Impact of E-commerce on the Business

Published: 05th April 2011
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Impact of E-commerce on the Business

SHAIKH MOHAMMED FAISAL, Matrix 012010110114

MSU Graduate School of Management, January 2011

Electronic commerce (also referred to as e-commerce) is synonymous to a marketplace on the internet and has exploded over the last 10 years. It consists primarily of distributing, buying, selling, marketing, exchanging and servicing of products or services over electronic systems such as the internet and other computer networks with no barriers of time. This means e-commerce is becoming an increasingly essential tool for organizations in general, and for small and medium-sized enterprises (SMEs) in particular, in gaining competitive advantage and in accessing global. E-commerce is also advantageous to consumers since there is no geographical boundary for companies and a variety of products is available at anytime and anywhere with better prices. While the conventional commerce literature holds sufficient evidence to support the effect of culture on purchase decisions, less empirical evidence is available to support this phenomenon in the e-commerce context reported the influence of citizens' attributes, including gender, education, income, age and households with regard to opportunities to access information and communication technologies (ICT's).

In the emerging global economy, e-commerce and e-business have increasingly become a necessary component of business strategy and a strong catalyst for economic development. The integration of information and communications technology (ICT) in business has revolutionized relationships within organizations and those between and among organizations and individuals. Specifically, the use of ICT in business has enhanced productivity, encouraged greater customer participation, and enabled mass customization, besides reducing costs.

With developments in the Internet and Web-based technologies, distinctions between traditional markets and the global electronic marketplace-such as business capital size, among others-are gradually being narrowed down. The name of the game is strategic positioning, the ability of a company to determine emerging opportunities and utilize the necessary human capital skills (such as intellectual resources) to make the most of these opportunities through an e-business strategy that is simple, workable and practicable within the context of a global information milieu and new economic environment. With its effect of leveling the playing field, e-commerce coupled with the appropriate strategy and policy approach enables small and medium scale enterprises to compete with large and capital-rich businesses.

What is e-commerce?
E-commerce is usually associated with buying and selling over the Internet, or conducting any transaction involving the transfer of ownership or rights to use goods or services through a computer-mediated network.1 Though popular, this definition is not comprehensive enough to capture recent developments in this new and revolutionary business phenomenon. A more complete definition is: E-commerce is the use of electronic communications and digital information processing technology in business transactions to create, transform, and redefine relationships for value creation between or among organizations, and between organizations and individuals.2

Economic drivers of e-commerce
Five broad themes have emerged as important for understanding the economic and social impact of electronic commerce:

1. The effect on the marketplace...
Electronic commerce transforms the marketplace. E-commerce will change the way business is conducted: traditional intermediary functions will be replaced, new products and markets will be developed, new and far closer relationships will be created between business and consumers. It will change the organization of work: new channels of knowledge diffusion and human interactivity in the workplace will be opened, more flexibility and adaptability will be needed, and workers’ functions and skills will be redefined.

2. The catalytic role...
Electronic commerce has a catalytic effect. E-commerce will serve to accelerate and diffuse more widely changes that are already under way in the economy, such as the reform of regulations, the establishment of electronic links between businesses (EDI), the globalization of economic activity, and the demand for higher-skilled workers. Likewise, many sectoral trends already under way, such as electronic banking, direct booking of travel, and one-to-one marketing, will be accelerated because of electronic commerce.

3. The impact on interactivity...
E-commerce over the Internet vastly increases interactivity in the economy. These linkages now extend down to small businesses and households and reach out to the world at large. Access will shift away from relatively expensive personal computers to cheap and easy-to-use TVs and telephones to devices yet to be invented. People will increasingly have the ability to communicate and transact business anywhere, anytime. This will have a profound impact, not the least of which will be the erosion of economic and geographic boundaries.

4. Openness...
Openness is an underlying technical and philosophical tenet of the expansion of electronic commerce. The widespread adoption of the Internet as a platform for business is due to its non-proprietary standards and open nature as well as to the huge industry that has evolved to support it. The economic power that stems from joining a large network will help to ensure that new standards remain open. 

