These infomediaries have the potential to facilitate online transactions, reduce information
asymmetry and information overload, and protect privacy in online transactions. The next
chapter examines a seminal infomediary business model, several infomediary firms that
followed this model, and other online intermediary firms. As our historical analysis
shows, wholesalers gained importance during the early years of the Industrial Revolution,
and then faced disintermediation as the market became more efficient. They were forced
to reinvent themselves and reinsert themselves into the value chain. If infomediaries are
the wholesalers of the digital age, do they face the same fate? Will infomediaries succeed
in the digital age? If not, what types of intermediaries will?
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Introduction
Chapter 5. Infomediaries in e-Commerce: Case Studies
New uncertainties in the digital age are transforming the role of the intermediary.
Businesses and consumers now face problems of information overload, privacy concerns
and lack of trust in online transactions. Like intermediaries in the Industrial Revolution,
digital intermediaries must address these new uncertainties and reinvent their roles to
remain viable. In particular, a new type of intermediary—an “infomediary”—has
emerged. Because almost all online activities require searching for, obtaining, and
processing information in some form or another, infomediaries step in to simplify the
process, becoming information brokers.
In 1999, John Hagel and Marc Singer laid out a business plan for a specific kind of
infomediary in their book Net Worth. Shortly after the book’s release, several companies
set out to launch infomediary services. This chapter examines these hopefuls, and seeks
to determine why Hagel and Singer’s infomediary model failed to make an impact in e-
commerce. In addition, it seeks to determine why other digital-age intermediaries have
had greater success.
To this end, this chapter first describes Hagel and Singer’s infomediary model, and
considers its potential to alleviate transaction costs and uncertainties. Second, it examines
three businesses efforts—Lumeria, AllAdvantage and Passport—based on Hagel and
Singer’s plan and analyzes why infomediaries failed. Third, it considers two successful
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online merchants—eBay and Amazon.com—to determine how they act as intermediaries
to generate trust and facilitate transactions.
Hagel and Singer’s infomediary model
John Hagel and Marc Singer propose an infomediary business model in the book
Net Worth: Shaping Markets When Customers Make the Rules (1999). They recommend that
infomediaries act as a trusted third party to aggregate customer information, using their
combined market power to negotiate with businesses on these customers’ behalf, while at
the same time protecting consumer privacy (Hagel & Singer, 1999). Accordingly,
customers would receive a privacy tool kit providing them with an anonymous email
address and filtering technology to block unauthorized vendors. Customers would use an
infomediary-issued credit card, allowing the infomediary to track all of the customer’s
online and offline purchases, and to create a detailed personal profile of their purchasing
behaviors. This anonymous payment mechanism would also prevents vendors from
accessing personal data (Hagel & Singer, 1999).
By performing searches for the customer, the infomediary would alleviate
problems of information overload. If a customer wanted a specific product, the
infomediary would solicits bids from vendors by literally commodifying the customer’s
personal information and selling it to prospective vendors. To protect the customer’s
privacy, the transaction would be carried out anonymously, using email and targeted
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marketing. Assured of their security and privacy, individuals would welcome this targeted
marketing (J. E. Campbell & Carlson, 2002; Downes & Mui, 1998; Hagel & Singer, 1999).
Under this system, both the infomediary and the customers would profit from the
sale of personal information. For the consumer, the basic cost of membership—including
the privacy and profiling services—would be free, and customers would pay a 2 ½ percent
agency fee when purchasing products through the infomediary. However, they would
receive a portion of the vendor’s payment for accessing their information profiles. Hagel
and Singer estimate that, by revealing their information, a household would save
approximately $1,400 per year through lower purchase prices and payments (Hagel &
Singer, 1999).
Hagel and Singer contend that their infomediary model creates value not only for
consumers but also for businesses. For, while customers have lower transaction costs and
reduced uncertainties, businesses benefit by obtaining direct access to interested
customers. For example, currently, 98 percent of customers ignore marketing messages
such as pop-up ads and spam. By offering vendors direct access to customers that are
known to be interested, businesses can save money through higher response rates, which
in turn increase the value of the customer information (Hagel & Singer, 1999).
As we have seen from the previous chapter, for an intermediary to achieve a
critical mass, customers must be able to trust them. Thus, to gain this trust, the
infomediary must be “customer-facing” and not “vendor-facing”. Customers must trust
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the infomediary to prevent unauthorized access and abuse of their personal information
(Hagel & Singer, 1999). The infomediary would need to build trust through reputation
and a positive feedback cycle, whereby it would then achieve market dominance and
sustained growth.
