the economic impact of e-commerce

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BRAC University Journal, Vol. II, No. 2, 2005, pp. 49-56

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THE ECONOMIC IMPACT OF E-COMMERCE

Ziaul HoqSchool of Business

American International University-Bangladesh (AIUB)

Banani, Dhaka 1213, Bangladesh

and

Md. Shawkat KamalDepartment of Management and Business

BRAC University, 66 Mohakhali C/A

Dhaka, Bangladesh.

and

A H M Ehsanul Huda ChowdhurySchool of Business

American International University-Bangladesh (AIUB)

Banani, Dhaka 1213, Bangladesh

ABSTRACT

E-commerce has a significant impact on business costs and productivity. E-Commerce has a chanceto be widely adopted due to its simple applications. Thus it has a large economic impact. It givesthe opportunity for boundary crossing as new entrants, business models, and changes intechnology erode the barriers that used to separate one industry from another. This increasescompetition and innovation, which are likely to boost overall economic efficiency.

Key words: E-Commerce, Bangladesh, B2B, B2C, Logistics

1. INTRODUCTION

E-commerce is a way of conducting business overthe Internet. Though it is a relatively new concept,it has the potential to alter the traditional form ofeconomic activities. Already it affects such largesectors as communications, finance and retail tradeand holds promises in areas such as education,health and government. The largest effects may beassociated not with many of the impacts thatcommand the most attention (i.e. customizedproduct, elimination of middlemen) but with lessvisible, but potentially more pervasive, effects onroutine business activities (i.e. ordering officesupplies, paying bills, estimating demand).

2. OBJECTIVE OF THE STUDY

To examine impact of e-commerce onbusiness cost and productivity.

To evaluate present status of e-commerce.

To identify how e-commerce reduces cost

of customer services and after salesservices.

To identify key success factors of e-commerce

To provide insights for policy formulationin the area of e-commerce.

3. METHODOLOGY

The article has been written on the basis ofsecondary information. The secondary informationand data were collected from published books,journals, research papers, and official statisticaldocuments. Reports published on e-commerce byOrganization of Economic Cooperation andDevelopment (OECD) provides important ideasregarding the topic.

4. DEFINITION OF E-COMMERCE

Electronic commerce, or e-commerce, is thebuying and selling of goods and services on the


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Internet. Other than buying and selling, manypeople use Internet as a source of information tocompare prices or look at the latest products onoffer before making a purchase online or at a

traditional store. E- business is sometimes used asanother term for the same process. More often,though, it is used to define a broader process ofhow the Internet is changing the way companies dobusiness, of the way they relate to their customersand suppliers, and of the way they think about suchfunctions as marketing and logistics. For thepurpose of this study e-commerce is taken to meandoing business electronically. (Lindsay P., 2002)

Other terms that are often used when talking aboute-commerce are B2B and B2C, shorthand forbusiness-to-business, where companies dobusiness with each other, and business-to-consumer, where companies do business withconsumers using the Internet. These are consideredto be main forms of e-commerce.

5. THE ONLINE ECONOMY

The advent and spectacular growth of the Internethave spawned claims of a new economygoverned by a new economics. Economists rarelyendorse such claims, pointing out that basic micro-economic and macroeconomic principles stillapply. Shapiro (1999, p. 2) for example commentsthat Fortunately, history can still be our guidewhile we cannot rely much on the classicalmodel of perfect competition and price setting

firms, we dont need a fundamentally neweconomics. Shapiro and Varian (1999, p. x) arguethat, even though technology advances breath-lessly, the economic principles we rely on aredurable. However, while the underlying economicprinciples remain unchanged, e-commerce and theInternet have significantly altered firms coststructures and raised the importance of certain eco-nomic phenomena, including network economics.

Shapiro (1999) argues that, networks,interconnection and leveraging are not newphenomena, just increasingly important. Whilethe prominence of network effects may not

constitute new economics, or even a neweconomy, it is clear that there has been a markedand permanent break with the past.

