MOVERS & SHAKERS By Steve Hamm	March 17, 1999

Even though he advises companies on electronic commerce as a principal at McKinsey & Co., John Hagel III brings a very personal interest to his specialty. Among his eclectic tastes are rare economics books, Algerian Rai music, and 1940s pinup art -- all of which are almost impossible to find in local Silicon Valley stores. "I'm very frustrated with physical establishments' ability to serve me," he says.

So it's no surprise that in his latest book, Net Worth, coauthored with McKinsey colleague Marc Singer, the Silicon Valley-based consultant envisions the rise of a new class of online middlemen to help consumers find whatever they want on the Web (you can read Chapter One of Net Worth here on BW Online). Even more than that, Hagel believes that consumers will come to trust these "infomediaries" with their most personal information -- from marital status to buying habits -- in return for extracting the best deals from competing merchants. He calculates that the average household ultimately will save some $1,110 a year from these cyberservants.

Indeed, Hagel thinks the Web will bring a wholesale shift in power from sellers to buyers, thanks to consumers' ability to get almost unlimited information and compare products online. "This is going to create the greatest wealth transfer we've seen since the Industrial Revolution," he says. "A lot of new, small companies will gain a lot of wealth, and a lot of major players will lose wealth."

That's why Hagel's books are required reading for both Internet startups and established companies going online. His previous book, Net Gain, coauthored with McKinsey manager Arthur G. Armstrong, explored the rise of Net communities. Many, such as iVillage and Geocities, are now Web mainstays -- though some are taking longer than he predicted to jell into profitable enterprises.

Indeed, some experts wonder if he's too early this time, too. "Hagel's not completely right" in predicting that the buyer will always prevail, says Joseph P. Bailey, a professor studying Internet economics at the University of Maryland's Smith School of Business. In many cases, he contends, sellers will still hold many cards online, including established brands and sheer size. Even so, says Trevor Traina, CEO of the online comparison shopping service CompareNet, Hagel has the trend nailed: "Everywhere you look, companies are trying to turn themselves into infomediaries."

Despite the shift in power to the buyer, Hagel is concerned about how merchants and infomediaries will handle all that personal data -- especially his own. One day, he did a Web search on his name and found on an Australian student's site a paper on the Vietnam War that he wrote about 30 years ago for the Students for a Democratic Society. "It gave me a very strong sense of the footprints you leave," he says. Now, to protect his privacy, he creates a variety of online personas depending on whom he's dealing with.

Hagel, 49, became interested in history as a boy when his family moved to a new country every year thanks to his father's oil-industry job. "I got to see a lot of different cultures," he says. Ultimately, he got a bachelor's degree in economic history at Wesleyan, later earning a master's equivalent at Oxford and MBA, and law degrees at Harvard. He started out with Boston Consulting, got the entrepreneurial bug and sold computers to physicians, then joined Atari as senior vice-president for strategic planning, where he helped negotiate the company's sale to Jack Tramiel. He went back to consulting at McKinsey as a way to explore bigger issues and trends.

In an interview between consulting visits, Hagel recently discussed E-business trends with Business Week Correspondent Robert D. Hof. Here are excerpts from their conversation:

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Q: In your book, you contend that the Internet's potential to reduce transaction costs will lead to a big shift in power from seller to buyer. Why will buyers be the main beneficiaries?

A: The key issue on the part of buyers has always been this difficulty in getting sufficient information about a broad enough frame of choices to make the best purchase possible. And what the Internet is doing now is, for any comparable amount of time or energy or budget, allowing you to compare in a much more detailed way -- across more suppliers and more offerings on a more regular basis.

For example, in many industrial markets, you end up focusing on a very narrow range of suppliers, because the whole cost of getting to know a supplier well enough to be able to count on their ability to deliver the products and the right specs at the right time just makes it too difficult to regularly switch from one supplier to another. But with the enhanced information available through electronic commerce on the Internet now -- the ability to more systematically compare supplier offerings on a more frequent basis -- makes it much easier to switch from one supplier to another. This is going to lead to a much more challenging environment for suppliers over time, because customers will just have much more information about them.