To help achieve market dominance, Hagel and Singer’s infomediary model would
take advantage of information commodities. Although infomediaries can operate in any
market, their prospects are greatest in information markets where market failures tend to
generate high transaction costs. Thus, products and services with a high content of
information, such as computer goods, mortgages and telecommunications services offer
good opportunities for infomediaries (Hagel and Singer, 1999, 53). Because infomediaries
would operate over the Internet, consumers would benefit from the infomediaries’
capacity to search for and bundle information goods.
Infomediaries in practice
Shortly after the release of Net Worth in 1999, several new companies that used
Hagel and Singer’s infomediary model emerged. These newcomers included Lumeria,
Privaseek, AllAdvantage, Firefly, PrivacyBank.com, Popular Demand and Enonymous.
Three of these cases are discussed briefly below.
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i. Lumeria
In 1999, Lumeria was poised to become the most successful of the new
infomediary businesses. Lumeria was founded on the principle that a customer’s personal
information must be safely guarded, yet easily accessible and anonymously shared with
others (Lumeria Inc., 2000b). In keeping with Hagel and Singer’s model, Lumeria adopted
a “customer-facing” strategy. Customers stored data in a “SuperProfile,” giving Lumeria
permission to sell that information to a network of vendors. The vendors could then
perform highly targeted, permission-based marketing to those people who had expressed
interest in the merchandise. Vendor fees would be paid directly to consumers, with
Lumeria taking a small percentage (Lester, March 2001; Lumeria Inc., 2000b).
Closely following Hagel and Singer’s plan with its “Sunshine Platform”
technology, Lumeria promised to “dramatically improve the security, efficiencies, and
effectiveness of any online transaction, whether for commerce or content, for business or
for individuals,” (Lumeria Inc., 2000a). The Sunshine technology offered the following
services:
Privacy and Cookie Agent—protects user’s identity by hiding their IP address
and managing cookies.
Form-Filler/e-Wallet—allows forms to be filled-out and secure purchases to
be made based on data in the user’s profile.
Content Filtering Agent—allows user-specific pop-up windows or other
content add-ins to appear on web pages. It also provides a method for
replacing web banner ads according to each user’s profile.
XML Standards—promotes creation of XML by web developers, thus
supporting aggregated personal profiling of customers. (Lumeria Inc., 2000a)
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In the words of Lumeria’s founder, Fred Davis, “basically, we created a new piece
of Internet infrastructure for the secure communication and authentication of
transmissions across the Internet. It took us a few years and millions of dollars to develop
it, but now it's here, and it's pretty cool,”(Lester, March 2001). Unfortunately, Lumeria
was not cool enough. As of 2002, Fred Davis was seeking a buyer for the company
(Delevett, 2002, February 19).
ii. AllAdvantage 12
Another online infomediary, AllAdvantage, also followed Hagel and Singer’s plan.
Launched in March 30, 1999, AllAdvantage allowed individuals to sell their attention and
personal information to advertisers while maintaining their personal privacy. To
accomplish this, AllAdvantage provided a software program —the “ViewBar”—that
allowed customers to view targeted advertisements on their personal computers.
AllAdvantage paid customers fifty cents and hour (up to forty hours per month) for
viewing the advertisements, while businesses paid AllAdvantage for this targeted
advertising opportunity. To increase participation and build a critical mass, AllAdvantage
encouraged its members to make referrals. For example, it paid its members small fees
(based on a descending scale of four levels) for the time that a referral, or referral of a
referral, etc., spent searching the web. In addition to its advertising fees, AllAdvantage
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intended to capitalize on the information stored in members’ browsers, which
documented keyword searches and sites visited. By exploiting this information,
AllAdvantage could better target ads, and thus charge a premium for advertising space
(Beal, 2002).
Although AllAdvantage successfully generated a critical mass, the overall business
model was unsuccessful. In 2000, AllAdvantage grew exponentially in popularity and
membership rates. Within five months of its launching, 10,000 to 20,000 members signed
on each day. By July of 2000, total membership to AllAdvantage surpassed seven million
(Beal, 2002). Nonetheless, problems mounted. As AllAdvantage’s founder, Jim
Jorgenson, explained, “It was a chicken and egg problem,” (Beal, 2002). Because the
market for targeted advertising was still young, few businesses were ready to subscribe to
AllAdvantage’s service. Furthermore, due to software constraints, only 2 to 3 percent of
the ads were actually targeted to members. Another fatal flaw in the business model was
customer behavior. Receiving money for merely looking, most members did just that—
only rarely did they purchase the advertised merchandise. Some even blocked the ads on
their computer screen with duct tape. As a result, AllAdvantage was unable to add value
for their advertisers. Moreover, they were obliged to pay members, regardless of whether
12 The following is a summary from Brent D. Beal’s report entitled AllAdvantage.com: an Internet Infomediary
(2002).
