E-commerce business models

Developments in computing technology and communication systems, most notably the Internet, have created many new business opportunities for electronic commerce. New mechanisms for making money have developed. The below overview discusses the most common of these business models.

The canonical work in this field is professor Michael Rappa's Business models on the Web, part of his course Managing the Digital Enterprise. Most of the categories discussed below are discussed in his article in great detail.

Many patents have been granted in this field. When appropriate, a reference to a relevant patent has been included. Please note that this does not mean that that patent covers the technique in question, or even that the patent is a valid one. All it means is that the patent in some way relates to the technique in question.

The merchant

A merchant is a wholesaler or retailer of goods and services. The merchant provides a website with product information and an online ordering mechanism. Users select the products they want to buy and place an order. The product price can be fixed or negotiable. The merchant makes his money the same way as traditional "brick-and-mortar" shops: through the profit margin in the product price. This model is mainly suited for physical goods and services, such as books, computers or a pizza delivery service. The merchant can directly reach end users and sell to them without needing wholesalers or retailers.

Click-and-mortar merchants

"Click-and-mortar" shops, combining a website with a physical store, have the additional advantages that they (usually) already have an established brand name, and that they can use their physical store to promote the website. Further, users can return unwanted or defective products simply by going to the store, rather than mailing it to a web site operator.

Traditional mail-order businesses (catalog merchants) already have the necessary facilities to process orders over the Internet (basically, orders come in by e-mail rather than by letter or phone, the shipping and handling is the same).

Build to order merchants

A manufacturer such as a computer vendor can use this model by not only offering his goods or services for sale, but also by offering the ability to order customized versions. The customized product is then assembled individually and shipped to the customer (US 6,167,383). This provides added value to consumers and allows the manufacturer to create only those products that will be sold.

The service provider

For some services, the merchant model is quite appropriate. A pizza delivery service can operate on a pay-per-item basis. However, many Internet-based services cannot easily be handled this way. It is often difficult to define the "product" that is sold, or to set a price for this product. For instance, a news site can offer the service of access to its archive, but even one dollar is probably too much for retrieving one article. Some service providers provide advertising-based access to their service, hoping to recover the costs through revenue from the advertisers. However, this appears to be a doomed strategy, since few ad-driven sites are able to get sufficient income (Yahoo! being one of the very few successful ones).

Subscription-based access

Many service operators provide subscription-based access to their service. A user pays a fixed amount per month or year and in return gets unlimited actions to the service. Alternatively, a base fee can be paid per month and all access beyond a certain limit is subject to a surcharge. This model is typically used when accessing databases with articles, news, and patents but also for online games or adult websites. However, the viability of subscription-based models is doubtful. A 2000 survey by Jupiter Communications found that almost half of all Internet users would not pay to view content on the web.

To entice users into subscribing, "teasers" or selective portions may be made available for free. For example, showing headlines for articles in a news archive or allowing access to patent documents one page at a time.

Prepaid access

Some services, in particular telephony, require payment by the minute. This can be handled via a subscription, but a viable alternative is prepaid access. In this scheme, users pay a certain amount of money, which gives them access to the service for a certain amount of time, or access to a certain amount of content. When the amount is spent, the user can prepay another amount for further access.

Often, implementations involve a smartcard on which the available credit is stored. Payment is realized by buying such a smartcard. The available credit on the smartcard is reduced during usage of the service. Prepay schemes have the advantages that they do not require subscription details to be maintained, and that they give users greater control over how much to spend on the service.

The broker

Brokers or intermediaries create markets by bringing buyers and sellers together and facilitating transactions between them. Those can be business-to-business (B2B), business-to-consumer (B2C), or consumer-to-consumer (C2C) markets. A broker makes money by charging a fee for every facilitated transaction, for instance as a percentage of the price of the transaction. Some special types of brokers are:

The sales representative

Sales representatives often work on a commission basis: they sell an item for someone else and get a percentage of the price. On the Web, this model has developed into what is known as affiliate programs or referral fees. Someone creates a website on a particular topic and adds links to products on a merchant site which are related to his topic, so his visitors can buy those. For example, a music reviewer can add a link in a review to an online music store where the CD being reviewed can be ordered. If the reader likes the review, he can following the link and buy the CD. The merchant then pays the reviewer a commission or referral fee to the reviewer for referring to his site (US 6,029,141).

This model is realized as follows. The reviewer registers at the merchant site and receives a unique code. He adds this code to all the links to the merchant site whenever he links to a product at that site. When a reader follows the link, the merchant site sees the code and couples the reader's actions to the code. When the reader buys something the site registers the sale together with the code. Later all sales matching that code can be collected so the percentage can be computed and credit to the reviewer.

