The SPRU and MERIT contributions to the FAIR project this year focus on key developments in new interactive services associated with the development of the Internet and the consequent adjustment of the incumbent telecommunication industry to compete with new service providers, to develop its own new services, and to forge alliances and new ventures with the most innovative of the new entrants to the services market (the Insurgents and the Virtual Community providers). The core theme is the emergence of digital intermediation and its limitations.

Three principal issues are at the heart of the adjustment processes that are currently underway and they are fundamentally concerned with uncertainty in the marketplace.

The first two themes lead to insights concerning the likely need for policy intervention and changes in regulation to ensure that both social and economic aspects of emergent markets provide opportunities for European services providers and users. The third theme suggests new directions for RTD programmes aimed at accelerating the rate of take up of advanced communication technology and services. Special attention in this year’s work is given to the opportunities for formating of new virtual communities who provide potentially profitable target markets for interactive service providers.

The marketplace is a primary social and economic institution, and the implications of extensive electronic intermediation, or, for that matter, disintermediation, concern far more than the ICT industry sector itself. It is now taken for granted that Electronic Commerce represents the future for many commercial activities. Up to this time, however, some types of commercial activities have proven to be more receptive than others to the implementation and diffusion of Electronic Commerce. A focus of FAIR research has been to look for some of the reasons by examining critically some of the key assumptions that underlie many of the expectations of this new market environment.

The opportunity of exploiting the Internet for consumer transactions is enticing, but the business challenges in this new environment can be considerable. Indeed, Electronic Commerce provides an ideal laboratory for examining how digital intermediation is or is not becoming a factor in more aspects of daily life, and it provides many practical examples of the three principal issues listed above - the extent of dematerialised economic activity, uncertainty about citizen/consumer preferences, and the increasing technical acumen of users.

Electronic Commerce is more than simply another application of ICT. Commercial activities are fundamental to market economies, and they permeate virtually every aspect of daily life for individuals, firms, and organisations. The digitalisation of the commercial environment raises many important questions about the digital intermediation of human and organisational relationships in general. For example, it is common to see the WWW as a means for ‘broadcasting’ information rather than as a means for facilitating person-to-person communication except when the latter involves commercial transactions or requests for information.

People and institutions decide when, why and where to acquire which ‘staple’ and ‘discretionary’ goods and services according to complex social and cultural criteria. The ability to valorise goods and services in a market economy was first learned in a ‘materially-based’ social context. In a digitised dematerial environment, many of these social skills will have to be re-learned, and this has implications in terms of the formation of new social strata, cultures and sub-cultures. For sellers of goods and services, this highlights the challenges involved in replacing material transaction and product environments with dematerial ones, and with building new commercial relationships with customers in a dematerial trading medium. For customers, it highlights the extent to which their dematerial relations will be dominated by interactions with impersonal and automated ‘servers’ and how they will be able to achieve trust and confidence in the new environment. These are often embodied in concerns about whether advanced communication technologies and services offer merely an advanced interactive ‘catalogue’ as well as the security of electronic transactions, the privacy of transaction-generated information, and the real versus perceived social and economic advantages of electronically-mediated transactions.

The Internet is the first example of an open network environment that in principle could be available to every kind of trader in the marketplace (individuals as well as firms and organisations). The Internet is infinitely ‘scalable’ to the requirements of large and small transactions. However, FAIR research found that the dynamics of inclusion and exclusion for Internet commerce are far from simple. We concluded that established trading communities will play critical roles in cyberspace.

The overarching analytical framework governing the FAIR project has been the evolution of Incumbent-Insurgent-Virtual Community relationships. In this framework, Virtual Communities provide most of the scope for ICT markets to be shaped by user communities. The ‘users’ of Electronic Commerce are the buyers and sellers of goods and services of all descriptions. As such, there is a high potential for the formation of Virtual Communities around various types of commercial activities. However, FAIR research found that within these Virtual Commercial Communities themselves, many structural asymmetries persist in the interactions between various types of participants in markets for all manner of material and dematerial goods and services. In the electronic marketplace as a whole, many Incumbent effects can be seen within Virtual Commercial Communities that are similar to those identified in FAIR studies of the ICT supply industries.

FAIR outputs have noted persistent tendencies for ICT markets to be ‘technology led’ and for (particularly Incumbent) suppliers to be in favourable positions to enmesh their clients in path dependent relationships with technologies. Even in new service areas where the technology is presumed to offer more flexible alternative customer/supplier relationships, many options remain open to Incumbents to exploit centralised control over key architectural elements of the network. This was demonstrated, for example in the FAIR study of the Global Mobile Personal Communication System (GMPS). The INMARSAT-led initiative, ICO Global Communications, is designed to keep most of the network management functions ‘on the ground’, a solution that plays on the strengths of Incumbent Public Network Operators. The Iridium system, on the other hand, uses more advanced technology to keep as much of the management function as possible ‘in the sky’, thereby reducing dependency on the Incumbent-controlled fixed network.

However, many leading corporate implementers of Electronic Commerce are also among the leading innovators in terms of the specification and configuration of trading systems. Large corporate users have often played dominant roles in the development of Electronic Data Interchange (EDI) and Value Added Network (VAN) applications. Indeed, the general pattern has been for (often incompatible) EDI and VAN applications to be developed within discrete, sector-based trading communities - banking, transport, retailing, and so forth. In the process, substantial ‘in-house’ ICT design and operations capabilities have been generated in user firms - particularly in large firms that dominate industry sectors.

If we accept the possibility that in Electronic Commerce the supply and demand relationships between ICT suppliers and business users could be ‘levelled’ to some extent, we must then broaden our horizons from assessing the importance to the ICT industries of markets for Electronic Commerce platforms (hardware and software) and services, to the intermediary role of ICT in the evolution of the market economy as a whole.

