Information Technology Revolutions

Djordje Petkoski

A “new economy” defined the last decade of the twentieth century, and seems to promise never-ending prosperity for all. The “new economy” apparently defied history and carried with it optimism and massive increases in wealth. Inflation in 1998 was one percent, and unemployment has recently fallen bellow four percent. The economy has been growing for almost ten years without interruption. This has been the longest expansion in the history of the United States. Many experts attribute this phenomenal economic performance to the “Information Technology Revolution”, or the revolutionary changes brought about by the spreading use of the Internet and the continually advancing capabilities of computers and telecommunications. Information Technology (the Internet, computers, and telecommunications equipment) increases market efficiency by increasing access to information and providing it more cheaply.

The most important impact of Information Technology (IT) is its ability to fundamentally alter transactions between businesses. For example, the use of IT, and most importantly the Internet, in business-to-business transactions cuts procurement costs by making it easier to find the cheapest supplier and by increasing overall efficiency. Orders placed online are both cheaper and result in fewer errors in the orders themselves and in invoicing. Online commerce also makes supply-chain management more efficient by cutting out layers of middlemen. Furthermore, firms need to keep much lower inventory stocks when they use the Internet in transactions with other businesses. Finally, and most importantly, the changes enumerated above have the potential to change the very structure of companies and industries, to cause a revolution in the US economy.

Many scholars, however, are skeptical that IT will impact the economy in a very significant way. For example, Robert Gordon of Northwestern University argues that IT has had only a minimal impact on productivity so far and is unlikely to increase productivity in the near future. He claims that during the last ten years productivity has only increased in the durable manufacturing sector, mainly because of the productivity takeoff in the computer hardware and telecommunications equipment manufacturing1.

Gordon pokes fun at the New Economy enthusiasts and firmly asserts that computers and the Internet “do not merit the label of “Industrial Revolution”. (He treats the “New Economy” as “synonymous with an acceleration in [the] rate of technical advance in Information Technology”). He defines an industrial revolution as “any great acceleration of output and productivity growth that is pervasive and economywide.” The Industrial Revolution label does not fit computers and the Internet, because of the “failure of computers and the Internet to achieve a breakthrough in either the [average labor productivity] or [multifactor productivity] growth outside of durable manufacturing”.

But, productivity growth has been reported by the economic indicators. Moreover, economic indicators show that productivity growth levels have finally reached levels experienced between World War II and the early 1970s. However, the productivity figures are deceiving, Gordon argues. He calculates a 2.82 percent annual growth in output per hour since 1995. This rate translates into a 1.35 percentage point revival in growth, comparing the period 1995-1999 with the period 1972-1995. Gordon discounts the significance of this growth revival by classifying 0.54 percentage points as an unsustainable cyclical effect2. Even so, the remaining 0.81 percentage points are a remarkable increase in productivity growth. However, Gordon calculates that this entire growth is attributable to accelerated multifactor productivity growth in the durable manufacturing sector, which accounts for only 12 percent of the economy. (The durables sector consists of computers, peripherals, telecommunications, and other goods). Productivity has only increased in the durable manufacturing sector, mainly because of the productivity takeoff in the manufacture of computer hardware and telecommunications equipment. There has been no productivity growth in the remaining 88 percent of the economy. In fact, the rest of the economy has experienced a deceleration in multifactor productivity growth (MFP) under some statistical qualifications3.

Gordon’s productivity calculations are valid. Therefore, Gordon uses them as a central proof that there is no New Economy. Or, in other words, IT hasn’t had any major impact on the economy. But, Gordon looks beyond the elementary discussion of productivity discussed so far to argue that IT has not and will not change the economy. For instance, he adds business-to-business commerce to his discussion of productivity growth. He concludes that since there has been no productivity revival, discussing business-to-business commerce is not relevant:

To the extent the e-commerce is provided by one business to another, it is an intermediate good and not directly relevant for computing the productivity of final output in the non-computer economy. In this sense we do not need to debate whether business-to-business (“B2B”) e-commerce is a fruitful invention. If the development of more efficient links in the supply chain reduces costs and allows the elimination of people that appear in the chain of intermediate transactions, then we should see the payoff in faster productivity growth in the non-computer economy (Gordon 37).

