value creation in e-business

Strategic Management JournalStrat. Mgmt. J.,22: 493–520 (2001)

DOI: 10.1002/smj.187

VALUE CREATION IN E-BUSINESS

RAPHAEL AMIT1* and CHRISTOPH ZOTT2

1The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania,U.S.A.2INSEAD, Fontainebleau Cedex, France

We explore the theoretical foundations of value creation in e-business by examining how 59American and European e-businesses that have recently become publicly traded corporationscreate value. We observe that in e-business new value can be created by the ways in whichtransactions are enabled. Grounded in the rich data obtained from case study analyses and inthe received theory in entrepreneurship and strategic management, we develop a model of thesources of value creation. The model suggests that the value creation potential of e-businesseshinges on four interdependent dimensions, namely: efficiency, complementarities, lock-in, andnovelty. Our findings suggest that no single entrepreneurship or strategic management theorycan fully explain the value creation potential of e-business. Rather, an integration of thereceived theoretical perspectives on value creation is needed. To enable such an integration,we offer the business model construct as a unit of analysis for future research on valuecreation in e-business. A business model depicts the design of transaction content, structure,and governance so as to create value through the exploitation of business opportunities. Wepropose that a firm’s business model is an important locus of innovation and a crucial sourceof value creation for the firm and its suppliers, partners, and customers.Copyright 2001John Wiley & Sons, Ltd.

INTRODUCTION

As we enter the twenty-first century, businessconducted over the Internet (which we refer toas ‘e-business’), with its dynamic, rapidly grow-ing, and highly competitive characteristics, prom-ises new avenues for the creation of wealth.Established firms are creating new online busi-nesses, while new ventures are exploiting theopportunities the Internet provides. In 1999,goods sold over the Internet by U.S. firms wereestimated to be $109 billion and by the end of2000 should reach $251 billion.1 By 2002, it is

Key words: value creation; e-business; business model*Correspondence to: R. Amit, The Wharton School, Universityof Pennsylvania, 3620 Locust Walk, Philadelphia, PA 19104-6370, U.S.A.1 Source: Forrester Research.

Copyright 2001 John Wiley & Sons, Ltd.

likely that over 93 percent of U.S. firms willhave some fraction of their business trade conduc-ted over the Internet.2 Although U.S. firms areconsidered world leaders in e-business, the rapidgrowth of the number of businesses that use theInternet is a global phenomenon. Over the periodof 1999 to 2001, Europe is expected to bridgethe e-business gap with the United States byexperiencing triple-digit growth in this area. Bythe end of 2000, European firms’ e-retail revenuesare estimated to be worth $8.5 billion, increasingto an estimated $19.2 billion by 2001, as com-pared to North America’s figures of $40.5 billion(for 2000) which are expected to increase to

2 Source: Forrester Research Report, ‘eMarketplaces BoostB2B Trade,’ February 2000.

494 R. Amit and C. Zott

$67.6 billion (for 2001).3 The increase in thenumber of e-business transactions at major websites (60,000 per day in 1999 compared to 29,000per day in 1998)4 highlights the extraordinarygrowth and transformation of this new globalbusiness landscape.5

E-business has the potential of generatingtremendous new wealth, mostly through entrepre-neurial start-ups and corporate ventures. It is alsotransforming the rules of competition for estab-lished businesses in unprecedented ways. Onewould thus expect e-business to have attractedthe attention of scholars in the fields ofentrepreneurship and strategic management.Indeed, the advent of e-business presents a strongcase for the confluence of the entrepreneurshipand strategy research streams, as advocated byHitt and Ireland (2000) and by McGrath andMacMillan (2000). Yet, academic research on e-business is currently sparse. The literature to datehas neither articulated the central issues relatedto this new phenomenon, nor has it developedtheory that captures the unique features of vir-tual markets.

This paper attempts to fill this theoretical gapby seeking to identify the sources of value cre-ation in e-business. To do this, we begin thepaper with a theory section that highlights thevalue creation potential embedded in virtual mar-kets, and that explores the sources of value cre-ation in the received entrepreneurship and stra-tegic management literatures. Specifically, wereview how value is created within the theoreticalviews of the value chain framework (Porter,1985), Schumpeter’s theory of creative destruc-tion (Schumpeter, 1942), the resource-based viewof the firm (e.g., Barney, 1991), strategic networktheory (e.g., Dyer and Singh, 1998), and trans-action costs economics (Williamson, 1975). Wealso discuss the applicability of these theories in

3 Source: Forrester Research Report, ‘Global eCommerceApproaches Hypergrowth,’ April 2000.4 Source: Jupiter Communications (2000).5 While e-business is still growing at an overall impressiverate, we are now witnessing a slowdown in the Business-to-Consumer (B2C) growth rate and an acceleration of theBusiness-to-Business (B2B) growth rate. The B2C segmenthas grown at an annual rate of 76 percent since 1998 com-pared to an annual growth rate of 110 percent in the B2Bsegment (source: the Gartner Group). This argument isadditionally strengthened by the forecasts that predict B2B e-business to reach $2.7 trillion in 2004, representing over 17percent of the total trade, while online retail (B2C) is expectedto represent less then 7 percent of total retail at that time.

Copyright 2001 John Wiley & Sons, Ltd. Strat. Mgmt. J.,22: 493–520 (2001)

the context of the emergence of virtual markets.In the data and methods section that follows thetheory section, we describe the grounded theorydevelopment methodology (Glaser and Strauss,1967) that we used to determine which of thesources of value suggested by the literature aregermane to e-businesses. The terms ‘source ofvalue creation’ and ‘value driver’ (which are usedinterchangeably in this paper) refer to any factorthat enhances the total value created by an e-business. This value, in turn, is the sum of allvalues that can be appropriated by the participantsin e-business transactions (Brandenburger andStuart, 1996). The data and methods section isfollowed by a presentation of the findings thatemerged from our analysis of 59 e-businesses.Although we do not go into detail on each ofthe businesses studied, we use examples from ourexploration to illustrate the concepts that emerged.Our analysis reveals four primary and interrelatedvalue drivers of e-businesses: novelty, lock-in,complementarity, and efficiency. We observe thatvalue creation in e-business goes beyond thevalue that can be realized through the configu-ration of the value chain (Porter, 1985), the for-mation of strategic networks among firms (Dyerand Singh, 1998), or the exploitation of firm-specific core competencies (Barney, 1991). E-business firms often innovate through novelexchange mechanisms and transaction structuresnot present in firms that are more traditional.Throughout the discussion of the value drivers ofe-business, we include some observations regard-ing the interrelationships among the four drivers.

In the discussion section of the paper, we buildon our findings to offer some new ways ofintegrating the entrepreneurship and strategicmanagement literatures. Our central observationsare that no single entrepreneurship or strategicmanagement theory can fully explain the valuecreation potential of e-business. Rather, each ofthe theories offers an important insight into oneaspect of value creation in e-business. In anattempt to contribute to the work that seeks tointegrate entrepreneurship and strategic man-agement perspectives (e.g., Jones, Hesterly, andBorgatti, 1997; Gulati, 1999; Hitt and Ireland,2000; McGrath and MacMillan, 2000), we pro-pose the business model construct as a unifyingunit of analysis that captures the value creationarising from multiple sources. The business modeldepicts the design of transaction content, struc-

Value Creation in E-Business 495

ture, and governance so as to create value throughthe exploitation of business opportunities. Byaddressing the central issues in e-business thatemerge at the intersection of strategic man-agement and entrepreneurship, we hope to con-tribute to theory development in both fields. Thepaper concludes with final observations andavenues for further research.

THEORY

Before reviewing the sources of value creationimplied by a range of theoretical perspectives inthe entrepreneurship and strategic managementliteratures, we begin this section by highlightingthe value creation potential embedded in virtualmarkets. Our literature review then focuses onvalue chain analysis, Schumpeterian innovation,the resource-based view of the firm, strategicnetwork theory, and transaction cost economics.For each of these perspectives, we describe themain theoretical approach, expose the mainsources of value creation suggested, and discussthe theoretical implications of the emergence ofvirtual markets.

Virtual markets

Virtual markets refer to settings in which businesstransactions are conducted via open networksbased on the fixed and wireless Internet infra-structure. These markets are characterized by highconnectivity (Dutta and Segev, 1999), a focus ontransactions (Balakrishnan, Kumara, and Sundare-san, 1999), the importance of information goodsand networks (Shapiro and Varian, 1999), andhigh reach and richness of information (Evansand Wurster, 1999). Reach refers to the numberof people and products that are reachable quicklyand cheaply in virtual markets; richness refers tothe depth and detail of information that can beaccumulated, offered, and exchanged betweenmarket participants. Virtual markets have unprec-edented reach because they are characterized bya near lack of geographical boundaries.6

6 The difficulty that some e-business firms experience in estab-lishing a pan-European presence indicates that there still existcertain barriers to business, due, for example, to local languagesand tastes, or to cross-border logistics. However, the importanceof geographical boundaries still appears to be vastly reducedrelative to the traditional ‘bricks-and-mortar’ world.


As an electronic network with open standards,the Internet supports the emergence of virtualcommunities (Hagel and Armstrong, 1997) andcommercial arrangements that disregard tra-ditional boundaries between firms along the valuechain. Business processes can be shared amongfirms from different industries, even without anyawareness of the end customers. As more infor-mation about products and services becomesinstantly available to customers, and as infor-mation goods (Shapiro and Varian, 1999) aretransmitted over the Internet, traditional inter-mediary businesses and information brokers arecircumvented (‘dis-intermediated’), and the guid-ing logic behind some traditional industries (e.g.,travel agencies) begins to disintegrate. At thesame time, new ways of creating value are openedup by the new forms of connecting buyers andsellers in existing markets (‘re-intermediation’),and by innovative market mechanisms (e.g.,reverse market auctions) and economicexchanges.

There are several other characteristics of virtualmarkets that, when considered together, have aprofound effect on how value-creating economictransactions are structured and conducted. Theseinclude the ease of extending one’s product rangeto include complementary products, improvedaccess to complementary assets (i.e., resources,capabilities, and technologies), new forms of col-laboration among firms (e.g., affiliate programs),the potential reduction of asymmetric informationamong economic agents through the Internetmedium, and real-time customizability of productsand services. Industry boundaries are thus easilycrossed as value chains are being redefined(Sampler, 1998). This in turn may affect thescope of the firm as opportunities for outsourcingarise in the presence of reduced transaction costsand increased returns to scale (see Lucking-Reileyand Spulber, 2001; for example, many companiesnow find it economically viable to outsource theirIT services).

In summary, the characteristics of virtual mar-kets combined with the vastly reduced costs ofinformation processing7 allow for profoundchanges in the ways companies operate and in

7 According toThe Economist, 23 September 2000 (‘A surveyof the new economy’, p. 6) the cost of sending 1 trillion bitselectronically has dropped from $150,000 to $0.12 in the past30 years.


how economic exchanges are structured. Theyalso open new opportunities for wealth creation.Thus, conventional theories of how value is cre-ated are being challenged.