Clearly, some traders in the marketplace are in a stronger position than others to influence the technological and service paradigms for Electronic Commerce and to determine the terms of market entry and participation. Moreover, as digital intermediation of the marketplace increases, there may be commercial advantages for established ‘Incumbent’ traders. For example, Incumbent ‘brand name’ advantages could prove critical in the process of securing the trust and confidence of new ‘electronic customers’.

These observations have potentially important implications for commercial and social governance and for industrial policy. Arguably, Electronic Commerce offers a very high potential to be ‘user led’, at least by business users. The combined economic power and escalating technical acumen of trading communities as a whole could turn the ICT supply industries firmly away from ‘technology led’ strategies in many key areas, thus generating a new era in the relationship between suppliers and users of ICT.

For this to come about many economic, social and political factors must be considered. During the past year, FAIR research examined these issues from several perspectives.

2.1 Overview of FAIR Research on the Digital Intermediation of Trade and Commerce

FAIR researchers examined Electronic Commerce as a trading environment, focusing on the crucial role of trading communities themselves in developing Electronic Commerce in Europe. In developing both business and policy strategies for Electronic Commerce, it is especially important to examine carefully the many kinds of commercial transaction structures that operate in the conventional as well as in the electronic marketplace, in order to assess likely incentives and disincentives for digital intermediation to grow.

Most business strategies involve the careful management of key transaction points, both in supply chains and with final customers. Changes in these transaction structures due to digital mediation can provide incentives for some traders and disincentives for others. Traders do not embrace Electronic Commerce with the intention of giving up advantages in the market that they enjoy already. Traders become proactive in Electronic Commerce because they perceive that it will confer advantages that might not be available (or not available to the same extent) in the conventional marketplace or because they are threatened by rivals seeking these advantages.

Electronic Commerce portends many new transaction forms. Some will be revolutionary, but most will appear as parts of evolutionary trajectories, many of which were established as long as 30 years ago, driven largely by commercial rather than technological criteria. FAIR did the groundwork for an assessment of the transaction structure in an Electronic Commerce environment, an evaluation of the incentives and barriers to participation, and a critique of current assumptions about the implications of Electronic Commerce for industry and market structure. In particular, it examined the evolution of business and product models, the logic of disintermediation, and the prospect of digitally intermediated ‘virtual’ business structures.

This work was amplified by two extended case studies that yielded many practical examples in industry areas that, arguably, are indicative of the kinds of challenges that face buyers and sellers in the electronic marketplace.

Electronic Cash Payment Systems

One of these deals with the problem of payment systems, focusing on the implications of electronic cash. Especially for low cash value consumer-oriented Internet transactions, the electronic cash concept has many advantages over Electronic Funds Transfer (designed for inter-institutional exchanges) and credit cards (which have relatively high administrative costs for small transactions).

FAIR research found that the nature of the payment system was of central concern to both suppliers and customers.

The immediate benefits of electronic cash for the retailer are that they can increase the security of their operations by lowering the amount of cash they have to handle, and they can reduce the substantial amount of financial ‘leakage’ that occurs in the physical cash environment due to simple counting errors. The longer term advantage is that electronic cash could bring the possibility of Internet payment systems closer to the average retailer, thus potentially facilitating access to wider markets.

By comparing three major electronic cash initiatives - Mondex, DigiCash, and Visa Cash - FAIR showed that each is based on quite different assumptions about how different types of traders will wish to interact in the electronic marketplace. In particular, it raises questions about where the future impetus for innovation will come from, as traditional intermediaries in the cash provision and handling process (i.e. banks) are supplemented or even replaced by other institutions.

As a result, despite the fact that transaction settlement and funds transfer is a central component of any commercial structure, it is proving also to be one of the areas in which industry-wide agreement is proving most difficult to achieve with respect to co-ordinating the technology base. This is an especially important question for European Union countries in that European interests are leading players internationally in electronic cash initiatives - Mondex and DigiCash are both European in origin.

Technical Change in the On-Line Music Industry

The second case study examined the impact of technical change on the music industry - particularly on the distribution of recorded music. Digital audio broadcasting and digital audio radio can now provide music-on-demand services. Moreover, the Internet can be used both to sell music products like Compact Discs and tapes, or to allow customers to download these products directly. The on-line retailing of music could make products available in these ways on a global basis, but as yet only a small proportion of total revenues from on-line services is attributable to music sales (estimated to be only US$ 100,000 in 1995). Given the particular suitability of music industry products for distribution in a dematerial environment, the fact that the potential of on-line technology in this industry has yet to be turned into profits for the music companies yields a number of important lessons about the dynamics of dematerial markets which will be summarised below.

Developments in the media industries generally are especially important for Europe in that European firms have many significant comparative advantages in this field. The European music industry in particular is one of the strongest international competitors. Three of the world’s six largest music groups are European - Bertelsmann Music Group (Germany), Polygram (Netherlands) and Thorn-EMI (UK). Together with Time Warner (US), Universal (formerly MCA) (Canada) and Sony (Japan) they account for about 75% of a world market for recorded music that by 1995 was worth ECU 31.5 billion. Sixty percent of recordings sold in the EU originate there, indicating that substantial markets for ‘localised’ products persist despite globalisation pressures in the music industry as a whole. In 1995 the EU music industry provided more than 300,000 full time jobs and had a turnover of ECU 18.8 billion. There are over 3,000 record companies in the EU, issuing over 25,000 albums and singles every year. The record companies themselves employ about 45,000 people. There are also about 85 CD manufacturing plants and about 80,000 people involved in the music retailing trade.

Digital Intermediation and Social Exclusion

In order to assess the real potential of digital intermediation in trade and commerce, consideration was given also to a number of important social and political factors that have direct bearing on the terms of access to the electronic trading environment, and the behaviour of buyers and sellers in cyberspace. FAIR research explored these issues extensively referencing important debates about social inclusion and exclusion. Among the key observations is that a fundamental problem for developers of Electronic Commerce is that we have a very inadequate conceptual basis for designing the kinds of consumer-oriented studies - quantitative and qualitative - that will be needed to manage and/or reduce levels of uncertainty about citizen/consumer preferences in a digitally intermediated commercial environment.

