Geographic and Socially Embedded Electronic Transactions:Towards a Situated View of Business-to-Consumer andBusiness-to-Business E-Commerce1

Charles Steinfield

Department of Telecommunication, Michigan State University, East Lansing

Abstract

Electronic commerce development was shaped by a number of assumptions about how it adds value toeconomic exchange. These assumptions focused attention on the ability of e-commerce to transcenddistance and reach into markets without physical presence, replace costlier in-person transactions withelectronic ones, and demonstrate network effects that reward rapid growth. In this paper, I argue that sucha view does not fully conform to the way much trade occurs, resulting in efforts by many firms toimplement e-commerce in a manner that at best fails to capitalize on existing assets and at worst disruptsexisting relations and reduces value. In particular, work on the dynamics of click and mortar firms is usedto highlight opportunities posed by taking a more situated view of e-commerce in business-to-consumer e-commerce. In addition, such a situated view is further suggested in the business-to-business arena byexamining the importance of local and regional business clusters. Some evidence suggests that a situatedapproach to e-commerce in both contexts would yield benefit, although this approach is as yet relativelyunderutilized.

Introduction

The term electronic commerce quite naturally conjures up visions of relatively anonymous onlinetransactions with companies like Amazon or Buy.com, where personal contact is non-existent and therelative locations of buyers and sellers is irrelevant. To be sure, much business to consumer e-commercehappens this way, and this approach was also prevalent in trade among businesses in electronicmarketplaces such as those provided in the dot.com era by Verticalnet and biz2biz.com. These visionsreflect what was the dominant perception of the role of e-commerce in economic exchange leading up tothe widespread failure of “dot.com” firms in 2000 and 2001. That is, e-commerce enables companies toaccess new markets, replace outmoded or inefficient supply chains and distribution channels, and achievedramatic growth in the number of customers served (Cairncross, 1997; Choi, Stahl and Whinston, 1997;Wigand and Benjamin, 1995). These perceived opportunities stem from several basic assumptions thatshaped much of the e-commerce activity leading up to the widespread failure of “dot.com” firms in 2000and 2001. Steinfield (Steinfield, in press-b) describes three influential beliefs that have shaped e-commercepractices and strategies:• Geography is irrelevant in e-commerce. Electronic exchanges cost the same regardless of the distance

between sender and receiver (Cairncross, 1997). Indeed, on the Web, unless a site explicitly highlightsgeographical information, the physical address of the destination site is unknown to most users. Theimplication for economic exchange is that buyers and sellers no longer have to be co-located, becausethe Internet has reduced the transaction costs associated with doing business with a distant partner to thepoint where distant sellers are competitive with local ones (Bakos, 1997; Bakos, 1998).

• Internet transactions are substitutable for transactions formerly occurring in person or via other forms ofdirect communication. Rich graphics and multimedia enable even highly complex products to be sold.

1 To appear in Cooper, R. and Madden, G. (eds.), Frontiers of broadband, electronic and mobile commerce,

Heidelberg: Physica-Verlag, forthcoming.

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Customization and personalization features substitute for the work formerly done by sales personnelwho interacted directly with customers (Rayport and Sviokla, 1995). Modern logistics and transportsystems ensure rapid fulfillment of online orders. Hence all the elements needed to effectively automatetransactions are present, and enable online transactions to substitute for offline ones (Choi et al., 1997).

• E-commerce businesses experience network efforts, implying that those attracting the largest number ofusers will achieve sustainable competitive advantage (Afuah and Tucci, 2001; Choi et al., 1997; Kaplanand Sawhney, 2000; Shapiro and Varian, 1999). Network effects result in greater customer value withmore users of an e-commerce site. This is believed to apply in a variety of business models. Networkeffects are thought to be crucial, for example, for sites that function as third-party market makersoffering brokerage services. In order to improve the liquidity of the market such sites must be able toattract a critical mass of buyers and sellers. The more of each a market maker can attract, the better theprobability any member has of finding a desired match. Another common type of network effect isevident in sites that offer recommendation systems, since the ability to develop such recommendationsimproves with more users and more data (Dieberger, Dourish, Hook, Resnick and Wexelblat, 2000).

The premise of this paper is that these assumptions about e-commerce do not always apply, and manycompanies that rigidly pursue an e-commerce strategy based upon them may experience less benefit thanotherwise. I argue that this dominant perspective has led to an underestimation and underutilization of e-commerce in local and regional settings, with a corresponding lack of emphasis on the ways that e-commerce works in concert with traditional forms of transactions, and with established trading partners.Based on a review of research findings, an alternative “situated e-commerce” approach is offered.2Following Steinfield (2003), a situated view of e-commerce implies that 1) physical location still matters,both for B2C and B2B e-commerce, 2) for firms with an existing physical retail presence, e-commerce maybe better viewed as complementary to, rather than a substitute for in-person transactions, and 3) particularlyin B2B situations, e-commerce may be best used to strengthen pre-existing relationships, and a focus purelyon network effects, especially in the supply chain, may do more damage than good.

The paper is organized as follows. In section two, the results of a multi-year program of research onthey dynamics of click and mortar firms are used to highlight the relevance of a situated perspective inbusiness-to-consumer e-commerce. Section three explores the business-to-business arena, paying particularattention to how a situated view explains many of the existing B2B e-commerce developments. It alsoexplores how such a view might enhance the relevance of e-commerce to local and regional businessclusters. Section four summarizes the key points and concludes the paper.