So far Gordon’s analysis fails at several points. His observations of the facts are good, but his interpretation of the facts is incomplete. The facts are that MFP growth is not as impressive as some are apt to conclude. But, MFP statistics from 1998 or 2000 do not tell us what those numbers will be in 2010, or 2005, or even 2002. Gordon focuses on the present and the recent past too much.

In fact, Gordon deduces that the computer’s major contributions have come and gone. The computer has very little left to offer, Gordon argues, because the rapid decline in the cost of computer power has already pushed the marginal utility of extra processing power and memory close to zero.

Gordon goes on to argue that the Internet, which he calls “the main revolution within the information revolution”, has had a small impact on the economy, and is unlikely to have a major impact in the future. He argues that the Internet has already failed to change the economy because “the invention has not boosted the growth in demand for computers.” He goes on to argue, “if the Internet was the important invention the many assume, the growth in the demand for computer power should have accelerated after 1995 relative to the rate of decline in price… The response of the computer quantity to the decline in computer price was much larger before 1987 than afterwards and did not accelerate after 1995”. This leads Gordon to conclude that “the speed at which diminishing returns have taken hold makes it likely that the greatest benefit of computers lie a decade or more in the past, not in the future”.

Gordon is again making incomplete arguments. He is correct in noting that the marginal utility of extra memory or processor speed is low and that the Internet has not boosted the demand for computers. But, these facts do not indicate that the contribution of computers and the Internet lie in the past. They indicate that computers and the Internet have developed enough power that people are no longer rushing to Best Buy to get the newest Pentium. But more importantly, the facts show that computers and the Internet are now powerful enough to support a revolution that has just begun. Moreover, the fact that people, or for our purposes corporations, are not rushing to Best Buy indicates that they already have computer and Internet access, that computers and the Internet have reached the penetration levels necessary for the revolution to start4. And as we shall see later, the revolution is well on the way.

But, before we get to the revolution we must examine a few more of Gordon’s skepticisms. Gordon accounts for the productivity disappointments with a number of other factors:

1. Because consumer time is limited, the Internet simply substitutes for other sources of information and entertainment.

2. Much of the investment in the Internet is a fight for market share, and fighting for market share only redistributes sales, it does not create them. For example, Borders Books and Barnes and Noble are investing in the Internet to defend their market share from Amazon.com. Taking away customers, profits, or capital gains is a zero-sum game. It redistributes wealth without increasing it. Yet, it forces all firms to make heavy investments in IT, lest they loose their business. Micro studies, which sight firms where investment in IT has greatly increased productivity suggest that firms, which have invested in IT, may be biting into the market share of competitors who have made smaller investments.

3. There is little new content on the Internet. The Internet is basically preexisting information now provided more cheaply and conveniently. The great inventions of the past created new products and activities. Shopping on the Internet is basically the same as shopping out of the mail order catalogs invented in the 1870s. Costs are smaller, but the mailman still delivers catalogs to our door.

In short, Gordon argues that IT investment today creates nothing novel, that it duplicates existing forms of commerce and information without replacing them. But past innovations have also duplicated existing forms of commerce and information, substituted older sources of information, and redistributed market share. But these past innovations still managed to drastically change the economy. For example, the information that was delivered via a telegraph was still text, just like the text that appeared in letters delivered by the pony express. But, as we shall see in the next section, the telegraph was one of two innovations that turned American business on its head in the late nineteenth and early twentieth centuries. The other innovation was the railroad. Economic historians have also argued that the railroad created nothing new in the sense that older forms of transportation, namely canals, would have interconnected the United States5. However, the subtle advantages of the railroads, most importantly speed and volume-carrying ability, were crucial for the transformation of American business some one hundred years ago. Returning to Gordon’s arguments, specifically to his claim that because the Internet does not create new products its is not a revolutionary change, we can recall that the wheat delivered on the railroad was the same wheat delivered through the canals or on the backs of mules. But, again we will see that the railroad was crucial for revolutionary changes that occurred in the US economy between 1840 and 1920. And through the analysis of the changes occurring in at this time, this paper will show that IT is likely to significantly change today’s economy (Nerlove).