Q: And this isn't just sort of a temporary phenomenon before vendors learn to use the medium as much as consumers?
A: No. At the end of the day, we're going to see even more buyer power emerge. One of the big obstacles right now is that most people are going to the Internet with the traditional or conventional mind-sets and haven't really reconfigured the business system to more accurately reflect the shift in power. So most of the business models on the Internet today I would characterize as being vendor-centric. Very few are really flipping the mind-set and taking this customer-focused view.

Q: So what's going to change the situation?
A: One of the key elements that will drive this process is that we're moving from a battle for traffic to the battle for customer profiles. What's driven valuation so far on the Internet has been the ability to get people to come to your Web site and to come back repeatedly over time, and spend more time on your Web site. But the paradox is that driving traffic is only a cost driver, right? It costs you to serve traffic. You have to build up more capacity, you have to add more content and services to keep people coming back.

But the real economic value is going to come from having information about the customers, the people who are visiting your Web site [so you can target products and services to them]. So as people move from the battle for traffic to the battle for profiles, there's going to be a whole set of issues around privacy, around building trust with people, whether they're willing to let you capture information about them and to use that information for commercial purposes.

And our sense is that it's at this point that we're going to see a lot of businesses take a more explicit customer focus, to say, "You should feel comfortable giving us information about yourselves, because in fact, we're representing you, not the vendor." And those companies who make that kind of shift will be the most successful in actually getting privileged access to information about customers. And that, in turn, is really going to drive the next wave of value on the Net.

Q: You propose that these companies, which you call "infomediaries," will emerge to handle those profiles for consumers. But no companies currently appear to play this role.
A: No one is a pure-play infomediary. It just takes time. People are experimenting their way into this and evolving as they learn.

Q: Are any getting close?
A: There are a number of companies in the financial portal or services arena that show promise in this regard. You've got Intuit, and potentially E*Trade with their portal -- and Charles Schwab, for that matter -- all trying to broaden out from a discount brokerage base to add more value and know more about what your investment needs and trying to be helpful to you in terms of finding the right investment vehicles.

Q: This role seems a natural for, say, Consumer Reports or trade magazines on the industrial side. But they don't seem to be playing a leading role online.
A: No. Companies have to move to a much more transaction-centered relationship with the customer, and most media companies still have the mind-set that the primary value is in the content and not in the transaction relationship with the customer. Very, very few companies have moved aggressively to merge the transaction capability with the information.

Q: What sort of form will the infomediaries take, and how will they make money?

A: There are many ways the infomediary could evolve. Our sense is that probably the most likely evolution is to start with a business that's what I would call a search or agent-oriented business that helps customers go out and find things that are useful to them. Then move over time to replenishment or browsing kinds of products, where the infomediary can leverage a deeper understanding of that customer. They could introduce the customer to new products or services that they haven't requested, based on what they've bought in the past.

So in the early days, our sense is that the business model will be built around commissions for successful searches. Over time, more of the revenue will start to focus on the marketing services that an infomediary can provide in terms of just helping to connect vendors with the right customers based on the profiles. Our sense is that there's a very large untapped revenue stream around aggregated marketing data -- being able to capture a rich sense of who's buying what kinds of products.

Q: So most infomediaries are probably going to be focused narrowly on the customer relationship?

A: Exactly. They will become much more pure businesses. In most industries, in most companies, you have three very different kinds of businesses that are going to end up unbundling and becoming very focused companies. One is the customer relationship business, and that's what an infomediary is all about. It's identifying a set of customers, developing relationships with them, becoming more knowledgeable about who they are and more helpful as a result in connecting them to the right kinds of products and services they're looking for.

There's a second set of businesses, which we would call product innovation and commercialization businesses that are all about just how do you get the latest and greatest new products quickly into the marketplace and commercialize them effectively? And then there's a third set of businesses, which are infrastructure management businesses -- very large-volume, routine operations kinds of businesses that can be anything from managing a delivery logistics fleet to managing a customer call center.

So if that's correct, if there are these three different kinds of businesses, they each have a very different set of economics. The infrastructure management businesses are driven by economies of scale. The customer relationship businesses tend to be driven by economies of scope: How much of a wallet or relationship do I have with the customer, and how many customers do I have more relationships with? Those two kinds of businesses are likely to become very concentrated over time -- very large business entities. It's a real challenge to the traditional wisdom about the Internet, which says this is a level playing field where the smallest company can compete successfully with the largest company.