FAIR developed a critique of the crude quantitative techniques applied currently to Internet use, arguing that variations in institutional circumstances matter, and that we need to assess the quality as well as the quantity of Internet access. In particular, there are questions about the transposition of social values, and, more importantly, the generation of new values through digital intermediation. FAIR also examined the question ‘What are people really doing with new technologies?’

A major policy issue is access, but it is difficult to define what exactly is it that some (possibly the privileged) are said to have advantageous access to, or that others want and should be able to access. Participation in the Information Society will require access at the technology, networks and information levels, but the access regime for each of these levels is quite different. Technical know-how and networking capabilities do not in themselves guarantee the quality of the information transmitted, much less provide the ability to interpret this information in socially productive ways. Access issues must be framed in terms of balancing access to resources (technical and economic), access to the competencies required to retrieve and interpret digitised information, and some degree of socialisation, a process that often requires the development of interpersonal interaction among users.

In the following sections, specific findings from the above research are related to individual problems and issues in the digital intermediation of the commercial environment.

2.2 The Dynamics of Intermediation and Disintermediation

FAIR defined Electronic Commerce as the application of ICT to any or all of three basic activities related to commercial transactions:

This definition opens up many intermediation possibilities - indeed, it defines Electronic Commerce largely in terms of a structure of intermediary functions. However, our findings were that some of these functions were more likely candidates than others to be intermediated, or in some cases, disintermediated.

FAIR research questioned the overall logic of many assumptions to the effect that existing intermediation of commercial processes is inherently inefficient economically and that one of the chief advantages of Electronic Commerce is that these processes can be disintermediated, thereby putting more buyers directly in touch with producers.

Also, in many cases it was found that what appeared to be disintermediation was in fact ‘re-intermediation’ in that the intermediation function remained even though the sources and/or the nature of the intermediation had changed. On balance, FAIR found more evidence to support the position that intermediation will grow and become a strategic source of economic opportunity, and less evidence supporting the position that economic gains in an electronic marketplace will be made through ‘efficiency’ gains achieved through disintermediation.

One of the problems FAIR found with disintermediation is that it can cut two ways. In some respects it might lead to more open market structures, but in others it could weaken the revenue-generating potential of whole industries. The music industry is a good example. The potential of the Web as a high-speed digital distribution channel implies that record companies eventually will no longer be in a position to control the distribution chain. When music is distributed over the Internet, only one master copy is required. If new artists will be able to produce, market and distribute their work without the involvement of the major record producers and retailers, these companies may be unable to continue shaping the demand for recorded products. In the extreme case, this would result in the collapse of the record business as it is presently structured.

But would or could this occur? In the first place, the scenario disregards the possible actions that the key players in the record business may take to re-position themselves competitively in the Internet environment. In the second place, it downplays the historical difficulties in putting specialist ‘sole traders’ in touch with a sufficient mass of customers to ensure their growth or even viability. Indeed, many new types of digital intermediation seem likely to arise precisely in response to this difficulty.

More grain can be added to the evolving intermediation picture by looking at the position of banks with respect to new developments like electronic cash. In this case, it is becoming clear that although banking will remain a necessary function, banks as such may not always be needed. The necessary extent of their participation in establishing electronic cash systems is open to question, as banks may not necessarily be the only organisations that can issue electronic cash. Banks can be disintermediated very easily in this market by any number of players, such as telecommunication companies, Internet Service Providers (ISPs), and ICT companies. This means that there is likely to be increased competition between banks and non-banks for financial services business. Competition possibilities arise from the steady blurring of traditional boundaries within the financial sector. Many financial services, such as personal loans, are now being offered by car manufacturers, insurance companies and merchant retailers. The main obstacles for these players to become issuers of money are the inertia of the market and the legislative protection accorded to the banking industry.

FAIR research indicated that only during the pre-launch phase was the participation of the banking industry likely to be crucial. But are banks needed to ‘lead’ the innovation process as well? Banks have the necessary government support and legal jurisdiction to issue stores of monetary value, but opportunities for supplying electronic cash services are not only available to banks. There may be other actors on the supply-side who can lead the market and whose participation will be crucial for the development of this technology.

Whether these developments actually will occur, however, depends upon the degree to which banks might use their existing officially sanctioned intermediary functions, such as clearing and settlement, in order to capture a protected structural position in the electronic cash market. The electronic cash approaches examined by FAIR - Mondex, DigiCash and VisaCash - all displayed variations in their relationships to the clearing function. Of the three systems, only Mondex needs no third party to settle and clear transactions between its users. This has the advantage of increasing the speed and adding to the simplicity of the transaction. DigiCash works by transferring funds anonymously between conventional bank accounts over the Internet. VisaCash uses smart card technology similar to Mondex in order to load pre-determined cash value, but utilises centralised clearing and settlement facilities similar to credit card operations. Arguably, the greater the degree of centralisation in the technical architecture for clearing and settlement, the greater the commercial opportunities for centralised financial institutions like banks.

By developing electronic cash systems of their own, they can accomplish this while benefiting substantially in other areas - such as saving on cash-handling costs. In addition, banks will be able to tie electronic cash to their other banking services on the same smart cards, in a way not possible with physical cash. This has the potential for fostering customer allegiance and even ‘lock-in’, which would be profitable for banks and meet the threat posed by disintermediation.

One of the critical factors in digital intermediation identified in FAIR research is supply chain control. In the FAIR working paper on the environment for the development of Electronic Commerce, we demonstrated that in the medium to long run, there are advantages in a dematerial commercial environment for firms that learn to exploit entrepreneurial niches while at the same time retaining control over supply chains and the transaction structures imbedded in them. This control allows firms to exercise flexibility in deciding which products to transpose into a dematerial distribution mode, and when to transpose them.