Modern developments in IT parallel past technological advancements. Critics like Gordon fail to see these parallels. The impact of IT today is likely to mirror the main consequences of past inventions, namely the railroad and the telegraph.

Some twenty years ago the great historian of American business, Alfred Chandler Jr., proposed that the modern American economy owes its structure and success to the nineteenth century technological revolution, most importantly to the railroad and the telegraph, which brought about important organizational innovations. This paper will explore the parallels of IT’s impact on modern distribution systems with Chandler’s analysis of the railroad’s and telegraph’s impact on the distribution of goods in the late nineteenth and early twentieth centuries. The similarities between the two are so striking that they suggest that IT will change the economy in dramatic ways just like the railroad and telegraph transformed the economy in the late nineteenth and early twentieth centuries.

Alfred Chandler, one of the most prominent US business historians, showed that in the period between 1840 and 1920 organizational innovations revolutionized the way business was conducted in the United States. The organizational innovations were spurred by the technological innovations of the late nineteenth century, namely the transportation and communication revolutions brought about by the railroad and telegraph, (along with the widespread use of anthracite coal)7.  And the organizational innovations eventually created a revolution in the way business was organized in the United Sates.

The new transportation and communication improvements along with the organizational innovations allowed large mass marketing enterprises to coordinate the flow of food products and finished goods from a great number of individual producers to individual customers throughout the nation. The large mass marketing enterprises were the revolution described by Chandler. And they wholly depended on the speed, volume, and regularity in the movement of goods and communication that the railroad and telegraph made possible; and on the increased market size created by the railroad in particular. However, real market growth, population, output, and income growth, between 1850 and 1860 was not significantly greater than during other decades in the nineteenth century. What made these decades unique was the laying of the railroad and telegraph infrastructure, which made much wider markets accessible to late nineteenth century businesses.

These large mass marketing enterprises, dubbed “modern business enterprises” by Chandler, were a completely new and revolutionary form of business organization. The main differentiating characteristics of modern business enterprise (MBE) over earlier business enterprises was that MBE brought many units under its control, it operated in many different locations, it carried out a diversified set of economic activities, it handled different lines of goods and services, and it was much larger than its predecessors. The activities of these units and the transactions between them were monitored and coordinated by a hierarchy of salaried top and middle managers, not by the market mechanisms that dominated the pre-MBE period. While middle managers replaced some functions of the market, Chandler argues that the market still played a role in the economy:

Modern business enterprise took the place of market mechanisms in coordinating the activates of the economy and allocating its resources. In many sectors of the economy the visible hand of management replaced what Adam Smith referred to as the invisible hand of market forces. The market remained the generator of demand for goods and services, but modern business enterprise took over the function of coordinating flows of goods through existing processes of production and distribution, and of allocating funds and personnel for future production and distribution. As modern business enterprise acquired functions hitherto carried out by the market, it became the most powerful institution in the American economy (Chandler, 1).

The market was the exclusive force that coordinated the allocation of goods and services prior to the arrival of the MBE. At this time, the predecessor of the MBE, the traditional American business firm, was the main form of business organization. The traditional business firm was a single unit enterprise. It was operated by a single owner or a small number of owners. It usually carried out only one economic function, it had a single product line, and it did business in one geographic area. The activities of a traditional firm were coordinated by the invisible hand of the market and by the market’s price mechanisms.

The MBE replaced the traditional firm, because the MBE was more profitable. Namely, MBE rose to dominance because administrative coordination proved superior to market mechanisms. Administrative coordination allowed superior productivity, lower costs, and higher profits. The MBE was in essence a collection of small business enterprises that in theory could operate independently; MBE internalized small firms and the transactions that were or could be carried out between them. This internalization carried numerous advantages. It routinized the transactions between the small units, thereby lowering the costs of these transactions. It linked the administration of producing units with distributing and buying units, reducing the costs of information on markets and sources of supply. The internalization also allowed administrative coordination of the flow of goods from one unit to another. The administrative coordination, for example, permitted more effective scheduling, which in turn lead to more intensive use of facilities and personnel involved in the production and distribution process. Thus, productivity increased while costs fell. Furthermore, with administrative control cash flows were more certain and payments for services rendered were more rapid.