Value chain analysis

Porter’s (1985) value chain framework analyzesvalue creation at the firm level. Value chainanalysis identifies the activities of the firm andthen studies the economic implications of thoseactivities. It includes four steps: (1) defining thestrategic business unit, (2) identifying criticalactivities, (3) defining products, and (4) determin-ing the value of an activity. The main questionsthat the value chain framework addresses are asfollows: (1) what activities should a firm perform,and how? and (2) what is the configuration ofthe firm’s activities that would enable it to addvalue to the product and to compete in its indus-try? Value chain analysis explores the primaryactivities, which have a direct impact on valuecreation, and support activities, which affect valueonly through their impact on the performance ofthe primary activities. Primary activities involvethe creation of physical products and includeinbound logistics, operations, outbound logistics,marketing and sales, and service.

Porter defines value as ‘the amount buyers arewilling to pay for what a firm provides them.Value is measured by total revenue … A firm isprofitable if the value it commands exceeds thecosts involved in creating the product’ (Porter,1985: 38). Value can be created by differentiationalong every step of the value chain, throughactivities resulting in products and services thatlower buyers’ costs or raise buyers’ performance.Drivers of product differentiation, and hencesources of value creation, are policy choices(what activities to perform and how), linkages(within the value chain or with suppliers andchannels), timing (of activities), location, sharingof activities among business units, learning, inte-gration, scale and institutional factors (see Porter,1985: 124–127). Porter and Millar (1985) arguethat information technology creates value by sup-porting differentiation strategies.

Value chain analysis can be helpful in examin-ing value creation in virtual markets. Forexample, Amazon.com decided to build its ownwarehouses in order to increase the speed andreliability of the delivery of products ordered


online. By doing so, it was able to add value tosales and fulfillment activities. Stabell and Fjeld-stad (1998) found the value chain model moresuitable for the analysis of production and manu-facturing firms than for service firms where theresulting chain does not fully capture the essenceof the value creation mechanisms of the firm.Citing the example of an insurance company,they ask: ‘What is received, what is produced,what is shipped?’ (Stabell and Fjeldstad, 1998:414). Similar questions can be asked about theactivities of e-business firms such as Amazon.comand about e-businesses whose main transactionsinvolve the processing of information flows.Building on this insight, Rayport and Sviokla(1995) propose a ‘virtual’ value chain thatincludes a sequence of gathering, organizing, se-lecting, synthesizing, and distributing information.While this modification of the value chain conceptcorresponds better to the realities of virtual mar-kets, and in particular to the importance of infor-mation goods (Shapiro and Varian, 1999), theremay still be room to capture the richness of e-business activity more fully. Value creationopportunities in virtual markets may result fromnew combinations of information, physical prod-ucts and services, innovative configurations oftransactions, and the reconfiguration and inte-gration of resources, capabilities, roles andrelationships among suppliers, partners and cus-tomers.

Schumpeterian innovation

Schumpeter (1934) pioneered the theory of eco-nomic development and new value creationthrough the process of technological change andinnovation. He viewed technological developmentas discontinuous change and disequilibriumresulting from innovation. Schumpeter identifiedseveral sources of innovation (hence, valuecreation) including the introduction of new goodsor new production methods, the creation of newmarkets, the discovery of new supply sources, andthe reorganization of industries. He introducedthe notion of ‘creative destruction’ (Schumpeter,1942) noting that following technological changecertain rents become available to entrepreneurs,which later diminish as innovations become estab-lished practices in economic life. These rentswere later named Schumpeterian rents, defined asrents stemming from risky initiatives and entre-


preneurial insights in uncertain and complexenvironments, which are subject to self-destruction as knowledge diffuses. In his earlywork, Schumpeter (1934, 1939) highlighted thecontribution of individual entrepreneurs andplaced an emphasis on the innovations and ser-vices rendered by the new combinations ofresources.

In Schumpeter’s theory, innovation is thesource of value creation. Schumpeterian inno-vation emphasizes the importance of technologyand considers novel combinations of resources(and the services they provide) as the foundationsof new products and production methods. These,in turn, lead to the transformation of markets andindustries, and hence to economic development.Teece (1987) adds that the effectiveness of pro-tective property rights (appropriability regime)and complementary assets can add to the valuecreation potential of innovations. Moran and Gho-shal (1999) highlight the role of economicexchange through which the latent value imbed-ded in the new combination of resources is realiz-able. Hitt and Ireland (2000) contribute to thistheory by addressing the determinants and conse-quences of the innovation process and by linkingthis process with the strategic management ofgrowing enterprises.

As innovative entrepreneurs exploit new oppor-tunities for value creation, the evolution of theresulting virtual markets can be described in termsof Schumpeter’s model of creative destruction.However, virtual markets broaden the notion ofinnovation since they span firm and industryboundaries, involve new exchange mechanismsand unique transaction methods (rather thanmerely new products, or production processes),and foster new forms of collaborations amongfirms. Furthermore, while innovation is certainlya major driving force of the economic develop-ment of new and established markets, it may notbe the only source of value creation in virtualmarkets, as suggested by the other theoreticalframeworks reviewed in this section.

Resource-based view of the firm

The resource-based view (RBV) of the firm,which builds on Schumpeter’s perspective onvalue creation, views the firm as a bundle ofresources and capabilities. The RBV states thatmarshalling and uniquely combining a set of com-


plementary and specialized resources and capa-bilities (which are heterogeneous within an indus-try, scarce, durable, not easily traded, and difficultto imitate), may lead to value creation (Penrose,1959; Wernerfelt, 1984; Barney, 1991; Peteraf,1993; Amit and Schoemaker, 1993). The supposi-tion is that, even in equilibrium, firms may differin terms of the resources and capabilities theycontrol, and that such asymmetric firms maycoexist until some exogenous change or Schum-peterian shock occurs. Hence, RBV theory postu-lates that the services rendered by the firm’sunique bundle of resources and capabilities maylead to value creation.

A firm’s resources and capabilities ‘are valu-able if, and only if, they reduce a firm’s costsor increase its revenues compared to what wouldhave been the case if the firm did not possessthose resources’ (Barney, 1997: 147). While theRBV literature has often been concerned withquestions of value appropriation and sustainabilityof competitive advantage (e.g., Barney, 1991), arecent extension to RBV, the dynamic capabilitiesapproach (Teece, Pisano, and Shuen, 1997),explores how valuable resource positions are builtand acquired over time. Dynamic capabilities arerooted in a firm’s managerial and organizationalprocesses, such as those aimed at coordination,integration, reconfiguration, or transformation(Teeceet al., 1997; Eisenhardt and Martin, 2000),or learning (Lei, Hitt, and Bettis, 1996). Thesecapabilities enable firms to create and captureSchumpeterian rents (Teeceet al., 1997).Examples of such value-creating processes areproduct development, strategic decision-making,alliance formation, knowledge creation, and capa-bilities transfer (Eisenhardt and Martin, 2000).

The emergence of virtual markets clearly opensup new sources of value creation since relationalcapabilities and new complementarities among afirm’s resources and capabilities can be exploited(e.g., between online and offline capabilities).However, virtual markets also present a challengeto RBV theory. As information-based resourcesand capabilities, which have a higher degree ofmobility than other types of resources and capa-bilities, increase in their importance within e-business firms, value migration is likely toincrease and the sustainability of newly createdvalue may be reduced. Also, time compressiondiseconomies (Dierickx and Cool, 1989) providean effective barrier to imitation for firm-specific


resources and capabilities that had to be builtover time due to factor market imperfections,and hence enable the preservation of value. Theprospect of value preservation or sustainability isan important incentive for value creation. In anetworked economy, however, there is an alterna-tive to ownership or control of resources andcapabilities (either through building or acquiringthem). Accessing such resources through part-nering and resource sharing agreements is moreviable in virtual markets yet the preservationof value, and hence its creation becomes morechallenging, because rivals may have easy accessto substitute resources as well.

Strategic networks

Strategic networks are ‘stable interorganizationalties which are strategically important to participat-ing firms. They may take the form of strategicalliances, joint ventures, long-term buyer–supplierpartnerships, and other ties’ (Gulati, Nohria, andZaheer, 2000: 203). The main questions that stra-tegic network theorists seek to answer are asfollows: (1) Why and how are strategic networksof firms formed? (2) What is the set of interfirmrelationships that allows firms to compete in themarketplace? (3) How is value created in net-works (for example, through interfirm asset co-specialization)? and (4) How do firms’ differentialpositions and relationships in networks affecttheir performance?

Traditionally, network theorists with a back-ground in sociology or organization theory havefocused on the implications of network structurefor value creation. The configuration of the net-work in terms of density and centrality (Freeman,1979), for example, has been considered animportant determinant of network advantages,such as access, timing, and referral benefits (Burt,1992). Moreover, the size of the network and theheterogeneity of its ties have been conjectured tohave a positive effect on the availability of valu-able information to the participants within thatnetwork (Granovetter, 1973).

The appearance of networks of firms in whichmarket and hierarchical governance mechanismscoexist has significantly enhanced the range ofpossible organizational arrangements for valuecreation (Doz and Hamel, 1998; Gulati, 1998).Consequently, strategic management andentrepreneurship scholars have moved beyond


structural arguments to explore the importanceof governance mechanisms such as trust (e.g.,Lorenzoni and Lipparini, 1999), and the impor-tance of resources and capabilities (e.g., Gulati,1999), especially those of suppliers and customers(Afuah, 2000), for value creation. For example,in their study of the Canadian biotechnologyindustry, Baum, Calabrese, and Silverman (2000)found that biotech start-ups can improve theirperformance by configuring alliances into net-works that enable them to tap into the capabilitiesand information of their alliance partners. Inaddition to enabling access to information, mar-kets, and technologies (Gulatiet al., 2000), stra-tegic networks offer the potential to share risk,generate economies of scale and scope (Katz andShapiro, 1985; Shapiro and Varian, 1999), shareknowledge, and facilitate learning (Anand andKhanna, 2000; Dyer and Nobeoka, 2000; Dyerand Singh, 1998), and reap the benefits thataccrue from interdependent activities such asworkflow systems (Blankenburg Holm, Erikssonand Johanson, 1999). Other sources of value instrategic networks include shortened time to mar-ket (Kogut, 2000), enhanced transactionefficiency, reduced asymmetries of information,and improved coordination between the firmsinvolved in an alliance (Gulatiet al., 2000).

The network perspective is clearly relevant forunderstanding wealth creation in e-businessbecause of the importance of networks of firms,suppliers, customers, and other partners in thevirtual market space (Shapiro and Varian, 1999;Prahalad and Ramaswamy, 2000). However, itmay not fully capture the value creation potentialof e-businesses that enable transactions in newand unique ways. For example, strategic networktheory and the formal tools provided by networkanalysis (e.g., notions of network density, cen-trality, network externalities) only partiallyexplain the value creation potential of a companysuch as Priceline.com. This business, which hasestablished stable interorganizational ties, forexample, with airline companies, credit card com-panies, and the Worldspan Central ReservationSystem, is fundamentally anchored in the inno-vation of its transaction mechanism—namely, theintroduction of reverse markets in which cus-tomers post desired prices for sellers’ accep-tance—by which items such as airline tickets aresold over the Internet. Priceline.com has evenbeen granted a business method patent on their


innovative transaction method. This methoddistinguishes the firm from an ordinary, onlinetravel agency and poises the firm to tap themore traditional, well-known sources of valuein networks discussed above. As this exampleindicates, virtual markets, with their unprec-edented reach, connectivity, and low-cost infor-mation processing power, open entirely newpossibilities for value creation through the struc-turing of transactions in novel ways. These newtransaction structures are not fully captured bynetwork theory.