Towards a situated view of B2C E-Commerce

In the B2C arena, a situated view of e-commerce contrasts resource-based theories of how informationtechnology conveys competitive advantage with transaction cost theory. Resource-based theories explorehow companies can leverage existing assets in order to achieve benefit from IT investment (Teece, 1986;Zhu and Kraemer, 2002). Such assets include the existing outlets and supplier and customer relations, andthus are situated in firms’ particular geographical and business context. Transaction cost theoriesemphasize the nature of costs that firms incur in the process of conducting transactions with buyers orsellers (Williamson, 1975; Williamson, 1985). Such costs include information gathering and search costs,negotiation and settlement costs, and monitoring costs to ensure that trading partners adhere to the terms ofany agreements made.

In this section, we first note how a transaction cost view heavily influenced initial conceptions of B2C e-commerce. We then review a research program on click and mortar business models that highlights how asituated view of e-commerce can benefit companies with an existing retail presence. Unfortunately, despitesome evidence that such an approach yields benefits, we found that remains an under-developed businessmodel.

2 The term situated e-commerce is borrowed from the more popular notion of situated computing, which is used to refer

to computing that is contextually embedded in real world settings.

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Transaction Costs vs. a Complementary View of B2C E-Commerce

In the early years of Web-based commerce, much emphasis was placed on sources of competitiveadvantage that Internet firms had over traditional ones, primarily using a transaction cost logic (Bakos,1997; Choi et al., 1997). Information systems researchers relied heavily on transaction cost theory topredict that a major effect of the Internet would be to lower critical transaction costs, such as search andmonitoring costs (Bakos, 1997; Malone, Yates and Benjamin, 1987). Once search costs were reduced,buyers could then find sellers in distant geographic markets who had lower prices, provided better service,offered higher quality, or had products that better matched needs (Bakos, 1997; Cairncross, 1997; Choi etal., 1997; Malone et al., 1987; Wigand, 1997; Wigand and Benjamin, 1995; Wildman and Guerin-Calvert,1991). Virtual firms were thought to enjoy many advantages over traditional firms, including access towider markets, lower inventory and building costs, flexibility in sourcing inputs, improved transactionautomation and data mining capabilities, ability to bypass intermediaries, lower menu costs enabling morerapid response to market changes, ease of bundling complementary products, ease of offering 7X24 access,and no limitation on depth of information provided to potential customers (Afuah and Tucci, 2001;Anonymous, 2000; Bailey, 1998; Choi et al., 1997; Wigand, 1997; Wigand and Benjamin, 1995).

Many traditional retailers started with e-commerce by attempting to imitate Internet companies, fullyseparating their physical and virtual channels (Steinfield, Bouwman and Adelaar, 2002b). More recently,however, researchers have begun to focus on the potential synergies that can be obtained from thecombination of physical and e-commerce channels (Friedman and Furey, 1999; Otto and Chung, 2000;Rosen and Howard, 2000; Steinfield, Adelaar and Lai, 2002a; Steinfield et al., 2002b; Steinfield, DeWit,Adelaar, Bruin, Fielt, Smit, Hoofslout and Bouwman, 2001; Steinfield and Klein, 1999; Ward, 2001). Inthese works, the advantages of hybrid, “click and mortar” approaches to e-commerce are emphasized. Atthe same time, the history of e-commerce offers some empirical support for the notion that click and mortarapproaches to e-commerce are more successful than non-integrated approaches. By one estimate, only tenpercent of the dot.com firms that began in 1995 still survived in 2001 (Laudon and Traver, 2001).Moreover, Laudon and Traver (2001) also note that click and mortar retailers began to rapidly replacedot.com retailers in lists of top e-commerce firms in the years following the dot.com bust.

The underlying sources of advantage of click and mortar firms have been extensively analyzed bySteinfield and colleagues (Steinfield et al., 2002a; Steinfield et al., 2002b; Steinfield et al., 2001). Thebasic framework used by Steinfield and colleagues is depicted in Figure 1.

Fig. 1. Click and Mortar Conceptual Framework, Adapted from Steinfield et al., (2002a).

Sources ofSynergy

Common Infrastructure

Common Operations

Common Marketing& Sales

Common Buyers

Other ComplementaryAssets

SynergyBenefits

Potential Costs Savings

Differentiation through Value Added Services

Improved Trust

Market Extension

ManagementStrategies to

Achieve Synergies

Goal Alignment

Explicit Coordination& Control

CapabilityDevelopment

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Sources of Synergy Between Physical and Virtual Channels

Click and mortar firms have a number potential sources of synergy not necessarily available to pureInternet firms or traditional firms without an e-commerce channel. Among the sources spelled out inclassic competitive advantage theory are common infrastructures, common operations, common marketing,and common customers (Porter, 1985) (see Figure 1). An example of the use of a common infrastructure iswhen a firm relies on the same logistics system (warehouses, trucks, etc.) for handling distribution of goodsfor e-commerce activities as well as for delivery to its own retail outlets. Another critical infrastructure thatcan be shared is the IT infrastructure. Recent empirical work suggests, in fact, that the more firms buildtheir e-commerce capability in conjunction with an existing IT infrastructure the more likely they will seeperformance improvements (Zhu and Kraemer, 2002). An order processing system shared between e-commerce and physical channels is a good example of a common operation as a source of synergy. Thiscan enable, for example, improved tracking of customers’ movements between channels, in addition topotential cost savings. E-commerce and physical channels may also share common marketing and salesassets, such as a common product catalogue, a sales force that understands the products and customer needsand directs potential buyers to each channel, or advertisements and promotions that draw attention to bothchannels. Finally, an alternative perspective on the cannibalization issue is the fact that e-commerce andphysical outlets in click and mortar firms often target the same potential buyers. This enables a click andmortar firm to be able to meet customers’ needs for both convenience and immediacy, enhancing customerservice and improving retention. Hence, to the extent that virtual and physical channels are able to sharethese various assets in a coordinated fashion, a variety of benefits can emerge.