In the recording industry, for example, the relatively low cost of setting up a retail outlet on the Internet presents smaller or specialist record companies with the possibility of selling directly to the consumer. In this way, they may be able to undercut the prices of the major retailers (the largest of which like HMV and Virgin are also record producers and distributors) and to increase their profit margins. However, general retailers, both large and small, have the advantage of being able to sell stock from a variety of different record labels, and this may be more attractive and efficient from the customer standpoint. Moreover, general retailer sales of smaller record labels often occur as the result of the knock-on effects of buyers being presented with point-of-sale advertising or sampling opportunities.

This was clearly observable with the major recording companies, partly because they must protect their manufacturing and distribution operations, but also because the institutional environment for on-line distribution of dematerial products is in need of much clarification, and many of the technological requirements are not yet in place in the public network.

In particular, many international licensing and copyright issues are complicated by Internet distribution. Copyrighted music in digital form can be duplicated easily, re-used and re-combined with other materials. Especially in the case of direct downloading, there are both technology and institutional concerns. The bandwidth needed to distribute music products efficiently in a ‘download’ mode is not yet available to most potential customers. Even if the technology were not a problem, however, some types of downloading straddle a fine line between royalty collection regimes. Downloading a musical property other than in a ‘pay-per-performance’ mode might be considered to be a ‘record sale’, thus subject to a once-only sales-based royalty, or it could be construed as broadcasting or re-broadcasting of ‘pre-recorded’ material, thus subject to a mechanical or performing right royalty each time it is played.

The arrival of technologies for recording music CDs using personal computers to download individual songs poses further difficulties for the distribution of audio material. Record companies can no longer be sure that on-line distribution of ‘sample’ tracks is not creating a new basis for the pirating of their products. These companies are busy attempting to shut down the proliferating array of sites that offer pirated (and compressed for user convenience) versions of their published material.

FAIR found that although the Internet can provide the means for producers to sell directly to the consumer, it also provides the means for existing retailers and distributors to widen their markets. As shown in the music industry examples, distribution is only part of the marketing problem. The other is visibility and promotion, and the smaller independent market participants are likely to lack the mechanisms to promote their wares in an economically viable way.

2.3 The Evolving ‘Incumbent Factor’ in Intermediating Commercial Relationships

FAIR found that there was generally less of a case than commonly supposed for commercial disintermediation on economic or social grounds.

The principal issue in this regard is the role of Incumbent traders in reacting to or actively shaping these changes. In this context, ‘Incumbents’ are traders that have an already established presence in the ‘material’ marketplace. Incumbent traders are sellers and buyers of all descriptions (SMEs as well as large firms), many of them linked into trading communities that revolve around specific product characteristics, supply chain dynamics and customer profiles.

The questions concern the constitution of Virtual Commercial Communities in cyberspace. Are economically significant communities more likely to emerge from Incumbent Commercial Communities - the ‘evolutionary’ scenario - or to form around new entrepreneurial initiatives that were born in a cyber environment in the first instance - the ‘revolutionary’ scenario? FAIR found evidence for both possibilities, but concluded that the case is stronger for evolution than for revolution. The key factor in this respect was found to be the economic power of dominant Incumbent firms within Virtual Commercial Communities.

For example, our electronic cash case study showed that for at least the last 30 years banks have been learning incrementally how to manage their information and financial networks more efficiently through the application of ICT in many operational areas. This does not mean that banks will necessarily take the lead in the development and diffusion of electronic cash technology, but banks are nevertheless in advantageous positions as guarantors of monetary value of this new payment medium, and they are not disadvantaged technologically. They have latent reserves of customer trust, and pre-existing regulatory frameworks that most industry observers believe will be necessary both in the pre-launch and post-launch phases.

Indeed the banking example shows how service innovations can follow a reverse product cycle. In the first stage, applications of new technology increase the efficiency of existing services. In the second stage, the technology is applied to improve the quality of existing services. In the third stage, the technology assists in generating entirely new services. This effect was clearly visible in the innovation trajectory that led to electronic cash. The first stage involved the computerisation of bank records. The second stage saw the development of Electronic Funds Transfer (ETF) and EDI. The third stage is yielding a wider range user-oriented services. Third stage services like electronic cash are not just improved versions of existing services, but entirely new service concepts, giving rise to competitive product differentiation in the market and the generation of new employment. It is in this third stage that far-reaching demands are most likely to be placed upon institutional structures, and this is exemplified by the ongoing discussions over the regulatory implications of electronic cash systems.

The potential importance of Incumbent business capabilities is intensified in these later stages.

Business substitution is driven largely by complementarity effects. Electronic applications originally designed to service one particular transaction element become capable of encompassing other elements. There are historically strong structural links, for example, between electronic financial and trading systems and the manufacturing and retail sectors. Systems designed originally to handle financial settlements can evolve such that they encompass other business functions like orders and inventories. For example, the global reservation systems of airlines and hotels have been linked for some time, due largely to the complementarity between the business models of these two industries.

Overall, however, FAIR found that there are also disincentives to business substitution even though there could be close integration of service bases. For example, in conjunction with British Telecom, the UK Mondex pilot allows users to load value onto their Mondex chip card over the telephone However, for British Telecom, or other potential non-bank players in the electronic cash market - like micro-electronics companies, transport authorities, and large retailers - there may be heightened risks in entering this market directly. Although companies like these may be advantageously placed to enter the electronic cash market, firms of this type when interviewed by FAIR were reluctant to enter this business lest their existing highly profitable business of supplying ICT products and services to financial institutions should be threatened.