Transaction cost economics

The central question addressed by transaction costeconomics is why firms internalize transactionsthat might otherwise be conducted in markets(Coase, 1937). The main theoretical frameworkwas developed by Williamson (1975, 1979,1983). He suggests that ‘a transaction occurswhen a good or service is transferred across atechnologically separable interface. One stage ofprocessing or assembly activity terminates, andanother begins’ (Williamson, 1983: 104). Willi-amson identified bounded rationality coupled withuncertainty and complexity, asymmetric infor-mation, and opportunism in small-numbers situ-ations as conditions under which transactionalinefficiencies may arise that vary with the adoptedgovernance mechanism (Williamson, 1975). Atits core, then, transaction cost theory is concernedwith explaining the choice of the most efficientgovernance form given a transaction that isembedded in a specific economic context. Criticaldimensions of transactions influencing this choiceare uncertainty, exchange frequency, and thespecificity of assets enabling the exchange (Klein,Crawford, and Alchian, 1978; Williamson, 1979).Transaction costs include the costs of planning,adapting, executing, and monitoring task com-pletion (Williamson, 1983).

Transaction cost economics identifies trans-action efficiency as a major source of value, asenhanced efficiency reduces costs. It suggests thatvalue creation can derive from the attenuation ofuncertainty, complexity, information asymmetry,and small-numbers bargaining conditions(Williamson, 1975). Moreover, reputation, trust,and transactional experience can lower the costof idiosyncratic exchanges between firms(Williamson, 1979, 1983). Recently, researchers


have focused on the ways in which investmentin information technology can reduce coordinationcosts and transaction risk (Clemons and Row,1992). In general, organizations that economizeon transaction costs can be expected to extractmore value from transactions.

One of the main effects of transacting over theInternet, or in any highly networked environment,is the reduction in transaction costs it engenders(Dyer, 1997). Hence, the transaction costapproach critically informs our understanding ofvalue creation in e-business. Transaction costsinclude ‘the time spent by managers andemployees searching for customers and suppliers,communicating with counterparts in other com-panies regarding transaction details … the costsof travel, physical space for meetings, and proc-essing paper documents,’ as well as the costs ofproduction and inventory management (Lucking-Reiley and Spulber, 2001). In addition to decreas-ing these direct costs of economic transactions,e-businesses may also reduce indirect costs, suchas the costs of adverse selection, moral hazard,and hold-up. This may result from an increasedfrequency of transactions (because of open stan-dards, anyone can interact with anyone else), areduction in transaction uncertainty (by providinga wealth of transaction-specific information), anda reduction in asset specificity (for example,through lower site specificity––the next site isonly ‘one click away’). The small-numbers bar-gaining condition may be relieved in the virtualmarket situation because of the possibility forlarge numbers of previously unconnected parties(e.g., buyers and sellers) to interact.

Nonetheless, the emphasis of transaction costeconomics on efficiency may divert attention fromother fundamental sources of value such as inno-vation and the reconfiguration of resources(Ghoshal and Moran, 1996). The theory alsofocuses on cost minimization by single partiesand neglects the interdependence betweenexchange parties and the opportunities for jointvalue maximization that this presents (Zajac andOlsen, 1993). In addition, governance modesother than hierarchies and markets (e.g., jointventures) receive relatively little attention, whichcontrasts with the importance of strategic net-works in e-business. Finally, Williamson (1983)implies that a transaction is a discrete event thatis valuable by itself, as it reflects the choice ofthe most efficient governance form and hence can


be a source of transactional efficiencies. However,in the context of virtual markets, considering anygiven exchange in isolation from other exchangesthat may complement or facilitate that exchangemakes it difficult to assess the value created bya specific economic exchange. This is evidentfrom the absence of direct empirical validationof the relationship between exchange attributesand market and firm performance (Poppo andZenger, 1998), and the absence of estimates oftransaction costs themselves (see Shelanski andKlein, 1995, for a review).

Summary

Each theoretical framework discussed abovemakes valuable suggestions about possiblesources of value creation. As we have seen, manyof the insights gained from cumulative researchin entrepreneurship and strategic management areapplicable to e-business. However, the multitudeof value drivers suggested in the literature raisesthe question of precisely which sources of valueare of particular importance in e-business, andwhether unique value drivers can be identified inthe context of e-business. We have also drawnattention to the fact that each theoretical frame-work that might explain value creation has limi-tations when applied in the context of highlyinterconnected electronic markets. We believe thatthis reinforces the need for an identification andprioritization of the sources of value creation ine-business. We begin this process by groundinga model of the sources of value creation in e-business in using data on e-business firms.

DATA AND METHOD

Research strategy

A lack of prior theorizing about a topic makesthe inductive case study approach an appropriatechoice of methodology for developing theory(Eisenhardt, 1989). Hence, to gain a deeperunderstanding of value creation in e-business, weconducted in-depth inquiries into the sources ofvalue creation of 59 e-business firms. Ourresearch analysts, two of our former MBA stu-dents carefully selected from a pool of applicantsbased on their sound understanding of e-businesstransactions, investigated each firm using approxi-mately 50 open-ended questions to guide their


inquiry. The analysts wrote up the answers tothe questions using information gathered frommultiple data sources, writing up to several para-graphs in response to each question.

Our research design was based on multiplecases and multiple investigators, thereby allowingfor replication logic (Yin, 1989). That is, wetreated a series of cases like a series of experi-ments. Each case served to test the theoreticalinsights gained from the examination of previouscases, and to modify or refine them. This repli-cation logic fosters the emergence of testabletheory that is free of researcher bias (Eisenhardt,1989), and allows for a close correspondencebetween theory and data (Glaser and Strauss,1967). Such a grounding of the emerging theoryin the data can provide a new perspective on analready researched topic (e.g., Hittet al., 1998).However, it is especially useful in the early stagesof research on a topic, when it is not clear yetto what extent the research question is informedby existing theories (for a recent example of suchan inductive study, see Galunic and Eisenhardt,2001). Both motivations hold in the context ofe-business. Furthermore, using case studies is agood research strategy for examining ‘a contem-porary phenomenon in its real-life context,especially when the boundaries between phenom-enon and context are not clearly evident’ (Yin,1981: 59). This difficulty is present in the e-business context.

Population of e-business firms

We define an e-business firm as one that derivesa significant proportion (at least 10%) of itsrevenues from transactions conducted over theInternet. This definition of an e-business firm isquite broad. It includes, for example, InternetService Providers (e.g., European ISP Freeserve),and companies that have not aligned all of theirinternal business processes with the Internet butthat use the Internet solely as a sales channel(e.g., companies such as the speech recognitionsoftware provider Lernout and Hauspie). On theother hand, it excludes providers of Internet-related hardware or software, that is, firms thatfacilitate e-business but that do not engage inthe activity themselves (e.g., a backbone switchmanufacturer, such as Packet Engines Inc.).

Companies that derive all of their revenuesfrom e-business (so-called ‘pure plays’) are rela-


tively easy to identify using publicly availabledescriptions of their major lines of business (e.g.,Amazon.com). In other instances, however, it ismore difficult to establish whether a firm derivessignificant revenues from e-business. This is thecase for many incumbents (e.g., the Britishretailer Iceland). It is often impossible to assertif this criterion has been met since companiesseldom report their e-business revenues as a sep-arate category. In these cases, we used otherinformation to determine the company’s fit withour target population. For example, we checkedwhether at least two trade publications such asthe Wall Street Journaland theFinancial Timesreferred to the company as an e-business, or apioneer or early innovator in the virtual marketspace.

Sample

For the United States, we created a list of e-businesses that went public between 2 April 1996(Lycos)8 and 15 October 1999 (Women.comNetworks) using information available onwww.hoovers.com. This list includes about 150firms, most of which are ‘pure plays.’ Our initialsubsample of 30 U.S. e-business companies wasthen taken at random from this list on the basis ofa uniform probability distribution over all samplecompanies. The U.S. subsample represents abroad cross-section of firms (see Appendix). Bycontrast, the challenge in creating the Europeansub-sample was in identifying public e-businesses.The number of European firms engaged in e-business, as well as the development of indicatorsof Internet usage and e-business activity in Eu-rope, have lagged behind the corresponding fig-ures in the United States in recent years (MorganStanley Dean Witter, 1999). Despite thesedifficulties, we established a sample of 29 publicEuropean e-businesses (also listed in theAppendix). Companies were found on all majorEuropean exchanges, as well as on new venturemarkets (such as Germany’sNeuer Markt).

To be eligible for inclusion in our sample, ane-business had to (a) be based either in the United

8 The principal reason for choosing 2 April 1996 (date ofLycos’s IPO, which was followed a few days later by Yahoo’sIPO) as a start date for sampling was that this date markedthe beginning of a period of multiple IPOs of e-businesscompanies that occurred in quick succession. This enabled usto create a data set of sufficient size and breadth.


States or in Europe, (b) be publicly quoted on astock exchange, and (c) involve individual con-sumers in some of the electronic transactions itenables. The international scope of our studynot only reflects the decreasing importance ofgeographic boundaries in virtual markets, it alsostrengthens our theory development. Theorybuilding on value creation in e-business frominductive case studies is less idiosyncratic if oneallows for cases from different economic environ-ments.9

We chose to include only public companies inour sample to ensure the availability and accuracyof information. We are aware that this limits thescope of our analysis, as there are many privatefirms with interesting business ideas. However,unlike private firms, publicly traded companiesprovide a wealth of data that can be collected,organized, and analyzed. At this point, it isunclear whether or not this choice introduces alarge-company bias into our sample, and henceinto our conceptual development, because thereare many large, private e-business operations, andseveral large, public firms not included in oursample (e.g., AOL and Yahoo).

Including only public companies in our samplemay bias it towards surviving companies. Whilelimitations on the availability of data prevent usfrom broadening the sample to firms that ‘failed’(according to some definition of failure), we donot believe that the survival bias affects the theo-retical development. First, some of the firms westudied will likely fail eventually. Second, theargument can be made for theoretical rather thanrandom sampling of cases, and for studying‘extreme situations and polar types in which the

9 The decision to include U.S. as well as European firms inour sample has several implications. E-business activity inEurope is dominated less by start-ups, as is the case in theUnited States, and more by established companies (MorganStanley Dean Witter, 1999). For example, the United King-dom’s Freeserve is a spin-off of Dixons, a large ‘bricks-and-mortar’ retailer, and Spain’s Terra Networks is a spin-off ofTelefonica, a large telecommunication firm. An affiliation (pastor present) with established companies probably influences theparticular business models of respective e-business firms. Forexample, some spin-offs may benefit from the alliance networkof their parent companies, while others may suffer fromimposed organizational constraints. However, a possible sam-ple bias toward (mostly former) subsidiaries of establishedcompanies should not affect our ability to develop a generalframework for evaluating the value creation potential of e-business firms. In fact, such a general framework should beindependent of the mode of business creation.


process of interest is transparently observable’(Eisenhardt, 1989: 537).

