Notes

[MUSIC]
In this segment, let me illustrate how the concept of
transaction cost applies to the Internet and Internet business models.
So there are many ways.
When we look at the Internet business models, there are many ways to analyse.
People have made them, you know,
there are retailers, and then there are auctions, and whatever.
But let's try and use the lens of transaction cost to
look at Internet companies and understand why are they successful. In fact,
transaction cost might be the basis of some of the most successful Internet
business models, and the idea is very simple,
that what the Internet does is to reduce transaction costs.
And if you are going to be a new start-up, if you are looking for
opportunities, what should you do?
You find an industry in which there is very high friction, you reduce that
particular friction and that's going to be a great economic opportunity and
the Internet is going to be very, very valuable.
So, the Internet in some ways is only going to be valuable in
an industry if it's able to reduce transaction costs.
That's something that we want to keep in mind.
So, why are certain industries getting transformed by the Internet?
Because of the fact they have very high transaction cost, and
the Internet allows a reduction in that particular transaction cost.
That's a fundamental concept.
Let's look at some successful business models and try and
see how the concept applies.
I mentioned eBay earlier.
Think about the fact why has eBay been so
successful, and there are many, many wonderful reasons.
eBay's a great company, profitable from day, day one.
Look at all the things eBay sells.
What's the common characteristic of all the items eBay sells?
Well, it's hard to generalize perhaps,
all of a sudden right now, but maybe we go back a little bit and try and
see go back in history a little bit and try and
see what's the first item which eBay ever sold, the foundations of eBay?
What was the first item which was ever sold on eBay and
that might surprise you, it was a laser pointer pen as it says on the slide but
actually that's not entirely accurate.
It wasn't a laser pointer pen.
It was a broken laser pointer.
Think about the fact, founder of eBay put a broken laser pointer on eBay and
somebody actually bought it for about 14 bucks.
It's not a question of, you know, there's always a sucker online, but
that's not the point.
Think about broken laser pointers.
What's the transaction cost of buying a broken laser pointer?
Is it high, or is it low, as compared to a new laser pointer?
I ask you to go buy a laser pointer, a new laser pointer, you will know where to go,
you go to a shop and you buy one, you know what it looks like.
If I ask you to buy a broken laser pointer, where would you get it from?
Where's the visibility?
And then look at your search cost.
Even if you were to find one, somebody really realizes your need,
imagine how much they're going to charge you.
There'll be again negotiation cost.
So the transaction cost of a broken laser pointer is really high.
And what was eBay's appeal?
It was reducing that particular transaction cost.
Think about almost every item which is sold on eBay.
eBay sells hard to find items.
What does it mean hard to find items?
Hard to find items means transaction costs are extremely high.
Search costs are extremely high.
The price visibility does not exist, so the visibility cost is extremely high.
So if I was to rephrase it another way,
eBay's value preposition is reducing the transaction cost of items or
selling those items whose transaction cost is extremely high.
Contrast this with Amazon.
What are the items which are sold on eBay.
If you want to buy a book, what's the transaction cost of buying the book?
Well, you know what the book is all about.
I mean, there is nothing ambiguous about it.
And it's easy to buy.
So most of the things which Amazon sells and items which Amazon sells.
Think about that transaction cost.
Are they high or low?
Contrast that with the one with eBay.
And look at those particular differences.
All of a sudden you realize that though both might be reducing transaction cost,
they're at different ends of the continuum.
eBay only sells items with high transaction cost and
they charge a price for reducing that transaction cost.
On the other hand, Amazon is not about transaction cost,
it's about availability, about many, many other value propositions, so
that might be a fundamental difference of these two particular companies.
Think about something even broader than that.
There's a huge debate going on right now,
about, how online is going to evolve along with bricks and mortar companies.
For example, is it going to be companies like Amazon which are going to survive and
be successful?
Or is it going to be companies like a Wal-Mart which essentially have
a physical presence which are going to be more successful in the long run?
It's a, it's a tough question.
And today, one of the trends that you see happening is what's called people,
why do people go to existing stores, physical stores, today?
Well, if people are going to physical stores,
they are saying physical stores are becoming like showrooms.
Before you buy an item you know you can find it cheaper online but
you want to see it first, you want to experience this first, you go to a store,
you look at the item in the store, and once you feel comfortable with it, you take out
your smartphone, you look at where its available, you order it online. So
some people say stores are nothing but showrooms for online retailers.
But they cannot survive like this, they cannot survive.
So how is it that retailing is going to evolve?
Is the future of online?
Is online stores, are they going to be successful,
because they should be selling items with low or high transaction cost?
Where does the future of online lie?
In high transaction cost item or low transaction cost item?
Similarly, if you're going to be a physical store today,
you want to keep items.
What kind of items do you want to keep?
High transaction cost item, or low transaction cost item.
So we can use that lens to try and build a strategy for the future.
I won't answer this question for you.
I leave it up to you because different industries might evolve differently.
But the lens remains the same.
Think about something else.
We keep on saying high transaction cost,
what kinds of items have a high transaction cost?
Like, eBay sells hard-to-find items, memorabilia.
They have high transaction cost.
What about other kinds of items?
Let's say, take digital goods.
Do digital goods have high transaction cost or low transaction cost?
Make it, let me make it more specific, let's say, digital music,
does it have high transaction cost or low transaction cost?
So what kind of products have high transaction cost,
because once we understand that we can try and
see which, how these industries are going to be evolving.
And sometimes when technology changes, transaction cost totally change.
For example, take a very successful company like Netflix.
If some of you, as some of you might know, Netflix rents movies.
So if you want to see a movie, you rent a movie from Netflix, and
Netflix's original traditional model was DVDs by mail.
You specify what movie do you want.
They send it to you by mail, the DVD in the mail.
You watch it and you send it back.
And then they'll send another one to you, right.
That's what Netflix's very successful model was for, for decades.
Today, Netflix is evolving to what's video on demand.
What does video on demand mean?
I sit at home, I have a Netflix box, and I can watch any movie that I want online.
It's on demand.
Now, when it becomes on demand, what happens to transaction cost?
Does it become lower or higher?
As compared to, let's say, DVDs.
In DVDs, what was the transaction cost?
I have to order a DVD, somebody has to deliver it, I have to pack it,
something etc.
All these things are gone.
So, let's say if you presume that the transaction cost for
a digital movie are going to be lower.
And Netflix value preposition was reducing transaction cost.
But technology has now reduced the transaction cost of the product.
Will Netflix survive?
Or does it need new competencies?
It's a rhetoric question right now, but a relevant and important one, because,
and all we are trying to do is to illustrate the lens of transaction cost,
simple company like Netflix.
Once technology changes, once move something which is digital.

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See, in an airline industry is probably, according to me, one of
the industries which has transformed much more dramatically than any other industry.
It's almost unrecognisable today.
I mean, it's almost unthinkable.
Let's say you want to travel today.
How do you do your booking?
You would go online and do your booking today, right?
Wasn't that long ago that we actually earlier had travel agents.
Think about the role of travel agents today, what are they going to be doing?
Travel agents have all been replaced by online sites, right?
Why did online sites make such a difference in this industry?
Why didn't online players emerge in other industries?
How did they come about?
Why are they so, will they continue to be successful?