5. The relative importance of time are fundamental to understanding the economic and social impact of electronic commerce…
Electronic commerce alters the relative importance of time. Many of the routines that help define the "look and feel" of the economy and society are a function of time: mass production is the fastest way of producing at the lowest cost; one’s community tends to be geographically determined because time is a determinant of proximity. E-commerce is reducing the importance of time by speeding up production cycles, allowing firms to operate in close co-ordination and enabling consumers to conduct transactions around the clock. As the role of time changes, so will the structure of business and social activities, causing potentially large impacts.

The impact of e commerce on the business
Rapid technological progress in information and communication technologies (ICTs) along with their widespread diffusion have led to speculation about "frictionless" economies in which transaction costs are nearly zero, barriers to entry and contestability disappear, and markets clear instantly. Some think that electronic commerce, with producers selling directly to consumers over computer networks such as the Internet, will eliminate existing intermediaries ("disintermediation") and drastically reduce transaction costs. These lower production costs will encourage the entry of new businesses and thus increase competition and pressure to pass lower costs on to consumers as lower prices. In addition, consumers will be able to search among thousands of merchants for the lowest prices, thereby increasing the downward pressure on prices and leading to a shift in market power from producer to consumer. In general, it is thought that electronic commerce can significantly improve the efficiency of economies, enhance their competitiveness, improve the allocation of resources, and increase long-term growth.3

Because electronic commerce is still at a very early stage in its development, much of this thinking is based on speculation or anecdotal evidence. This chapter begins to analyze these claims by looking first at price declines in key technologies that enable electronic commerce: information processing, communication, and data storage. The price declines in these supporting technologies allow firms to replace old inputs and processes by new, less expensive inputs, thereby changing the firm’s production function and reducing its production costs. Because these are information and communication technologies, the main impact is on transaction costs. However, given the intangible nature of e-commerce, new transaction costs are generated, many of which are associated with creating trust and managing some of the risks perceived to exist on the Internet. The impact of e-commerce on transaction costs is analyzed both for firm specific transaction costs and for costs incurred between firms. Equally important is the redistribution of some of these costs among the various parties, including consumers. Finally, the potential impact of changes in firms’ costs on prices is examined.

The impact on production costs
Assessing the collective impact of these technological developments and their associated price declines on production costs, productivity, and prices is very difficult. Indeed, the impact of computers alone on productivity has been extraordinarily difficult to ascertain and has led to a sub-field of economics that tries to explain the "productivity paradox": why the widespread introduction of computers has not resulted in increases in the official productivity statistics.4 As work on this question progresses, it is becoming clear that the paradox is unlikely to have a single solution, and the issue of whether or not computers significantly increase productivity has not been resolved. 

Changing firms’ cost structure
The impact of electronic commerce on firms’ internal production and transaction costs falls into three broad categories: the cost of executing the sale, costs associated with the procurement of production inputs, and costs associated with making and delivering the product. This list probably represents only a subset of the cost impacts associated with electronic commerce as firms implement the technology, since by and large they only represent savings over existing processes and thus do not factor in quality improvements. Similarly, beyond mere substitution, it is likely that electronic commerce techniques may foster completely new ways of conducting business. While these are hard to envision, they may lead to more significant cost savings. For example, when electricity first replaced water power, it typically used the same site near the water and the machines were vertically aligned to take advantage of the belts connected to the water wheel. While this represented an improvement over water power, large productivity gains were only obtained when new, horizontal buildings were constructed to fit the technology, allowing for the formation of assembly lines. A similar pattern may occur for electronic commerce.5

Order placement/execution
By placing the necessary information on line in an accessible format, electronic commerce merchants generally transfer transaction costs (e.g. obtaining product information, selecting the product) to the customer. As a result, even when customers execute the transaction in a traditional way (off-line), for example by buying a PC over the phone or coming to an auto dealer’s showroom to test drive a car, they come "pre-qualified". They know more precisely what they do and do not want and are more likely to buy. This greatly increases the efficiency of the sales process. Micron Computers reports a productivity gain of a factor of ten: their Web sales people spend on average two minutes on the phone with a customer who has looked at their Web site but 20 minutes with traditional customers. Auto dealers report similar gains: they spend about $25 to deal with an e-commerce generated bid but several hundred dollars for a face-to-face transaction. 