6. THE ECONOMICS OF NETWORKS

The Internet is a global network. Use of theInternet for commercial purposes, as in e-

commerce, is therefore subject to significantnetwork effects or demand side scale economies.Network effects are not new but they are endemicin the online economy (Shapiro 1999b). As

Shapiro and Varian (1999,p.173) remark, the oldindustrial economy was driven by economies ofscale; the new information economy is driven byeconomies of networks.

Shapiro (1999 a, p.1) describes the networkeconomy as follows:

The essence of the network economy is thatconsumers place greater value on large networksthan on smaller ones. Such network effectsclearly apply to real networks, such as networks oftelephone user, compatible fax machines, orcompatible modems. Perhaps less obviously, they

also apply to virtual networks, such as the networkof Apple Macintosh users, the network of users ofMicrosoft excel, or the network of users of DVDmachines. In industries ranging from computersoftware and hardware, to credit cards, ATM cardsand smart cards to telecommunications networksand the Internet itself, network effects are a criticalpart of the competitive landscape.

For information- intensive industries, the globalscale of the Internet releases both demand-side andsupply side scale economies, producing whatShapiro and Varian (1999, p. 182) describe as:

A double whammy in which growth on thedemand side both reduces cost on the supply sideand makes the product more attractive to otherusers- accelerating the growth in demand evenmore. The result is especially strong feedback,causing entire industries to be created or destroyedfar more rapidly than during the industrial age.

7. E-COMMERCE IN USA AND EUROPE

At present, United States of America is typicallycredited with about four-fifths of worldwide e-commerce activity. The figures roughly suggestthat Eastern Europe represents about 10% and Asia

about 5% of the world total. In Europe, UnitedKingdom and the Nordic countries are the currentleaders, although some estimates attributesignificant activity to Germany. For each of themajor categories of e-commerce activities liveaudio, shopping, finance, and content (sports,adult) USA typically has 67 to 85 of the top 100sites. Canada comes in second for five out of the


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six categories. Over the near term, the US lead isexpected to decline to about two-third of worldstotal e-commerce activity, particularly becauseFrances Minitel and Germanys T-online services

have accustomed their citizens to online buying; as

these services migrate the Internet, e-commerceshould expand. Also, Europe may see a user leddemand pull, in contrast to the technology pushthought to characterize the US situation (Hawkins,

1998).

Table1: Selective individual firms e-commerce revenues by activity

Activity 1995-97 ($ million)

E-commerce (B2B)

CSX 3000

GE 1000

NEC 1528

Cisco 2496

Dell Computer 730

E-commerce (B2C)

Autos: Auto by tel. 14

Books: Amazon 148

Groceries (peapod) 60

Toys (e toys) 7

Music (N2K) 148Source: OECD, 1999

Table 2: Estimates of e-commerce sales compared to various benchmarks.

E-commerceestimates ($billion)

US cataloguesales (%)

US credit cardpurchase (%)

Directmarketing (%)

OECD-7 totalretail sales (%)

(1996/97) 26 37 3 2 0.5

(2001/02) 330 309 24 18 5

(2003/05) 1000 780 54 42 15

Source: OECD estimates, 2003

8. E-COMMERCE IN BANGLADESH

Despite being a under developed country, selectedsegments of the Bangladeshi business communityhas embraced technology with reasonable success.The Facsimile in the 1980s and mobile telephonesin the 1990s popularized modern technology inthe mass market. Personal computers and theInternet are also emerging as day-to-day businesstools. These positive indicators are favoring theprospects of e-commerce in Bangladesh.

B2C e-commerce is unlikely to be of much use inthe near future in Bangladesh because of low percapita income, a weak infrastructure, lack of aproper legal environment and lack of trust betweenbusiness and consumers. B2C for cross bordertrade is also limited by the factors suggested forthe domestic front. In addition, difficulties in

accessing international credit cards, foreigncurrency remittance restrictions, delays andinformal payment at customs clearance even forsmall value and quantity items will discourageB2C.