As implied by sampling criterion (c), wefocused our study on e-business firms that enabledtransactions in which individual consumers wereinvolved. These companies are hereafter collec-tively referred to as ‘with-C’ companies. Forexample, our sample included so-called ‘B-to-C’ (business-to-consumer) companies, which arecompanies that directly and exclusively engagein transactions with individual customers. Wedid not sample businesses that solely engaged incommercial activities with other businesses (so-called ‘B-to-B,’ or ‘business-to-business’companies). We made this choice based primarilyon the fact that the quality of data available for‘with-C’ firms was higher than that available for‘B-to-B’ firms at the time this research projectwas launched.10

Data collection

We gathered detailed data on our sample com-panies mainly from publicly available sources:IPO prospectuses (our major source), annualreports, investment analysts’ reports, and com-panies’ web sites. A structured questionnaire wasused to collect information about: (a) the com-pany (e.g., founding date, size, lines of business,products and services provided, and some finan-cial data); (b) the nature and sequence of trans-actions that the firm enables (e.g., questionsincluded: ‘What is the company’s role in consum-mating each transaction?’ and ‘Who are the otherplayers involved?’); (c) potential sources of valuecreation (e.g., questions included: ‘How importantare complementary products or services?’ and‘Are they part of the transaction offering?’); and(d) the firm’s strategy (e.g., questions included:‘How does the company position itselfvis-a-vis competitors?’). Most of the approximately 50questions enumerated in the questionnaire wereopen-ended, which was consistent with our pri-mary objective of developing a conceptual frame-work that was informed by empirical evidence.

Much high-quality data about U.S. firms wasobtained from the SEC’s EDGAR data base,

10 We do not believe that our focus on ‘with-C’ firms seriouslyaffects the theory development. The value driver categoriesidentified in the analysis should also apply to ‘B-to-B’ models,albeit perhaps with different weights.


which is available to the public online. Data oncompanies included in the data base adhere to asingle, U.S. standard set by the SEC. In Europe,however, there is no central data depository. Inaddition, company reporting requirements varyacross European countries, ranging from strict(e.g., the United Kingdom) to relatively lax (e.g.,Italy). European firms also vary widely in theiraccounting and disclosure practices, making com-parisons across firms difficult. This made the useof multiple sources of information particularlyimportant.

Data analysis

In inductive studies, data analysis is often hardto distinguish from data collection since buildingtheory that is grounded in the data is an iterativeprocess in which the emergent frame is comparedsystematically with evidence from each case(Eisenhardt, 1989). Some researchers argue for adeliberate process of joint data collection andanalysis (e.g., Glaser and Strauss, 1967). Weemployed this joint process by frequently movingbetween the data and the emerging theory as wedeveloped our model. The value driver categoriesderived from our preliminary analysis of theinitial data clearly influenced the design of thesubsequent questionnaire that we used for furtherdata collection.11

We used standard techniques for both within-case analysis and cross-case analysis (Eisenhardt,1989; Glaser and Strauss, 1967; Miles and Huber-man, 1984; Yin, 1989). Within-case evidence wasacquired by taking notes rather than by writingnarratives. For this purpose, research analystsanswered the questions enumerated in the ques-tionnaire, integrating and triangulating facts fromthe various data sources mentioned above. Asobserved by Yin (1981: 60), ‘The final casestudies resembled comprehensive examinationsrather than term papers.’ The authors then ana-lyzed these products sequentially and indepen-

11 We started with an initial version of the questionnaire thatreflected a working framework we had already constructed.This was intended to bring focus and clarity to the questionsasked. This initial questionnaire had been pretested on severalcases. Subsequently, we modified, added, and dropped ques-tions about 2 months into the research project, and madesimilar revisions again about 1 month later. After everyrevision, all cases that had hitherto been examined wereupdated accordingly.


dently, and periodically discussed their obser-vations in order to reach agreement about thefindings. These analyses were the basis for gener-ating initial hypotheses about the value drivercategories, and for helping us gain insight intowhat makes e-business firms tick.

The final model was shaped through intensivecross-case analysis. We first split the sample intotwo groups, with different researchers responsiblefor each set. Eisenhardt (1989) notes that thisstrategy of dividing the data by data source isvalid for cross-case analysis. We then identifiedthe predominant sources of value creation andcompared these patterns across the subsamples.In order to corroborate our findings, we tabulatedthe evidence underlying the sources of value cre-ation as suggested by Miles and Huberman(1984).12

Two key theoretical insights emerge from ourdata analysis. One is that four potential sourcesof value creation are present in e-businesses,namely efficiency, complementarities, lock-in, andnovelty. The other is that, in e-business, the mainlocus of value creation, and hence the appropriateunit of analysis, spans firm and industry bound-aries and can be captured by the business model.In the next section we discuss the four valuedrivers and the interdependencies among them.In the discussion section, we then offer a precisedefinition of a business model and show how thisconstruct captures the identified sources of valuein a more comprehensive way than more tra-ditional units of analysis such as the firm, theindustry, the individual transaction, or the net-work.

EMERGENT THEORY: SOURCES OFVALUE CREATION IN E-BUSINESS

Figure 1 depicts the four sources of value creationin e-business that emerged from the data analysis.The term ‘value’ refers to the total value createdin e-business transactions regardless of whetherit is the firm, the customer, or any other partici-pant in the transaction who appropriates thatvalue. We therefore adopt Brandenburger andStuart’s (1996) view of total value created as thesum of the values appropriated by each party

12 See Table 1 below.


involved in a transaction.13 Each of the fourmajor value drivers that were identified in theanalysis—efficiency, complementarities, lock-in,and novelty—and the linkages among them, arediscussed below. We suggest that the presence ofthese value drivers, which are anchored in thereceived entrepreneurship and strategic man-agement theory, enhances the value-creationpotential of e-business.

Efficiency

The data analysis points to transaction efficiencyas one of the primary value drivers for e-business.This finding, which is consistent with transactioncosts theory (Williamson, 1975, 1983, 1989), sug-gests that transaction efficiency increases whenthe costs per transaction decrease, where ‘costs’are broadly defined (as elaborated in detailbelow). Therefore, the greater the transactionefficiency gains that are enabled by a particulare-business, the lower the costs and hence themore valuable it will be.

Efficiency enhancements relative to offlinebusinesses (i.e., those of companies operating intraditional markets), and relative to other onlinebusinesses (i.e., those of companies operating invirtual markets), can be realized in a number ofways. One is by reducing information asymme-tries between buyers and sellers through the supplyof up-to-date and comprehensive information. Thespeed and facility with which information can betransmitted via the Internet makes this approachconvenient and easy. Improved information canalso reduce customers’ search and bargainingcosts (Lucking-Reiley and Spulber, 2001), as wellas opportunistic behavior (Williamson, 1975). Byleveraging the cheap interconnectivity of virtualmarkets, e-businesses further enhance transactionefficiency by enabling faster and more informeddecision making. Also, they provide for greater

13 For example, Brandenburger and Stuart (1996) show thatthe total value created in a simplified supply chain with onesupplier, one firm, and one customer is equal to the customer’swillingness-to-pay minus the supplier’s opportunity cost. Thisis derived from expressing total value created as the sum ofthe values appropriated by each party. The customer’s willing-ness to pay is defined as the amount of money at which thecustomer is indifferent between owning a product/service orthe money. Opportunity cost of the supplier is defined as theamount of money at which the supplier is indifferent betweenowning the resource (and hence deploying it in an alternativeuse) or trading it for money.


Figure 1. Sources of value creation in e-business

selection at lower costs by reducing distributioncosts, streamlining inventory management, simpli-fying transactions (thus reduce the likelihood ofmistakes), allowing individual customers to bene-fit from scale economies through demand aggre-gation and bulk purchasing, streamlining the sup-ply chain, and speeding up transaction processingand order fulfillment, thereby benefiting both ven-dors and customers. In a recent study, Garcianoand Kaplan (2000) find that using an online ratherthan an offline auction format for trading carsbetween businesses halves transaction costs. Mar-keting and sales costs, transaction-processingcosts, and communication costs can also bereduced in an efficient e-business, and the firm’svalue-creating potential can be enhanced throughscalability (i.e., increasing the number of trans-actions that flow through the e-business platform).

Autobytel.com is a case in point. Potential autobuyers are supplied with detailed and comprehen-sive comparative shopping information on differ-ent models and the costs to the dealers of thesemodels. Potential buyers can then quickly makewell-informed decisions. The buying process issubstantially simplified and accelerated, and bar-gaining costs are reduced. While vendors’ mar-gins on each sale might be lower, sales volumesincrease at essentially no marginal costs. It shouldbe noted, however, that the overall efficiency gainenabled by Autobytel.com depends partially onthe quality of contributions of Autobytel.com’spartners. Car dealers, for example, must be ableto deliver without delays the products offered to


customers, otherwise inefficiencies associatedwith the implementation of a customer’s decisionmay offset efficiency gains associated with thecustomer’s decision-making process.

Efficiency gains in highly networked industriesare well documented in the management litera-ture. A study of highly networked Japanese firms,for example, suggests that information flows andreduced asymmetries of information, among otherfactors, are important in reducing the potentialtransaction costs associated with specialized assets(Dyer, 1997). More generally, information tech-nology is believed to lead to a reduction in thecosts of coordinating and executing transactions(Clemons and Row, 1992).

Complementarities

Complementarities are present whenever havinga bundle of goods together provides more valuethan the total value of having each of the goodsseparately. In the strategy literature, Branden-burger and Nalebuff (1996) have highlighted theimportance of providing complementary outputsto customers.14 They state that, ‘A player is your

14 Complementarities can be defined with respect to outputsor inputs, that is, with respect to the determinants of a firm’sprofit function. A profit function that is well behaved (i.e.,concave, continuous, and twice continuously differentiable) iscomplementary in its inputs if raising the level of one inputvariable increases the marginal return to the other inputvariable. This notion of complementarity goes back to Edge-worth, Milgrom, and Roberts (1990, 1995), who present ageneralization of this idea that is relevant for the strategy field.


complementor if customers value your productmore when they have the other player’s productthan when they have your product alone’(Brandenburger and Nalebuff, 1996: 18). RBVtheory also highlights the role of complementari-ties among strategic assets as a source of valuecreation (Amit and Schoemaker, 1993); and net-work theory highlights the importance of com-plementarities among the participants in the net-work (Gulati, 1999). Hence, complementaritiescan be expected to increase value by enablingrevenue increases.

The data analysis suggests that e-businessesleverage this potential for value creation by offer-ing bundles of complementary products and ser-vices to their customers. These complementarygoods may be vertical complementarities (e.g.,after-sales services) or horizontal complementari-ties (e.g., one-stop shopping, or cameras andfilms) that are provided by partner firms. Theyare often directly related to a core transactionenabled by the firm. For example, e-bookers, aEuropean online travel site, grants its customersaccess to weather information, currency exchangerate information, and appointments with immuni-zation clinics. These services enhance the valueof the core products (airline tickets and vacationpackages) and make it convenient for users tobook travel and vacations with e-bookers.