Customer support/after-sales services
In what are increasingly knowledge-based economies dominated by sophisticated products, customer service and after-sales services are a major cost for many firms. Traditionally, this meant placing service personnel in the field to visit clients, staffing call centers, publishing extensive documentation, or issuing software. For many firms, these costs are substantial, accounting for more than 10 per cent of operating costs. Through electronic commerce, firms are able to move much of this support on line so that customers can access databases or "smart" manuals directly; this significantly cuts costs while generally improving the quality of service. A classic example is the Federal Express Internet site which allows customers to order package pick-up, generates a bar-coded label for the package, permits customers to pay for the service and allows them to track the delivery.6 With over 1 million "tracks" a month, half of which would have meant phone calls to FedEx’s call centre, the system has saved FedEx millions in labor costs. Forrester Research estimates that it generally costs $500 to $700 to send a service representative into the field, $15 to $20 to handle a customer question over the phone, and about $7 to set up and maintain an Internet-based customer service system.

Changes in the nature of what constitutes a store and the productivity of sales and customer services staff have a direct impact on the number and nature of staff hired. By and large, e-commerce shops require far fewer, but high-skilled, employees., the e-commerce books merchant, has 24,300 employees (for sales of $24.5 billion), while Barnes & Noble, the largest physical US bookstore, has 39,000 (for sales of $5.1 billion). While these numbers are not strictly comparable, they give a rough sense of the difference in employment levels and sales per employee ($1,010,000 per Amazon employee versus $131,000 for Barnes and Nobel).7&8 

Federal Express reports that their online customer service system has represented a savings of 20,000 new hires (about 14 per cent of their total labor force). Cisco reports that, thanks to its e-commerce Web site, they did not have to hire 1,000 new staff for their sales/support group (out of a total of 4,500 sales and marketing employees and 11,000 total staff). GE reports that their TPN has resulted in the transfer of 60 per cent of their staff involved with requisition and that labor costs associated with procurement have declined by 30 per cent. These cases suggest that personnel savings are significant and represent a major cost savings associated with electronic commerce. The nature of employment is also changing: employment that supports an e-commerce Web site is relatively highly skilled; it is more akin to a fixed asset (e.g. a building) than traditional retail employment, which is relatively low-skilled and has a variable cost. This will limit to some degree the cost savings obtainable.

Purchase orders/procurement
Just as electronic commerce can significantly reduce selling costs, it can also lower the costs associated with buying. While the actual transaction takes place outside the firm, the costs associated with procurement constitute significant internal costs. Even for low-value requisitions for office supplies or travel, the typical purchase order costs between $80 and $125 to process, a sum that in many cases exceeds the value of the material being bought, owing to the error-prone and time-consuming process generally required to control purchasing costs and the fact that a typical purchase must go through several departments. Attempts to circumvent these processes usually result in even higher costs because negotiated discounts are not obtained or incompatible material is ordered. Internet-based e-commerce procedures now make it possible to apply EDI-type systems to relatively small purchases, thereby drastically reducing errors, ensuring compliance with organizational norms, and speeding the process. Estimates of the savings gained range from 10 to 50 per cent, although in many cases the largest savings are not monetary: MCI reports that using e-commerce to buy PCs reduces its computer purchase cycle from four to six weeks to 24 hours, Bell South has cut the time needed to approve an expense report from three weeks to two days, and by replacing its EDI system with an Internet-based system, the US General Services Administration (GSA) has more than halved the time needed to complete a purchase.9

Directly related to savings in time associated with procurement are savings in inventory carrying costs: the faster an input can be ordered and delivered, the less the need for a large inventory. In aggregate, in the United States, the average value of non-farm inventories represents some 2.3 per cent of yearly final sales and 4.2 per cent of sales of final goods. Since services are typically not inventoried, this may be a more appropriate indicator ( This is about the same as the sales of all motor vehicle equipment in the United States. Approximately 37 per cent of all inventories are "carried" by manufacturers, while 25 and 27 per cent of total non-farm inventories are held by wholesale and retail trade, respectively. Each stage of the value-added chain therefore holds considerable inventories. It is estimated that for retailers, the cost of carrying an inventory for a year is equivalent to at least 25 per cent of what they receive in payment for the product.10 Therefore, a two-week reduction in inventory represents a cost savings of 1 per cent of sales. As most retailers operate on margins of 3 to 4 per cent, this is significant.