Industries that exploited the new technologies and operated in bigger markets were the first to adopt MBE. On the other hand, MBE appeared late in industries that did not exploit new technologies to increase output sufficiently, or did not operate in large markets.

The MBE became the dominant business institution in many sectors of the economy by the First World War. The MBE was owned by thousands of shareholders, and its annual revenues often amounted to billions of dollars. During the ascendancy of the MBE, between 1840 and the 1920s, the United States transformed itself from and agrarian/rural society to and industrial/urban one. Chandler writes, “Rarely in the history of the world has an institution grown to be so important and so pervasive in so short a period of time” (Chandler 4). The MBE was truly a revolutionary institution.

The MBE revolution created mass distribution and mass production processes. The most important new aspect of mass distribution was the modern mass marketer, who purchased goods directly from the manufacturers, growers, and processors of goods and commodities and sold directly to the final consumers or to mass retailers. The most important innovation in mass production was the concentration of all or almost all of the processes involved in producing a good within a single enterprise. Again, this concentration was directly encouraged by the railroad and the telegraph.

Recall that the goal of this paper is to show that the railroad’s and telegraph’s creation of MBE can help us understand how Information Technology may change the economy today. The above discussion of the railroad and telegraph has shown that the two “information technologies” created a revolution personified by the MBE. The next section will discuss in greater detail the efficiency gains achieved by MBEs, through their use of the railroad and telegraph. The MBE revolution began first in the distribution process, and was followed by a similar revolution in the production process. The transformations in production are not discussed here. The focus is on distribution because the transformations in distribution are analogous to the transformations taking place today as a result of modern information technology improvements.

In 1840, the traditional merchants distributed goods in much the same way their European predecessors had done since the 1300s. For example, an Iowa merchant would buy produce from small farmers. He would load the produce on a flat boat and travel down the Mississippi River in search of a “good price.” At best he had only a general idea of what prices to expect, and what town or region would offer the best price. Traveling down to New Orleans, the main commercial center on the Mississippi, would take an Iowa merchant six weeks (Besanko).

The development of the railroad and telegraph networks displaced the traditional merchant by the 1850s and 1860s. During this period the modern commodity dealer took over the marketing and distribution of agricultural products, purchasing directly from farmers and selling directly to processors. Slowly, full service wholesalers dominated the market for most standardized goods. The transformation of business was so intense that by the 1870s and 1880s, the modern retailer (department store, mail order house, and chain store) was moving into the wholesaler’s market.

The new transportation and communication improvements that drove these transformations allowed large mass marketing enterprises to coordinate the flow of food products and finished goods from a great number of individual producers to individual customers throughout the nation. Distributors achieved economies of scale. The number of transactions in the supply chain decreased dramatically. The speed and regularity of the flow of goods increased. Costs fell. The productivity of the American distribution system skyrocketed.

The railroad and the telegraph first sparked the transformation in the agribusiness, most importantly in the distribution of grain and cotton coordinated by the modern commodity dealer. The railroad allowed the modern commodity dealer to move grain and cotton to the market at speeds previously inconceivable, while the telegraph gave him and his partners increased and better information about the commodities they dealt with. When used in unison, the telegraph and railroad gave the commodity dealer unimaginably greater control over the movement of the commodities. Utilizing these new capabilities, the modern commodity dealer was able to gather and utilize better information on prices, to more efficiently integrate supply and demand, and to eliminate layers of middlemen from the distribution chain. These improvements worked to stabilize commodity prices and to lower the modern commodity dealer’s credit costs.

The modern commodity dealer’s accelerated communication capabilities were mainly a result of the telegraph’s ability to quickly rally information across the country and to power commodity exchanges. By trading through the telegraph-powered exchanges, the dealer had better knowledge of prices offered throughout the nation. Through the commodity exchanges, he could also trade the grain and other produce while they were still in transit or even before they were harvested; dealers in the east, for instance, could purchase grain directly at the point of production. Moreover, the dealer in the West could quickly exploit sudden price fluctuations in the East. Chandler writes, “The telegraph put western markets in close touch with price changes in eastern centers, and the railroads facilitated delivery so that a favorable price change could be exploited”.