The data also point to offline assets that com-plement online offerings. Customers who buyproducts over the Internet value the possibility ofgetting after-sales service offered through bricks-and-mortar retail outlets, including the con-venience of returning or exchanging merchandise.This complementarity between online and offlinebusinesses is the essence of ‘click-and-mortar’offerings such as that provided by a companysuch as barnesandnoble.com. The complementar-ity between barnesandnoble.com and its bricks-and-mortar counterpart creates value for cus-tomers by offering them the opportunity tobrowse and order online, and to receive books inbricks-and-mortar stores. It also creates value forits business partners by allowing them to utilizethe interconnectivity of virtual markets to cross-market their products on computer screens thatare placed in Barnes & Noble bookstores.

The data further suggest that it is desirable fore-businesses to offer complementary goods thatmay not be directly related to the core trans-actions. Consider, for example, Xoom.com, a


company that facilitates community buildingamong Internet users and exploits its customerbase through a mix of e-business activities, suchas auctions, sales, and direct marketing.Xoom.com attracts customers by offering an arrayof free complementary Internet services, such ashome page building and hosting, access to chatrooms and message boards, e-mail, online greet-ing cards, downloadable software utilities, andclip art. These services are not directly related tothe products Xoom.com sells or to the auctionsthey host. However, they fit well with the com-munity aspect of Xoom.com since they facilitatecommunication among members.

E-businesses may also create value by capi-talizing on complementarities among activitiessuch as supply-chain integration, and complemen-tarities among technologies such as linking theimaging technology of one business with theInternet communication technology of another,thereby unleashing hidden value.

Our analysis also highlights the inter-dependency between the sources of value cre-ation. Efficiency gains made possible by infor-mation technology pave the way for theexploitation of complementarities in e-business.Weaving together the resources and capabilitiesof distinct firms, a hallmark of e-businesses, iseconomically compelling when transaction costs,and hence the threat of opportunism, are low.We note that the reverse is also true: complemen-tarities may lead to increased efficiency, at leastfrom a customer’s point of view. When customershave access to products and services that arecomplementary to the primary product of interest,efficiency may be enhanced, for example, throughreduced search costs (e.g., when purchasing a carwith the help of Autobytel.com, one is automati-cally offered car insurance, a complementaryproduct) and improved decision-making.

Lock-in

The value-creating potential of an e-business isenhanced by the extent to which customers aremotivated to engage in repeat transactions (whichtends to increase transaction volume), and by theextent to which strategic partners have incentivesto maintain and improve their associations (whichmay result in both increased willingness to payof customers and lower opportunity costs forfirms). These value-creating attributes of an e-


business can be achieved through ‘lock-in.’ Lock-in prevents the migration of customers and stra-tegic partners to competitors, thus creating valuein the aforementioned ways. Lock-in is mani-fested as switching costs, which are anchored inWilliamson’s (1975) transaction cost framework,and as network externalities, which has its rootsin network theory (Katz and Shapiro,1985; Shapiro and Varian, 1999). It shouldalso be noted that, as RBV theory suggests,a firm’s strategic assets, such as its brandname, and buyer–seller trust, both contribute tolock-in.

The data analysis reveals several ways in whichcustomer retention can be enhanced. First, loyaltyprograms (Varian, 1999) rewarding repeat cus-tomers with special bonuses can be established.U.S. retailer barnesandnoble.com’s rewards pro-gram in collaboration with Master Card is a goodexample. Bonus points collected via the use ofMaster Card are redeemable towards barnesand-noble.com reward certificates which in turn maybe used to purchase barnesandnoble.com products.Second, firms can develop dominant design pro-prietary standards (Teece, 1987) for businessprocesses, products, and services (e.g., Amazon’spatented shopping cart). Third, firms can establishtrustful relationships with customers, for example,by offering them transaction safety and reliabilityguaranteed by independent and highly crediblethird parties. Consodata, a European direct mail-ing firm, demonstrates this ideal by promotingin-house systems to protect data from misuse,but, more importantly, by accommodating inspec-tions by the French government agency CNIL(Commission Nationale Informatique et Liberte´s).To the extent that customers develop trust in ane-business company through such measures, theyare more likely to remain loyal to the site ratherthan switch to a competitor.

Familiarity with the interface design of a website requires customer learning; once this learninghas begun, it inhibits customers from switchingto other sites where their learning would have tobegin again (Smith, Bailey, and Brynjolfsson,1999). This argument gains strength when oppor-tunities for customization (initiated by thecustomer) and personalization (initiated by the e-business) are exploited. Our data suggest that e-businesses enhance lock-in by enabling customersto customize products, services, or information totheir individual needs in a variety of ways. For


example, E∗Trade’s web site contains a customiz-able, one-stop ‘market command center’ that pro-vides frequently updated commentary on stocktrading throughout the day, customized news,alerts, and real-time stock-quotes. Other e-business sites offer customized ‘one-clickordering’ as a standard feature. In addition, manyonline vendors use data-mining methods to per-sonalize products, information, and services.These methods include the analysis of submittedcustomer information, click streams, and past pur-chases in order to set up personalized storefrontsor create a personalized interface, conduct directadvertising, target emails, and facilitate cross-selling. For example, online electronics retailerCyberian Outpost uses click analysis software andpast purchase analysis for effective cross-selling;even impulse items (i.e., ‘add-ons’) are rec-ommended to customers at the checkout. Per-sonalization can also be achieved with filteringtools that compare a customer’s purchase patternswith those of like-minded customers and makerecommendations based on inferred tastes (Smithet al., 1999). This mechanism exhibits the inter-esting property that the more the customer inter-acts with the system, the more accurate thematching results become. Customers then havehigh incentives to use the system. This createsa positive feedback loop (Arthur, 1990). Moreimportant for our discussion of e-business,however, is the idea that increasing returns(Arthur, 1996) and positive feedback may derivefrom network effects (Katz and Shapiro, 1985;Shapiro and Varian, 1999). These are discussedbelow.

Virtual markets also enable e-business firms tocreate virtual communities that bond participantsto a particular e-business (Hagel and Armstrong,1997). Such communities enable frequent inter-actions on a wide range of topics and therebycreate a loyalty and enhance transaction frequency(e.g., Verticalnet.com). We note how all of theabove measures use and leverage the uniquecharacteristics introduced by virtual markets, suchas high interconnectivity, speed of informationprocessing, and lack of geographical constraints.Given the enormous reach of virtual markets, e-business firms often connect numerous partiesthat participate in commercial transactions. Theycan thus be considered network generators. Net-works may exhibit externalities in that the pro-duction or consumption activities of one party


connected to the network have an effect on theproduction or utility functions of other parti-cipants in the network. This effect is not trans-mitted through the price mechanism. Networkexternalities are usually understood as positiveconsumption externalities in which ‘the utilitythat a user derives from consumption of thegood increases with the number of other agentsconsuming the good’ (Katz and Shapiro, 1985:424). Henceforth, we will refer only to consump-tion externalities when discussing network exter-nalities. In the context of e-business, networkexternalities are present when the value createdfor customers increases with the size of the cus-tomer base. Consider, for example, a communitysite such as that created by Fortunecity, where auser benefits when there are more participantswith whom she or he can interact in chat rooms,on bulletin boards, etc. After a new member hasjoined the community, it becomes more attractivefor other potential members to subscribe.The opposite is also true—if a site is unattrac-tive and loses members, it becomes lessattractive for existing subscribers, who may dropout. A dangerous downward spiral is set inmotion that, in the extreme case, can destroythe business.

There may also beindirect network exter-nalities that arise when economic agents benefitfrom the existence of a positive feedback loopwith another group of agents. Consider, forexample, online auction companies such as eBayor QXL. A buyer on one of these auction siteshas no immediate advantage from the presenceof additional buyers. On the contrary, other buy-ers who are willing to purchase the same mer-chandise may prevent the desired trade. However,the presence of more buyers (a signal of currentand future market liquidity) makes it more attrac-tive for potential sellers to put their products upfor sale at that particular site. This, in return,enhances the site’s attractiveness to potential buy-ers. Buyers thus benefit indirectly from increasingthe numbers of other buyers. The same logicholds for sellers.

The indirect network effect, which Katz andShapiro (1985) term the ‘hardware–software para-digm,’ can be attributed to the complementarynature of some of the major components of thenetwork in which an e-business firm is embedded(Economides, 1996). In an auction setting, thecomplementary components of the network would


be the buyers and sellers. Here, the total valuecreated is a direct function of network size.

Although some e-businesses (for example,those revolving around online communities andauctions) are more likely than others (forexample, those focusing mainly on direct, onlinesales) to exhibit important network externalities,e-business operations can be designed to harnessthe power of this lock-in mechanism. Ama-zon.com, for example, has adopted various com-munity features (Kotha, 1998) such as its ‘com-munity of interests’ allowing its customers towrite book reviews. (This, by the way, is aninteresting example of how highly networked e-businesses can enable customers themselves tocreate value.) Even stronger are the networkeffects created by online vendors of video gamesoftware, such as Cryo-Interactive or Game-play.com, that provide a web location where cus-tomers can interact and play games (obtainedfrom the web provider) with each other.

Efficiency and complementarities as sources ofvalue creation (as described above) can also behelpful in fostering lock-in. The efficiency fea-tures and complementary product and serviceofferings of an e-business may serve to attractand retain customers and partners. The higher therelative benefits offered to these parties, thehigher their incentives to stick with or join thenetwork established by the e-business. Theincreasing return properties inherent to networkeffects then magnify the relative benefits offered,thus triggering positive feedback dynamics.

Conversely, when an e-business creates lock-in, this can also have positive effects on itsefficiency and on the degree to which it providesfor complementarities. For example, many auctionsites enable buyers to rate sellers. This featureincreases buyers’ trust in the fairness of trans-actions and therefore fosters stickiness. This fea-ture also provides a strong incentive for repeatsellers to refrain from cheating, which clearlyenhances transaction efficiency. Moreover, astrong potential for lock-in provides an incentivefor high-profile partners to contribute complemen-tary products and services because of the promiseof high-volume (repeat) business. There are thusimportant relationships between lock-in,efficiency, and complementarities as sources ofvalue creation. The potential value of an e-business depends on the combined effects of allthese value drivers.


Novelty

The value creation potential of innovations hasbeen articulated by Schumpeter (1934). While theintroduction of new products or services, newmethods of production, distribution, or marketing,or the tapping of new markets have been thetraditional sources of value creation through inno-vations, our data analysis reveals that e-businessesalso innovate in the ways they do business, thatis, in the structuring of transactions. For example,eBay was the first company to introduce cus-tomer-to-customer auctions on a large scale. Inthis architecture, even low-value items could besuccessfully traded between individual consumers.Priceline.com introduced reverse markets,whereby individual buyers indicate their purchaseneeds and reservation prices to sellers. Autoby-tel.com revolutionized the automobile-retailingprocess in the United States through linkingpotential buyers, auto dealers, finance companies,and insurance companies, thus enabling round-the-clock one-stop car shopping from home.These companies all introduced new ways ofconducting and aligning commercial transactions.They create value by connecting previouslyunconnected parties, eliminating inefficiencies inthe buying and selling processes through adoptinginnovative transaction methods, capturing latentconsumer needs (such as haggle-free car purchas-ing from the convenience of your home), and/orby creating entirely new markets (e.g., auctionsfor low-ticket items).