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or not they sold advertising space. Because membership rates were so high, payments to
members reached the millions, and AllAdvantage quickly burned through its investor
money. In the wake of the dot.com crash, funds disappeared, and AllAdvantage folded
(Beal, 2002).
iii. Firefly/Passport
A third infomediary, Firefly, predates Hagel and Singer’s infomediary plan. Firefly
began in 1995 as a program called Helpful Online Music Recommendations (HOMR),
using intelligent software to recommend music and bands (Oakes, 1999, August 12a).
Later, Firefly developed an infomediary service called “Passport”, which collected
demographic and psychographic information from consumers. Passport also used
customer information to offer personalized suggestions and reviews on items of interest
(Kannan, Chang, & Whinston, 2001).
In 1998, Microsoft acquired Passport so it could bundle the software with its XP
operating system and accelerate the delivery of its privacy-enhancing services. Microsoft’s
Passport Wallet, which collected a user’s credit card and password information in a
database, was designed to simplify e-commerce transactions. However, the purchase met
opposition from privacy advocates who accused Microsoft of becoming “Big Brother,”
and trying to control customer profile databases (Luening, 1998).
Then, in October of 2001, the Passport software exhibited a serious flaw, which
would expose users’ password, credit card information and other personal data
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(McWilliams, November 2, 2001). In 2001, privacy advocates filed a complaint with the
FTC, claiming that Microsoft’s Passport had threatened the privacy of the 100 million
users by deceptively collecting consumer information (Manjoo, August 16, 2001). In
2002, Microsoft settled the charges with the FTC. According to the complaint settlement,
Microsoft had falsely represented that:
It employs reasonable and appropriate measures under the circumstances to
maintain and protect the privacy and confidentiality of consumers' personal
information collected through its Passport and Passport Wallet services,
including credit card numbers and billing information stored in Passport
Wallet;
Purchases made with Passport Wallet are generally safer or more secure than
purchases made at the same site without Passport Wallet when, in fact, most
consumers received identical security at those sites regardless of whether they
used Passport Wallet to complete their transactions;
Passport did not collect any personally identifiable information other than that
described in its privacy policy when, in fact, Passport collected and held, for a
limited time, a personally identifiable sign-in history for each user. (Federal
Trade Commission, August 8, 2002)
Passport software is still available for Microsoft users, but the security and privacy
flaws have prompted many users to opt out of its services. The case illustrates that, even
for companies that have tremendous resources at their disposal, the infomediary model
has some inherent flaws.
Shortcomings of infomediaries
Notwithstanding the myriad uncertainties in the digital age, infomediaries built
along the lines of Hagel and Singer’s model have yet to succeed. The NASDAQ crash of
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2000 and the subsequent withdraw of investments from e-commerce contributed to the
demise of Lumeria and AllAdvantage. But equally, if not more, important was the fact
that a large majority of businesses and consumers rejected these privacy-based
infomediary business models (Bodorik & Jutla, 2003). As we have seen in chapter four, a
successful infomediary must follow seven rules for success. Hagel and Singer’s model
followed two of these rules: it took advantage of information commodities and helped
organize and bundle large amounts of information, and it attempted to offer consumers
advice on e-commerce purchases in specialized industries. As described below, by
neglecting five of the seven rules, infomediaries failed to reduce uncertainties for
consumers and businesses.
1. Provide value for consumers and businesses
Infomediaries did not provide value for both businesses and consumers. For
customers to trust infomediaries with their personal information, the infomediaries must
be totally “customer facing” (Levin, 1999). However, by focusing on consumers almost
exclusively, infomediaries were unable to provide enough value for businesses. To make a
profit, infomediaries must have the participation of a vast network of businesses. But
businesses will only participate given a significant positive net gain. Moreover, an
infomediary must be more efficient than businesses that act independently to bring buyers
and sellers together. In the case of AllAdvantage, businesses did not benefit from targeted
advertisements to interested customers, leading to its failure (Chen, Ganesh, &
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Padmanabhan, Fall 2002; Oakes, 1999, August 12b). In some cases, working through an
infomediary can decrease net gains for businesses. With direct access to an increased
number of customers, businesses can poach on their competitors’ customers. Thus,
infomediaries can unravel, meaning that no business will gain a net profit from joining,
even if the access is free (Chen et al., Fall 2002).