Better knowledge of prices, better control of the flow of goods, and the new trading flexibility, allowed the modern commodity dealer to solidly integrate supply and demand—the dealer had a clearer picture of demand and more control over supply (where, when, and how much he sold). Thus, he had the ability to optimize his earnings and to better meet the needs of his customers. Moreover, the better integration of supply and demand decreased the dealer’s uncertainty, allowing him to make larger purchases in markets like Chicago and Buffalo—he achieved economies of scale.

Moreover the dealer was able to cut lines of middlemen from the supply chain as the telegraph increased the information available to dealers and allowed them to coordinate the flow of goods along great distances. In essence, the dealer cut middlemen when the middlemen’s monopoly on information disappeared, when their reason for existence vanished. Despite the elimination of middlemen, the new process of commodity trade was far more intricate and complicated then before. The complication of processes along with the high volume trade that developed in the 1850s demanded impersonalized grading, weighing and inspection standards. This need for standardization further encouraged the establishments of grain exchanges, which cooperated in the standardization effort8. The exchanges cooperated in standardizing and systematizing procedures, further decreasing costs and transforming financing methods.

The improving standardization, telegraphic communication, and the assured delivery dates permitted by the railroad spurred further innovations in the way the modern commodity dealer conducted his business. Most importantly, the commodity dealer now used “to arrive contracts.” To arrive contracts specified the quality, the price, and the deliver date of the grain. Under these contracts, the dealer shipped and delivered grain at the moment retailers or manufacturers requested it. To arrive contracts tended to stabilize prices because there was less need to sell at the going price when the grain reached its destination. Moreover, they either cut or eliminated the commodity dealer’s credit costs, and with them the need to undergo long and risky negotiations in order to obtain credit. The elimination of the need for credit had a tremendous effect on trade, as the following report from the 1860 New York state legislature indicates:

While the railroad interest has been growing up, and extending all over our country, a most important change has been wrought thereby, in distributing trade through the whole year. Formerly all surplus productions of the western country were purchased… on credit of large commission houses… It was, though necessary, always an uncertain mode of conducting business. The property must be held, and so held on the credit of some parties. If the value rose, it was maintained; then acceptances were met and all went well… If the value fell… then the commission house failed, and often the ruin extended widely into the interior. All this is now changed… It is the substitution of cash for credit… It is the practical working of actual correct business, for the slow and uncertain working of the old system. It is a great reform. It will never go back (Chandler, 212).

The modern commodity dealers maintained offices in the main grain centers, owned seats on the grain exchanges, had buyers in the grain-growing regions, and contracted brokers who bought and sold on commission. Following the Civil War, modern commodity dealers coordinated the trade in many other crops—cotton, rye, oats, and barley. The dealers created administrative networks that were often worldwide in extent. However, the majority of the business activities involved were controlled from a single central office.

As we have seen this new form of organization, personified by the modern commodity dealer, brought many efficiency improvements. The modern commodity dealer allowed a closer integration of supply with demand by improving information and scheduling. He cut the number of transactions involved and the number of men in the distribution chain. And he lowered or eliminated credit costs. The modern commodity dealer, however, was not the only innovation in the distribution process. The distribution process was further revolutionized by the wholesale jobber. The wholesale jobber is briefly discussed in the next section.

The wholesale industry was affected in a number of ways by the increased speed, regularity, and dependability brought on by the railroad and telegraph. Most importantly, the merchant involved in the handling of goods became a wholesale jobber—he no longer worked on commission, but took title to the goods. The jobber eliminated the middlemen in the distribution process. He purchased directly from manufacturers through large buying networks, and sold directly to general stores and specialized retailers by creating extensive marketing organizations. The jobber also spurred changes in financing practices by cutting middlemen from the supply chain, and by using the increasingly faster and more dependable forms of transportation and communication.

The transportation revolution also eliminated the jobber’s need to carry large inventories, and allowed him to carry out greatly increased volumes of trade9. Greater volume in turn cut the jobber’s unit costs, increased his profits, and made his cash flow more certain. These changes then lowered the jobber’s credit needs.