The B2B application already exists in the exportsector of Bangladesh, especially in the Ready-Made Garments (RMG) industry. RMG has thelions share of the export earnings in Bangladesh.The RMG sector has begun to use the Internet, andits dependence on e-commerce is likely to grow in

the coming years. The Internet would enable themto seek information about potential buyers as wellas raw material suppliers. Similarly the practice ofposting a website by individual producers hasbegun. However, if Bangladeshi producers areunable to accommodate electronic transfer ofpayment and other facets of e-commerce, the


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business opportunity will move on to countries thathave developed such systems.

B2G e-commerce is possible in Bangladesh, but on

a limited scale at this stage. The government is amajor buyer of goods and services from the privatesector. Typically, the government procures goodsand services by inviting tenders. The availability ofthe Request For Proposal (RFP) and otherrelevant documents on-line provides an alternativechoice. Transactions involving informationcollection, obtaining various governmental forms,registering activities can also be conducted on-line.This will reduce time costs, corruption and thenecessity of going through lengthy bureaucraticprocedures as well as increasing transparency.(Hossain, 2000)

9. A FRICTION FREE SOCIETY

Rapid technological development, progress ininformation and communication technologiesalong with their wide spread diffusion led tospeculation about frictionless economies inwhich transaction costs are nearly zero and barriersto entry and contestability are non-existent. Somethink that Internet will eliminate existingintermediaries and drastically reduce transactioncosts.

These lower production costs will encourage theentry of new business and thus increasecompetition and pressure to pass lower costs on toconsumers as lower prices. In addition, consumerswill be able to search among thousands ofmerchants for the lower prices, thereby increasingthe downward pressure on prices and leading to ashift in market power from producer to consumer(Hage and Armstrong, 1997).

In general, it is thought that electronic commercecan significantly improve the efficiency ofeconomies, enhance their competitiveness,improve the allocation of resources, and increaselong-term growth.

10. IMPACT OF E-COMMERCE

Because electronic commerce is still at a very earlystage in its development, much of this thinking isbased on speculation on sketchy evidence. Theseclaims can be analyzed by looking first at pricedeclines in key technologies, which enableselectronic commerce. The price declines in these

supporting technologies allow firms to reduce itsproduction costs. However, given the intangiblenature of e-commerce, new transaction costs aregenerated, many of which are associated with

creating trust and managing some of the risks.

10.1 The Falling Cost of Information and

Communication Technologies

As electronic commerce is an Internet application,it runs on an infrastructure composed ofcomputers, software and communication systemsand uses the Internets key infrastructureapplications (e.g. e-mail, world wide web,browser). This group of technologies hassupported the development of electronic commerceand in turn is the source of much of electroniccommerces value. Advances in microelectronics

have caused the price of memory chips andsemiconductors to decline steadily. While theseprice declines are among the most spectacular,many other elements of computing disk drivesfor data storage, printers and other peripherals have also seen significant price declines. Thesefalling prices allow firms to engage in e-commerce. In fact, the cost of processing,analyzing, storing, and presenting data has fallento such an extent that computing power is nowwidely diffused in applications like skins, greetingcards etc.

Fiber optics technology, radio and satellitetransmission have also fuelled large price declinein communications costs. However, because ofnetwork nature of the communication sector andits regulatory environment, the overall drop inphone call prices has been more modest. Segmentsthat are exposed to competition, such as the tariffbasket for business communication charges incompetitive markets and the price of leased lineshave declined.

New technologies such as digital subscriber lines(DSL), continued liberalization of regulations, thearrival of new entrants, and addition of significantnew capacity have lead some to suggest thatcommunication prices may begin to follow asimilar performance to price path as informationtechnologies (Gilder, 1994).