The unique characteristics of virtual markets(i.e., the removal of geographical and physicalconstraints, possible reversal of information flowsfrom customers to vendors, and other novel infor-mation bundling and channeling techniques) makethe possibilities for innovation seem endless. Forexample, e-business firms can identify andincorporate valuable new complementary productsand services into their bundle of offerings innovel ways. Another dimension of innovation ine-business refers to the appropriate selection ofparticipating parties. For example, firms can directand intensify traffic to their web site by initiatingaffiliate programs with third parties, who arecompensated for enabling the execution of trans-actions from their own web sites.

There can be substantial first-mover advantagesfor e-business innovators (Lieberman andMontgomery, 1988). Being the first to market


with a novel business method (such asPriceline.com’s) makes it easier to create switch-ing costs by capturing ‘mindshare,’ and bydeveloping brand awareness and reputation. Also,e-business innovators can gain by learning andaccumulating proprietary knowledge, and by pre-empting scarce resources (e.g., eBay.com’s pro-prietary data set on sellers’ auction history).15

Novelty and lock-in, two of the four valuedrivers in our model, are linked in two importantways. First, e-business innovators have an advan-tage in attracting and retaining customers,especially in conjunction with a strong brand.Second, being first to market is an essential pre-requisite to being successful in markets that arecharacterized by increasing returns (Arthur, 1996;Shapiro and Varian, 1999). First movers are in agood position to initiate the positive feedbackdynamics that derive from network externalities(Katz and Shapiro, 1985; Arthur 1990), and toachieve a critical mass of suppliers and/or cus-tomers before others do. In ‘winner-takes-most’markets, it is imperative to enter a new marketfirst (Shapiro and Varian, 1999).

Novelty is also linked with complementarities.The main innovation of some e-businesses residesin their complementary elements, such as theresources and capabilities they combine (e.g.,Schumpeter, 1934; Penrose, 1959; Moran andGhoshal, 1999). Cyberian Outpost, a U.S. Inter-net-only computer retailer, lets customers selectcomputer configurations along with accessoriesand peripheral solutions by giving them access toan up-to-date data base containing over 170,000products, including information on their func-tionality and compatibility. The data base containsinformation on many complementary productsfrom partner firms (for example, computer hard-ware manufacturers, accessories producers, andsoftware developers). Each product is presented

15 In some market spaces such as Internet-based retailing (‘e-tailing’) a number of start-up firms that were early moversare currently faced with important difficulties (see, forexample, the recent high-profile bankruptcies of Boo.com,Garden.com, and MotherNature.com). At the same time, latemovers who extended their ‘bricks-and-mortar’ business toembrace the Internet like Wal-Mart, Lands End or Staplesare able to effectively leverage their strong brand name andoffline operations in the virtual market space, thus unlockingthe value provided by strong complementarities betweenonline and offline activities, assets, and capabilities. Our modelexplains this advantage of late movers in e-tailing throughthe importance of complementarities as a source of valuecreation in this particular market space.


to interested buyers with possible complementarysolutions, including warranty options. Of course,the data base also contains information on substi-tute products. From the customer’s perspective,however, information about any of these productsis complementary because it enables them tomake better choices. Cyberian Outpost is thus agood example of a novel e-business architecturethat is based almost exclusively on the logic ofharnessing complementarities for customers.

Finally, there is also an important relationshipbetween novelty and efficiency. Certain efficiencyfeatures of e-businesses may be due to novelassets that can be created and exploited in thecontext of virtual markets. For example, Art-net.com, a European company that enables onlineart auctions, reduces the asymmetry of infor-mation between the buyers and sellers of art(traditionally a source of severe inefficiencies)through maintaining and expanding a data baseof transactions (including information on price)that is accessible to its clients. This informationservice, which allows participants in auctions tobenchmark current transactions against historic artsales, is novel in the art auction business. Italso increases transaction efficiency by reducingmarket failures that are due to informational prob-lems.

Table 1 illustrates, in summary form, theresults of our in-depth, case-based analyses ofthe sources of value creation of three of oursample firms. The table depicts the specific waysin which novelty, lock-in, complementarities, andefficiency are manifested in these particular firms.While some traditional strategy frameworks suchas RBV (e.g., Barney, 1991) focus on the com-petitive advantage of firms, and hence on valueappropriation, our model, which emerged fromthe analysis of the data, is concerned with totalvalue creation. We believe that value creationstrikes at the heart of the strategic managementand entrepreneurship fields, as it is an essentialprerequisite for value appropriation (see alsoPorter, 1985; Brandenburger and Stuart, 1996).

DISCUSSION

Two major insights emerge from the precedingsection. The first is that four potential sources ofvalue creation are present in e-businesses, namelyefficiency, complementarities, lock-in, and nov-


elty. However, as Table 2 shows, the theoreticallenses that are commonly used in the fields ofstrategic management and entrepreneurship forviewing and explaining wealth creation emphasizedistinct sources of value. In our analysis, each ofthe identified sources of value creation (each ofwhich cuts across established theoreticalframeworks) commands equal attention. Ouranalysis thus suggests that no single theoreticalframework discussed in this paper (i.e., valuechain analysis, Schumpeterian innovation, RBV,strategic network theory, transaction costeconomics) should be given priority over theothers when examining the value creation poten-tial of e-businesses. In other words, our analysiscalls for an integration of the various frameworks,in particular for the linking of strategic man-agement and entrepreneurship theories of valuecreation (Hitt and Ireland, 2000; McGrath andMacMillan, 2000). Scholars in both fields haverecently made considerable progress in advancingthis idea. For example, Gulati (1999) and Afuah(2000) have successfully begun to integrate RBVand strategic network theory, emphasizing theimportance of resources and capabilities of net-work partners for a firm’s performance. Jones,Hesterly, and Borgatti (1997) have initiated theintegration of transaction cost economics and net-work theory, arguing that because they enableflexibility, enhance cooperation, and create trust,networks arise under conditions of asset speci-ficity, demand uncertainty, and task complexityand frequency. These works are promising andimportant steps towards an improved theoreticalunderstanding of the phenomenon of wealth cre-ation. However, as our analysis shows, there areabundant lessons to be learned from studies ofe-businesses in action.

The second theoretical insight emanating fromthe preceding section refers to the inter-dependence of the sources of value and to thelocus of value creation in e-business. As we haveseen, the presence of each value driver canenhance the effectiveness of any other driver.This gives even more weight to our call for animproved integration of the various theories ofvalue creation in order to yield a more completepicture of the functioning of e-businesses andcapture the various sources of value creation.

One stepping stone on the road towards anintegrated theory of value creation would be thedefinition of a unit of analysis that captures the

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Table 1. Value sources attributes of selected e-business firms

Efficiency Complementarities Lock-in Novelty

Autobytel.com (ABT) O Consumers benefit from O Complementary services O Repeat purchases supported O Introduced reverse on-lineinformed decisions enabled offered by business model by strong incentive schemes markets to auto retailing

(Automobile retailing) by rich online content, participants (cars, insurance, (reward points) O Compared with offlinevaluation reports, photos of financing) O Affiliated dealers have high competitors, the quality and

(U.S. firm) vehicles, and inspection O Company combines the switching costs because of depth of links betweenreports for used vehicles reach and richness of virtual investments in the Extranet business model members is

O Dealers benefit from lower markets with the bricks-and- connection and subscription novelinventory costs due to mortar necessities (viewing, contracts O Company is recognized as aautomated online order test drive, delivery, service)O Products and services pioneer—continuouslytaking, higher volume, lower O Hence, ABT achieves offered to end-users are implementing tailored andselling costs, lower important vertical and personalized (click stream innovative services (onlinemarketing, advertising, and horizontal complementarities analysis, cookies, targeted vehicles auctions)personnel costs emails, ‘Your Garage’)

O Product research is fasterthan with offline models

Cyberian Outpost O Customers can make O Online presence has no O Customers can customize O Business model enablesinformed decisions through ‘shelf space’ constraints, products by comparing novel competencies division

(Ordering PCs, software use of extensive information therefore a wide range of product features and (Outpost focus on clientsolution) O Online presence allows the complementary products is choosing according to their acquisition, while suppliers

company to offer a larger offered preferences on product innovation and(U.S. firm) range of products than O Large number of O Affiliate programs enable competitive offerings)

offline competitors (over participants and goods virtual store creation on O Integration of information170,000 products) and enable cross-selling individual affiliates’ pages flows enables overnight andpowerful search capabilities O Vertical and horizontal O Click Miles program is same-day delivery

O Warehouse, shipping, complementarities are offered: for each purchaseO Outpost picks productpurchasing, and order- important for this business subscriber receives points returns at the client’sprocessing information are model (never achieved on house/officeintegrated in order to such scale in bricks-anddeliver ‘the next day’ mortar firms)

Ricardo.de O Transaction actors are either O Participants in business O Offers loyalty program O Online auction of low-costidentified or reviewed, model offer many O Partners promote transaction goods

(Auctions) therefore clients can make complementary products safety and reliability throughO New incentive for biddinginformed decisions O Company sometimes takes goods insurance, password, has been introduced (i.e.,

(European firm) O Information asymmetry possession of items offered and encryption technologies entertainment)reduced through photo and in auctions, thus provides O Participant lock-in is created O Continuous introduction ofproduct descriptions complementary products through reputation, building innovative solutions and

O Clients find online bidding itself upon transactions history, offerings (expansion intoeasier then the offline O Strong supply chain and participant rating system B2B offerings, life auctionsbidding integration pioneering)

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Table 2. Theoretical anchoring of sources of value creation in e-business


Value chain analysis Medium Medium Low MediumSchumpeterian innovation Low Low Low HighResource-based view Low High Medium MediumTheory of strategic networks Medium Medium High MediumTransaction cost economics High Low Medium Low

Note: Table entries describe the degree to which the identified sources of value in e-business are viewed, directly or indirectly,by different theoretical frameworks in strategic management and entrepreneurship as important for value creation.

various interdependent sources of value identifiedin this paper. Note that the different theoreticalapproaches reviewed above suggest distinct unitsof analysis that are commensurate with thealleged main locus of value creation. In the valuechain framework, it is the firm’s activities, inSchumpeter’s theory of economic development, itis the firm (and in particular the entrepreneur),in RBV, it is the resources and capabilities thatconstitute the firm, in strategic network theory, itis the network of firms, and in transaction costeconomics, it is the transaction that is both theunit of analysis and the presumed locus of valuecreation. Using any of these theoretical frame-works in isolation would result in some crucialaspects of value creation in e-business eitherbeing ignored or not being given due importance.The question thus arises as to the appropriateunit of analysis for understanding how e-businessfirms create wealth.

Based on our analysis of the sources of valuecreation in e-business, and drawing on thereceived theories of strategy and entrepreneurship,we propose thebusiness modelas a unit ofanalysis.

Definition: A business model depicts the con-tent, structure, and governance of transactionsdesigned so as to create value through theexploitation of business opportunities.

Transaction contentrefers to the goods orinformation that are being exchanged, and to theresources and capabilities that are required toenable the exchange.Transaction structurerefersto the parties that participate in the exchangeand the ways in which these parties are linked.Transaction structure also includes the order inwhich exchanges take place (i.e., theirsequencing), and the adopted exchange mech-


anism for enabling transactions. The choice oftransaction structure influences the flexibility,adaptability, and scalability of the actual trans-actions. Finally,transaction governancerefers tothe ways in which flows of information,resources, and goods are controlled by the rel-evant parties. It also refers to the legal formof organization, and to the incentives for theparticipants in transactions.