There are many variations on this theme. A fixed percentage can be paid to all sales resulting from the referral or a high percentage can be given to the actual product to which he linked, possibly with a low percentage on other sales that resulted from the link. This model is used by Amazon, Proxis, CD-Now and others. Some book authors link to their own book this way, making more money to the referral fee than to the royalties they get in. Subscription-based services also sometimes offer a referral fee to anyone who brings in a new subscriber.

It is easy and safe to participate in an affiliate model, even for individuals. Anyone who can set up a website can link to a product, and if things go well, make money. If not, then no effort or investment is wasted. This explains the popularity of the model on the World-Wide Web.

The advertiser

Advertising-driven sites are currently one of the cornerstones of E-commerce. The principle is simple and well known. A site offers free access to something and shows advertisements on every page. When a user clicks on an advertisement, he goes to an advertiser's page. The advertiser pays the site operator for showing his advertisement (eyeballs) or for every time someone clicks on the advertisement (click-through).

The same idea is popular in computer programs. Users can download and use the program for free but advertisements are shown during operation or startup of the program. In particular, advertisements can be shown when the user needs to wait for some time-consuming operation, such as printing or scanning (US 5,781,894).

Targeted advertising

It is well known that an advertisement related to the topic at hand on the site will get higher exposure and click through since such advertisements are targeted to the site visitors. So, the site operator earns more money if he places targeted advertisements (US 6,026,368). When displaying advertisements in a computer program, it is possible to target the advertisements to the purpose of the program, e.g., a spreadsheet shows advertisements for a stock brokering service (US 6,141,010). Racing games, soccer games and the likes commonly show billboards in the game to emulate the look of the real playing field. The advertisements thereon can be chosen as "real" advertisements (US 5,946,664).

Search engines use this idea as well, but relate the advertisements to the keywords entered in a query. For instance, if someone searches information on holidays, an advertisement is shown for a hotel chain on the page with search results (US 6,098,065). The advertisement can further be targeted based on the user profile for the user doing the search (e.g., if the profile shows the user likes to swim, an advertisement is shown for a beach hotel).

The existence of advertising-driven sites created a business opportunity for companies such as DoubleClick, which collects advertisements from many sources and arranges for placements on different sites. The sources pay DoubleClick for placing their advertisements, and this revenue is then shared with the site owners. Additionally, DoubleClick tracks the users that view all the advertisements, which allows it to built a user profile. This profile can then be used to more accurately target advertisements to these users (US 5,948,061).

Updating advertisements

It is desirable to be able to present the user fresh advertisements periodically, even when he is not connected to the network. To this end, his browser or other client can download multiple advertisements simultaneously and display them one at a time when he is offline (US 5,809,242). A screensaver can also be used to present advertisements when the system is idle (US 5,740,549). The screensaver periodically downloads new advertisements and/or news messages, and presents them to the user.

Portal sites

A portal offers one-stop access to different content and services, such as searching, news, e-mail, stock information, message boards or chat. By offering the option to personalize the interface and presented content (see, for example, my.cnn.com or my.yahoo.com), the portal is made more attractive to the user. The portal site can target its advertisements based on the personalization information.

Attention/incentive marketing

In this model, a user downloads and views many advertisements and clicks on them, which generates revenue for the intermediary which provided these advertisements to the users. This revenue is then shared with the users in proportion to the number of advertisements they viewed and clicked on. Often, the user is asked to enter demographic information, which the intermediary shares with the advertisers (US 5,794,210; US 5,855,008).

A difficult problem in this area is how to guard against fraud. A user could employ a computer program that automatically clicks on all advertisements sent by the intermediary. This way, he collects a large amount of money without actively seeing the advertisements. Thus, it is recommended to measure the time between showing the advertisement and the user's reaction. If that time is too short, or the same every time, it is likely that something is amiss.

If the advertisement is in the form of a video or audio fragment, the user could also be asked to press a particular button or answer a question at some point during the advertisement.

Another solution involves the use of a smartcard. The user must insert a smartcard in a television system or the like, and the reward (usually in the form of credits, although digital cash can also be used) is recorded on the smartcard. When the advertisement has been shown, the card is ejected, so that the user must re-insert the card for the next advertisement.

