The Interchain

Abstract

Internet technology, in the form of an Interchain, can be used to reduce the barriers to entry to an interorganizational system. An Interchain is created by using Internet technology to support a value chain relationship. This paper demonstrates the comparative advantages of an Interchain (lower asset specificity, less risk, more information, just-in-time buying, lower costs). The paper suggests three adoption strategies (replacement, extension, innovation) for the Interchain, indicates that the Interchain is a device for redesigning interorganizational structures, and it is further evidence of the creative destruction of existing business practices.

Introduction

Internet technology is changing the face of commerce and government in many ways because it is facilitating the creation of a massively interconnected electronic world. We first witnessed the massive interconnection of computer networks to create the Internet. Next, the same technology was used to create intraorganizational networks-Intranets-to connect an organization's employees. Now, we see the emergence of the Interchain, another interconnection variant based on Internet technology, being used to extend interorganizational systems (IOS) to many more organizational partnerships. In this paper, it is illustrated how Internet technology has changed the economics of IOS.

Interorganizational Systems

Interorganizational systems were discussed as early as 1966 (Kaufman, 1966) and resurfaced in the 1980s (e.g., Barrett and Konsynski, 1982; Johnston and Vitale, 1988). According to Cash, an IOS is a networked information system used by two or more separate organizations to perform a joint business function. An IOS often involves electronically linking a production company to its suppliers or to its customers in such a way that raw materials are ordered, production takes place, and finished goods sent to the customer to meet demands with little or no paper changing hands. However, there are two important factors that can retard the adoption of IOS. First, the cost of establishing a connection to the supplier may be prohibitive for some small businesses. Second, the buyer wants to avoid incurring switching costs that make it expensive to change suppliers (Mata, Fuerst, and Barney, 1995). Fortunately, the Internet overcomes these problems, as we will demonstrate in this paper.

The most common form of IOS in use today is based on electronic data interchange (EDI), which uses value-added networks (VANs) or private networks instead of the regular telephone system. Because EDI requires the use of expensive VANs or private networks, it has been found to be too expensive for all but the largest 100,000 of the 6 million businesses in existence today in the United States. As a result, many businesses have not been able to participate in the benefits associated with IOS. However, the Internet may enable these smaller companies to take advantage of IOS.

Using the Internet to Implement IOS

Internet technology (the communication protocols and software such as e-mail, FTP clients and Web browsers) and Internet infrastructure (a national information infrastructure and competitive local Internet access providers) have created a low cost platform for linking computers. In addition to the global network of networks that is commonly referred to as the Internet, many organizations are creating internal versions of the Internet called Intranets (Haapaniemi, 1996).

These structures enable organizations to take advantage of low cost Internet technology to communicate with and deliver information to employees. The Internet and Intranet are network structures designed to support communication with a large number of external stakeholders or internal employees, respectively.

Third structure that is represented in this paper is the Interchain, which uses Internet technology to link partners in a value chain. Because of the economies gained from low-cost Internet software and infrastructure, organizations of all sizes can now participate in the advantages of IOS. Many more buyers and supplier pairs can now cooperate

electronically because the cost of linking using Internet technology is an order of magnitude lower than using a VAN. Previously, many small suppliers did not have the internal infrastructure needed to adopt the IOS , but the ease of use of the Web and the pervasiveness of the Internet lower this barrier.

To understand the concept of an Interchain, we need to look at the value chain model (Porter, 1985), which views the firm as a chain of activities each of which add value to the firm's products or services. The value chain model divides an organizations tasks into primary and support activities. Primary activities are directly related to the production and distribution of the firm's products and services that create value for the customer. Included as primary activities are inbound logistics, operations, outbound logistics, marketing and sales, and service. On the other hand, support activities include administration and management, human resources, technology, and procurement.

 In terms of IOS, each firm's value chain is linked to the value chains of other firms to create what Porter referred to as a value system. For example, the inbound logistics value chain activity of a firm must link up to the marketing and sales, service, and outbound logistics activities of its suppliers. On the other side of the firm, its marketing and sales, service, and outbound logistics activities must match up with the inbound logistics activity of its distributors.

The Interchain handles this linking of value chain activities by using the Internet to provide the communications between the firm and its suppliers and distributors. With the exception of the operations activity, all primary activities are suited to the Interchain. On the other hand, all support activities other than procurement can generally be handled by an Intranet. Thus we can see that Interchains can support inbound logistics, outbound logistics, marketing and sales, service, and procurement.

