The recent proliferation of e-commerce has led to a great deal of analysis probing the who, what, where, when, and why’s of new opportunities for conducting business online. In this publication alone, articles have ranged from theoretical predictions of the economic forces that will mold the Internet market (see [1]) to invasion-of-privacy issues reflected in empirical analysis of online consumer preferences (see [5]). Cookies, clickstream data trails, and the ease of conducting online surveys have permitted unprecedented tracking of what consumers search for, click on, and ultimately buy. Aggregating that data results in an entrepreneur’s dream for extracting significant characterizations of the Internet consumer population. The consumer-side research has already repeatedly stated that existing risks in e-commerce pose substantial barriers to consumer participation online. Never before has our understanding of the consumer been both so intimate and so extensive.
However, the firm side of e-commerce has comparatively been forgotten. Amazon.com, which operates primarily on a business-to-consumer level, is now the cliché shorthand for describing what the firm side of the online market is all about. Yet in many ways, Amazon.com is an extremely misleading representative of e-business: it is the exception, rather than the rule, for online commerce. The only characteristic it shares with the majority of firms online is that is has not turned an actual profit.
Indeed, popular knowledge of the firm behavior in the online environment is reserved exclusively to a few case studies of those businesses that have entered the Internet market. While skyrocketing stock values for virtual firms’ IPOs generate media coverage, the bulk of the U.S. GDP is still attributable to the traditional, brick-and-mortar firms [4]. What are their preferences and concerns regarding the eventual translation of their business online? If we truly want to understand what the future holds for e-commerce, insight into consumer behavior online must be complemented by insight into firm behavior online, and the analysis of firm behavior must give due weight to the actions of firms expanding onto the Web, alongside firms that began on the Web.
To make any concrete characterizations of both Internet startups and traditional firms not yet online, we need to balance case studies with extensive surveys of the type already conducted on consumers. Unfortunately, few such studies have probed the supply side. One exception is a comprehensive survey, The Electronic Commerce Enquête 97/98, which was conducted by the University of Freiburg’s Telematics Department [9]. Upper-level decision-makers at 914 German-speaking companies responded to a written, offline survey form regarding their attitudes toward e-commerce. The study thus escapes some of the self-selection bias of online surveys. The more traditional composition of German firms presents a useful reference for understanding the problems facing traditional firms (as opposed to the new, purely online startups) in translating their businesses into e-commerce initiatives. In addition, in contrast to case studies that focus on business-to-consumer relationships, 80% of the Enquête respondents were dedicated to business-to-business level operations. This more accurately reflects the findings of the Organization for Economic Cooperation and Development (OECD), which indicate that currently 80% of e-commerce value is in business-to-business transactions [7].
Due to the focus on German companies, this study cannot perfectly mirror the situation that American firms face, which clearly limits generalizations based on the survey. However, the international convergence of business practices, the expanding global linkages between companies, and the inherently borderless nature of e-commerce create an increasingly homogenous business environment. Throughout this article, research by the U.S. Department of Commerce, Federal Reserve, and the OECD confirms the fundamental issues faced by German firms are shared by U.S. firms and firms located in other developed countries.
The survey addressed why some firms hesitated to use the Web, examining in detail the risk-return tradeoff these firms perceived with e-commerce and how perceptions of risk differ from industry to industry. In an extensive set of questions with a total of 32 statements, opinions were collected on the barriers to electronic commerce success. The participants were asked to rate statements on technology, organization and regulations, the economy, security, payment, and application. The major result is that the greatest barriers to the business success of electronic commerce are the lack of security and organizational/legal issues. Through a deeper investigation of the dimensions of risk, the study reveals firms consider legal risk, above client or financial risk, as the greatest barrier to e-commerce and that different industries place different degrees of importance on the various types of risks.
The U.S. Department of Commerce echoes these findings in its general assessment of the digital economy, noting that U.S. businesses had cited taxes, an unpredictable legal environment, and security/technical failures of the Internet as potential barriers to further growth of e-commerce [6]. Understanding the more complex nature of the problems the firms face with e-commerce points to solutions beyond just a new business plan: the institutional environment around e-commerce must adapt to business needs, whether through government input or private rules of business conduct.
