The Not-So-Frictionless Digital Economy

Research extensively found that relationships between consumers, relationships between companies and relationships between companies and consumers in the digital economy do not follow the patterns predicted by the frictionless model of the Internet economy, both in BtoC and BtoB markets. As we are going to review in the following paragraphs, there is solid evidence that:

• Inter-firm networking has demonstrated to be constrained by cultural and social frictions;

• The community business model in e-commerce has proved widely unsuccessful both in BtoC and BtoB;

• Information and organizational concentration has demonstrated to be an important competitive lever also in the digital economy;

• Price discrimination in digital economy has been found, supporting the idea that brands also have a differentiation role in the uncertain territories of the Internet markets;

• The establishment of new relationships on digital networks requires the investment of relevant cognitive and social resources.

These results may be interpreted as the support to the idea that the Internet is "business as usual." Here we try to bring theoretical support and evidence for the opposite view. The Internet diffusion does, indeed, call for a change in business management and marketing paradigms, but in a different (and more complex) way than it is predicted by the frictionless and reverse-marketing vision.

We claim that in the Internet economy there are different kinds and degrees of digital hierarchies, because there is not easy and equal access to knowledge, because there still are transaction costs and social resource scarcity, and because organizational concentration in the content and infomediation activities still matters. The sources of the new hierarchies are to be found just in the network nature and economics: the economics of content and gatekeeping (infomediation), the cognitive logistics ^[2] of the web, the increasing complexity of social networked systems and the economics of individual cognitive mediation and selection (bounded rationality and bounded sociability).

Hierarchies in the Inter-Firm Networks

Adler and Kwon (2002) propose to go beyond the dichotomy between the market and the hierarchy organizational concepts, in the study of post-capitalism. In their vision, networks are not just hybrids, they are a new ideal-typical form of organizing, with its new corresponding coordination mechanism: trust.

Several authors predict that dynamical network-based organizational forms will replace hierarchical organizations (Saxenian, 1994; Fukuyama, 1995, 1999; Adler, 2001; Adler & Kwon, 2002). According to these views, this is possible in a world where complexity makes fixed contracts and hierarchical ties incapable to address the growing need to adapt to environmental changes, and technology offers easier ways to build dynamic connections. We address this issue more in depth in Mandelli (2004). Here we focus on empirical studies that provided evidence challenging the idea that technological networks can easily and almost automatically transform into network-based coordination.

In the BtoB Internet world, vertical e-marketplaces managed by independent infomediaries were assumed to become the new network business model (Bakos, 1998; Kaplan & Sawhney, 2000). It is widely recognized now that the main reasons why these open network-based marketplaces have failed were their inadequacy to deliver a superior value proposition to the members, and a lack of a legitimated and trusted system of knowledge-sharing (Grewal, Comer & Mehta, 2001; Devine et al., 2001; Hoffman et al., 2002). In the Grewal et al. (2001) study on a vertical e-marketplace in the jewelry industry, the researchers applied the motivation-ability framework (Merton, 1957) to interfirm cooperation, and found that motivation to cooperate was both efficiency-driven and legitimacy-driven; that is also suggested by the new-institutionalism theoretical framework (see DiMaggio & Powell, 1983). None of these expectations were met.

The new supply-chain collaboration formulas in which the incumbent players orchestrate the networks have proved more successful (Hoffman et al., 2002). Devine et al. (2001) report that though buyers can shop for a better price elsewhere, they have found that they are rarely inclined to do so and prefer private exchanges. Customer relationships built on trust and supported by nondisclosure agreements are essential for knowledge sharing, for example, if suppliers have to monitor a customer's sales and inventory levels, to forecast product demand, and to assure the delivery of goods or services as needed. Also McDuffie and Helper (forthcoming), in their study of global Internet consortia, found that social interaction patterns, which differ by company history, country, laws, institutions, geography and resources, have been critical variables in these network projects. These new networks are not "business as usual," but neither are they frictionless webs of relationships. They provide a completely new, more efficient and richer, communication environment to previous economic communities, consolidated by accumulated knowledge and trust.

One lesson that we can draw from this experience is that managers cannot build communities in the laboratory; they emerge historically from the complex dynamics of relationships in industries and society. Also Internet business networks are built on frictions. Communities are built on social capital and willingness to share knowledge, and these two assets are not readily available. Institutions emerge when they offer to all the economic actors added value compared to the alternatives. In this case, open community-based value networks failed to deliver higher value to the involved nodes than it was possible through more hierarchical organizations. Social capital is the relative advantage of the new hierarchical formats; the cost of building trust was the transaction cost and the main reason of failure of the previous open formulas.

This phenomenon can be better understood using the conceptual tools offered by the research on the role of trust in building competitive advantage in post-fordist economies (Barney & Hansen, 1994; Vicari, 1995; Costabile, 2001; Busacca & Castaldo, 1996) and the literature on social inter-firm networks (Grandori & Soda, 1995; Kogut & Zander, 1996; Koka & Prescott, 2002). Trust, in the resource-based view of management, is considered one of the intangible assets of firms, which build on it for achieving differentiation and sustainable competitive advantage. It works as a strategic (and not-easily-replicable) asset just because it is not readily produced.