The jobber also benefited manufacturers—he paid manufacturers in cash at the moment he took title to the manufacturers’ goods. Consequently, the manufacturers no longer needed to wait for six months to a year until their products were sold, and their requirements for working capital fell substantially.

The changing world of wholesale jobbers created large enterprises, with new functions. One new function is an improved form of salesman. The salesman improved and increased information flow with the aide of telegraphic communication. One of his most significant contributions was improved knowledge of demand, as Chandler emphasizes: “The salesmen provided a constant flow of information back to their headquarters. They reported on changing demand, items particularly desired, and the general economic conditions of different sections, and, above all the credit ratings of local storekeepers and merchants” (Chandler, 219)

The preceding sections described the revolution in American business, and therefore economy, brought on by two information technology revolutions, the railroad and the telegraph. The remainder of the paper returns to the present. It discusses the current information technology revolution, the revolution driven by the Internet. The Internet is strikingly similar to the railroad and the telegraph. The Internet will increase efficiency in much the same way that these past innovations did—by improving information. Moreover, efficiency gains are seen in the same domains: the coordination of flows of goods and services becomes more efficient, middlemen are eliminated, inventory management is improved, and there is a closer integration of supply and demand.

The Internet’s power lies in its ability to make information widely available; it “all” relevant information accessible to everyone, everywhere, in effect creating what has been dubbed “the transparent marketplace”. The transparent marketplace is exemplified by web sites that list all manufactures of a particular product, and all the relevant product characteristics, such as quality and price. These sites then match the manufacturers with interested buyers. Doing so, they create numerous efficiency-increasing opportunities to their users. These opportunities are almost identical to the opportunities afforded to businesses of the late nineteenth and early twentieth centuries by the railroad and telegraph. However, the opportunities opened up by the Internet are more pronounced, in effect allowing today’s firms to drastically improve on the capabilities first permitted by the railroad and telegraph. The Internet gives businesses still better knowledge of suppliers, it allows businesses to further eliminate middlemen, to exploit sudden, unexpected opportunities or needs, to take advantage of greater economies of scale, and to manage inventories more efficiently.

The key advantage of electronic marketplaces is their ability to cheaply provide better knowledge of suppliers, by placing on a single web site all potential suppliers, and the attributes of the suppliers’ various goods. This way electronic marketplaces drastically improve buyers’ knowledge of supply.

Obtaining good knowledge of supply has been a difficult task in the past, because finding the right suppliers has been cumbersome and difficult for purchasing staff, the staff responsible for contracting suppliers. Finding the right supplier normally requires purchasing staff to maintain a large volume of information, consult different sources of supply, and to keep updated price lists, catalogs, and other product information. Even if all of this is done, purchasing staff is often left with incomplete knowledge of potential suppliers. Consequently, purchasing staff typically award 90 percent of purchases to only 20 percent of suppliers and uses unauthorized suppliers for a high percentage of purchases (Economist).

In addition to contracting suppliers, purchasing staff are usually responsible for administering transaction with the suppliers. Administering transactions, like finding the best suppliers, has been a costly and inefficient process that has further hindered companies’ abilities to find best suppliers. For example, Goldman Sachs estimates that purchasing staff spends almost three quarters of their time administering transactions. They spend only seven percent of their time searching for suppliers. This problem will also be eliminated by electronic market places, because they automate the transaction process. Equipped with automated transaction processes, purchasing staff will no longer be required to keep extensive information on potential suppliers. And they will be able to concentrate on evaluating suppliers described on electronic market places, instead of administering transactions.

Through the improved capabilities of purchasing staff, companies can save millions of dollars. For example, British Telecom reports that its transaction processing costs fall by 90 percent when goods and services are bought and sold on-line. The direct costs of its purchases fall by 11 percent. Other companies report similar successes. For instance, Cisco had to rework a quarter of its orders, before switching to on-line procurement because of errors in its fax and phone ordering system. After the switch only two percent of its orders had errors, and Cisco saved $500 million (Economist).

Electronic marketplaces further increase efficiency through disintermediation, or the elimination of middlemen. Electronic marketplaces make middlemen obsolete and superfluous, by making the key information widely available, and by matching buyers with “all’’ possible suppliers. The middlemen have developed because in most markets it has been impossible for all producers and all end customers to communicate with each other. Moreover, customers could not gather enough information to make good purchases (Larsson).