These various sources of synergy represent the many forms of situated or complementary assets thatclick and mortar firms possess that purely Internet firms may not. Established firms have existing supplierand distributor relationships, experience in the market, a customer base, and other complementary assetsthat can enable them to take better advantage of an innovation like e-commerce (Afuah and Tucci, 2001;Teece, 1986).

Click and Mortar Benefits With a Situated View of E-Commerce

The right-hand side of the framework in Figure 1 focuses on the potential benefits that click and mortarfirms may achieve when synergies between the Web and existing physical assets are exploited. In a seriesof case studies conducted in the Netherlands (Steinfield et al., 2002b) and the United States (Steinfield etal., 2002a), four broad areas of benefit were observed. These include: 1) lower costs, 2) increaseddifferentiation through value-added services, 3) improved trust, and 4) geographic and product marketextension. In general, each area of benefit reveals the importance of leveraging each firm's existingphysical presence, and treating e-commerce as a complementary rather than a substitute channel tocustomers.

Lower Costs

Cost savings may occur in a number of areas, including labor, inventory, marketing and promotion, anddistribution. Labor savings result when costs are switched to consumers for such activities as looking upproduct information, filling out forms, and relying on online technical assistance for after-sales service.Inventory savings arise when firms find that they can avoid having to stock infrequently purchased goods atlocal outlets, while still offering the full range of choices to consumers via the Internet. Marketing andpromotion efficiencies are garnered when each channel is used to inform consumers about services andproducts available in the other. Delivery savings may result from using the physical outlet as the pick-uplocation for online purchases, or as the initiation point for local deliveries.

Differentiation Through Value-added Services

Physical and virtual channel synergies can be exploited at various stages in a transaction in order to helpdifferentiate products and add value. Examples of pre-purchase services include various online informationaids to help assess needs and select appropriate targets, or, conversely, opportunities in the physicalenvironment to test out products. Examples of purchase services include ordering, customization, and

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reservation services, as well as easy access to complementary products and services. Post-purchaseservices include online account management, social community support, loyalty programs and variousafter-sales activities that may be provided either online or in the physical store. Typical opportunities are inthe areas of installation, repair, service reminders and training. Although many of these value-addedservices are potentially available to single-channel vendors, combined deployment of such services (e.g.online purchase of computer with in-store repair or training) can enhance differentiation and lock-in effects(Shapiro and Varian, 1999).

Improved Trust

Three reasons for improved trust, relative to pure Internet firms, derive from the fact that click and mortarfirms are physical and socially situated in the markets they serve. These include reduced consumer risk,affiliation with and embeddedness in recognized local social and business networks, and the ability toleverage brand awareness. Lower perceived risk results from the fact that there is an accessible location towhich goods can be returned or complaints can be registered (Tedeschi, 1999). Affiliation andembeddedness in a variety of social networks can facilitate the substitution of social and reputationalgovernance for expensive contracts or legal fees (Granovetter, 1985). DiMaggio and Louch (DiMaggio andLouch, 1998) show that, particularly for risky transactions, consumers are likely to rely on social ties as agovernance mechanism. Such ties are more likely to exist between geographically proximate buyers andsellers, suggesting that there may indeed be a preference for doing business with firms that are alreadyphysically present in the local market. Finally, marketing theorists have long recognized the power ofbranding as a means of building consumer confidence and trust in a product (Kotler, 1999). Establishedfirms are able to leverage a familiar name to make it easier for consumers to find and trust affiliated onlineservices (Coates, 1998).

Geographic and Product Market Extension

Many click and mortar firms seek to extend their reach beyond traditional physical outlets, addressing newgeographic markets with e-commerce. Even this benefit can be enhanced when companies realize thesituated nature of their e-commerce channel. Steinfield and colleagues found that several of click andmortar cases reported that online shoppers from distant markets were actually former physical customerswho had moved away but wanted to continue doing business with the firm. This was particularly the casefor culturally specific products that were hard to obtain in a shopper’s new home market. Moreover, somemarket extension comes not from reaching into new geographical locations, but from expanding into newproduct markets. Virtual channels can extend the product scope and product depth of physical channels byenabling firms to offer new products that they do not have to physically stock locally but that nicelycompliment existing offerings. Moreover, firms may add new revenue generating information servicesonline that further add value to existing products and services.

Managing Situated E-Commerce

The kinds of benefits discussed above are certainly not guaranteed to all firms. Indeed, firms with suchmultiple channels may fall prey to channel conflict. Channel conflicts can occur when the alternativemeans of reaching customers (e.g. a Web-based store) implicitly or explicitly competes with or bypassesthe existing physical channels, and are nothing new to e-commerce (Balasubramanian, 1998; Stern andAnsary, 1992). One common problem is that one channel may simply cannibalize sales from the other.Perceived threats caused by competition and conflict across channels can have other harmful effects,including limited cooperation across the channels, confusion when customers attempt to engage intransactions using the two uncoordinated channels, and even sabotage of one channel by the other(Friedman and Furey, 1999; Useem, 1999; Ward, 2001). A situated view of e-commerce – one thatrecognizes the need to carefully manage the way it is integrated into an existing business – is underscoredby the center column of Figure 1. These represent the kinds of management actions needed to diffusepotential conflicts and ensure the cooperation needed to achieve synergy benefits.