2. Promote trust in online transactions
The infomediary’s inability to establish a high level of trust also helped to account
for the model’s failure. Although the infomediary is a third party, there are no guarantees
that it will be a ‘trustworthy’ third party (Shearin & Maes, no date). Especially in a rapidly
changing e-commerce environment, in which most companies are unstable, consumers are
unlikely to trust so much personal information to any company, third party or not (Muller,
2000). For example, customers who invested time creating profiles on Lumeria must be
wondering now what has become of their personal information. Thus, unless consumers
are offered substantial benefits for revealing their personal information, they will be
uncomfortable with computer programs tracking their every move, and unwilling to
transact through a single infomediary (Bodorik & Jutla, 2003; "The rise of the
infomediary," 1999, June 24; Vora, December 1999).
3. Respect information privacy
Ironically, although infomediaries were conceived to protect individual privacy,
they ultimately generated additional privacy concerns (Dix, no date). Controlling personal
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information, infomediaries determine the perceived level of privacy. And how can
consumers be one hundred percent certain that these agents will act entirely on their
behalf? As the case of Microsoft’s Passport illustrates, once such comprehensive personal
profiles have been put together, there is a significant risk of malicious misuse by the
infomediary or an outside agent (Bodorik & Jutla, 2003).
4 & 5. Achieve critical mass, and gain a first-mover advantage
As we have seen in chapter four, network effects are essential to an infomediary’s
success. Although Lumeria heeded many rules for success, it failed to achieve a critical
mass of users and a first mover advantage, so it could not sustain its efforts. In contrast,
AllAdvantage achieved a critical mass of users, but the expense involved, together with
the fragile economic environment of 2000, caused it to lose its edge. AllAdvantage also
failed to take advantage of positive network effects to the detriment of its vendor
network. Unable to properly analyze its customers’ browsing and purchasing records, the
company could not infer needs and preferences for the benefit of its vendors (Vora,
December 1999).
These failures to gain a critical mass raise the question of who is better suited to
become an infomediary: a startup company or an incumbent. Newcomers must convince
millions of consumers to join, promising them benefits down the road. Given their
existing customer database and a critical mass of customers, existing companies might
have better luck. But herein is the paradox. An existing company is unlikely to be a
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successful infomediary, because customers would be wary that the company would act on
its own behalf. Even if a startup infomediary were to form a joint venture with an existing
company, it would not likely solve the problem of trust. If the infomediary ran into
financial trouble, there would be no guarantees to prevent the sale of personal information
to un-trusted third parties (Hagel & Singer, 1999; Muller, 2000; Rosenblatt, July 1999).
The case studies described above suggest that the business model of the
infomediary is not financially viable. The authors of the plan estimated that an
infomediary based on a joint venture would require an up-front investment of $380
million. According to their estimates, positive returns could be expected in the eighth
year, with revenues of $5 billion by the tenth year. These high fixed costs and low profit
margins are unattractive to venture capitalists, who want to see more immediate returns
on their investments. Even Hagel and Singer admit that for a startup company, the
investment would be significantly more (Hagel & Singer, 1999; Muller, 2000; Rosenblatt,
July 1999).
Alternatives
Although no company has yet to develop a successful infomediary on the order
conceived by Hagel and Singer, more modest versions of infomediaries, taking the form
of search engines, communities of interest, and corporate sites, do exist (Grover & Teng,
2001). Amazon.com, eBay, Expedia.com and PriceLine.com are forms of infomediaries.
They work to reduce search costs and uncertainties associated with e-commerce. The
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main difference between these digital intermediaries and Hagel and Singer’s infomediary is
that the latter do not deal with digitally related uncertainties by commodifying consumer
information and privacy. Rather, these companies succeed because they establish a social
contract with their customers. Social contracts define collective privacy policies that e-
commerce businesses adhere to, and they constrain the behavior of companies while
protecting individuals (Kaufman & Powers, 2002).
i. eBay
eBay, the largest Internet auction site, exemplifies a successful infomediary.
Unlike the physical auction houses of the 19 th century, eBay brings buyers and sellers
together in cyberspace, allowing millions of goods to be auctioned off simultaneously. It
does not act as a principal, because it has no ownership interest in the goods sold. As an
infomediary, its only interests are to protect the integrity of the online auction process by
providing information links. eBay profits by charging fees to list items, and collecting a
percentage of the profit of transactions (Bunnell & Luecke, 2000).
Although eBay was not the first online auction site, it was the first to achieve
critical mass, capturing a dominant share of buyers and sellers. By achieving critical mass,
it gained the first-mover advantage necessary for success. Thus, eBay benefits from
positive network effects, because each additional member benefits both buyers and sellers
(Bunnell & Luecke, 2000).