The above example indicates a general FAIR finding that digital intermediation often results in new kinds of confusion between supply and demand factors. For example, there are three main kinds of players in the electronic money market: independent issuers of electronic cash, banks and credit card schemes (or payment associations), none of which can be placed definitively on the supply-side or the demand-side of the market. Most of the players can play the role of technology suppliers as well as users. DigiCash and Mondex, moreover, are also designers and producers of the technology. Users may be either final users of the technology, such as individual consumers, or ‘intermediate users’, who deploy the technology to enhance other services they provide. However, some of these intermediaries can also participate (initially or subsequently) in the design, production and supply of the technology.

Issues related to how new intermediation products and services will be developed and exploited within inter-firm networks, and how they might contribute to new forms of inter-organisational co-operation, were explored or exemplified in several FAIR studies. One of the most common assumptions about the effects of digital intermediation is that inter-organisational relationships will become steadily more ‘virtual’. A ‘virtual’ enterprise can be defined as an electronically intermediated commercial collaboration in which entry to and exit from the structure is flexible and determined on an ‘as required’ basis. This model is the apogee of much current management thinking about computer integrated business and logistics processes, and is largely predicated on assumptions that business partnering in an

electronic environment will be highly price sensitive, and that one of the principal advantages of computer intermediation is to lower the costs of forming and operating dynamic, temporary business structures.

As firms mediate more business processes and networks electronically, historical experience with partners and their technological capabilities becomes an important factor in partner selection and collaboration management. Moreover, information pools that develop through commercial exchanges and collaboration can become commercially sensitive. There can be high incentives to share this information fully only with trusted partners.

FAIR research found also that past linkages are important to business evolution and substitution. Organisations that have had profitable interactions in the past, tend to be more likely to collaborate in the future. For example, it was partly due to Barclays’ relationship with Visa that the bank decided to run a Visa Cash pilot. The same applies to Lloyds-TSB and its allegiance to Visa. British Telecom joined the Mondex Swindon pilot due to the significant business relationship they have with the NatWest Bank. Collaboration is necessary especially in the early stages of product development, particularly as standards and regulatory instruments must be developed in a collaborative environment. Competition follows the launch of the product. The issue is that, arguably, the network of firms that developed the new product or service environment in the first place has an advantage in terms of understanding, implementing and controlling subsequent development of the technology.

The evolution of banking services shows how Incumbent organisations are facing increasing competitive pressure to provide a larger and more varied range of financial services. In order to do so, they must rely on both internal and external learning processes to accumulate the ‘know how’ to innovate technologically as well as in terms of service concepts. This involves interactions with other agencies, including ICT suppliers, in which user firms act as collaborators or even leaders in the innovation process.

FAIR examined the extent to which this ‘maker’ role could become incorporated into the mainstream of technology co-ordination activities in the ICT industry. The most vital task in establishing a market presence for new ICT product and services environments is to co-ordinate interactions between suppliers of the ‘primary’ technologies that are required to provide the basic technical capabilities of these new environments, and the providers of the complementary products and services - consumer electronics, software, digital content, commercial services and so forth - that are absolutely essential if this environment is to be sustained. The institutional mechanism that appears to be taking a leading role in this activity is the industry consortium. Consortia are informal alliances of firms and organisations, financed by membership fees, formed for the purpose of co-ordinating technology development and/or implementation activities, within discrete technological and/or product and services boundaries.

Industries like financial services and media are becoming more and more active in these organisations and may eventually take the technological lead in some areas, perhaps forming consortium structures of their own. Our general finding, however, was that the international structure of consortia that has emerged over the past decade or so, remains dominated by ICT suppliers, and that user firms will have difficulty integrating their specific agendas into those of the supplier industry in the overall development of the public and private network environments. This could lead to increased tension between innovative users wishing to exploit new digitally intermediated business opportunities, and the overall innovation trajectories of ICT platforms and facilities.

Aside from questions about technological innovation, however, defining viable product and services markets in a dematerial environment is the principal concern of commercial traders. Much of this involves defining the position and value of various kinds of information. In a dematerial environment, information about material products can become a product in its own right. For example, the FAIR study of the music industry found that the Internet is already saturated with music, but that few of the sites are oriented to the sale of music. Most are used for marketing and the commercial benefits appear elsewhere. These promotional sites aim to advertise a company’s brands, goods and services. Likewise, transaction-equipped sites also promote new products or special offers, and deliver real time content and pricing and information to potential buyers. They also have a customer service dimension and, correspondingly, an information capture capability for marketing purposes.

Transactions were defined to include any exchange between participants in a market that is directly or indirectly related to the acquisition of goods and services, irrespective of whether these goods or services are finally acquired. Some transactions involve product and service delivery and the direct exchange of money, but many others are exploratory, involving the acquisition of market information - advertising, personal enquiries, and so forth. The main operational factor at a transaction point is the intent to provide or acquire goods and services. Access to information can be just as vital to the transaction structure as access to the goods and/or services being traded.

FAIR studies identified many examples of potential opportunities in the area of ‘information transactions’ that were left largely unexploited. For example, one of the on-line CD retailers studied by FAIR was offering more than 165,000 titles on CD and cassette, and 8,500 music videos. More importantly in terms of business substitution possibilities, this site offers a facility that allows the catalogue to be searched according to album or composition title, performer, record label, primary instrument, genre, and so forth. The site can connect potential buyers to a wealth of information about the product - including reviews, ratings, biographies, discussion groups and sound samples.

Particularly for diversified Incumbents, value often can be added easily to their on-line facility by provision of a basket of related or derivative products at the same site, and by exploiting the existing market visibility of particular brand-names. This possibility is especially likely in the media industries, which tend to be dominated by conglomerates. A simple example is WH Smith, the UK-based bookseller and stationer that is also the parent company of Virgin/Our Price, the record retailer. Together, WH Smith and Virgin developed Virgin Entertainment Direct (VED), an early entrant to the UK on-line music market. The Virgin brand name was considered to be more appealing in an Internet environment than that of WH Smith, but VED could also merchandise the books and magazines associated with the parent company. Likewise, the merchandising visibility of conglomerates like Time-Warner and the Disney Corporation does not reside in their corporate image but, respectively, in the ‘WB’ shield, and the Walt Disney signature, both popular icons that have been in the public eye since the 1930s.