Q: Not for long, right?
A: At least in those two businesses, our sense is not for long. In the product innovation and commercialization businesses, in fact, you might see a lot of fragmentation in smaller businesses, because small organizations can often be the most innovative and the fastest to market, relative to large organizations.

Q: Where are we seeing these things unbundle themselves?
A: You can see early evidence in certain businesses already. For example, in the banking industry, for quite a while now you've seen -- particularly in things like credit cards and the mortgage business -- an unbundling where you have a set of financial institutions that are much more focused on marketing and commercializing, developing relationships with customers; another set of companies that focused on developing innovative new financial products and services; and then another set of companies that are focused on doing back-office processing.

So in the credit-card business, you often have the credit card that you own, and the actual transactions are being processed by a very different company who's doing that because they have the scale in the transactioning side. And then there's another set of companies that are marketing these cards because they have customer relationships, they have these affinity cards where you may have a Visa because you're an American Airlines frequent flyer and you want to build that relationship. And then you've got another set of companies that are just all being innovative, new credit-card features and options and getting those into the market place quickly.

These activities have tended to be bundled together in companies historically, because of the inefficiencies of the transaction costs. Coordinating activities across organizational boundaries across companies has been very difficult in physical markets and physical space. What the Internet is doing is systematically driving down these transaction costs or coordinating costs, so if these don't work well in one business, why not have two very focused businesses do these activities?

In some very subtle ways, these businesses have extremely different cultures, and it's not just their economics that are different. For example, in an infrastructure management business, the whole culture is around routine, and predictable and standardized [activities]. You don't want to have a lot of variation, because variation drives up your costs. On the other hand, if you're in the customer relationship business, you want to have the offer tailored down to the actual customer. You want to do everything you can to make it the right thing for that individual customer. And so your whole value system in a customer relationship business is around tailoring and variation. If you try to bundle those two in one company, it's very hard to have both cultures coexist. That's why you see a lot of friction within large companies between different areas of the business, because they attract different kinds of people, different kinds of skills, different values.

Q: How does a company doing two or three of these things now decide what their core business really is?
A: It's certainly not obvious. And that's one of the reasons this hasn't happened more quickly. I think part of it is that senior management has grown up in a business where the wisdom is you bring all these things into one company and that's the way it's done. But even if you can get over the mind-set issue and you recognize that there's an opportunity to unbundle, it is an untrivial issue which of these activities or businesses you focus on. It really hinges both on an objective evaluation of your own capabilities, which is pretty hard to do. I mean, the natural reaction is, "We're really superior in all three of these kinds of businesses."

The answer in part may be not to necessarily choose one of the three, but [management] may want to think about a process, a systematic process of divestiture, where you unbundle and give back to the shareholder the ownership of three companies, if you will.

Q: A lot of these businesses seem to veer toward a monopoly situation, or certainly a lot more concentration. I wonder what kind of impact that's going to have in these industries.

A: Well, our sense is it's going to create some very significant public policy issues. If you think Microsoft is a monopoly, just wait. There's the prospect of even higher-level concentration in some of the businesses over time. You know, I think it's a particularly challenging one in the customer relationship business side, because our sense is that these monopolies will be quite different from monopolies in the past in the sense that their focus is on serving the customer and extracting value from the vendors.

So in contrast to traditional monopoly controversies, where it's been customers getting together and saying, "We want to fight the abuse of the monopoly power," in these situations, it may actually be vendors getting together and lobbying to avoid or to minimize the abuse of monopoly power and extracting value from the vendors. It's a very different kind of challenge, a public policy challenge. And one of the big uncertainties over time is how public policy is going to evolve to deal with these situations.

Q: How will these infomediaries change their industries?
A: One change is that, in positioning itself as a customer agent and helping to extract value from the businesses, it's going to force businesses to become much more focused and efficient in what they do. So if they're bundling together activities that are unnatural combinations, this is going to force them to rethink that and to unbundle into more natural business entities.