In the successful click and mortar companies, firms went through a process of goal alignment acrossphysical and virtual channels. They worked to ensure that all employees involved realized that the parent

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firm benefits from sales originating in either channel. Management and employees recognized the value ofexisting physical assets and did not seek to replace them with e-commerce, nor did they expect e-commerceto function as a stand-alone business. One problem faced by click and mortar firms is that the contributionsmade by the Internet channel may be intangible and hard to measure (Tedeschi, 2001a). Managers have tobe open to such intangible benefits and not, for example, evaluate e-commerce divisions purely on the basisof their own sales and profitability. Moreover, there must be agreement on what types of customers (e.g.existing vs. new) are targeted by the new e-commerce channel.

Aligning goals is only a first step. The more successful cases go further and implement explicitcoordination and control mechanisms to exploit synergy opportunities. These include mechanisms such asIT systems integration for ensuring interoperability so that customers may move freely between channels.In most cases, firms also demonstrated coordination by using each channel to promote the other. One ofthe most common strategies for enforcing cross-channel cooperation is to build in incentives, such as theallocation of e-commerce sales credit to specific outlets based on customers' addresses. Here again, thephysical location of customers and of outlets matters greatly. Finally, the successful click and mortar firmmanager recognized the differing cost structures and capabilities associated with each channel, anddeveloped measures that encouraged customers to use the most appropriate channel for the services theywere seeking.

In many situations, traditional firms may lack important competencies needed to achieve synergybenefits with e-commerce. For example, traditional firms may lack Web development skills, or logisticsskills needed to serve distant markets. In these situations, alliances may be more useful than attempting todevelop a virtual channel in-house.

Empirical Analyses of Click and Mortar Prevalence and Benefit

Although anecdotal evidence suggests that click and mortar retailers are emerging as a leading force in e-commerce (Laudon and Traver, 2001), a recent study in the United States finds that most retailers haverelatively underdeveloped integration strategies (Steinfield, in press-a). A content analysis of nearly athousand retailer websites in nine different retail industry sectors revealed that truly integrated physical andvirtual channels were not very uncommon and mainly focused on informational strategies. Nearly all of thesites studied provided an address and a telephone number to a physical outlet, and slightly more than twothirds provided a map or driving directions to stores. About half (52%) offered hours of operation orinformation on in-store events or specials (45%). However, most retailers did not address synergies beyondthese simpler forms of integration with click and mortar applications that required more IT sophistication.For example, in less than a fifth of sites could online shoppers search the inventory of a nearby store.Fewer than ten percent allowed customers to return online purchases at a physical retail outlet. About aquarter of the sites provided coupons or gift certificates online that could be redeemed in a physical outlet.In only six percent of the sites examined could online shoppers pick-up the item they ordered at a localphysical outlet. Clearly, many of the potential synergies between physical and virtual channels are goingunrealized in the majority of retailers that establish an e-commerce channel.

Some empirical evidence suggests that the pursuit of a more integrated e-commerce strategy yieldsbenefits to retailers (Steinfield, in press-a). A survey of eighty-one U.S. retailers measured aspects of ITand marketing integration, as well as changes in several business processes made to take better advantageof e-commerce. Each of these factors predicted the extent to which firms believed they had gained morethan their competitors from their e-commerce endeavors, over and above any differences from size orindustry sector. Although based on a relatively small sample, the results nonetheless suggest the potentialof situated e-commerce.

B2C Summary

Based on this review, we find that many of the advantages of click and mortar firms stem directly fromtheir ability to leverage existing physical presence in a given community. They are able to complementonline services with in-person customer interactions, and build on customer retention with an establishedcustomer base rather focusing primarily on costly customer acquisition. Hence, this review of B2C

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developments contradicts the three assumptions outlined at the outset of the paper and supports a situatedview of e-commerce.

Towards a Situated View of B2B E-Commerce

E-commerce researchers generally expect the value of B2B electronic transactions to vastly exceedbusiness-to-consumer (B2C) retail trade due to the enormous volume of goods and services traded betweenfirms (Garicano and Kaplan, 2001; Kaplan and Sawhney, 2000; Laudon and Traver, 2001; Subramami andWalden, 2000). Laudon (2001), reporting figures from a Jupiter Media Metrix report, estimated U.S. B2Btrade at $12 trillion in 2001, a surprising figure in that it exceeds the estimated GDP of the U.S. that year.As e-commerce began to take off in the late 1990s, the potential for even a small fraction of this trade to beconducted over the Internet attracted hundreds of new entrants seeking to established B2B marketplaces.As early as 2000, the U.S. Department of Commerce (2000) reported that more than 750 B2B e-marketswere operating worldwide in a range of different industries. Laudon and Traver (2001) estimated that morethan a thousand B2B network marketplaces were created prior to 2001.

Even before B2B trade moved onto the Internet, researchers focusing on interorganizational networksbegan to emphasize how open, standards-based data networks were leading to the establishment ofnetwork-based marketplaces (Malone et. al., 1987). Using transaction cost theory, these researcherspredicted that formerly limited and tightly-coupled electronic relationships (known as electronichierarchies) between a buying and a selling firm would give way to exchanges governed by the invisiblehand of the market (Malone et al., 1987). When Internet-based electronic commerce appeared, manybelieved that such an open network was here, and predicted the growth of vast electronic marketplaces thatwould add value by reducing search costs, increasing transaction efficiencies, and aggregating buyers andsellers to improve the likelihood that firms would be able to find a trading partner (Kaplan and Sawhney,2000). Just as with B2C e-commerce, a decidedly “unsituated” view of e-commerce was influential inshaping early Internet-based B2B marketplaces. These marketplaces sought to expand members’ options byreducing search costs, facilitating transactions, and aggregating buyers and sellers to improve liquidity(Kaplan and Sawhney, 2000).