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By outsourcing some of its core services, eBay maintains a vertically disintegrated
business model. The most important outsourced activity, web hosting, is assigned to
AboveNet and Exodus Communications. In addition, eBay maintains relationships with
PayPal, its preferred secured payment service, and Mailboxes Etc., which provides a 10-15
percent discount for eBay users. By relying on others to perform these key tasks, eBay
can focus on its core business practices (Bunnell & Luecke, 2000).
eBay’s culture has served to enhance an image of trustworthiness. eBay was
founded on core values of honesty, openness, equality, empowerment, trust, mutual
respect and mutual responsibility. This foundation has prevented it from becoming
opportunistic, decreasing uncertainties for its members (Bunnell & Luecke, 2000). In
online transactions, trust is established through ‘feedback’—reviews submitted by buyers
and sellers, vouching for the quality of the product, ease of payment processing and arrival
time of the good purchased.
Nonetheless, eBay’s trusted system is subject to fraud, raising concerns about
eBay’s validity as a model infomediary. With computer technologies, it is easy to cheat on
the Internet, so online companies must continuously struggle to keep swindlers at bay. In
fact, according to the Federal Trade Commission, online auction frauds are more
prevalent than any other type of online fraud. In 2003, they accounted for 48 percent of
all fraud complaints filed (Krebs, January 23, 2004). Yet eBay itself claims that only one-
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hundredth of one percent of the 20 million items that it lists at any given time are
fraudulent (Hafner, March 20, 2004).
To cope with the possibility of fraud, eBay complements the feedback system,
acting as its own intermediary to build trust and provide protection. To this end, eBay
takes the following security measures:
fraud protection service
escrow service for buyers to examine items before making
payments
Verification of seller identities
Independent appraisal services
Protection against non-paying bidders
Dispute-resolution and mediation services
Anti-fraud investigation and enforcement. (Swire, 2002)
Although eBay began as a person-to-person channel of exchange, small businesses
increasingly use its services to attract customers. In 2000, an estimated eighty percent of
eBay’s revenues were generated by twenty percent of its users, most of which are
businesses using the site as a portal to their own website. Thus, by simplifying the search
and transaction process, eBay benefits businesses and consumers (Bunnell & Luecke,
2000).
To address privacy concerns, eBay adheres to a strict privacy policy. It does not
sell or rent personal information to other businesses without explicit consent of its
members (eBay, 2004). The information that eBay does collect allows the company to
customize its services. Thus, eBay uses cookies to track web flow, measure promotional
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effectiveness, and promote trust and safety. It aggregates personal information and
discloses it to advertisers and third parties for marketing and promotional purposes.
However, this information is disclosed in a way that precludes any personal identification
(eBay, 2004). By forming privacy-based social contracts with its members, eBay has
decreased the uncertainties entailed in e-commerce.
ii. Amazon.com
Amazon.com, “the earth’s largest bookstore,” is another example of a successful
digital-age infomediary. Some refer to Amazon.com as an example of disintermediation,
because it allows customers to bypass traditional brick-and-mortar bookstores to purchase
books online. But Amazon.com does not disintermediate—it does not produce books, it
only distributes them. Amazon.com.com is in fact an intermediary, bringing buyers and
sellers together, establishing trust and reducing search costs associated with e-commerce.
To support its activities, Amazon.com embeds filtering technology that enables
personalized recommendations to be shown based on buy and search history, thus
digitizing its expertise in the book market (Chircu & Kauffman, 2001; A. L. Shapiro,
1999).
Amazon.com benefits handsomely from its first mover advantage, which in turn
provides positive network effects. As more users participate, everyone benefits from
Amazon.com’s search functions, recommendations, and user reviews. Amazon.com’s
first-mover advantage has allowed it to amass market value over thirty times that of
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BarnesandNoble.com (Chircu & Kauffman, 2001). This market dominance has enabled
Amazon.com to expand its selection to music and merchandise as well.
Like eBay, Amazon.com vertically disintegrated by forming partnerships and
alliances with other firms. Amazon.com follows three business models: retailer, a
platform provider for other retailers (such as Circuit City) and an auction marketplace. It
forms partnerships with manufacturers (such as the Disney Store), smaller businesses and
individual sellers (E-Business Strategies, 2001, October). Furthermore, Amazon.com
employs other companies to perform functions such as shipping, filling orders, analysis,
marketing, processing payments and customer service (Amazon.com, 2004)
Amazon.com is a trusted web merchant, building a reputation through branding
and service. In fact, consumers trust Amazon.com so much that they frequently buy from
the site even when it does not have the lowest prices, confirming the importance of trust
in e-commerce (M. D. Smith et al., 2000). Yet Amazon.com ran into trouble in 1999
when the public discovered that publishers were paying more than $10,000 to have their
books featured with accolades such as “New and Notable” and “Destined for Greatness.”