Moreover, there is value to be had from maintaining links between material and dematerial environments. In the US, for example, automobile manufacturers are beginning to sell cars on the Internet. Some customers purchase cars in this way, but most use the dematerial environment to compare prices and specifications, the results of which they use in negotiations with dealers in the material environment. In other words, there is a reinforcing rather than a substitution effect in terms of sales. Similar effects were noted in the music industry where large high street retailers use in-store marketing campaigns to advertise their Web sites, and vice versa.

There is nothing new in this and the risks for ‘first movers’ are as well documented historically as the benefits. A productive interchange of this sort has been a characteristic of the record industry for many years. For example, in the UK the roughly 25 per cent of the market that is not supplied by the top five companies (EMI, Polygram, Sony, Warner and BMG) is supplied by some 600 independent record companies. Many of these companies are very small with only one or two releases per year. However, the independent companies are a very important part of the record industry since they are often at the leading edge of developments, particularly in the most lucrative popular music markets. Small companies discover new talent, establish new fashions, and, in the process, accept many of the risks inherent in developing new repertoires. Once the new market has been established, however, scope emerges for its broader exploitation by larger firms.

Although different views exist on the nature of first-mover advantages, FAIR found it to be unlikely that the entrepreneurs will be able to sustain a competitive lead in the marketplace once the major players arrive. The main first-mover advantages identified by the entrepreneurs are the opportunity to build customer loyalty and to develop competitive advantage through acquiring both tacit knowledge and information about customers’ shopping habits. However, where significant consumer demand has not materialised and on-line profits are minimal, such advantages are unlikely to yield a sustained competitive edge. The main disadvantages facing the large retailers are associated with organisational rather than technical problems. These disadvantages are likely to be outweighed by the benefits relating to their dominance in terms of market share. Most importantly, the larger companies have the resources to promote on-line retail outlets heavily whenever it seems advantageous so to do. This, plus retention of their existing dominant market share, will likely enable them to compensate for any first mover advantages that may accrue to the first entrepreneurial cyber firms that may appear in the UK and other parts of Europe.

Other FAIR research examined the whole phenomenon of the entrepreneurial cyber-trader in some detail. The mythology surrounding the cyber trader phenomenon is that start-up entrepreneurs can gain special advantages over Incumbents by using ICT to minimise the requirement to maintain material facilities.

In the longer term, where first mover advantages might be available in niche markets, they are just as likely to be captured by firms who can learn to exploit existing brand images in new ways and who can control key supply chains and transaction points in a given market segment. For example, the five major UK recording companies also own and operate their own production, manufacturing and distribution systems through which they provide both their own and some of their competitor’s products to retailers, wholesalers and smaller distributors.

In the music industry, for example, there are two alternative scenarios On the one hand, cyber entrepreneurs might manage to build a large market share quickly, and the slow reaction of the major retailers may leave them lagging behind. On the other, it could be that the major firms are simply waiting until the entrepreneurs have absorbed most of the initial learning costs. Both HMV and Virgin Megastores are planning to launch Internet retail outlets, and can either model these ventures on the experiences of pioneer entrepreneurs, or simply buy out these companies. Therefore, it is strategically important for a company considering whether to enter the on-line music market to understand the significance of timing its market entry in relation to its competitors.

The key first-mover advantage for the major retailers is the need to have a reputation for innovation. It is now becoming standard practice for all organisations to have a Web site or at least an e-mail address. Customers soon will expect to be able to contact customer services and enquire about stock, even if they do not want to make purchases on-line.

In the process of describing the characteristics and dynamics of a digitally intermediated commercial environment, it is impossible not to note that there are many questions about the actual commercial potential, and particularly about the consumer potential.

The difference involves orders of magnitude - hundreds of millions for consumer transactions versus hundreds of billions for inter-organisational transactions.

The music industry example showed that even where products exist that are eminently suitable to cross over between material and dematerial environments, commercial viability can remain some distance away. Furthermore, we even uncovered an example of a product developed specifically for the Internet - namely DigiCash - which had to be re-configured for off-line use as well in order to remain viable. For DigiCash, it turned out that to focus its product on the seemingly limitless possibilities of the Internet was in effect to severely limit its scope as a contender in the electronic cash industry as its stands at the moment.

Clearly, there are technical barriers that thwart participation in this new milieu. At this point in time, the market interface for consumers is extremely inefficient. It can take as long or longer to locate comparable retail merchandise on the Internet than in the high street, much less to compare prices, make the purchase, and, in many cases, wait for delivery. It takes a determined customer to negotiate the endless lists of on line merchants and forgive the delays as each graphics-heavy electronic shop-front downloads.

On balance, however, we did not find that eliminating these barriers would in itself be enough to stimulate growth in digital intermediation of commerce. Even problems with the security and privacy of customer information, though clearly important to solve, were found nevertheless not to be primary obstacles to potential cyber customers.

Specifically, it can be difficult to establish a productive match in the minds of both corporate customers and individual consumers between perceptions about the benefits to them of digital intermediation, and perceptions about the benefits for service and product suppliers. In other words, the benefits of something like electronic cash to the consumer seem quite evident to banks, technology providers, and some retailers, but this is not necessarily the case with other potential suppliers of electronic cash, or with customers.

An essential role can be provided in the intermediation process by the development of virtual communities based upon interaction between users of electronic communication. Because these communities are located in virtual space already, they have the potential to reference and to include information essential to matching their ongoing discussions of products and services with suppliers. Stronger development of the social interactions in the use of network communication is likely to put a greater focus on the means of acquiring products and services electronically.

In part, these obstacles can be addressed through change in the institutions of governance.