To support a need for a situated view of B2B e-commerce, in this section we review evidence suggestingthat businesses tend to pursue electronic transactions with a small network of established and trustedtrading partners. We further argue that, in general, B2B electronic marketplaces that focused onaggregating buyers and sellers either for horizontal or vertical supplies, have largely failed. Rather mostB2B trade still occurs over private industrial networks, not open Internet-based exchanges. Whencompanies do join exchanges, it is more likely in private consortia dominated by larger buyers that limitparticipation.

Additional opportunities for a more situated application of B2B e-commerce can be deduced from theemerging focus on local and regional business clusters as a critical facet of economic growth and vitality(Breschi and Malerba, 2001; Porter, 1998). Unlike most e-commerce research, which usually begins fromthe assumption that electronic networks make distance and physical location irrelevant (Cairncross, 1997),those who study business clusters emphasize the crucial importance of proximity in encouragingknowledge sharing, reducing transaction costs, and stimulating innovation (Breschi and Malerba, 2001).

The section closes by noting that there is likely to be an underutilization of e-commerce for coordinationamong firms in local clusters. The success of local business clusters is often linked to social capitalexplanations, such as the importance of trust and social relationships, as a catalyst for knowledge sharingand innovation across firms that may not even be trading partners (Maskell, 2001). It appears that morepersonal forms of coordination enable coordination without the need for the types of B2B systems infashion today. We suggest that to succeed in these settings, e-commerce systems must be geographicallyand socially embedded, emphasizing rich communication and collaboration in addition to transactionsupport.

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The Evidence for Electronic Hierarchies and Small Networks

Research on inter-organizational systems embedded within particular business communities suggests thefallacy of ignoring the socially-embedded nature of inter-firm transactions. A case study of media buyersand sellers in France illustrates the conflicts that can arise when an information systems built from atransaction cost rationality opposes existing practices based upon personal relationships (Caby, Jaeger andSteinfield, 1998). The market for TV advertising had become more complex due to the liberalization of themarket and the resulting increase in private channels. An electronic marketplace was created by the mediaindustry, allowing media buyers to find available time slots and reserve them. Theoretically this wouldreduce selling costs and improve transaction efficiencies. It was built on France’s Minitel system, and sorequired minimal investment by the buyers. However, it soon failed, largely because it prevented many ofthe relationship-based selling strategies that media representatives preferred. They could not offer the besttimes and prices to their preferred customers, for example. Moreover, customers behaved strategically,often reserving time slots only to prevent competitors from obtaining them. Before long, the mediarepresentatives were bypassing their own system, and returned to their prior methods of selling media time.

An empirical study by Kraut and colleagues (Kraut, Steinfield, Chan, Butler and Hoag, 1998)investigated personal and electronic forms of transaction coordination between 250 producers and theirsuppliers in four different industries. Their research supports the application of a situated view of B2Belectronic trade. Kraut and colleagues found that electronic networks were more likely to be used whenthere were existing relationships between producers and suppliers, and greater use was associated withmore tightly-coupled producer-supplier relations. They explain this by pointing out that to be able toconduct electronic transactions, investments are required by the participants. Suppliers are unlikely tomake such investments unless they can expect a certain amount of business. This contradicts a rationalitybased on network effects, and predisposes firms to see more value when the number of participants in aB2B system is smaller rather than larger. In addition, e-commerce was complementary to, rather than asubstitute for personal relationships. This was evident in the finding of a positive association between thepresence of personal links and the extent to which firms engaged in electronic transactions. Moreover,there was an interesting interaction between the two: the more firms attempted to substitute electronictransactions for personal forms of coordination, the more errors and quality problems they experienced withtransactions. If they complemented electronic transactions with personal coordination, such problems weremitigated.

These results extend to the Internet. A recent study of a health insurance reseller provides evidence ofthe damage that can occur when an Internet-based B2B market approach replaces direct personal relationsbetween buyers and sellers (Schultze and Orlikowski, 2002). The study identified the mechanisms bywhich the provision of Internet-based services can turn relationships that formerly were partner-like intoweaker, broker-like ones. Agents in the firm complained that the reliance on information provided over theWeb enabled clients to bypass them, and reduced the sense of obligation that had formerly led clients tovoluntarily funnel claims through them. This loosening of a sense of obligation meant a real loss ofincome, as their commissions were dependent on having served as the intermediary for such claims.

The Rise and Fall of B2B Electronic Marketplaces

The initial Internet B2B electronic marketplaces mainly focused on the opportunities for improvedefficiencies in procurement processes (Kaplan and Sawhney, 2000; Laudon and Traver, 2001; Segev,Gebauer and Färber, 1999). The logic is similar to B2C e-commerce, with higher stakes. Transactionefficiencies arise from the ability of B2B electronic marketplaces to reduce the search and monitoring costsfor participating firms (Bakos, 1997; Bakos, 1998; Garicano and Kaplan, 2001; Segev et al., 1999;Steinfield, Chan and Kraut, 2000). In the height of the dot.com euphoria, the B2B e-hub was one of themost prominent new business models in what was then called the “digital economy” (Timmer, 1998).However, despite the widespread optimistic projections by industry consultants, academic analysts andgovernment policy makers (Katsaros, Shore, Leathern and Clark, 2000; U.S.DepartmentofCommerce,2000), most third party-provided B2B marketplaces have failed (Laudon and Traver, 2001; Tedeschi,2001b).