Also, more focused product companies can dramatically expand their reach in a way that they just can't do in traditional environments, where shelf space is a scarce resource. Getting on a shelf is a major challenge for a smaller product company. With these infomediaries which have rich search capabilities, the shelf space becomes unlimited. Anybody's product can be located, regardless of where they're based. It gives a huge economic incentive for companies that are focused product companies to simply stay focused on the challenge of innovating and rapidly commercializing new products and services, and counting on the infomediary to help connect them to the right customers.

Q: Most of what you talked about with the infomediary is aimed at you and me as consumers. Do you see a role for these in the business-to-business realm?
A: Very much so. I think we made a choice in Net Worth to focus more on the consumer markets just in the interest of simplifying the message and the analysis. But our sense is there's a huge opportunity to apply the infomediary concept in business-to-business markets. And, in fact, what we're seeing is that much of the early value creation on the Internet has been in the business-to-business marketplace and particularly industrial companies or large companies more effectively extracting value from the suppliers that they deal with.

Q: Obviously, infomediaries are just one sort of middleman. Do you think the infomediaries will be the dominant middlemen, or will there be others?
A: My sense, over time, is that the customer-oriented ones will certainly be the more successful in terms of creating sustainable positions. One of the early myths or half-truths about the Internet was that this was all about radical disintermediation and picking out an intermediary that stands between the product vendor and the ultimate customer. And in most cases the value that's being created today is being created by intermediaries, new kinds of intermediaries coming between customers and vendors, often in markets where they didn't even have an intermediary before.

So banks, for example, are very worried about these intermediaries emerging to help customers maximize their financial investments. Or in the automobile industry, with the Auto-by-Tels of the world coming into where there already was an intermediary, now you have a second level of intermediary coming in between the dealer and the customer.

Q: The funny thing is, both sides seem to be benefiting.
A: Absolutely. That's the irony. It's often a different kind of value than the traditional intermediaries have provided. But our sense is that this is where a lot of the opportunity exists -- to think about creating new kinds of intermediaries that leverage the unique capabilities of the Internet. Over time, this will favor very heavily the ones that choose to take a more explicit customer-oriented view, but there's enough room to play here for many models for quite a bit of time.

Q: Some intermediaries are positioning themselves not as buyer advocates, but as neutral third parties. Is that a sustainable way to go?
A: I know from dealing with clients in this area that many of these neutral intermediaries are positioning themselves in the near-term as neutral because they've very concerned about how to get vendor cooperation. But once they get a sufficient mass of vendors in place, the opportunity is to take a much more explicit customer-oriented view. I think it'll be interesting to see how that evolves over time, whether they remain truly neutral or end up becoming more aggressive on behalf of customers.

Q: In your previous book, Net Gain, you spoke of virtual communities playing a dominant role in online commerce. Will such communities act as infomediaries, or will they remain distinct?
A: In Net Gain, it was...the notion that as you move online, you need to think creatively about the new kinds of relationships with customers. It's not just about a bilateral relationship where you as a vendor connect with a customer, but in fact, there's a lot of value in helping customers to connect with each other. And you need to rethink what content is all about, that it's not just published content that's valuable but, in fact, a lot of it is user-generated or at least user-enhanced content.

There's still a lot of potential to develop more pure-play virtual community business models. But I think, in general, what people have started to recognize is that -- particularly as you move from the battle for traffic to the battle for profiles, virtual community kinds of offerings are very effective in both developing deeper relationships with the traffic that you have, and to get to know more about the people and to increase your retention over time.

As a result, you're seeing many kinds of businesses, not just pure-play virtual communities. The portals, for example, are all adding virtual community elements to their offerings. Transaction aggregators and market makers of various types are adding virtual community kinds of offerings and services. Even individual product vendors are starting to be more aggressive or ambitious in this area. So I'd say, on the one hand we have yet to see a pure-play virtual community, [but] on the other hand, we see a lot of Internet-based businesses recognizing much more of the value related to a virtual community kind of offering.

Q: It's particularly difficult to do given the inherently global nature of online business, isn't it?
A: You know, it really depends on the kind of virtual community that you're talking about. For example, the interest-oriented virtual communities have a much easier time of doing that, because there's such a passion around scuba diving, it doesn't matter whether you're from Copenhagen or from Baja, Calif. If you've got an interest in scuba diving, you're going to want to connect with other people and talk about different dive sites you've been to, etc. On the other hand, if you're talking about demographically oriented virtual communities or, at the other extreme, the geographically oriented virtual communities, then it's much harder to create a global presence.