Also the organizational network literature provides support for the idea that social capital is not an easy-to-build asset. Koka and Prescott (2002) define social capital, in organizational contexts, in terms of the information benefits available to a firm due to its strategic alliances. Using longitudinal data on the population of strategic alliances formed during the period 1980-1994 by firms in the global steel industry, they provide evidence that social capital yields distinctly different kinds of information benefits in the form of information volume, information diversity and information richness. But these benefits are different because the distribution of social capital is not equal. Networks are not all the same. Not all the members of a network are the same. Some members are more equal than others.

The resource-based approach (Barney & Hansen, 1994) has had a significant impact on how we see the way firms leverage their resources and capabilities, in particular knowledge and social resources, for building competitive advantage. The emergence of intangible resources as a major component of firm capital, often overshadowing traditional capital (Barney & Hansen, 1994; Vicari, 1995; Costabile, 2001; Busacca & Castaldo, 1996), has contributed to refocusing strategic management on organizational advantage (Nahapiet & Goshal, 1998). The firm has been, therefore, redefined as "a social community specializing in speed and efficiency in the creation and transfer of knowledge" (Kogut & Zander, 1996). The trade-off between market and hierarchy is illuminated by a new perspective. The reason why organizations emerge is not to leverage tangible resources anymore, but rather to leverage the intangible unique sources of competitive advantage: knowledge and social capital. This approach to institution formation can be applied to both firms and networks.

Even in the over-studied Linux case (Browne, 1998; Axelrod & Cohen, 1999; Moon & Sproull, 2000) of open-source and distributed software development, researchers found that the project was working because it was based on specific and not-generalizable resources: a natural community with strong commitment, trust and diffuse expertise.

Also, speaking about organizational social ties, we can fall in the symmetry fallacy we have already described for information flows, when we take a technologically deterministic stance. Technological connections do not necessarily create social connections. Network-based relationships do not simply stem from technological connections. They are the output of choices, but also socially and culturally emergent phenomena. Their structures are influenced by the history of prior relationships and the stock of available social resources. In Adler and Kwon's (2002) perspective, "Social capital is the resource available to actors as a function of their location in the structure of their social relations" (p. 18).

Networks are not cost-free coordination formats. We can consider social capital as both a cost and a benefit of relationships (Adler & Kwon, 2002). It is a cost because it requires investments and needs maintenance (Adler & Kwon, 2002, 22). Networks have coordination costs, which stem from the organizational complexity of these new forms of organizing (Gulati & Singh, 1998). Network formation is a path-dependent, evolutionary process, and trust can help diminish transaction costs only after a complex and long history of social investments (Lorenzoni & Lipparini, 1999).

Also, social capital in networks can create frictions and inertia, instead of liberating creativity and innovation. Local cultural and social forces can hamper the ability of networks to go beyond the originally local base, in search of optimization coming from the diverse and global reach of the new technologically connected networks (Powell, Koput, Bowie, Smith-Doerr, 2002). Tsai's (2000) study shows that also in intra-organizational networks, prior network centrality, trustworthiness, and strategic relatedness significantly affect the rate of new linkage creation and network structure.

One of the examples often used to show the relevance of the network-based model of inter-firm governance is the "local distretti" form of organizing of the Italian small companies (Saxenian, 1994). These local network-based industrial systems are characterized by flexibility, but also by the ability of adaptively learning in a cooperative context. But in these network-based systems relationships are not symmetrical (Grandori & Neri, 1999; Brown, Durchslag, Hagel, 2002; Dagnino & Padula, 2002), and cooperative learning is complemented with control and command, reproposing the old role of the bigger and more powerful firms in the construction of new dynamic networks in local and global economies (Gottardi, 1998). The structures of networks evolve and change over time, and they can be designed and managed by network leaders (Lorenzoni & Lipparini, 1999). Technological diffusion increased the geographical outreach of the networks originally only local, but this also increased the importance of the local leader firms and their role in leading vast networks of smaller and subordinated firms (Gottardi, 1998). This system integrates competition and cooperation, but "it is governed by the leaders" (Gottardi, 1998, p. 142).

Also, the cases of wide global networks of smaller firms organized by powerful orchestrators such as Nike and Cisco (Brown et al., 2002) confirm this highly hierarchical option of network-based governance forms. The hypothesis that networks drive almost automatically cooperative behavior does not correspond to empirical evidence. Studying the importance of the relational dimension of inter-firm exchanges, Wathne, Biong and Heide (2001) found that interpersonal relationships between buyers and suppliers serve as a switching barrier, but are considerably less important than both firm level switching costs and marketing variables. Gulati and Singh (1998) found that previous social ties reduce coordination costs and the need for hierarchical control, but they also found that reciprocal interdependence, that we can call the complexity of the system, increases the need for coordinating the hierarchy.

In short, networks are not simply a more democratic and socially richer alternative to hierarchies, coordinated through trust instead of price or authority. They include elements of markets and hierarchies, and are coordinated through different control mechanisms: prices, trust and authority. Control mechanisms require investments at the node level and at the social level. The real novelty of networks does not seem to be the differential degree of hierarchy, but the differential degree of interconnection (complexity) and flexibility (dynamism of connections) of the systems.

This is consistent with the recent call of researchers (Dagnino & Padula, 2002) for studying the interconnected (and not dichotomical) role of competition and cooperation in networks. They suggest rebalancing the focus of research attention, in order to study the "variable-positive-sum game" and the potentially "unfair" nature of the network mutual exchanges (Dagnino & Padula, 2002).

^[2]We use this concept (Mandelli, 1997, 1998) for describing the special logistics of information and relationships on the Internet, not constrained by geography anymore, but constrained by complexity.