The failure of third party B2B marketplaces does not mean that B2B e-commerce is unimportant. Just aswith B2C e-commerce, B2B e-commerce continues to grow. However, it is based upon different

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approaches that are not shaped so forcefully by the earlier dominant assumptions. In particular, it isimportant to distinguish between Internet-based network marketplaces and private industrial networks(Laudon and Traver, 2001). B2B Internet marketplaces are generally classified according to two importantdimensions of business purchasing: how businesses buy and what businesses buy (Kaplan and Sawhney,2000). The “how” dimension distinguishes between spot purchasing to fill an immediate need, andsystematic purchasing for planned, long term needs. The former is often done using ephemeral, market-based transactions, without long term contracts. The latter is often done after significant negotiation, and isused for purchasing in large volumes from trusted trading partners. The “what” dimension normallydistinguishes between vertical (also called direct or manufacturing) inputs that relate to the core products ofa firm and horizontal (often called indirect or MRO for maintenance, operating and repair) inputs, such asoffice supplies, that are acquired by all firms.

Laudon and Traver (2001) distinguish between the four types of Internet-based B2B marketplaces: 1) E-distributors such as Grainger.com or Staples.com that offer electronic catalogues representing thousands ofsuppliers in support of spot purchasing for horizontal inputs. They add value by reducing search costs. 2)E-procurement services such as Ariba.com that also offer MRO supplies, but focus on systematicpurchasing rather than spot purchasing. They offer a range of procurement services, including the licensingof procurement software that supports a range of value-added services. They do not own the supplies, butoffer the catalogues of thousands of suppliers from whom they also obtain fees and commissions. Theytheoretically bring value by aggregating both buyers and sellers, decreasing search costs for both parties,and therefore are subject to significant positive network externalities. 3) Exchanges (e.g. the former E-Steel) are intermediaries that focus on bringing together buyers and sellers within a particular industry, andconcentrate on the spot purchasing of manufacturing inputs. They charge commissions, but offer a range ofpurchasing services to buyers and sellers, supporting price negotiations, auctions, and other forms ofbidding in addition to normal fixed-price selling. Buyers benefit from greater choice and lower prices,while sellers gain access to large numbers of buyers. Often these vertical markets are used to unloadsurplus materials, for example, via auctions. They are also subject to network externalities. 4) Industryconsortia are best represented by Covisint, the electronic procurement system developed by the leadingautomobile manufacturers. These exchanges are typically jointly owned by large buying firms seeking torely on electronic networks to support long term relationships with their suppliers. Entrance is by invitationonly, and the buying clout of the founding companies influences suppliers to make the investments neededto participate.

In contrast to these various forms of network marketplaces, private industrial networks are closed usergroup affairs, mainly linking a small set of strategic partners together with private infrastructure (Laudonand Traver, 2001). These strategic partners may be organized by a focal firm such as a manufacturer,which, together with its suppliers and downstream channels is seeking greater efficiencies in serving theircommon market. Well known examples of such interorganizational networks organized by large focalfirms include those set up by WalMart, Siemens, and Procter & Gamble (Laudon and Traver, 2001). Theseprivate industrial networks often encompass a particular value chain enabling just-in-time inventory,efficient consumer response, and collaborative design and production. Increasingly, industry observers arefocusing on value-webs, in which the respective value chains of all the strategic partners are incorporatedinto the network to seek out new ways to gain efficiencies and add value for end-customers. Clearly, thesenetworks span distances, allowing firms to do business more efficiently with remote suppliers. However,an important caveat is that the empirical evidence suggests that such buyer seller relations are more likelyto have preceded the formation of the network, rather than having resulted from it (Kraut et al., 1998).

Supporting the situated view of B2B e-commerce is the fact that the vast majority of B2B electronictrade occurs over private industrial networks. Laudon and Traver (2001), in fact, estimated that 93% ofelectronic B2B trade occurred on private networks, rather than Internet-based e-marketplaces. Moreover,among the network marketplace models described above, the fastest growth is in the area of industryconsortia, which is arguably the most situated of all the Internet-based market models. The high failure rateof third-party B2B e-hubs, coupled with the dominance of private networks and the growth of industryconsortia reflects an important dynamic. Businesses have established relations with their suppliers, and thetrust engendered by reliable performance and commitment over the long term may be more valuable tofirms than any short term price advantages offered by the supposedly neutral marketplaces. Indeed animportant trend in the B2B electronic trade arena is the rise of “collaborative e-commerce” where networksare used for far more than simple transaction support. Joint product design, more tightly integratedinventory databases, and other forms of coordination between producers and suppliers occur over private

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intranets. In a sense, these developments are merely the latest manifestation of what Malone andcolleagues (1987) referred to as electronic hierarchies, where firms rely on networks to facilitateoutsourcing, but only to a small number of firms with which they are tightly integrated. Substantialempirical evidence exists suggesting that these inter-organizational forms are more common and long-lasting than the market exchanges (Kraut et al., 1998; Steinfield, Kraut and Plummer, 1995).

Rarely is the role of location discussed in the literature on Internet-based B2B electronic markets, andthe relationship between geography and B2B e-commerce is not as straightforward as with B2C click andmortar e-commerce. There is some empirical evidence, however, showing that even over public Internet-based B2B exchanges, geography plays an important role in shaping trading patterns. A recent study ofpublic B2B e-markets in Korea examined two types of markets - those in which buyers and sellers foundeach other and completed transactions and those in which the marketplace functioned as an agent,completing the transaction on behalf of the buyer (Choi, 2003). The spatial patterns of transactions over asix month period in 2002 were examined, revealing that when buying firms made the purchases themselves,they were more likely to purchase from suppliers within their own region of Korea. However, agent-mediated purchases were more likely to be directed toward suppliers outside the region, and mainly tosuppliers located in the Seoul metropolitan area. The former finding suggests that firms prefer to buy fromknown local trading partners, even when using a public e-marketplace. The latter finding at first suggeststhat e-marketplaces do provide access to distant suppliers. However, some impact of location exists evenhere, since nearly all public B2B e-marketplaces in Korea are based in the Seoul region and it may be thatthe agent that prefers known local suppliers.