Q: What is the larger picture you want companies to come away with?
A: The broader theme of information capture being a critical determinant of who's going to win and who's going to lose. One of the things that brought us to write Net Worth was looking at many large companies as they start to think about the Internet -- taking for granted as they move online that they're going to have access, and not just access, but increased access to customer information. In fact, that assumption has yet to be tested, because in many cases we're seeing situations where companies that previously had access to information are now finding it being captured by somebody else. And in many cases it goes back to these new intermediaries that are coming between vendors and their customers. Being able to develop privileged access to customer information is going to be a major strategic challenge in the online environment.

I often tell a story about being called in by senior management of large companies to evaluate strategic relationships that are being proposed to them by some of these newer Internet-based companies. And the whole discussion starts with the notion of: "These are the royalty streams, here's how much they're paying to us up front, and over what period of time and based on what performance measures." And I'll often stop the conversation and say, "That's interesting, but what about the rights to information about the customers in these relationships? Who has the right to that?" And the number of times that senior management can't even tell me what the terms of that part of the deal is, and to find out when they look into it that, in fact, the right to the information is being held by the other party--

Q: --which knows full well--
A: --which knows full well that this was not a coincidence. You know, it illustrates the fact that large companies, in general, are not sufficiently focused on the whole challenge of: How do I capture information about customers, and how do I continue to be in a position to capture that information?

Q: Once you lose it, you're in trouble, right?
A: That's right. Aother message that comes out of a lot of the work we've done in this area is you have a phenomenon in physical markets where you have these huge data warehouses that are being built to house all the information that you accumulate as a byproduct, really, of interactions or transactions with customers, right? So every time they buy something from you, you automatically store that in the data warehouse. And because it's a free good, because it's a byproduct of another activity, there's much less economic incentive to develop the skills necessary to take that information and convert into some kind of tangible value, back to the customer.

Checking into large hotels -- each time I check in I have to reenter a whole set of information that I've entered in many times in the past. Even at that trivial level, they're not taking the information they already have and converting it back into value by saying, "Well, here's what you told us last time, is this information still accurate?"

Q: Even my local pizza joint can do that.
A: Right. The more we move to an environment with infomediaries and other kinds of entities that require payment for information, access to information about customers, [the more] you increase the incentive necessary for companies to actually develop the skills to take the information and generate value from it. Because if I've paid something for it, I sure as heck want to get a return on the payment. Increasingly, the strategic advantage is going to be with companies that have the skill necessary to take information about customers and deliver tangible value from it.

Q: You believe that the most successful infomediaries will be a combination of new Net companies and traditional companies. Isn't that a very difficult combination?
A: It's very challenging. There are a number of key elements required to be successful as an infomediary. Some of them have to do with being able to quickly develop trust with a broad set of customers so that you can start to leverage that relationship to be more successful in bringing vendors together that are relevant to the customers. That's very hard for a startup to do.

You know, a startup going to somebody and saying, "Look, tell me about yourself and I'm here to help you" -- it's hard to overcome the skepticism on the part of customers vs. somebody with a very well-established brand name and an existing set of trusted relationships with customers, saying, "You've come to trust me in the past in this area. Now if you give me a little more information in this other area, I can be helpful to you." It's a more plausible proposition.

On the other hand, large companies just don't have the specific skills and speed necessary to really move quickly in this Internet environment, so having a relationship with somebody who has that skill set and cultural bias for speed is also essential. So the basic conclusion we came to was no single company has the full range of elements required to be successful as an infomediary. And what it is going to take is some form of relationship between both larger companies and some of these small entrepreneurial companies.

This is a very challenging proposition. Very few companies have those kinds of successful relationships, and the risk is obviously that the large company unintentionally smothers the smaller company by virtue of its size. And that the culture of the larger company ends up undermining and overwhelming the very reason they wanted the relationship with the smaller company -- which was their distinctive culture and skill set.

Steve Hamm covers information technology for Business Week in New York

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