Firms and organisations must be encouraged, or even compelled in some cases, to co-operate in order to set standards and specifications, and this may involve new approaches to standardisation procedures and approval mechanisms. Several roles for government in encouraging migration to electronic services were noted in FAIR studies. Governments can have a decisive role in the standardisation of smart card technology, for example, by issuing smart cards for social security or health insurance. These can also be used for commercial applications like electronic payment. Some issues need to be addressed at the global level such as the measures needed to harmonise and update intellectual property protection.

Institutional change is unlikely to be successful without a clearer understanding of the social and cultural issues that influence firms, organisations and individuals in their decisions to engage or not in the digitally intermediated environment.

Our preference is to speak not of a dematerialised economy or society, but of processes of dematerialisation which affect national and international economic activities at different rates and in different ways.

In the case of Intranets, for example, the process of dematerialisation involves the transfer of information traditionally distributed through non-electronic means into the electronic environment. While substantial cost saving appears to be possible by reducing or eliminating the traditional modes of distribution, the costs of new forms of intermediation, the need for which is often not apparent prior to implementation, are proving to be substantial.

One of the major social adjustment issues in this dematerialisation process that was highlighted by FAIR over the past year was how social mechanisms for determining the ‘value’ of goods and services might evolve in digitally intermediated milieux. This problem is related closely to questions about the generation of social and cultural ‘values’ as such, and it is critical to customer/consumer perceptions about the benefits of digital intermediation in commercial life.

We noted, for example, that the stereotyping of technologies by such factors as gender and associations with specific sub-cultures is an important factor affecting inclusion and exclusion. In this respect it is important to understand better the changing demographics of the Internet. Already, commercial decisions to explore the potential are being made in order to exploit specific known sub-cultural elements. For example, when the potential of the Internet as a sales medium for music was investigated at EMI International two or three years ago, it was noted that the demographics of the Internet at that time were equivalent to the demographics of the popular music market - i.e. dominated by ‘young white males’.

However, the ‘young white male’ stereotype may be changing.

Social deprivation and inequality factors alone cannot explain access problems - individuals and social groups can be non-participants in the digitally mediated environment even when the financial and physical resources are available. The acquisition of competencies and, perhaps more important, shared cultural values is vital to social inclusion irrespective of resource questions.

The formation of virtual communities using computer mediated communication over the past twenty years has been an active process that has produced a number of important legacies which are now on the threshold of transformation to creating demands for more advanced technologies and services. By building a common perception of the utility and value of these networks for user-defined purposes, it is much more likely that they will achieve widespread acceptance than if they are pushed as solutions to problems that may or may not exist for these users.

The changes signalled by the growth of ICT call into doubt the future validity of the ‘status map’ that once gave hierarchical meaning and order to life in market societies. A suspicion lurks that the internal status maps we carry may require re-dimensioning. There is a real possibility that these maps may no longer fit emerging, shared perceptions of what is socially valued and, hence, the projection of these values onto products and services in the marketplace.

The question of how social valorisation of products and services is or is not related to commercial valorisation is critical, in that price competition is expected to become an increasingly important factor in the global marketplace facilitated by the Internet. Already problems of over-supply, or of indiscriminate marketing are being noted in industry. Our study of the recorded music market, for example, revealed a concern in this industry of the potential danger of ‘devaluing’ music products in general by flooding the market. As with all of the media industries, the music business relies heavily on highly subjective consumer perceptions of value.

In a similar fashion the existence of a global communication medium does not suggest that social interactions occurring on the Internet will be predominantly based on remote distances in either geographic or cultural terms.

In each successive historical period, and in each cultural context, the points at which social values are generated must be re-located with reference to the intermediating role of the technological environment. Post-war industrial societies have been highly materialised. For example, transport technologies like automobiles, trains and then aeroplanes, have played a role also in the configuration and consolidation of social positions. Similarly, now that Personal Computers are ubiquitous, our interactions with the particular forms of intermediation they support have the potential to re-frame portions of the internal maps we carry around concerning who and what is deemed to have status and value.

In its strongest definition, ‘dematerialisation’ refers to certain macro-level views that posit a shift from an economy based on atoms to an economy based on bits - that is, from an economy that socially values material production, to one that values bitstreams and knowledge and views the dematerial environment as the preferential site for production and consumption. At the ‘meso’ level, however, various social and institutional mismatches can be found that illustrate the gaps and lags that occur during this transition. At the micro level, is the generation of new status markers and status differentiators. These are more or less continuously negotiated community perceptions through which social status and ranking are assembled and reinforced.

The Internet is widely thought of as a levelling device - ultimately open and highly egalitarian. However, this perception is not sustained by current Internet user profiles and is also subverted by the still-overwhelming commitment to computer mediated forms of communication that Internet access requires. Different status markers apply to different kinds of Internet access and use. Simple access to information and knowledge resources via now relatively mundane media like e-mail and the Web is probably by now a relatively low ranked activity within the status order. Ownership or control of more extensive digital resources (by persons or institutions) can begin to signal higher status, and the ability to develop and produce information or to codify skills can symbolise still higher status.

Thus, evaluating social status and position in the emerging information and knowledge-based economies is only partly about property and ownership, income and life-style consumption patterns, or occupational position or location.

The Policy and Regulatory Framework

In the face of the many changes in the processes of intermediation that are enabled by the implementation of various forms of Electronic Commerce, it is to be expected that the major task of the policy framework in key areas should be subject to changes in orientation and focus. FAIR looked at these changes in three key areas - standardisation and regulatory policy and practice.

In the first area, we undertook an analysis of the origins and dynamics of standards consortia. This research led us to question many assumptions about the relationship of consortia to Standards Development Organisations (SDO) like CEN and ETSI.