Untapped Resources
A surprisingly large number of firms do not employ Web resources to their fullest capacity. Many commercial Web sites are merely multimedia advertisements that fail to employ the information-gathering and interactive powers of the Web to forge close relationships between firms and their clients. For example, an online wine seller could offer supplemental information about a given wine through Web links suggesting complementary food, information about the particular region from which the wine comes, recommendations about the year, or other wines customers might enjoy if they were pleased with this one in particular. These strategies allow a wine seller, online or offline, to distinguish itself from the competition, create a stronger customer service bond, and broaden the consumers’ range of wines demanded. However, according to the Enquête, only 30% of companies consciously used supplementary information to distinguish themselves from the competition; 21% merely gave information that could be obtained from the product description.
Equally disappointing results are reported even for those who attempt to reap higher returns from Internet interaction. Despite the power of the Web to allow firms to solicit information from clients and customize marketing, if not customize products to individual consumers, 67% did not employ customization techniques, and nearly 20% of companies with online sales responded that they were not even familiar with the one-to-one marketing strategy capability using the Web. These results apply in particular to traditional firms that merely transfer their business image online, rather than translating their business into a more productive online model. A quick survey of commercial Web sites shows that the majority of online firms use the Web as just another form of broadcast advertising, reverting to traditional order and distribution channels when a purchase is executed.
One of the promises of Web technology was to quickly and easily transfer information between a customer and a firm so that customers’ needs could be met (see [1]). However, less than half of the companies surveyed took advantage of “mass customization,” meaning the mass production of goods and services with individual tailoring. Surprisingly, even those companies that replied stating they “completely” focused on the customer did not make full use of individualizing products and services to the customer’s need. In particular, business-to-business transactions, which tend to involve customized production of supplies, theoretically seemed the most likely to pursue the benefits of online search and solicitation for contractors. Instead, these firms were coasting on their established offline business. As a result, the marginal benefit from their Internet access was just that: marginal, rather than revolutionary.
Different industries also underutilize the Web in different ways. Although Internet services, printing/publishing houses, and service providers systematically acquire and use customer data gathered from the Web, the majority of industrial producers involved in manufacturing did not. Curiously, although industrial producers were not inclined to research information on their client market, they were more likely to engage in mass customization than financial services or the printing and publishing sector. A disconnect clearly exists between strategies for mass customization and strategies for one-to-one marketing, both in general and industry-specific ways.
Firms’ Risk Perceptions
Why are these firms failing to capitalize on all the opportunities the Web offers them? Some of the explanation may lie in slow adoption of new business practices. However, when surveyed through the Enquête, these firms provide reasons having more to do with external environment than internal process. Approximately 70% of the respondents replied that the greatest barriers to e-commerce were “the absence of generally accepted business practices” and “regulatory deficits, for example for electronically signed contracts.” Lack of security and organizational/legal issues also ranked high on the list of impediments. Overall, firms perceived a tradeoff between the benefits of e-commerce and the uncertainty and risk due to a lack of developed formal and informal institutions guaranteeing the fundamentals for a market to work: property rights and enforcement of contracts. A researcher from the Federal Reserve notes that the inability to clearly determine responsibility for mistakes prevents some potential e-commerce firms from switching over to e-commerce practices and mechanisms [10].
The Enquête broke risk down into three types: client, financial, and legal. Client risk reflects the uncertainty a buyer or seller may have about dealing with an anonymous firm or customer through online processes. In contrast, the more certain alternative is a regular client who has developed a reputation with the firm. Even if the regular client has a high probability of failing to abide by a contract, at least that level of risk is known and expected profits can be calculated (with high variance), as opposed to a new client. Financial risk reflects the value of goods or money exchanged in a transaction that could be lost through use of the Web as a channel of delivery. A firm would consider any transaction involving high value to be of higher risk through any channel, online or offline. Legal risk reflects assignment of responsibility and enforcement of contracts settled online. For example, inadequate means of tracing responsibility and verifying online transactions can result in a lack of legal liability, and thus higher risk, if there is a dispute. Thus, legal risk reflects some technical issues as well as institutional deficits.
The importance of these risk factors and how they affect the attitude of companies toward doing Web-based business can be quantified: legal risk is as influential as client risk and financial risk combined (see Figure 1).
When presented with eight different scenarios involving different combinations of legal, client, and financial risk (for example, “high legal risk, low client risk, high financial risk” (see Figure 2)), respondents were asked to rank on a scale of -4 to +4 whether they were less likely or more likely to want to use e-commerce. “0” indicated indifference between e-commerce and traditional sales and distribution methods. Through the combination of risk factors, the scenarios capture the fundamental tradeoff between danger of loss (risk) versus opportunity for profit making (return). The relative importance of these risk factors was then quantified using conjoint analysis, a multivariate statistical procedure particularly capable of dealing with tradeoff relationships.