Geographically Defined Business Communities as an Opportunity for Situated B2B E-commerce

Given the above evidence, an as yet under-developed opportunity exists to explore the applications of e-commerce in established geographically defined business communities. Economists and geographers havestudied the significant role that location plays in the formation and maintenance of business tradingcommunities, primarily within the context of discussions about business clusters (Porter, 1990; Porter,1998; Porter, 2000). Porter (1998) defines a cluster as a “critical mass of companies in a particular field ina particular location…” He further notes that they can include “…a group of companies, suppliers ofspecialized inputs, components, machinery, and services, and firms in related industries.” They can alsoinclude “firms in downstream industries, producers of complementary products, specialized infrastructureproviders, and other institutions that provide specialized training, and technical support” as well as industrygroups such as trade associations. This description parallels the structure of many of the electronicbusiness trading communities established in the past several years, except that Porter’s cluster members arephysically co-located in a particular region.

Several of the primary economic benefits ascribed to business clusters are similar to the main benefits ofparticipation in a B2B electronic market: improved access to specialized inputs, lower transaction costs,and access to complementary goods and services. Clusters are also thought to enhance the rate ofinnovation among member firms.

Rather than relying on electronic networks and automation to achieve these transactional andinformational advantages, clusters capitalize on proximity. A concentration of skilled workers, forexample, increases access to needed labor inputs. Proximity helps in many less formal ways, however. Ashas been shown repeatedly in analyses of such clusters as Silicon Valley, knowledge sharing can occurthrough spontaneous or chance encounters between professionals living in the same community, enhancingoverall innovation capacity (Maskell, 2001; Rogers and Larsen, 1984; Saxenian and Hsu, 2001). Porter(1998) further refers to the advantages of common language, culture, and social institutions in reducingtransaction costs, and notes that local institutions are likely to be more responsive to the specialized needsof a cluster (e.g. for creating public infrastructure). He even points to peer pressure and the presence ofrivals as causes for the enhanced competitiveness of firms that are embedded in a local cluster.

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The Potential of E-Commerce in Local Business Clusters

Given the economic importance of local and regional clusters, they would seem to offer an excellentcontext for e-commerce, both for intracluster coordination and to link clusters to the export markets theyserve. The research on IT use in local business clusters is somewhat mixed regarding the potential of e-commerce. In the early years of e-commerce, there were some efforts to establish regionally-oriented mallsto highlight area businesses and activities, such as the Electronic Mall Bodensee (Zimmermann, 1997).However, such regional malls were quite broad, and often were driven by local chambers of commerce,rather than focusing on a particular industry sector as in the above discussion of clusters. Many had a retailfocus, as well, and were not built mainly for B2B trade support.

Some hints regarding the importance of geography on electronic B2B trade can be found in studies ofInternet traffic. That electronic transactions might follow from physical proximity is suggested by Castell’s(2001) fascinating account of the geography of the Internet, where he points out the spatial concentrationassociated not only with producers of Internet content and infrastructure, but among firms that use theInternet. The following quote illustrates this line of reasoning (Castells, 2001): “…these advanced servicecenters are territorially concentrated, built on interpersonal networks of decision-making processes,organized around a territorial web of suppliers and customers, and increasingly communicated by theInternet among themselves (page 228).” Indeed, one study of Internet traffic demonstrated that themajority of IP traffic flows within, rather across locations (Kolko, 2000). Business-to-business transactionsare embedded in an enabling social and cultural context, yet in striving for transaction efficiencies, mostefforts to create electronic networks to support transactions go to great lengths to ignore and even bypassthis context.

Such analyses of Internet traffic are suggestive, but more specific analyses of IT use for commerce andcoordination in local business clusters reveal the fundamental challenges of replacing highly developedsocial exchange processes with electronic transactions. In these more specific studies, the outcomes ofinter-organizational systems suggest a lack of fit between typical B2B marketplace designs and localbusiness cluster needs. They offer insights into why private networks continue to dominate in B2Bcommerce.

A good deal of research on IT use in a geographically defined business cluster has been conducted in theindustrial region of Northern Italy. Some years ago, Johnston and Lawrence’s (1988) seminal work onvalue-adding partnerships focused extensively on the Prato area textile industry. Their analysis examinedhow the large textile mills formed had disaggregated into small, specialized firms that focused on one partof the overall value chain in textile production (e.g. washing, coloring, cutting,, etc.). They showed hownetworks of firms worked in concert to meet the market demands for the good of the network, and pointedout how an inter-organizational information system was being used to facilitate coordination (Johnston andLawrence, 1988). However, a decade later, Kumar and colleagues revisited the merchants of Prato, andfound that the information system had been all but abandoned (Kumar, van Dissel and Bielli, 1998). Thesystem offered no real added value in terms of transaction cost reductions over the personal forms ofcoordination that had evolved over centuries of textile production in the region. Kumar et al (1998) suggestthat trust and personal relationships – the social capital of the region – were effective substitutes for theinter-organizational system, rendering it unnecessary.

Social Capital Perspectives on the Undersupply of B2B Electronic Coordination in LocalBusiness Clusters

Many of the advantages of local clusters are rooted in the extent to which businesses capitalize on what hasbeen termed social capital. A growing group of theorists now explicitly recognize the importance of socialcapital as a resource that enhances competitive advantage (see Adler and Kwon, 2002; Nahapiet andGoshal, 1998 for reviews). Although definitions of social capital differ somewhat, especially given itsapplication across disparate contexts and disciplines, the primary focus is generally on the resources arisingfrom personal relationships that individuals may draw upon in various aspects of their social life(Huysman, 2002). Hence, it functions much like other forms in capital in that it can be accumulated, andthe “capital” from one relationship in one context may beneficial in other contexts. A businessperson may,for example, be referred to a new supplier through a common acquaintance met at an athletic club orchurch.