FAIR research found that, in general, consortia have different institutional objectives to SDOs, namely to create communities that link suppliers of ICT ‘producer’ goods and services, with users and suppliers of complementary networking products and services. Firms can elect to pursue initiatives in consortia with different expectations than they would have of SDO outcomes. Our research also showed that consortia form an international structure held together by the extensive cross-membership of multinational firms. The growing presence of consortia regionally and internationally is largely shifting the costs of standardisation and harmonisation from inter-organisational procedural costs to intra-organisational co-ordination costs. Although European firms are major participants in the consortium structure, the agenda of most of the important consortia are overwhelmingly oriented to US market conditions.

The logistical and resource limit for most SMEs would be to monitor and perhaps contribute to the work of one or two consortia, and the focus of many consortia on constructing communities of suppliers and users around technical specifications creates a much increased risk of technological ghettoisation. FAIR research suggests strongly that SMEs must be aware of this possibility when becoming involved in a consortium. They must be able to assess the linkages between the work of one consortium and another, or between consortia and SDOs. However, the scope of opportunity has yet to be explored for European interests to exploit the possibilities of the consortium approach. In particular, there is scope for consortia to emerge that could be led by European ICT implementers.

Policy-makers should draw clear distinctions between the goals and outputs of consortia and SDOs, and the ‘public interest’ aspect of the Standards Development Organisation (SDO) system should be re-emphasised in a policy context. A new role for SDOs in the ICT area is likely to involve the reorientation of the SDO business model towards inter-institutional co-ordination and information provision.

FAIR research this year also included a review and update of the measures taken by EU member states to implement directives for advanced communication technology and service markets. With the opening of the telecommunication market to full competition in January 1998, there have been numerous efforts to provide benchmarks of the relative performance of the member states in ensuring that they meet the targets for liberalising their markets. The FAIR research deadlines for completion of the update (30 January 1998) and deliverables prevented us from incorporating the most recent up-dates that are being prepared by the European Commission in this area. We therefore undertook an ‘unofficial’ bench marking of the state of liberalisation.

Despite major progress by the European Commission to put the elements of a competitive telecommunication and audio-visual market in place in Europe, the FAIR update shows that there continues to be significant heterogeneity in the timing and the mode of implementation of directives at the member state level. Given the diversity of markets within the EU and the continuing market dominance of incumbents in both the telecommunication and audio-visual sectors, it seems likely that competition policy will be the most important instrument of policy in the decade to come. However, given the importance of these sectors to the European economy and their role in contributing to the development of the European Information Society, it is likely that sector-specific policies and regulation - albeit with a strong emphasis on competition policy - will continue to be needed at both the European and member state levels.

The third area of examination within this year’s FAIR project was the issue of taxation in the sale of dematerialised goods and services on the Internet. While revenue projections suggest this issue will not have a major fiscal impact in the near future, there is value in examining where in the economy these effects will be located and when they will occur. Accompanying the specific implications of the location and timing of impacts there is the more general issue of the incentives provided by a ‘tax free’ zone in the European commercial world. While it is clear that this is an issue of significant concern with regard to goods that can be dematerialised effectively such as computer software, it is less clear that existing methods of collecting value added tax will be ineffective in the new environment.

The FAIR research on socio-political (SPRU WP 6) and techno-economic (MERIT WP 5) issues during the past year has suggested strongly that:

• Supplier and user trust and confidence in electronic commerce and related electronic networking activities require much more than the technical capacity for ‘digital intermediation’. In many instances, producer and consumer advantages are gained because of complementary intermediary processes that exist in both the physical and virtual worlds.

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• Interactive service use involving consumers and citizens is likely to grow only to the extent that user preferences are embedded in the design of service offerings. While ‘technology push’ can shape these preferences to some degree, the take off of many on-line markets depends critically upon whether consumers/citizens resist service configurations and pricing schemes that are not responsive to their requirements.

• Although there is evidence that the Commission’s RTD programmes are providing a foundation for the formation of virtual communities, considerably more is necessary to facilitate the formation of these communities. One key factor is the fostering of social interaction through the use of network communication and computer mediated communication services have a major role to play in this area. User familiarisation with Internet tools and techniques through the local provision of high level services in the large business context is likely to lead to accelerated demand for services in the home and in small business environments. Another important factor is the re-ordering of values and symbols that underpin shared perceptions of social status as the spread of the Internet and other advanced communication technologies and applications increases. This is an area where new indicators and measurement tools are needed to assess the likelihood of new levels of social exclusion.

• An important feature of the evolution of new electronic markets supported by advanced communication technologies and service is the transfer of knowledge and competencies between entrepreneurial start-up cyber firms and incumbent firms. For the most part, cyber firms are niche market players and it is unclear whether these market niches will be of limited or longer term duration.

• A key concern for policy and regulation must be the extent to which the strong economic performance of established traders in conventional marketplaces is replicated in ‘cyberspace’ markets. A key issue in the next few years will be the extent to which incumbent, insurgent and virtual community firms introduce successful new business models for conducting transactions in electronic environments. The focus of research in the future will need to be on the emergence of new processes of ‘re-intermediation’ whereby control of different elements in the value chain moves to different players. This means that the complete chain of transaction structures needs to be taken into account in assessing whether new market opportunities are likely to be open to smaller firms and to new entrants in the marketplace.

• The emergence of standardisation consortia should not be assumed to give rise automatically to efficiency gains in part because the growing diversity of standardisation activities appears to be fully accessible only to multinational players. Insofar as this is so, a key role for policy in the future is likely to involve bridging gaps between the standards requirements of ICT producers and users, and the suppliers of complementary products.

• With the opening of the EU market to competition at the beginning of 1998, it seems likely that competition policy will play an increasingly important role in ensuring the full implementation and enforcement of the regulatory provisions that have been introduced. Sector-specific regulation will continue to be needed at both the European and member state levels.

• Taxation and the sale of dematerialised goods and services on the Internet and the growth of electronic commerce are likely to bring the need for new policy measures to audit software producers and other service producers for tax compliance.