By allowing publishers to pay for placement, Amazon.com put the needs of the publisher
above the consumer. Customers lost faith in the site as a result. To overcome the
problem, Amazon.com quickly changed its policy, promising to disclose when publishers
had paid for placement. Still, the incident unfavorably affected the perceived level of trust
in Amazon.com as an unbiased intermediary (A. L. Shapiro, 1999).
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Like eBay, Amazon.com adheres to a strict privacy policy based on social
contracts. Amazon.com uses cookies to track information about its customers, using this
information to personalize the shopping experience by recommending future purchases,
one-click purchasing, personalized greetings, wish lists and shopping carts. Amazon.com
does not sell personal information to other businesses, but it does share its customer
information with its subsidiaries (Amazon.com, 2004). Consumers do not mind that
Amazon.com collects information, because it allows the site to offer personalized
recommendations.
Conclusion
Hagel and Singer laid out a complex model for infomediaries in their book Net
Worth: Shaping Markets When Customers Make the Rules. Their business plan attempted to
resolve many uncertainties of the digital age: information overload, information
asymmetry, privacy concerns, consumer data collection and trust in e-commerce. By
controlling and aggregating personal consumer information, infomediaries commodified
information privacy. Consumers then sold their personal information in exchange for
targeted marketing messages from approved vendors. At the same time, infomediaries
used the consumer information profiles to make recommendations and anticipate the
needs of their customers.
In 1999, infomediaries were the ‘next big thing’ in e-commerce. Companies such
as Lumeria, AllAdvantage and Passport closely followed Hagel and Singer’s plan. Yet, no
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infomediaries created after the release of Hagel and Singer’s book still exist today.
Although Passport, now owned by Microsoft, is still functioning, it faces serious
allegations over the misuse and violation of personal consumer information.
There are several reasons for the failure of infomediaries. First, Hagel and Singer
introduced their business plan before the dot.com bubble burst. Investors clamored to
sink money into potential e-commerce companies. The demise of AllAdvantage and
Lumeria corresponds with the crash of the stock market, signaling that it may have been
bad timing.
Second, in placing so much value on the consumer, infomediaries failed to create
enough value for the business. This lack of balance was especially evident in the case of
AllAdvantage; its business plan unraveled when businesses became disaffected, and the
company still had to pay millions of dollars to their customers. As we saw in chapters
Three and Four, an intermediary performs best when it meets both business and
consumer needs equally.
Third, infomediaries failed to garner enough trust from their customers. A high
level of trust is crucial in e-commerce, as without it transaction and agency costs are too
great to sustain a market. However, the benefits of having an infomediary did not
outweigh the risk entailed in revealing personal information. In Lumeria’s case, customers
were unwilling to trust an unknown company to handle all of their private information.
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Fourth, infomediaries overestimated their ability to reduce privacy concerns in e-
commerce. They failed to take into account the fact that consumers desired a perceived
level of control over their own personal information, and that entrusting that information
to an infomediary did not equate with control. This problem suggests that infomediaries
cannot resolve uncertainties relating to information privacy. Rather, privacy concerns
should be resolved through transparent privacy policies and social contracts.
Fifth, infomediaries failed to take into account key aspects of a networked
economy. To succeed, infomediaries needed a critical mass of users and a first-mover
advantage. Without a critical mass, infomediaries, most notably Lumeria, could not
sustain their high fixed costs. Although AllAdvantage had a critical mass of users, it was
unable to take advantage of the ensuing network effects.
The failure of Hagel and Singer’s infomediary plan does not suggest that all
infomediaries are doomed. In fact, several infomediaries have emerged in recent years to
become dominant market players. eBay and Amazon.com are most notable in this regard.
Shunning the personal information and privacy business, these companies are remarkably
distinct from the model business proposed by Hagel and Singer. They are intermediaries
in a more traditional sense— bringing buyers and sellers together, stepping in to reduce
search costs, transaction costs, information asymmetry and information overload in e-
commerce. They have succeeded by adhering to the seven rules of success for digital age
intermediaries. They resolve tensions in consumer information collection and privacy by
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entering social contracts with their customers, thus restraining tendencies for
opportunism.