Not surprisingly, under situations of low risk in all three categories, firms were very likely to want to utilize e-commerce, resulting in an overall score of 3.9 for that scenario. Quite different scores were obtained for those scenarios in which high legal risk was present. Each of these scenarios received a negative score (unlikely to want to use e-commerce), regardless of the level of financial or client risk. Only in the case where client risk and financial risk were low was the high legal risk offset to yield a positive score. Apparently, it takes established relationships and low potential loss to overcome a barrier of legal risk. The OECD study on e-commerce affirmed that reputation becomes even more important if there is a lack of security in transactions due to technical or legal difficulties [7]. The U.S. Department of Commerce reported that firms use the Internet to purchase “low value” materials because of the lack of third-party responsibility in case there is a dispute [6]. In any other environment, legal risk is the one barrier to online business. Indeed, both financial and client risk together are not enough to impede use of e-commerce as long as legal risk is low. That scenario received a score well above indifference of 1.5 (see Figure 3).
Clearly, businesses would like to take greater advantage of their online resources. The reasons they give for their hesitation to do so suggests a lack of clarity and/or power for legal institutions in the online environment. However, before trying to suggest solutions, we must recognize that the problem is not uniform across all industries.
Different Industries, Different Risk Perceptions
A further breakdown of the firms into their industry types reveals that the importance firms in particular industries place on legal, financial, and client risks is significantly different than the importance perceived by firms in other industries. For example, under the best scenario of low risk in all cases, the computer-related (hardware, software, Internet services) and print/publishing industries are more favorable to e-commerce than trade industries, consulting services, or financial services.
Surprisingly, financial services and trade do not consider financial and client risk as very relevant to online business, despite the significant role of finance and client relations in these industries. Legal risk seems to be even more of an impediment to overall attitudes toward e-commerce for financial services and trade than for any other industry. If we consider the number of small banks and import-export/retail-wholesale firms that exist in the U.S. and are contemplating their transition online, then we are dealing with a large volume of business that does not perceive the legal environment as friendly to their online progress.
On the other hand, the industry most indulgent toward legal risk is manufacturing. This might be explained by manufacturing companies having relatively intense and individual producer-client relationships and thus creating reputation and trust among the business partners offline. A combination of low client risk and low financial risk may be more prevalent in this industry than in others at counteracting the discouraging effects of legal risk. Therefore, attempts to increase online use in industry through reducing legal risk may not have as significant an effect as it would on financial services or trade.
Whenever traditional offline institutions are accessible, the legal risk associated with e-commerce is perceived as being smaller. For example, even if a product is bought online, if it requires physical delivery, then trace and proof of delivery is provided by a (trusted) third party, for example, FedEx. In contrast, a firm that is able to deliver completely online without the use of a trusted third party (financial services or news feed, for example) has higher risk perceptions. Since neither party in a fully online transaction comes face to face, there is no opportunity to establish a personal bond of trust. The IP address for delivery may not reveal the physical location of the buyer, denying the firm important information that could be helpful in assessing the risk involved in this particular transaction and in resolving any disputes.
Clearing the Barriers: Who Should Act and How
As previously stated, legal risk is a significant concern to e-commerce. However, since firms constantly face risk-return tradeoffs, why should we bother to help firms by reducing the level of risk? A level playing field for e-commerce should reasonably offer the same legal institutions and processes for protecting property and resolving transaction and contract disputes as used in traditional commerce. Currently, firms may not perceive an efficient risk-return tradeoff because they are incapable of properly calculating the level of risk or the level of return due to unclear knowledge of the legal environment online. Making all players more informed about what they may face in the online world can only improve total welfare, including that of consumers.
Already, there are several attempts to fill the vacuum created by the lack of online legal certainty and institutions. Individual firms, multi-firm entities, industry and trade associations, and government and related agencies have all been making efforts to create a less risky online environment (see Figure 4).