The intention of an Interchain is tighter integration and coordination of the activities of a supplier-buyer relationship. Consequently, the Interchain should provide support for the logistical link between the two parties by enabling the flow of data (e.g., describing shipments and production plans). In other words, the outbound logistics of the seller should be chained to the inbound logistics of the buyer.

IOS and the Interchain

One of the reasons that the Interchain has the potential to become a popular means of carrying out business functions is the effect of the Internet on the economies of an IOS. In general, the costs of an IOS can be reduced dramatically through the use of the Interchain. For example:

• Interchain communication costs are significantly less than with traditional EDI.
• Accessing the Internet though an Internet access provider (ISP) costs around $20 per month. These costs are probably are at least half those of using a VAN.

• The software costs associated with the Interchain are minimal, including only the cost of a Web browser. In many cases, browsers are free, but even when purchased, they usually cost less than $50.
• Learning costs associated with the Interchain are now lower than those with proprietary EDI software since the Web browser is a commonly used interface.

• Hardware costs associated with using the Interchain are quite low because all that is required is a low-end personal computer system and modem (approximately $1,000). These costs could be halved with the proposed introduction of dedicated network connection machines costing around $500.

As mentioned previously, the threat of switching costs is a potential inhibitor to the adoption of EDI, and the less powerful member of the partnership is likely to seek a solution that neutralizes the threat of switching costs. Switching costs are far less likely to be a constraint on an IOS when the total costs of installing hardware and software are an order of magnitude less than traditional EDI. Furthermore, the cost of learning the supplier's system is minimal because it is based on standard Web browsing software. Thus, with the Interchain model, the small business invests in highly flexible technology that can be easily adapted to other suppliers and other uses. There still may be some switching costs involved when suppliers maintain data on their corporate system for buyers. Switching costs should become significantly less important for an Interchain compared to traditional EDI solutions.

Implementing an Interchain

Implementing an Interchain frequently requires that the firm's legacy system, which contains data about the goods and services being sold or otherwise marketed, be linked to the Internet so that information can be transferred between the firm and its suppliers or distributors. Since the Interchain is created using the World Wide Web, this connection is accomplished by linking the firm's Web server to its legacy system. Since most companies are not interested in changing their legacy systems, it is necessary to develop a way for the Web server to send queries to the legacy system and to display the results of those queries on a Web browser. The key element in creating such a system is the software that links the server to a legacy system.

A user of a Web-based system responds to a Web page by submitting a form to the Web server. The Web server, in turn, is linked into an existing backend legacy system. Between the Web server and the legacy system is software, which we term chainware, that converts this query into a format which the legacy system can handle. This query is sent to the legacy system which responds with the matching data. These data are sent back to the chainware which creates a corresponding Web page that is returned to the Web user. Chainware is much like the middleware software used in client/server database systems. Middleware is software that sits between the application software on the client and application software on the server. In a similar vein, chainware is software that sits between the application software on the Web server and the application software on the legacy system. This allows each computer-the Web server and the legacy system-to do what they do best. An example of chainware is Tango, a cross platform product that runs on a Web server and can interrogate an SQL database. The chainware must also handle the security problems of dealing with the legacy system that are above and beyond those currently being considered in the Web client-server linkup.

While chainware is necessary for an Interchain, the concept of the Web server being connected to a legacy system extends to all three topologies: Internet, Intranet, and Interchain. For the Internet, consumers using a Web-based sales system will need to be able to determine if a product or service is available in a real-time basis. For example, a Web-based airline reservation system must be able to query the legacy system to determine if the seat is really for sale. The airline reservation system used by SouthWest airlines uses specially written chainware to enable consumers to use their Web browser to purchase seats on flights which the airline operates. Since SouthWest is a ticketless airline, no further communication between the ticket buyer and the airline is necessary after the SouthWest Web server communicates with its legacy system to reserve the seat. On the other hand, anybody who used the Atlanta Olympics Web-based ticket system was not sure that they had actually bought a ticket to a particular event until they received an e-mail later confirming the purchase. The reason for the delay was that the Atlanta Olympics Web server was not linked into the legacy ticket database. Instead, a person had to convert the ticket request query generated by the Web server into a query to the legacy ticket database, interpret the response, and then e-mail the hopeful purchaser the results of this query. In this situation, purchasing by telephone was a more certain way of acquiring a ticket to an Olympic event.