Assessing the collective impact of thesetechnological developments and their associatedprice declines on production costs, productivity,and prices is very difficult to ascertain and has led


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to a sub-field of economics that tries to explain theproductivity paradox. Paradox is unlikely tohave a single solution, and the issue of whether ornot computers significantly increase productivity

has not been resolved. This is not surprising, sincethe broad impact of the telephone, which has beenwidely diffused for generations, on socialinteraction, location decisions, and businessstructure is still not well understood. (Fisher, 1992)

E-commerce also affects manufacturing processes.Dell computers for example, have extended thesupply of customized products back into itsmanufacturing processes, facilitating masscustomization of its desktop computers(Borenstein & Saloner 2001). On the other hand,as Borenstein and Saloner (2001, p. 6) recognizes,there are impediments to capturing the cost savings

of e-commerce and the Internet, including inertialforces that relate more to organizational issues, theimportance of compatibility with legacy systemsand non-technological transactions costs.

10.2 Changing Firms Cost Structure

The impact of e-commerce on firms internalproduction and transaction costs falls into threebroad categories:

I) The cost of executing the sale,

II) Costs associated with the procurement ofproduction inputs, and

III) Costs associated with making and deliveringthe product.

This probably represents only a subset of the costimpacts associated with e-commerce as firmsimplement the technology. Similarly, beyond meresubstitution, it is likely that e-commercetechniques may foster completely new ways ofconducting businesses.

By placing the necessary information on line in anaccessible format, electronic commerce merchantsgenerally transfer transaction costs to thecustomer. As a result, even when customersexecute the transaction in a traditional way (off-line), for example by buying a pc over the phoneor coming to an auto dealers showroom to testdrive a car, they come pre-qualified. They knowmore precisely what they do and do not want andare more likely to buy. This greatly increases theefficiency of the sales process. (Kehoe 1998)

E-commerce is very effective at reducing the costsof attracting new customers. While far fromfriction free, advertising is typically cheaperthan other media and more targeted. For example

while CarPoint (an e-commerce auto referral site)typically charges dealers about $200 in advertisingand fees per car sold, car dealers typically spend$450 per car sold through traditional media(Kehoe, 1998).

Knowledge-based economies are dominated bysophisticated products, customer services and aftersales services. These are major costs for manyfirms. Traditionally, this meant placing servicepersonnel in the field to visit clients, staffing callcenters, and publishing extensive documentationsof issuing software. For many firms these costs aresubstantial. With the help of e-commerce, firms

are able to move much of this support on line sothat customers can access database. Thissignificantly cuts costs while generally improvingquality of services.

E-commerce has allowed companies tosignificantly decrease the number of employeesthey require to operate certain kinds of businesses.Changes in the nature of what constitutes a store,the productivity of sales and customer servicesstaff have a direct impact on the number andnature of staff hired. By and large, e-commerceshops require far fewer, but highly skilledemployees. Amazon.com, the e-commerce booksmerchant, has only 614 employees (for sale of$418 million) while Barnes & Noble; the largestphysical US bookstore has 27,200 (for sale of $2.8billion). Although these numbers are not strictlycomparable, they give a rough sense of thedifferences in employment levels and sales peremployee.

Federal Express reports that their online customerservices system has represented a saving of 20,000new hires (about 14% of their total labor force).Cisco reports that thanks to its e-commercewebsite, they did not have to hire 1000 new stafffor their sales/support group.