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Chapter 6. Conclusion
Although privacy-based infomediaries failed, evidence suggests that a market still
exists for other types of intermediaries in the digital age. This chapter summarizes the
lessons learned and draws conclusions on the likelihood of consumer and business
support for digital-age intermediaries. In addition, this chapter proposes further areas of
research.
This thesis sought to answer the following question: Are there any circumstances under
which an intermediary can succeed in the information economy? It hypothesized that there is a role
for intermediaries in the digital age, but that intermediaries will only succeed as specialized
agents for e-commerce, not as a solution for protecting consumer information privacy.
This thesis also questioned the failure of privacy- and personal information-controlling infomediaries
in the digital age. To account for the lack of supply for, and demand of, infomediaries, this
thesis hypothesized that the privacy-based infomediary could not equally balance
customer and business needs. Second, this thesis hypothesized that if they did not earn
enough trust or confidence from consumers, infomediaries would fail to achieve critical
mass and first-mover advantage, two crucial elements for success in a networked
economy.
To test these hypotheses, this thesis proceeded as follows. Chapter Two
developed a conceptual framework, focusing on the fundamental role that information
plays in an economic system. It defined information as an intangible, non-exclusive, and
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non-rivalrous commodity, and emphasized the ability of information to reduce
uncertainties as well as generate new ones. Furthermore, the chapter described how
advances in technology affect the dissemination, use and commodification of information,
information asymmetry, and uncertainties in changing economic environments. Chapter
Two presented two theories, agency theory and transaction cost theory, as a way of
explaining the roles uncertainty and information asymmetry and how they can be reduced.
An intermediary was defined as an agent that seeks to reduce uncertainties, transaction
costs and agency costs when information asymmetry is present. This chapter argued that,
as technology advances, some uncertainties are resolved, but others emerge at the same
time. Thus, the role of an intermediary depends on its ability to reduce the uncertainties
that exist at any given point in time. This phenomenon of intermediation-
disintermediation-reintermediation is essential to understanding the intermediary’s
evolving role in historical and present-day markets (Chircu & Kauffman, 1998).
Building on this conceptual framework, Chapter Three examined the roles that
intermediaries have played historically in reducing uncertainties and transaction costs. It
traces the evolution of intermediaries from traditional town markets to the international
markets of the Industrial Revolution. In a town market centered on personal
relationships, transaction costs and uncertainties were low, so intermediaries played a
small role. Buyers and sellers relied instead on trust and social contracts to solve
problems of information asymmetry. Yet the advance of communication and
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transportation technologies gave rise to new uncertainties, and intermediaries stepped in
to facilitate transactions over greater distances.
With the advent of the Industrial Revolution, and the corresponding
improvements in communication and technology, businesses found new ways to organize
themselves, eradicating the roles of certain intermediaries. To remain viable,
intermediaries had to reinvent themselves, taking on new roles in importing, advertising,
patents, and mass retailing. As Chapter Three makes clear, intermediaries succeeded when
they benefited both businesses and consumers, reducing uncertainties and transaction
costs for both parties. This historical analysis confirms the continual intermediation—
disintermediation—reintermediation cycle that intermediaries must follow to remain
viable in changing economic and technological environments.
Turning to the present, Chapter Four examined the emerging uncertainties of the
digital age. While increasing the scope and speed of communication, the Internet and the
World Wide Web introduced at the same time new uncertainties, especially information
asymmetry, information overload, privacy concerns, and trust. Just as in the Industrial
Revolution, intermediaries stepped in to reduce uncertainty, adapting themselves and
inventing new roles. The analysis in this chapter reconfirmed how intermediaries follow
an intermediation-disintermediation-reintermediation cycle (Chircu & Kauffman, 1998).
In this period, new types of intermediaries—infomediaries—appeared to organize
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information-based digital markets, facilitating online transactions and managing
information overload.
As Chapter Four made clear, intermediaries must not only reinvent their roles; to
be viable intermediaries, they must provide a service that benefits both buyer and seller. If
an intermediary’s behavior favors one party over another, it will lose its raison d’être.
Keeping this notion in mind, Chapter Four identified seven rules of success for digital-
age intermediaries: 1) provide value for businesses and consumers; 2) promote trust in
online transactions; 3) become experts in specialized industries; 4) respect information
privacy; 5) achieve critical mass; 6) gain first-mover advantage; and 7) take advantage of
information commodities.