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Recent theoretical work emphasizes the multidimensional nature of social capital (Adler and Kwon,2002; Nahapiet and Goshal, 1998; Tsai and Goshal, 1998). Nahapiet and Goshal (1998) develop aframework to explain how social capital can provide advantages to individuals and firm with three basicdimensions: structural, relational, and cognitive. The structural dimension refers to the pattern of social tiesfor a given individual. People are embedded in a network of ties, which can function as conduits to neededinformation and resources. The relational dimension underscores the importance of trust and a sense ofobligation that arises from close personal contacts. Empirical work has demonstrated that people often turnto trusted personal contacts, especially for high risk transactions, in order to reduce vulnerability toopportunism and other transaction costs (Dimaggio and Louch, 1999). The cognitive dimension focuses onthe notion that exchanges of information and other resources are facilitated by shared codes or knowledgethat enable common goals and common understanding. It offers a distinct resource not tied directly tospecific personal relationships, but develops as a public good in a particular social system based oninteractions among its members. As discussed by Huysman (2002), Nahapiet and Goshal’s (1998) threedimensions are quite similar to Adler and Kwon’s (2002) framework, in which social capital operates byproviding opportunities, motivation and ability. Opportunities arise from participation in a network(structure), motivation arises from the qualities embedded in relationships (relational), and ability requirescommon understanding (cognitive).

Social capital theory provides a powerful lens through which many of the advantages of geographicallyproximate business clusters can be understood and extended. Access to skilled labor may be enhanced, forexample, when complemented by referrals from social contacts that help link up people searching for workwith firms seeking employees. Spontaneous interactions, which Porter argues facilitate innovation, occurbecause social embeddedness and proximity afford opportunities for such encounters. The commonlanguage, culture and social institutions represent the basis for shared understanding and goals thatcomprise the cognitive/ability dimension emphasized by social capital theorists.

Although Porter does not dwell on the relational aspects of social capital, much of the cluster researchprovides ample evidence of the potential economic benefits arising from this dimension. The sense ofobligation, goodwill and reciprocity that emerges from strong relationships can have important economicbenefits. Social embeddedness researchers posit that, at least at the extremes, there are basically two kindsof relationships through which economic transactions occur: 1) arms-length ties characterized by short termand constantly shifting ties among loose collections of firms or individuals, and 2) embedded tiescharacterized by stable and long term relationships (Powell, 1990; Uzzi, 1997, 1999). Transaction costtheory considers the former to be market-like, and efficient, allowing self-interested actors to avoidopportunism through their ability to easily switch to a new buyer or seller (Williamson 1975). In atransaction cost economics view, economic exchanges that are dependent upon social networks can resultin inefficiencies as social obligations prevent actors from pursuing transactions with higher quality or lowercost partners. In contrast, social embeddedness researchers have found distinct advantages to a reliance byorganizational actors on a limited number of trusted relations for their most critical economic exchanges.These include reduced search costs to find appropriate trading partners, lower monitoring costs as trustarising from social obligation and the importance of maintaining a reputation within a social structure workagainst undue opportunistic behavior, time savings through personal advice and referrals, higher qualityinformation transfer among actors, greater emphasis on joint problem solving, and an increased likelihoodthat new transactions will remain within a relationship rather than be directed towards new partners(Granovetter, 1985; Powell, 1990; Uzzi, 1997). Uzzi (1997) found empirical support for these benefits inhis study of social embeddedness in the garment business in New York.

To the extent that such strong ties develop over a long period of time and are sustained by interactions inother social contexts such as community associations or social gatherings, then clearly proximity should becorrelated with their incidence. Hence, social capital theory offers fertile ground for understanding manyof the dynamics of local business clusters, including the relative underutilization of B2B e-marketplaces asinternal and external coordination mechanisms.

B2B Summary

The analysis of B2B electronic trade, focusing especially on the dramatic rise and fall of Internet-based,third party B2B marketplaces, provides further evidence for questioning the assumptions outlined at thestart of the paper. Most B2B electronic trade still occurs over private industrial networks rather than via

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open B2B exchanges (Laudon and Traver, 2001). The rise of industry consortia, and the growth ofcollaborative e-commerce suggest that a more situated view of B2B electronic trade is needed. Indeed, theemphasis exclusively on network effects may have unwittingly made electronic marketplaces less valuableto potential participants, as it implied that business with former trading partners might have to be sharedwith more competitors. Instead, empirical research suggests that electronic transactions are more likely tooccur between established trading partners in long term relations than via ephemeral spot trades (Kraut etal., 1998). A situated view is also suggested by the evidence of a preference for locally based suppliers,even on public B2B exchanges (Choi, 2003). A potential opportunity for geographically situated B2B e-commerce emerges from the focus on the importance of regional business clusters (Porter, 2000). The roleof social capital in these clusters also suggests that for B2B e-commerce to succeed, it also must be sociallysituated or embedded as well. The limited research on IT use in local business clusters suggests thattraditional forms of coordination often supercede electronic coordination, and may make it difficult forsuch e-commerce approaches to gain a foothold (Kumar, et al, 1998).

Conclusion

This review of B2C and B2B electronic commerce has attempted to illustrate the dangers of overlyfocusing on the distance insensitivity, transaction automation capability, and network externalitycharacteristics as the overriding logic guiding business model development. In place, a situated perspectivewas introduced, emphasizing the coupling of e-commerce to physical presence in a market, richer andoffline modes of interaction, and existing customers and supply chain partners. The analysis encourages anapproach to e-commerce that is sensitive to the potential complementary benefits it offers to existing offlinebusiness activities.

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