Disintermediation has three general benefits. First it cuts costs, because firms no longer have to hire middlemen. Second, and more importantly, it increases knowledge of supply by allowing buyers to gather information on suppliers independently of middlemen; buyers never get all the data they need when they deal with middlemen, because middlemen retain a lot of information and often the most important information. Finally, because businesses no longer have to go through intermediaries to address the buyers of their products and services, businesses are better able to manage their own inventory (Larsson) (Goldman Sachs).

Inventory management is further improved by the ability to quickly buy goods from suppliers, because electronic marketplaces provide faster information than traditional methods of contracting suppliers. A subgroup of electronic marketplaces, classified as “exchanges”, actually specializes in providing information quickly. Exchanges add the most value by allowing businesses to smooth out peaks and valleys in supply and demand by quickly exchanging the commodities involved in the production process (Kaplan).

The discussion of electronic marketplaces has so far focused on the markeplaces’ function to match buyers and sellers. But, in addition to matching buyers and sellers, some electronic marketplaces create value by aggregating the purchasing power of small and medium sized businesses. These marketplaces bring to a single site many small and medium buyers and many potential (large) suppliers. Doing so they eliminated a number of important inefficiencies. Most importantly, by aggregating the purchasing power of small and medium buyers (“virtual economies of scale”), the exchanges allow the buyers to negotiate price reductions. Price reductions on large purchases can be as high as 20 percent in some industries (B2B marketplaces).

Electronic marketplaces promise many efficiency improvements in addition to the ones described above. For example, some marketplaces eliminate the need to negotiate contracts, because they maintain relationships with sellers and buyers. Buyers and sellers often don’t even know each other.

Efficiency improvements growing out of electronic marketplaces will spur great savings in most sectors of the US economy. According to Goldman Sachs, electronic marketplaces will create savings of two percent in the coal industry, but as much as 40 percent in the electronics components industry. Overtime, these savings may boost output by an average of five percent in the rich economies. Over the next ten years purchasing through electronic marketplaces will increase growth by 0.25 percent, boosting output by some 2.5 percent. Savings will be even greater if firms reorganize their operations in the face of these changes (Goldman Sachs).

This paper opened with the claim that Information Technology in general, and the Internet in particular will revolutionize the economy. The paper first showed how two information technologies, the railroad and the telegraph, revolutionized the economy between 1840 and the 1920s. The railroad and the telegraph revolutionized the economy by essentially creating the modern business enterprise (MBE). The MBE utilized the improved information flow permitted by the railroad and telegraph to become the most efficient form of business organization.

Even though the railroad and the telegraph improved the flow of information, they still permitted the monopolization of information within companies or within alliances of individual buyers and sellers. In fact, information could best flow between units that were vertically integrated. Therefore, the MBE evolved into a multiunit organization that wielded monopoly-like power over important information.

However, the Internet is today eliminating the information monopoly, by essentially making “all information available to everyone”. As the information monopoly disappears, so does the need for numerous units and departments to remain tied together as they are in the MBE. Therefore, the MBE will disintegrate. In the (near) future it will be replaced by businesses that will be progressively more specialized, as they increasingly outsource activities like financial processing, accounting, human resources, technology services, and even large chunks of manufacturing processes.

The businesses of the (near) future will be significantly more efficient that the MBE. By outsourcing, these businesses free up large amounts of capital and energy that can be refocused on activities like brand development, supply network management, and customer focus. Moreover, the businesses of the (near) future will combine the advantages of outsourcing with the Internet’s advantages discussed in the previous section to drastically increase operating efficiency. This will be the Internet’s revolution. It will not be a revolution that creates new products, but it will create a new form of business enterprise—a business enterprise characterized by a network of independent, specialized firms tied together by the communication power of the Internet.