Free access

Users are given something for free, but the something comes with advertisements. A few examples: free web space providers typically provide advertising banners at the top or bottom of its users' sites (or as a separate, pop-up window). Free Internet access providers show advertisements on the starting page its users see when they go online. Electronic greeting cards are sent with a personal message and an advertisement. Since the user base is very diverse, it is hard to accurately target advertisements, making the expected revenue low.

The auction room

In an auction, the price of a product is made dependent on what buyers are willing to pay. There are a number of models for performing an auction, the two most well-known being the "open" auction and the "reverse" auction.

Open auctions

In the "open" auction, participants repeatedly place higher bids for a product under auction. The person who places the highest bid is awarded the product. Networks such as the Internet make it possible for a large number of bidders to participate simultaneously in one auction. Handling bids can even be automated, so that no human auctioneer is necessary (US 5,835,896).

Famous auction site eBay offers the option to participate in an auction automatically. The bidder enters an initial bid, an amount with which to increase the bid and a maximum amount. The system then automatically raises the bid with the indicated amount whenever someone else places a higher bid, until either the bidder has won the auction or his maximum is reached (US 6,044,363; US 6,151,589).

Reverse auctions

In a "reverse" or "Dutch" auction, the price is initially set at a very high level, and drops at regular intervals. Participants can pick the price at which they want to buy, and have to determine the chance that someone else will find a higher price acceptable.

In a variant of the reverse auction, customers indicate a product or service and a price, which they are willing to pay. Suppliers indicate a price at which they are willing to provide that product or service, and the auction service tries to match customers and suppliers. The intermediary pockets the difference between the price paid by the customer and the price paid to the supplier (US 5,797,127; US 5,794,207). This model is popular with high-priced items like automobiles or airline tickets.

The virtual mall

A virtual mall is a site that hosts many merchants, service providers, brokers and other businesses. The virtual mall operator typically charges a fee for setting up and maintaining the merchant's "booth", and for including him in the site-wide catalog. Additionally, he may charge a fee for every transaction the merchant performs. Virtual malls can operate within the context of a larger site, such as a portal.

The virtual mall can act as an intermediary between individual customers and the business it hosts, for instance by facilitating payment and guaranteeing a full refund if a merchant does not deliver in time.

When the virtual mall offers services such as payment facilitation or catalog browsing, it has the ability to create aggregated user profiles on the customers that visit any of the businesses in the mall. This can lead to the development of highly specialized malls (e.g., oriented at kids or sports lovers).

The virtual community

A virtual community is a website which has gathered a group of users with a common interest who work together on the site. Typically, users will share information and make contributions in other ways. Since they have contributed to it themselves, users feel highly loyal to the site and will visit it regularly. This offers possibilities for advertising.

Probably the largest virtual community can be found on Slashdot, a Linux-oriented site on which users share interesting news articles and websites (which invariably fail under the load of hundreds of thousands of people visiting it shortly after its URL got posted on Slashdot - this is called "slashdotting").

A specialized type of virtual community is the knowledge network or expert site, where people, layman and expert, share their expertise and experiences. These sites are typically ran like a forum where participants can get questions answered or raise topics for discussion. Long-time participants often meet together in real life. Usenet newsgroups are a good example of such a community.

When a knowledge network is devoted to a particular product or company, the active participation of employees of that company is often very much appreciated and can offer a great PR opportunity for the company.

A simple way to monitor a virtual community is to require registration for access to the website, preferably for free. This allows inter-session tracking of users' site usage patterns and thereby generates data of greater potential value in targeted advertising campaigns. Registration can be made more attractive by offering limited access or "teasers" to unregistered users, by offering the option to customize the site after registration, or by allowing only registered users to actively participate in chat or message boards.

The infomediary

An infomediary collects, analyzes and sells information on consumers and their buying behavior to other parties who want to reach those consumers. Typically, the infomediary offers the consumers something for free, such as free hardware or free Internet access. The later is especially useful, since it allows the infomediary to control and monitor the user's online activities. After all, the consumer connects through the infomediary's network. The information which the infomediary collects is extremely valuable for marketing purposes. Often the infomediary makes money with an advertising-based model, in which the advertisements are targeted based on the information it collected itself.

The infomediary needs to keep track of its users. A simple way to achieve this is to require registration for access to the website, preferably for free. This allows inter-session tracking of users' site usage patterns and thereby generates data of greater potential value in targeted advertising campaigns. Registration can be made more attractive by offering limited access or "teasers" to unregistered users, by offering the option to customize the site after registration, or by allowing only registered users to actively participate in chat or message boards.

The infomediary model is useful in combination with a virtual community model or virtual mall, since those models offer the ability to collect the necessary information.