In addition, the links that electronic commerce provides along the supply-chain make it possible to pass this information on to partners, thereby lowering their costs and probably the overall price. This practice, known as collaborative planning forecasting replenishment (CPFR), is estimated to lead to a reduction in overall inventories of $250 to $350 billion, or about a 20 to 25 per cent reduction in current US inventory levels. While this estimate seems optimistic, pilot studies on the US auto market obtained a 20 per cent. Even a 5 per cent reduction would have a significant economic impact. Gains can also be achieved from having the correct type of stock on hand so that customers can buy what they want, when they want it.

Although shipping costs can increase the cost of many products purchased via electronic commerce and add substantially to the final price, distribution costs are significantly reduced (by 50 to 90 per cent) for digital products such as financial services, software, and travel, which are important e-commerce segments. For these products, the cost reduction associated with electronic commerce could have large economic impacts and further fuel the migration of these sectors to electronic commerce. In the case of airlines, electronic tickets now account for almost all tickets for some major carriers; this has resulted in substantial savings and is forcing similar action in other industries. For sectors such as music, where songs can be downloaded directly from the producer, or news, where the journalist e-mails the reader directly, huge savings are reaped over traditional forms of distribution. This reduction in distribution costs is especially important for international trade, as the ability to "download" some products without incurring shipping costs is thought to be a strong stimulus to trade, particularly for small and medium-sized enterprises (SMEs). Even for tangible goods, e-commerce methods can reduce the administrative costs associated with trade and customs clearance by over 25 per cent.

Given the current relative size of electronic commerce with respect to other factors that may contribute to overall labor market turbulence (e.g. technology, trade, policies), the impact of electronic commerce on employment can only be very small, but, in the longer term, its effect may be felt more strongly. The direct employment impact of electronic commerce will depend on complementarily, substitution and market-size effects. Electronic commerce may also create new markets or extend market reach beyond traditional borders. The final effect on jobs will depend crucially on development of demand for electronic activities.

Direct job creation associated with electronic commerce is still fairly small and mainly driven by employment growth in the software sector. Evidence of substantial direct job displacement by e-commerce is lacking at this stage but it is most likely to occur in the retail, post office and financial sectors.

Electronic commerce is driving demand for IT professionals but it also requires IT expertise coupled with strong business applications skills. Therefore, it generates demand for a flexible, multi-skilled work force. Apart from contingent skill needs to support electronic commerce transactions and applications, there will be a more structural and long-term shift in the skills required to perform economic activities online. E-commerce is likely to accelerate existing up skilling trends in the OECD work force.

1. Business Software Alliance, 2001. E-commerce and Developing Markets: Technology, Trade and Opportunity.
2. Coward, Chris. August 2002, Obstacles to Developing an Offshore IT-Enabled Services Industry in Asia: The View from the US. A report prepared for the Center for Internet Studies, University of Washington.
3. E-commerce/Internet: B2B:2B or Not 2B? Version 1.1, Goldman Sachs Investment Research (November 1999 and September 14, 1999 issues).
4. Lallana, Emmanuel, Rudy S. Quimbo and Zorayda Ruth B. Andam. 2000, E-Primer: An Introduction to E-commerce. DAI-AGILE, a USAID-funded project.
5. Mann, Catherine with Sue E. Eckert and Sarah Cleeland Knight. 2000, Global Electronic Commerce: A Policy Primer. Washington DC: Institute for International Economics.
6. Press Release from ICDL, June 2010, e-Commerce in GCC to reach USD 100 billion in 2010.
7. (Barnes & Noble data).
8. (Amazon data).
10. http:/

Articles for Reference Reading
From The McKinsey Quarterly 2000 (The New World of Personal Financial Services). No. 3:
- "Will the Banks Control Online Banking?" by Sandra Boss, Devin McGranahan, and Asheet Mehta.
- "The Future for Bricks and Mortar" by Matthias M. Bekier, Dorlisa K. Flur, and Seelan J. Singham.
- "Banking on the Device" by David Maude, Raghunath R, Anupan Sahay, and Peter Sands.
- "How E-tailing Can Rise from the Ashes" by Joanna Barsh, Blair Crawford, and Chris Grosso.
- "Building Retail Brands" by Terilyn A. Henderson and Elizabeth A. Mihas.
- "M-Commerce: An Operator’s Manual" by Nick Barnett, Stephen Hodges, and Michael J. Wilshire.
- "The Real Business of B2B" by Glenn Ramsdell.

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