An Interchain case study: Manheim Auctions

Manheim Auctions is an example of an Internet-based IOS (Interchain). The Atlanta-based vehicle auction firm, with 50 plus auction sites in both the United States and Europe, auctions used vehicles to both retail dealers and to the general public. One particular type of vehicle that they handle are so-called program cars; autos that have been used by auto company executives, coming off lease, or have been returned by automobile rental companies. When it receives a program car, the automobile company typically turns these cars over to Manheim to dispose of at auctions around the country. In many situations, Manheim will receive a large number of program cars at a single location, which they then distribute around the country to avoid depressing the market for this type of automobile at the original receiving location. Moving these cars to other locations involves expenses which Manheim would like to avoid. When a program car arrives at an auction site, dealer representatives from nearby cities and towns attend the auction to purchase vehicles that they believe are in demand in their locale. Occasionally, they will have an order from a buyer, but more often, they use their experience to choose cars. Once a car is purchased at auction, it is then driven or trucked to the dealer's lot for eventual retail sale. The dealer has money tied up in inventory, plus the expense of sending a representative to the sale, and moving the automobile back to their lot. The dealer also is risking the cost of the vehicle in hopes of eventually selling it.

To reduce the cost of sending representatives to purchase program cars at auctions, there have been several attempts to create interactive auctions such as AucNet, which used a combination of live video feeds by satellite and telephone to link the dealer to a live auction. However, some of these efforts have involved the expense of adding a satellite disk to link into the live auction. In response to competition from such interactive auctions, Manheim approached Intellimedia Commerce Inc. (ICI) to create a Web-based system that would enable it to sell program cars to dealers without the expenses associated with live auctions. ICI at first considered a real-time Web-based auction system, but decided against this due to the complexities of ensuring that each buyer had an equal opportunity to participate in the auction. ICI and Manheim decided that instead of using a real time auction, they would create a system that would allow dealers to buy program cars at a set wholesale price determined by Manheim and the automobile company. With this system, any certified dealer with a PC connected to the Internet can purchase a program car by accessing the Manheim Web page, entering a user identifier and password, and then using a clickable query system to find the automobile they wish to purchase. This clickable query system generates a form that is submitted to the Manheim Web server on which the chainware software generates a corresponding SQL query against a database, stored on a separate server, of vehicles available for sale. The records on available vehicles matching the dealer's request are then returned to the Web server. At the Web server, the chainware software converts these database records into a Web page, which is transmitted back to the dealer's PC.

The Web page returned to the dealer contains information on vehicles that meet his needs including pictures both of the vehicle and of any problems (dents, scratch, etc.). If the dealer decides to order this vehicle, Manheim will arrange transportation to the dealer's location. The dealers know that Manheim stands behind the vehicles it auctions and feel confident that they will match the pictures and description in the Web page.

While it may not be immediately clear why a dealer would choose to buy a program car via an Interchain application like the one just described rather than going to a traditional automobile auction, consider what the Manheim Interchain system allows the dealer to do. First, the dealer can wait until a customer has been identified before ordering the car from a Manheim auction site. In essence, the customer is ordering the program car through the dealer and the dealer has far less risk in this transaction. Rather than sending a representative to an auction to purchase cars, which customers may or may not want, the dealer is able to order a car to a customer's specifications and have it delivered the next day. Second, the dealer is not tying up funds in an inventory of cars awaiting a customer to purchase them. Instead, with the Manheim Interchain system, the dealer has no money tied up in the transaction. They sell the car before they have to pay for it and, with Manheim's guarantee, they have no money at risk in the transaction. Finally, the dealer does not bear the expense of employing and sending buyers to the program car auctions; instead, they simply query the Manheim database for cars that match customer needs. 

The Manheim case clearly demonstrates that in an electronically interconnected world there are fundamental changes in how firms and markets organize the flow of goods and services . The selling of program cars has moved from a face-to-face auction to a product distribution system. Interchain technology has enabled this change because the underlying economic forces supported such a move. We now explain the reasons that supported this fundamental transition.

Asset specificity

An asset is highly specific if it cannot be readily used by another firm because of site, physical asset, human asset, or time specificity. Program cars have high site specificity, with many of them initially available in specific areas such as the automobile company headquarters or in Florida where many cars are rented. Under the physical auction scheme, Manheim had to ship cars to locations throughout the US so that it did not depress prices in a particular market, and then dealers had to ship the car to their lots. The site specificity of program cars increased shipping costs. Under the new system, shipping costs are reduced because the car is shipped directly to the dealer's lot. Site specificity has been reduced for Manheim. For dealers, time specificity is decreased because the car arrives when required to complete the sale and does not sit in the lot waiting for a buyer to appear.