This definition of a business model is consis-tent with the importance of transaction efficiency(emphasized by transaction cost economics), nov-elty in transaction content, structure and gover-nance (Schumpeterian innovation), complementari-ties among resources and capabilities (advocatedby RBV), and network effects (inherent in stra-tegic networks). It captures the sources of valuein e-businesses identified in this paper and ishence applicable in virtual markets in general(see Table 3). We believe that the business-modelconstruct is useful because it explains and predictsan empirical phenomenon (namely, value creationin e-business) that is not fully explained or pre-dicted by conceptual frameworks already in exis-tence (Shane and Venkatraman, 2000).

The business model construct builds on ideasadvocated by the main theoretical frameworks ofstrategic management and entrepreneurshipresearch. First, it is consistent with Schumpeter’s(1942) idea that innovation is an act of ‘creativedestruction.’ In the context of the business model,innovation refers not only to products, productionprocesses, distribution channels, and markets, butalso to exchange mechanisms and transactionarchitectures. Innovative business models such asthe ones adopted by Priceline.com (with its pa-tented ‘name your own price’ exchangemechanism) or Autobytel.com (with its innovativeattempt at re-intermediating transactions amongcar buyers, car dealers, service and information

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Table 3. Source of value creation and the business model construct


Business O Exchange mechanism O Cross-selling O Transaction reliability O New participantsmodel O Transaction speed O Activities of participants, e.g., O Affiliate programs O Unprecedented number ofstructure O Bargaining costs supply chain integration O Direct network externalities participants and/or goods

O Costs for marketing, sales, O Combination of on-line and O Indirect network externalities O New links betweentransaction processing, off-line transactions O Transaction safety mechanism participantscommunication O Learning investments made O Unprecedented richness

O Access to large number of by participants (quality and depth) ofproducts, services, linkagesinformation O Patents applied for or

O Inventory costs of accorded on businessparticipating firms methods

O Transaction simplicity O Business model structureO Demand aggregation relies on trade secrets andO Supply aggregation copy rightsO Scalability of transaction O First to introduce business

volume model

Business O Information made available O Combination of on-line and O Promotion of trust through O New (combinations of)model as a basis for decision- off-line resources and third party products, services,content making; reduces asymmetry capabilities O Participants deploy information

of information O Access to complementary specialized assets (e.g.,O About goods products, services, and software)O About participants information O Dominant design

O Transparency of transactions, O From firm O Customized and/ori.e., information that is O From partner firms personalized offerings andprovided about flows of O From customers featuresgoods O Vertical products/services

O Horizontal products/servicesO Technologies of participants

Business O Incentives to develop co- O Loyalty programs O New incentives (e.g.,model specialized resources O Information flow security and customers can create content)governance O Alliance capabilities of control processes

partners O Customers control use ofpersonal information

O Importance of communityconcept

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providers, and car manufacturers) have the poten-tial to disrupt existing industry structures andthereby pose a serious threat to incumbents.

Second, the notion of the business model drawson arguments that are central to the value chainframework (Porter, 1985), in particular on theideas that processes (e.g., activity chains) andmultiple sources of value (e.g., cost leadershipand differentiation) matter. However, because ofthe conceptual difficulties that arise in the contextof virtual markets with processes that are centeredon product flows (Rayport and Sviokla, 1995;Stabell and Fjeldstad, 1998), we propose to com-plement the value chain perspective by concen-trating on processes that enable transactions. Thatis, a business model does not follow the flow ofa product from creation to sale, but describes thesteps that are performed in order to completetransactions.

Third, the business model perspective offeredherein builds on the resource-based view of thefirm (Wernerfelt, 1984; Barney, 1991; Peteraf,1993; Amit and Schoemaker, 1993). Clearly, thevalue embedded in the business model increasesas the bundle of resources and capabilities itencompasses becomes more difficult to imitate,less transferable, less substitutable, more comple-mentary, and more productive with use (ratherthan less productive with use, as is the case withcapital assets). The business model perspectivetherefore takes into consideration the ways inwhich resources can be valuable, and is consistentwith the VRIO framework offered by Barney(1997).

Fourth, from strategic network theory we adoptthe central ideas that there is a link betweennetwork configuration and value creation (e.g.,Burt, 1992) and that the locus of value creationmay be the network rather than the firm. Thespectrum of potential alliance partnersencompasses suppliers, complementors, and cus-tomers with which the firm must cooperate orcompete. Brandenburger and Nalebuff (1996)refer to the latter idea as a ‘value net,’ whereasin the context of alliance formation within thestrategic management literature, it is commonlyreferred to as the ‘relational view’ (e.g., Dyerand Singh, 1998). It is worth emphasizing thatcustomers can play a critical role in value creation(as lead users, for example). They may workwith the firm to better assess their needs, actingas beta sites before the product is released to a


larger customer base (von Hippel, 1986). In fact,by electronically supplying information in realtime, customers can even ‘co-create value’(Prahalad and Ramaswamy, 2000), as vendorscan better tailor their offerings to the customer.This is why business models, while anchored ona particular firm that exploits a business oppor-tunity, are often customer-centric in their design.Such business models can be hypothesized tocreate more value for and with the help of cus-tomers. Further, the customer-centric view of abusiness model also helps in sharpening theboundaries of the network. Within the Gulatietal. (2000) view of a network, the strategicallyimportant ties are those which would contributein some way to satisfy the customer’s needs.

Table 4 illustrates how the business modelconstruct relates to strategic network theory. Weview the business model as an extension of astrategic network. It draws on network theory bybuilding on the insight that unique combinationsof interfirm cooperative arrangements such asstrategic alliances and joint ventures can createvalue (Doz and Hamel, 1998; Dyer and Singh,1998). While the strategic alliance and joint ven-ture perspectives suggest that these are usuallystrategic choices made as extensions to a firm’score competencies, the business model perspec-tive views interfirm cooperative arrangements(which might include equity investments in part-ner firms) as necessary elements to the firm’sability to enable profitable transactions.16

Lastly, we build on Williamson’s (1975) focuson the efficiency of alternative governance struc-tures that mediate transactions, to suggest thatin addition to efficiency enhancements there areadditional factors that contribute to value creation,namely: novelty, lock-in of customers, and com-plementarities. Also, value can be created throughany combination of transactions within a firm andthrough the market.

Note that each business model is centered ona particular firm. In other words, a particular firm

16 This is not to say that e-business firms solely rely oninterfirm cooperative arrangements to organize transactions.The example of Amazon.com mentioned earlier shows thatthe firm made the strategic choice to organize warehousinginternally. However, at the same time, Amazon.com relieson thousands of interfirm cooperative arrangements with its‘affiliate’ partners. We observe that this kind of externalorganization through interfirm cooperative arrangements isbecoming increasingly important in virtual markets.


Table 4. Sources of value addressed by strategic network theory and business-model construct

Content Structure Governance

Strategic network O Resources that actors O Network size O Trusttheory can access O Network density O Reputation

O Centrality of positionO Nature of ties (weak,

strong, bridging)

Business model O Information and goods O Network size O Locus of control ofconstruct that are being exchangedO Ways in which parties flows of information,

O Resources and are linked and goods, and financescapabilities required to exchanges are executedO Nature of controlenable exchanges O Order and timing of mechanism, e.g.

exchanges O trustO Market mechanism O incentivesO Flexibility and

adaptability oftransaction structure

is the business model’s main reference point. Thisis why one can refer to a particular businessmodel as ‘firm x’s business model.’ However,the business model as a unit of analysis has awider scope than does the firm, since itencompasses the capabilities of multiple firms inmultiple industries. A business model perspectiveon value creation in virtual markets thereforeseeks to answer the following questions: (1) Howdo the participants to a transaction, especially thefirm, which is the reference point of a businessmodel, enable transactions? and (2) How is valuecreated in the process of enabling transactions?We believe that our definition of a business modelis applicable to firms doing business in virtualmarkets as well as to more conventional busi-nesses.

As an illustration of the concept outlinedabove, we give the example of Autobytel.com, acompany listed on NASDAQ, which providesconsumers with automotive solutions. In one lineof business, Autobytel.com (through its AutobytelDIRECT unit) acts as a broker on behalf ofits affiliated car dealers, finance companies, andinsurance companies who, among others, consti-tute important business model participants. Thearchitectural configuration of the business modelcan be sketched as follows. Dealers upload infor-mation on their inventory directly onto Autoby-tel.com’s web site, providing information on pric-ing and vehicle features. Potential auto buyers


engage in a transaction by downloading a virtualcar lot and filling in an online purchase order.Following that, an Autobytel.com sales consultantcontacts the consumer within 24 hours to reviewvarious options such as at-home test drives(provided by a partner, Enterprise Rent-A-Car),or at-home delivery (provided by another partner,Movecars.com). In addition, Autobytel.com’sCustomer Care Center will suggest possiblevehicle financing, leasing, and insurance options.Buyers interested in obtaining credit may applydirectly through the web site. Autobytel.compasses their request on to a financing partner(such as Chase Manhattan) who will contact theconsumer and eventually grant a credit. In thelast step, the customer will either pick up the carat the dealership, or it will be delivered to heror his home. This rounds off the one-stop car-purchasing process, which is the opportunity thatAutobytel.com’s business model addresses. In thisprocess, the full set of transactions in which thecompany is involved is important, including themaking of a customer’s decision as well as theorder fulfillment, namely the implementationactions required for that decision to be satisfied.Autobytel.com takes responsibility for transactionhandling and closing, and for the coordination ofthe transaction with its business model partners.However, important roles, activities, and capabili-ties remain with the latter, for example orderfulfillment. Major sources of value created by


Autobytel.com’s business model include speed,convenience and ease of searching, evaluatingand choosing a vehicle (efficiency), reduced bar-gaining, marketing and sales costs (efficiency),and provision of complementary products such asfinancing and insurance (complementarities).

With the theoretical foundations of the businessmodel construct anchored in the value chainframework, Schumpeter’s theory of innovation,the resource-based view of the firm, strategicnetwork theory and the transaction perspective,we can now give a definition of the value thatis created through a business model. In doing so,we generalize from Brandenburger and Stuart(1996). According to these authors, total valuecreated can be expressed as the sum of the valuesappropriated by each party. We extend theirapproach by positing that total value createdthrough a business model equals the sum of thevalues appropriated by all the participants in abusiness model, over all transactions that thebusiness model enables.

The perspective of the business model is nearlyabsent from the academic literature. There are,however, a few exceptions. Venkatraman andHenderson (1998) define a business model as acoordinated plan to design strategy along threevectors: customer interaction, asset configuration,and knowledge leverage. Hamel (1999) relatesthe high capitalization of Silicon Valley firms toa certain business model rather than to the talentsof the entrepreneurs. Prahalad and Ramaswamy(2000): 81) state that ‘the unit of strategic analy-sis has moved from the single company to … anenhanced network of traditional suppliers, manu-facturers, partners, investorsand customers.’ AndTimmers (1998): 4) defines a business modelas an ‘architecture for the product, service andinformation flows, including a description of thevarious business actors and their roles; a descrip-tion of the potential benefits for the various busi-ness actors; and a description of the sourcesof revenues.’