What Firms Should Do
Firms have unilaterally articulated their policies regarding protection of consumer privacy and security of monetary transactions through their Web sites. In some respects, the lack of other means in cyberspace of establishing customer relationships and trust based on reputation and personal contact demands that firms reveal their policies on information disclosure, informed consent, and handling disputes. An extension from retail business-to-consumer policy to producer business-to-business policy simply requires a more inclusive definition of the customer as a business contractor. For further credibility, business can be certified by trusted third party organizations such as TrustE (www.trustE.org) and Better Business Bureau online (www.BBBonline.org) regarding their privacy protection practices. Similar third-party verification could certify the legal procedures and technical standards by which contract disputes would be settled between two firms that had both subscribed to the verification service. America Online has its own set of merchant guidelines for protecting the consumer (www.aol.com/amc/ certified_merchants.html). In the same way that consumers via AOL find more security in a firm that has subscribed to AOL’s policy, AOL merchants dealing with each other may feel they enjoy more legal certainty than outside the framework of AOL’s standard. Another approach is exemplified through E-bay’s reputation tracking service. Sellers and buyers can submit evaluations of each other, thus creating a reputation for the participants. Of course there are loopholes limiting the power of this approach such as changing one’s online identity frequently or falsely submitting favorable reputation reports on yourself. Nevertheless, reputation tracking at least provides more information than previously existed.
With little effort companies can and should adopt one or more of these approaches to reduce the risks they face. However, these approaches have limited reach and are mainly voluntary. It is unclear what legal position and options customers or business contractors have if they feel the other party did not uphold its end of the bargain.
What Industry and Trade Associations Should Do
At the industry level, industry and trade associations or multi-firm entities are in positions of authority to articulate how legal responsibility should be assigned and by what means it should be measured. For example, the bank-backed company “identrus” (www.identrus.com) provides identity assurance for secure business-to-business e-commerce. It supplements its security services by being a gatekeeper, according to the guild model of the Middle Ages in which all members know each other at least indirectly or are trusted through a member or a chain of members. In particular, the needs of the financial industry are served by this type of institution. The U.S. government encourages commercial guidelines for conduct, such as the International Chamber of Commerce’s model commercial code guidelines [6].
The flexibility of these guidelines to address specific industry concerns combined with the speed of industry institutions to determine policy with authority over their members render industry-level solutions most popular at this stage in e-commerce development. It is highly advisable for all industries to establish industry-specific rules of business conduct that go beyond any geographic limitation. However, in a case of conflict with national law, these rules are always subsidiary.
The Role of Government
As we move into a more mature and complex online market the role of the government and the legal system must be clarified. There are basically two approaches for government: hands-off and enabling.
In the U.S., government has mainly maintained a hands-off attitude toward e-commerce in order to promote the e-economy. However, unless contractual disputes can be resolved through private institutions, parties will appeal to the courts and demand interpretation of current law as applied to online circumstances. Unfortunately, with the time-consuming and unpredictable process of legal legislation through case-by-case decisions, no firm wants to be the test case establishing a precedence for online law. More and more firms are agreeing with Bill Harris, the president of Intuit, who at a recent Business Software Association meeting described regulation as “essential” and called upon government to “do its role as being an enabler” [2].
In some cases, laws need to be updated to reflect the existence of an online transaction by removing requirements for contracts to have a handwritten signature as opposed to an electronic signature. Accordingly, as an example of enabling legislation, the German Digital Signature Act came into force on August 1, 1997, becoming the first digital signature law in the world [8]. In addition, the German government has initiated even more legislation to govern e-commerce, covering online sales contracts, consumers’ rights, and disclosure policies (an English-language version of the law is available at www.iid.de/iukdg/). On the European level, the “Directive for a common framework for electronic signatures” will be adopted in the European Community this year.
If the Internet is to truly hold the promise of borderless commerce, laws and taxes must be harmonized at an international level. Only governments have the authority and extensive (international) reach to enact and enforce this level of coordination.
The emergence of various attempts to overcome the legal barriers creates complementary, not conflicting, systems. As argued, due to differing levels of authority, speed, reach, and ability to address specific industry differences, all players have their appropriate role (see Figure 5).
Careful analysis of the current e-commerce environment reveals barriers not only for consumers, but also for suppliers, particularly those transitioning to the online economy. Forrester Research’s predictions for e-commerce sales are $3.2 trillion in 2003, but “only $1.8 trillion if businesses and governments cannot work together” [3]. Certainly, we should expect the attitude toward government action to vary among individual firms or even among entire economies. However, a combination of solutions over time at the individual, industry, and government levels will develop needed enabling institutions in order to create a stable, less risky base for further e-commerce.
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