Less risk and more information

The dealer who buys at an auction is forecasting future demand. The dealer must anticipate what potential customers will want and hold the car on the lot until sold. This risk disappears when the dealer buys a car in response to a customer's order. In addition, there are no holding costs. The sales system is extremely low risk because the dealer has detailed knowledge of the product and the customer. The dealer has become an information intermediary using Manheim's Interchain application to match the buyer's needs to Manheim's vast inventory. This also means the customer has more choice than what is on the dealer's lot. Car dealers have shifted transactions in space and time-from the auction yard to the dealership and from anticipating sales to completing sales.

Just-in-time

Just-in-time has been used in the production process to significantly reduce inventory carrying costs. The same concept can be applied to the sales process, where the dealer procures a car minutes after the customer decides to buy it. And that is exactly what can happen with Manheim's system. Dealers who decided to specialize in program cars could dispense with showrooms and car lots and run the whole business out of an office suite.

Lower costs

Lower transactions costs are typically a benefit of an IOS . In this case, costs are lowered in several stages in the new system:

The car is shipped once instead of twice;

The dealer does not have to attend an auction;

Fewer cars are held in inventory.

Adoption strategies for the Interchain

Early Interchain applications are likely to be based on exploiting existing applications and extending EDI to smaller organizations. The simplest approach is to use the Internet as a means of replacing a VAN by using a commercially available Internet EDI package. EDI, with its roots in the 1960s, is a system for exchanging text, and the opportunity to use the multimedia capabilities of the Web is missed if a pure replacement strategy is applied. In the case of Manheim, the ability to deliver images makes the system feasible since more than text is required to describe a program car. Images are better for describing dents or scratches. Thus, the multimedia capability of the Internet creates an opportunity for new IOS applications that spawn a qualitatively different type of information exchange within a partnership. We label the addition of multimedia to traditional EDI transactions an extension strategy. An IOS is usually considered to support the flow of logistic (e.g., shipment status reports) and payment data (e.g., electronic fund transfers) between partners. Once multimedia capability is added to the information exchange equation, then a new class of applications can be developed. An Interchain, for example, could be used to support education of the other partner. An innovation strategy means moving beyond traditional EDI applications to using the Interchain to support the full range of value chain activities.

While it may be possible to recognize three strategies at this stage, it is likely that firms will first reap the benefits of a replacement strategy before moving to extension and innovation. The obvious gains are likely to be seized first and those changes that require a re-inventing of the relationship (e.g., educating customers via the Web) are likely to be adopted more slowly.

Conclusion

Compared to EDI, Internet technology reaches a much wider audience and permits the exchange of multimedia as well as text. The Manheim case is clear evidence of creative destruction in process. The initial success of this system, which far exceeds expectations, points to the demise of face-to-face auctions for program cars. We anticipate that this will be the forerunner of many Interchain applications that change the nature of business partnerships as the IOS concept is widely implemented and extended with multimedia innovations.

From an organizational perspective, the Manheim system has created a new interorganizational structure. Organizational design has been conceptualized as choosing an information structure and decision function that maximizes the net payoff to the group members . The information structure determines how members perceive and communicate information. In the Manheim case, the information structure has changed in two important ways. First, the dealer now has a totally electronic description of a car. The car is a remote commodity and no longer a physical object the dealer can see or feel, or gauge its value from the intensity of the bidding. The dealer has lost supply information. But, the dealer gains demand information because the customer is real and not some imagined person who appears on the lot at some future time. Thus, the information structure has gained symmetry as there is a better balance between supply and demand information. As mentioned previously, the decision function, which determines how members decide what actions to take, has moved in place and time to reduce the dealer's risk. The rapid acceptance of the new interorganizational structure suggests that both Manheim and the dealers have increased their net payoff. Obviously, the next stage of this study is to measure the incremental payoff of the new structure.

The Interchain is more than extending IOS to a greater number of partners. It is a new way of fashioning interorganizational structures by altering the information structure and decision function. The Interchain is further evidence that widespread adoption of Internet technology will fundamentally change commerce. As the third form of electronic commerce topology, the Interchain gives managers another model to provoke thinking about redesigning the corporation.

References

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