Just as electronic commerce can significantlyreduce selling costs, it can also lower the costsassociated with buying. While the actualtransaction takes place outside the firm, the costsassociated with procurement constitute significantinternal costs. Even for low value requisition foroffice supplies or travels, the typical purchase


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order costs between $80 and $125 to process, asum that in many cases exceeds the value of thematerial being bought, owing to the error proneand time consuming process generally required to

control purchasing costs. Internet based e-commerce procedures now make it possible toapply EDI-type systems to relatively smallpurchases, thereby drastically reducing errors,ensuring compliance with organizational norms,and speeding the process. Estimates of the savingsgained range from 10 to 50 percent (Girishankar,1997b)

Directly related to savings in time associated withprocurement are savings in inventory costs - thefaster an input can be ordered and delivered, theless the need for a large inventory. In the sales ofall motor vehicle equipment in the United States of

America, approximately, 37% of all inventories arecarried by manufacturers, while 25 and 27 percent of total non-farm wholesaler and retail tradehold inventories, respectively. Each stage of thevalue added chain therefore holds considerableinventories. It is estimated that for retailers, thecost of carrying an inventory for a year isequivalent to at lest 25% of what they receive inpayments for the product.

A key factor in reducing the costs of inventories isimproving the ability to forecast demand moreaccurately. E-commerce merchants who allowconsumers to customize their order or select form awide variety of choices obtain valuableinformation on consumer preferences. This helps

them improve their ability to forecast demand. In atraditional store, a consumer might buy a computerwith unwanted features or lacking certain featuresbecause that model was available. In such a

situation, the merchant is ignorant of theconsumers true preferences. The e-commercemerchant who offers a built to order computer,instead knows exactly what consumers prefers andcan adjust the product line accordingly.

Although shipping costs can increase the cost ofmany products purchased via e- commerce and addsubstantiality to final price, distribution costs aresignificantly reduced (by 50 to 90 per cent) fordigital products such as financial services,software, and travel, which are important e-commerce segments. For these products, the costreduction associated with e-commerce could have

large economic impacts and further fuel themigration of these sectors to e-commerce (seetable 3). In the case of airlines, electronic ticketsnow account for about half of all tickets for somemajor carriers; this has resulted in substantialsavings and is forcing competitors to follow suit.

For sectors such as music, where songs can bedownloaded directly from the producer, or news,where the journalists e-mail the reader directly,huge savings are reaped over traditional forms ofdistribution. This reduction in distribution costs isespecially important for international trade. Evenfor tangible goods, e-commerce methods canreduce the administrative costs associated withtrade and customs clearance by over 25%.

Table 3: E-commerce impact on various distribution costs. (US$ per transaction)

Banking Bill payments Term life insurancepolicy

Softwaredistribution

Airline tickets

Traditional system 1.08 2.22 400 15 8.0

Telephone based 0.54 N/A N/A 5 N/A

Internet based 0.13 0.65 200 .20 1.00

Savings (%) 89 71 50 97 87

Source: IBM preliminary estimates, quoted in Margherio et al., 1998

10.3 Changing Cost Structure of the Value

Added Chain

Just as electronic commerce reduces the internalcosts of many transactions, it also changes the coststructure that dictates a firms relationships withother businesses. This set of relationship is calledthe value added chain. At every stage of

processing, an intermediary often performs a

service, which facilitates this flow adding valuebut also adding cost. In many cases, this service isinformation-intensive, matching a buyer to seller,certifying parties in a transaction, providingsupport for the transaction and often involves sometype of risk sharing. Electronic commerce,especially in intangible products, may reduce the


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involvement of intermediaries in the value addedchain and thus lower costs.

A potential larger impact involves the

displacement of products whose basic function isto convey information that is asymmetricallypassed. Even in such cases, however, many sellerswill value the buffering and risk sharing serviceoffered by these intermediaries and will retainthem (Hawkins, 1998). The intermediaries mostvulnerable to disinter mediation are those that actas human modems and simply pass oninformation without adding much value. In almostall cases, e-commerce accelerates an existingtrend. For instance, the use of discount brokers inthe case of stock trading or many travel servicesdirectly available from the provider.

As e-commerce causes the disinter mediation ofsome intermediaries, it creates both greaterdependency on others and also some entirely newintermediary functions. The principal servicesprovided by many of these new intermediaries isestablishment of trust, a very important factor forelectronic commerce, as buyer and seller maynever meet, the openness and span of the Internetmake fraud easier than in traditional commerce.