These authors offer interesting insights aboutbusiness models, which broadly support ourconceptualization of the term. However, the theo-retical foundations of their business model con-cept are not fully developed. The same can besaid about business models in the nonacademicliterature, where ambiguity, contradiction, andmisconception about the concept prevail. Forexample, a business model is often conflated


with a mode for generating revenues (e.g., Green,1999). In order to avoid further confusion, weoffer the following definition of ‘revenue model.’

Definition: A revenue model refers to the speci-fic modes in which a business model enablesrevenue generation.

E-business firms generate revenues throughsubscription fees, advertising fees, and trans-actional income (including fixed transaction fees,referral fees, fixed or variable sales commissions,and mark-ups on direct sales of goods). Theysometimes use variants of these basic revenue-generating modes, and they often use them incombination. As our definitions show, the busi-ness model and the revenue model are comple-mentary yet distinct concepts. A business modelrefers primarily to value creation whereas a rev-enue model is primarily concerned with valueappropriation.

To summarize this discussion, we believe thatthe business model concept may enable scholarsof strategic management and entrepreneurship toaddress a unique set of questions pertaining tovalue creation that cannot be sufficientlyaddressed by prior frameworks. We also suggestthat as a firm’s scope and its boundaries becomeless clear through the advent of virtual marketsand through the impact of sophisticated infor-mation technology, strategic analyses of e-business ventures will have to move beyond thetraditional conception of the ‘firm’ as the unitof analysis. Scholars of strategic managementincreasingly recognize that the source of valuecreation may lie in networks of firms (Bettis,1998; Dyer and Nobeoka, 2000; Gulatiet al.,2000). We build on this line of reasoning tosuggest that value is created by the way in whichtransactions are enabled. In e-businesses in parti-cular, enabling such transactions requires a net-work of capabilities drawn from multiple stake-holders including customers, suppliers, andcomplementors. Business models may thus spanindustry and firm boundaries.

CONCLUSIONS

The rapid pace of technological developmentscoupled with the growth of e-businesses givesrise to enormous opportunities for the creation of


new wealth. In this paper, we have attempted tocontribute to theory development by investigatingthe theoretical foundations of value creation in e-business. The focus of this paper is on newwealth creation, which has occupied much of theentrepreneurship literature. We draw on a widebody of literature in entrepreneurship and stra-tegic management and use cross-case analysis ofa unique data set we developed, in order toidentify common patterns of value creation in e-business. The analysis led to the development ofthe value-drivers model, which includes four fac-tors that enhance the value creation potential ofe-business: efficiency, complementarities, lock-in,and novelty.

Our analysis and theoretical developmentattempt to bridge the strategic management andthe entrepreneurship literatures. Specifically, wehave grounded the development of the theory inthe received strategy and entrepreneurship researchand in the data set, respectively. Using thegrounded theory development approach, weobserved that none of the received theories in andof itself could explain the sources of new valuecreation in e-business. Rather, the value-driversmodel suggests that an integrative perspective tovalue creation is needed, a perspective that drawson the extensive research on value chains, Schum-peterian innovation, the resource-based view of thefirm, interfirm strategic networks, and transactioncosts economics. We suggest that research on e-business and, more generally, on competition inhighly networked markets, will benefit from anintegrative approach that combines both strategyand entrepreneurship perspectives.

This paper is a first step in attempting tounderstand the strategic issues faced by e-businessfirms in the emerging context of the Internet. Itraises a number of interesting and challengingpaths for future research including such questionsas: (1) What are the sources of competitiveadvantage in online markets versus offline mar-kets? and (2) Are strategy perspectives and toolsthat were formulated based on a competitive land-scape inhabited by offline firms still relevant inthe new world of e-business? Our paper suggeststhat the emergence of virtual markets opens newsources of innovation (e.g., business modelinnovation) that may require a parallel shift instrategic thinking towards more integrative,dynamic, adaptive, and entrepreneurial strategies.Although the possibility of deliberately designing


inter firm networks17 and the importance of adapt-ing business models are increasingly acknow-ledged in the strategy and entrepreneurship fields,further development of methodological approachesto the study of e-business dynamics and businessmodel design is needed.

ACKNOWLEDGEMENTS

We are most grateful to the SMJ Special Issueco-editors and two anonymous referees for theirguidance and patience, and for their constructivesuggestions and comments on earlier versions ofthis manuscript. We thank Iwona Bancerek, JonDonlevy, Dovev Lavie, and Alasdair Macauley fortheir research assistance. Raffi Amit acknowledgesgenerous financial support from the Wharton e-business research center (a unit of WeBI), theSnider Entrepreneurship Research Center, the Rob-ert B. Goergen Chair in Entrepreneurship at theWharton School, and the Social Sciences andHumanities Research Council of Canada (grantnumber 412 98 0025). Christoph Zott gratefullyacknowledges financial support from the 3iVentur-elab, eLab@INSEAD, and from the R&D Depart-ment at INSEAD. We also acknowledge the con-tributions of Jennifer Wohl, Janet Gannon, and theW. Maurice Young Entrepreneurship and VentureCapital Research Center at the University of Bri-tish Columbia, with which both authors were pre-viously affiliated. In addition, we acknowledge thevaluable feedback received from participants atthe 2000 SMS Conference in Vancouver, and atthe Kauffman Foundation ‘Creating a New Mind-set Conference’ in Kansas City. We received use-ful feedback on earlier versions of this paperfrom Howard Aldrich, Charles Baden-Fuller, IzakBenbasat, Max Boisot, Mason Carpenter, YvesDoz, Bo Erikson, Martin Gargiulo, SumantraGoshal, Anita McGahan, Ian MacMillan, PaulSchoemaker, Craig Smith, Belen Villalonga, Bobde Wit, George Yip, and from participants at afaculty seminar at the Wharton School.

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APPENDIX 1: U.S. Firms

Company Core product/ Country Foundation IPO date No. of Wherebusiness year employees traded

1-800- Flowers U.S.A. 1992 08/03/99 2100 NASDAQFLOWERS.COMAlloy Online Portal U.S.A. 1996 05/14/99 120 NASDAQAmazon.com Books U.S.A. 1994 05/15/97 7600 NASDAQAsk Jeeves Search engine U.S.A. 1996 07/01/99 416 NASDAQAutobytel.com Automobiles U.S.A. 1995 03/26/99 255 NASDAQbarnesandnoble.com Books U.S.A. 1997 05/25/99 1237 NASDAQBeyond.com Computer accessories U.S.A. 1994 06/17/98 389 NASDAQCareerBuilder Job portal U.S.A. 1995 05/12/99 179 NASDAQCareinsite Healthcare portal U.S.A. 1996 06/16/99 160 NASDAQCBSsportsline Sports content U.S.A. 1994 11/13/97 453 NASDAQCyberian Outpost Hardware, software U.S.A. 1995 08/05/98 234 NASDAQ

retailingE∗TRADE Online brokerage U.S.A. 1982 08/16/96 1735 NASDAQeBay Auctions U.S.A. 1995 09/24/98 138 NASDAQeToys Toys U.S.A. 1996 05/20/99 940 NASDAQfashionmall.com Clothing and U.S.A. 1994 05/21/99 43 NASDAQ

accessoriesFatbrain.com Books and U.S.A. 1995 11/20/98 315 NASDAQ

informationHealtheon Healthcare portal U.S.A. 1995 02/11/99 1825 NASDAQiTurf Community/retail for U.S.A. 1995 04/09/99 153 NASDAQ

youthLog On America ISP U.S.A. 1992 04/22/99 13 NASDAQMapQuest.com Mapping U.S.A. 1996 05/04/99 335 NASDAQMedscape Medical portal U.S.A. 1996 09/28/99 298 NASDAQmusicmaker.com Customized CDs U.S.A. 1997 07/07/99 73 NASDAQN2H2 Internet filtering U.S.A. 1995 07/30/99 179 NASDAQNet2Phone Internet telephony U.S.A. 1997 07/29/99 333 NASDAQNextCard Online credit U.S.A. 1996 05/14/99 287 NASDAQPriceline.com Reverse auction U.S.A. 1997 03/30/99 373 NASDAQStreamline.com Delivery goods U.S.A. 1993 06/18/99 350 NASDAQTalk City Communities U.S.A. 1996 07/20/99 197 NASDAQVerticalNet Trade communities U.S.A. 1995 02/11/99 669 NASDAQXoom.com Retail/auction/advertising U.S.A. 1996 12/09/98 92 NASDAQ


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Zajac EJ, Olsen CP. 1993. From transaction cost totransactional value analysis: implications for thestudy of interorganizational strategies.Journal ofManagement Studies30: 131–145.


APPENDIX 1 (Continued): E.U. firms

Company Core product/ Country Foundation IPO date No. of Where tradedbusiness year employees

AB Soft Communications France 1987 12/03/97 69 Nouveausoftware Marche´

Amadeus Airline tickets Spain 1987 10/19/99 2,860 MadridArtnet.com Art Germany 1989 05/17/99 97 Neuer MarktBeate Uhse Erotic goods Germany 1946 05/27/99 706 FrankfurtBoursedirect Online brokerage France 1996 11/10/99 22 Nouveau

MarcheBuecher.de Books Germany 1996 07/05/99 45 Neuer MarktCommtouch E-mail Israel 1991 07/13/99 214 NASDAQ

NMConsodata Consumer data France 1995 10/07/99 220 Nouveau

MarcheCryo-interactive Computer games France 1992 12/08/98 218 Nouveau

Marchee-bookers Travel booking U.K. 1999 11/11/99 160 NASDAQ

NM/NeuerMarkt

Fortunecity Community Germany 1996 03/19/99 164 Neuer MarktFreeserve ISP U.K. 1998 07/26/99 16 NASDAQ

NMGameplay.com Computer games U.K. 1999 08/02/99 37 LSEi:FAO Travel booking Germany 1977 03/01/99 112 Neuer MarktIceland Group Grocery U.K. 1970 10/16/84 11,895 LSEID Media Community/software Germany 1988 06/17/99 99 Neuer MarktInfonie/Infosources ISP France 1995 03/20/96 450 Nouveau

MarcheLernout & Hauspie Speech-related Belgium 1987 06/23/97 2,500 EASDAQ/

software NASDAQNM

QXL.com Auctions U.K. 1997 10/07/99 105 LSE/NASDAQNM

Ricardo.de Auctions Germany 1998 07/21/99 73 Neuer MarktScoot.com Directory services U.K. 1993 03/10/97 1,000 NASDAQ

NMSportingbet Online betting U.K. 1998 02/22/99 33 OFEXTerra Networks ISP Spain 1998 10/29/99 928 Madrid/NASDAQ

NMThe eXchange Financial services U.K. 1991 08/06/99 235 LSETiscali ISP Italy 1997 10/27/99 178 Nuovo

MercatoTopjobs.net Job portal U.K. 1996 04/28/99 64 NASDAQ

NMTown Pages Directory services U.K. 1995 05/05/99 270 AMEXVocaltec Internet telephony Israel 1994 02/07/96 343 NASDAQ


value creation in e-business

Documents

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positive feedback loop

forrester research report

strategic management literatures

transaction cost theory

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transaction cost economics

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