Using these seven rules as criteria for evaluation, Chapter Five examined the
infomediary model laid out by John Hagel and Marc Singer in their book Net Worth:
Shaping Markets When Customers Make the Rules, as well as three specific cases of
infomediaries. Hagel and Singer suggest that infomediaries might provide a useful and
lucrative service by aggregating customer information and acting on behalf of the
consumer in negotiations with businesses. Most importantly, infomediaries would protect
personal information, thus easing privacy concerns. Looking at the infomediary
businesses Lumeria, AllAdvantage, and Passport, Chapter Five found that Hagel and
Singer’s model is unsustainable. As the previous chapters suggested, and in accordance
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with the first hypothesis, intermediaries only succeed when they strike a balance between
customers and businesses.
This thesis also found support for the second hypothesis: the infomediary model
failed to account for the inherent aspects of a networked economy. As shown in Chapter
Four, infomediaries must achieve a critical mass and a first mover advantage to sustain a
competitive edge and leverage their high sunk costs. Lumeria, the infomediary that most
closely followed Hagel and Singer’s plan, did not acquire enough members to compensate
for their high costs. On the other hand, AllAdvantage had the opposite problem. It
achieved a critical mass so quickly that it could not sustain its “pay-to-click” business
model. It did not have enough vendor support to cover the payments promised to its
members.
Significantly, the thesis also found that customers were unwilling to trust all of
their personal information to a single source, and were thus unlikely to conduct all
purchases through a single infomediary. These findings support the third hypothesis:
infomediaries failed to gain consumer confidence. As we have seen in Chapters Two and
Four, trust is crucial in reducing transaction and agency costs in both traditional and e-
commerce business transactions.
However, the failure of these infomediaries does not suggest that
disintermediation is unlikely in the digital age. This thesis also examined successful
intermediaries in e-commerce, notably eBay and Amazon.com. Both eBay and Amazon
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classify as “infomediaries,” though not in the same sense as Hagel and Singer’s
infomediaries. They bundle and distribute large amounts of information goods, and offer
expertise in specialized areas of e-commerce. They do not address privacy concerns by
commodifying information; rather, they engage in social contracts and display transparent
privacy policies on their websites. Thus, by following the seven rules presented in
Chapter Four, as Amazon.com and eBay do, digital intermediaries are likely to find
acceptance from both consumers and businesses. These findings support the final
hypothesis: intermediaries will succeed as specialized agents to facilitate e-commerce by
bringing buyers and sellers together and reducing transaction costs, uncertainty and
information overload.
Thus, there are circumstances under which an intermediary can succeed in the
information economy. As we have seen in the conceptual framework and the historical
analysis, intermediaries can succeed in any economy, so long as they solve the
corresponding uncertainties brought about by technological and economical advances. In
the information economy, businesses and consumers will most likely enlist the services of
an intermediary when they receive substantial benefits, and when they perceive the
intermediary to be trustworthy. Likewise, intermediaries will most likely succeed if they
build a critical mass of users, gain a first-mover advantage and provide value to their
customers. Above all, intermediaries must balance consumer and business needs equally.
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Suggested areas of research
Business and policy solutions for information privacy
Given the failure of infomediaries to protect consumer information privacy, what
other solutions might address this problem? Presently, no clear solution for privacy exists.
In the digital age, we are in the midst of a radical reorganizing of business paradigms. We
have yet to discover if the solution will be market-based or policy-based. Clearly, this area
requires further exploration.
One possible solution would be for the government to adopt a legal framework to
facilitate e-commerce, imposing stricter regulations on privacy violations and designing
best practices for businesses. In this scenario, the government would act as a trusted
intermediary to increase privacy protection (Bailey & Bakos, 1997; A. L. Shapiro, 1999).
Another possible solution would be for businesses to implement self-regulated
privacy policies. As we saw in the examples of Amazon.com and eBay, businesses do best
when they make their privacy policies transparent, and offer the customer substantial
benefits in return for the collection of personal information. Furthermore, businesses
might engage in social contracts or procedural fairness. Further research may reveal the
best solution to this problem.
A market for privacy
Another possible solution to privacy concerns in the digital age calls for the
creation of a market for privacy. This market would give consumers control over their
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personal information, selling it for a price to interested buyers. Given the failure of
infomediaries to oversee this type of market, who might step in to monitor this market?
Is it likely to be government-controlled? Would a market for privacy really decrease
transaction costs, or will the time and effort result in increased transaction costs?(A. L.
Shapiro, 1999).
Disadvantages of intermediaries
This thesis explored the benefits of using an intermediary for both consumers and
businesses. Information intermediaries reduce information overload by filtering and
searching, but in so doing they potentially limit the user’s perspective. An intermediary
may unintentionally shelter the user from important information (A. L. Shapiro, 1999,
112-114). This raises a final question: can using an intermediary be disadvantageous, even
if it seemingly reduces transaction costs?
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