Keep the customer dissatisfied

What does the failure of e-commerce experiments tell us about the potential for making money on the Net?


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Scott Rosenberg
October 20, 2000 11:30PM (UTC)

Sen. Orrin Hatch, R-Utah, doesn't want us to buy wine on the Net. His argument is that minors are using online ordering to get their hands on booze. Maybe so. Or maybe the wholesale distributors of alcoholic beverages would rather not deal with online competition, and have found some friends in high legislative places.

Either way, Hatch's bill -- attached at the last minute to another piece of legislation about traffic in sexual slavery, of all things -- passed the Senate last week 95-0, and President Clinton is expected to sign it into law. The measure would bring the federal courts into the enforcement of states' laws against the direct shipping of alcoholic beverages and help turn what was a patchwork quilt of conflicting state regulations into a more uniform national prohibition.

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Personally, I think it's absurd that I won't be able to order my favorite boutique pinot noir or microbrew from out of state just because the government can't figure out how to stop a 16-year-old using a parent's credit card from doing the same thing. But my inconvenience is trivial compared with the larger lesson here: Clearly, it's time to abandon any lingering notion you might have that the Internet is somehow a free-market paradise, in which buyers and sellers connect with one another beyond the reach of existing (and sometimes arbitrary) social and political restraints.

Can the Net cut out the regulators and the middlemen? It can try. But they will strike back.

In this time of plummeting stock prices and dot-com bankruptcies, it's hard to remember back a mere two or three years ago, to an era when analysts spoke adoringly of the Internet's power to make good on the promises of "friction-free capitalism." The friction-free vision was bold and more than a little Utopian: Somehow, the technological power of the network itself would overwhelm all the messy government regulations and trade-restraining business practices that placed a drag on our economy -- all the "frictions" that prevented the free market from doing its thing.

Friction, however, seems to be alive and well. The offline alcoholic beverages industry isn't sitting back and thinking, "Gee, guess the Internet makes us irrelevant!" It's fighting for its turf by grabbing for all the usual levers of power. If you thought that the Internet's ability to evade the traditional state-by-state sales tax was a sign of some inherent freedom from government interference endowed by the Net's sheer coolness, the saga of the Hatch wine bill should make you think again.

And government rules are only one kind of friction slowing the march to free-market nirvana. Consider the humbling of Priceline's Jay Walker, who recently had to shut down his enormously ambitious and vastly unprofitable WebHouse Club operation. The WebHouse concept was classic friction-free thinking. The idea was to apply the Priceline model, in which consumers bid for unused airline-seat inventory, to gasoline and groceries. But WebHouse lost money on most transactions; it couldn't persuade wholesalers to participate wholeheartedly in the "name your own price" game (probably because grocery inventories have a stable value over time, unlike unused airline seats, which are worth zero after takeoff).

WebHouse also faced a kind of frictional resistance that a lot of e-commerce schemes are encountering -- the friction generated when complex innovations rub against entrenched consumer habit. A lot of entrepreneurs and not a few economists have viewed the Web as a vast laboratory to test novel pricing models -- and certainly, that's not an unreasonable plan, since you can start an e-commerce company quickly with little more than a domain name, an idea and some cash.

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But you also have to make sure that potential customers can quickly grasp what you're doing and why they should bother learning something new. That's where so many e-commerce ventures -- whether group-buying deals or price-comparison shopping bots or reverse auctions -- falter. How many shoppers have the time or patience to figure out these unconventional schemes and make sure that they are in fact to their benefit? And even if we're satisfied on that score, how many of us feel that the few cents or dollars they promise to save us are worth that precious time?

As the bankruptcies and closures mount in the e-commerce universe, it's apparent that investors and consumers alike are beginning to understand viscerally what skeptics have long outlined as the grim, iron paradox of e-commerce. Either e-commerce doesn't deliver much in the way of reducing friction, adding convenience and lowering prices, in which case there's no reason to embrace it; or it does manage to do so, in which case the consumer's gain is the industry's loss.

Friction, it turns out, is the parent of the profit margin. The more you move toward a perfect market mechanism the fewer opportunities there are for anyone to make money.

What's the ultimate embodiment of friction-free economics? A marketplace in which everything is free, instantly available and infinitely duplicable, with no cost of goods, no transaction costs and no inventory depreciation: in other words, Napster.

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Napster, unsurprisingly, turns out to be hugely popular with consumers -- and anathema to producers and distributors. The one thing that's missing from its model is cash. No friction? No revenue, and no profit. Whoops!

I don't mean to suggest that all e-commerce innovations are doomed or that there is no possibility for consumer benefit and corporate profit to find a happy balancing point. EBay is an example of a company that created a new marketplace online, reduced the general friction level by putting masses of individual buyers and sellers in touch with one another, enabled a huge volume of new transactions and managed to grab a small slice of them for itself.

But for every success story like eBay there are probably a hundred flops tanking -- because they failed either to make things easy for the consumer, to account for the "frictional" resistance of old-economy competitors or to build profits into their plans. Pundits have continually reminded us over the past few years that the new economy is all about inventing and experimenting with new business models. Every experiment reaches a moment of truth: Did it succeed or not? The roster of e-commerce failures and bankruptcies filling the headlines today isn't just the result of bad individual business decisions or some general economic downdraft; it's a sequence of research conclusions being tallied and notebooks being shut.

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In this lab, it's not very hard to tell what's working and what isn't. As they say on the subway: Watch the closing doors.


Scott Rosenberg

Salon co-founder Scott Rosenberg is director of MediaBugs.org. He is the author of "Say Everything" and Dreaming in Code and blogs at Wordyard.com.

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