The trend toward networks is already evident in a number of industries. One of these is the automobile industry. Automobile manufacturers are increasingly specializing and using the Internet to create networks of parts suppliers, subassemblies, and other products and services. Some of these networks are proprietary, while others actually allow many manufacturing and service providers to bid and to compete with each other on price, quality, and reliability to obtain the business of the large automobile manufactures. A number of manufacturers, General Motors, Ford, Daimler-Chrysler, and Renault-Nissan are planning to transfer all their business to a common electronic marketplace with 60,000 suppliers and a turnover of $250 billion. Manufacturing costs in the auto industry may fall by as much as 14 percent once dealing with suppliers is moved to electronic marketplaces. In time electronic marketplaces will become the norm in most sectors of the economy. When this happens, costs will fall and productivity will grow at immense speed (Elementary Watson—Economist) (Means).

1. Besanko, David, Dranove David, and Shanley Marc. Economics and Strategy. 2nd ed. 1999.

2. Chandler, Alfred D. Jr. The Visible Hand: the Managerial Revolution in American Business. Cambridge, MA: Harvard University Press. 1977.

3. “Survey: The New Economy—Elementary, My Dear Watson.” Economist.com. Monday, Oct. 9, 2000.

4. Goldman Sachs Investment Research. “B2B: 2B or Not 2B? Version 1.1” November 12, 1999.

5. Gordon, Robert J. “Does the New Economy Measure up to the Great Inventions of the Past?” National Bureau of Economic Research Working paper No. 7833.

6. Kaplan, Steven and Sawhney Mohanbir. “E-Hubs: the New B2B Marketplaces.” Harvard Business Review. May-June 2000.

7. Larsson, Mats and Lundberg, David. The Transparent Marketplace. New York: St. Martin’s Press. 1998.

8. Means, Grady and Schneider, David. MetaCapitalism: The e-Business Revolution and the Design of 21st-Century Companies and Markets. New York: John Wiley. 2000.

9. Nerlove, Marc. “Railroads and American Economic Growth.” Journal of Economic History. Volume 26, Issuer 1, 107-115. 1966.

1. Gordon’s views presented here were all taken from: Gordon, Robert J. “Does the ‘New Economy’ Measure up to the Great Inventions of the Past?” National Bureau of Economic Research, Working Paper 7833.

2. Gordon shows that productivity growth is unusually rapid during periods of high output growth. Since growth following 1995 has been “faster then the sustainable trend,” productivity was boosted by the fall in unemployment (from 5.6 to 3.9 percent), and the increase in the current-account deficit from 1.5 to 3.9 percent of GDP. (Unemployment from period 1995-2000, current-account from 1995-1999).

3. A deceleration in MFP growth is reported when the investment in computers in the nondurables sectors is not considered.

4. Computer penetration in businesses reached 63 percent in 1998, and according to estimates should be 67 percent today. Moreover, Internet penetration was 57 percent in 1998, and is estimated to be 60 percent today (Goldman Sachs Research).

5. For a detailed analysis about this claim consult: Fogel, Robert William, Railroads and American Economic Growth: Essays in Econometric History. Baltimore: The Johns Hopkins Press, 1964. For an opposing viewpoint see Jenks, L. H. “Railroads as an Economic Force in American Development.” Journal of Economic History, IV, No. 1, May 1944.

6. The analysis that follows is based on Chandler’s writings in The Visible Hand, Chandler, 1977.

For a detailed overview and analysis of Chandler’s work, and a discussion of his impact on economics and business thought see John, Richard R. “Elaborations, Revisions, Dissents: Alfred D. Chandler Jr.’s The Visible Hand After Twenty Years.” Business History Review. Summer 1997: v71, n2 pp. 151-201.

7. For a short history of the telegraph see Czitrom, Daniel J. Media and the American Mind. UNC Press Chapel Hill, 1982. pp. 3-29.

8. The more prominent examples of grain exchanges included the Chicago Board of Trade (est. 1848), the Merchants Exchange of St. Louis (est. 1854), and the New York Produce Exchange (est. 1850). There were also exchanges in Philadelphia, Milwaukee, Toledo, Omaha, and Minneapolis.

9. The growth in volume was immense. For example, one of the largest importers in the 1840s, Nathan Trotter of Philadelphia, had annual sales that rarely exceeded $250,000. In 1870, one of the largest dry goods distributors, Alexander T. Steward had annual sales of $50 million (including $8 million in retail sales).