10.4 Impact on costs related to logistics

A key feature of electronic commerce is theconvenience of having purchases delivered

directly. In the case of tangibles, such as books,this incurs delivery costs. The delivery agent playsan important role in assuring customers thatpurchases will arrive. Goldman Sachs conducted asurvey of prices for a market basket of 30 productssold by Wal-Mart both online and offline (SeeTable 4), while the prices for the two marketbaskets did not differ by much, the final price ofproducts purchased online was higher by 9 percentowing to shopping costs.

Some portion of the reduction in firms cost can beattributed to the shifting of costs formerly borne bythe firm to the customer in the form of self-service.

For example, customers are now expected to learnabout the product, answer their own customersupport questions, and pay for shipment of theproduct. It is difficult to ascertain what portion ofthe firms lower costs is due to shifting and whatportion to actual reduction. As some customerswill prefer not to pay these costs or to accept lowerquality of service, it may potentially limitreduction.

Table 4: A survey of studies analyzing the impact of e-commerce on prices

Survey Survey date Coverage Key findings

Ernst &Young Jan .1998 Comparison of 3 on-line and off

line vendors for 32 consumerproducts

Online prices wee lower for 88%

of products

Forresterresearch

July 1997 150 companies in 12 majorindustrial categories engaging inB2B e-commerce

Lower costs mean highermargin, most of which arecurrently being retained

GoldmanSachs

August 1997 Comparison of a 30 item marketbasket sold by Wal-Mart

Online prices were 1% higher,9% with shipping cost included

OECD March 1997 Comparison of 240000 prices forthree products: books, CDs, andsoftware

Online prices are slightly higherthan those of hybrid stores andchange more frequently

Source:http://www.ey.com/wired/pricing surveyhttp://www.forrester.comhttp://www.oecd.org/dsti/sti/it/ec

11. CONCLUSION

A key reason why e-commerce, especially thebusiness-to-business segment, is growing soquickly is its significant impact on costs associatedwith inventories, sales execution, procurement,

intangibles like banking, and distribution costs. Ifthese reductions become pervasive, e-commercehas the potential to be the application that ushers inthe large productivity gains. Achieving these gainsis therefore contingent on a number of factors,including access to e-commerce systems and the


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needed skills. However, what is unique about e-commerce over the Internet and the efficiencygains is that it promises the premium placed onopenness. To reap the potential cost savings fully,

firms must be willing to open up their internalsystems to suppliers and customers. This raisespolicy issues concerning security and potential anticompetitive effects as firms integrate theiroperations more closely.

REFERENCES

Borenstein, S. and Saloner, G. (2001), Economicsand Electronic Commerce, Journal of

Economic Perspectives, p. 23-45.

Fisher J. (1992), Some Market Effects of E-commerce, paper presented at University of

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Gilder C. (1994) Productivity developmentsabroad, Federal Reserve Bulletin,Washington D.C., p. 30

Girishankar P., (1997), E-commerce: The calmafter the storm, Australian financial review,Sydney, February 2.

Hage and Armstrong, (1997). Does the Neweconomy measure up to the great inventions

of past?Journal of Economic Perspectives, p.49-74

Hawkins B., (1998). Dot com survivors,Business review weekly, Canberra p. 45

Hossain N., (2000), E-commerce in Bangladesh:status, potential and constraints. researchpaper, p. 1, USAID, Bangladesh.

Kehoe C. (1998), E-tailing start to klick, Sydneymorning herald, Sydney

Lindsay P. (2002), E-commerce, The EconomistBooks. p. 1.

OECD, The social impact of electroniccommerce, 1999 p. 9 and 2003. p.7

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Taylor W. (1997), the twenty first century firm:changing economic organization ininternational perspective, PrincetonUniversity Press, Princeton, New Jersey, USA

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