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TR: Why does selling information require a different set of rules from selling physical goods?
Shapiro: Because the economics of information is different. Think about a book or a movie. There’s a huge upfront cost to create the content and then very little to make additional copies. That’s even more so with the Internet, where the information is in digital form and can be distributed at virtually no cost to large numbers of people. This is not the case with manufactured goods, where there is a substantial cost to produce and deliver each unit.

Varian: Another difference is on the demand side. Buyers of information goods really don’t know what they’re getting until they experience it, and by then they’ve already paid for it. The challenge that faces information providers, then, is this: How do they tell you what they’ve got without giving it all away? This is not a problem that’s unique to the Internet. Movie previews, book reviews, music radio and so on have helped solve this problem in the predigital world. Now we’re beginning to see the Web equivalents.

TR: Supposedly, the Web is going to allow us to get rid of the middleman and allow a free flow of goods and information. But aren’t you just trading one intermediary for another?
Shapiro: Yes-we like to say that the friction-free economy is a fiction. With e-commerce, the reputation of the seller, whether it’s L.L. Bean or Lands’ End, will be even more important than in the past because people are all the more concerned about things like the security of the transaction, the quality of the merchandise, service and support. Sure, people will be able to shop around efficiently for the lowest price-but reputation is always going to be very important, and that’s where middlemen come in. Take stock trading sites, which offer an inexpensive and convenient way to buy and sell securities. A lot of investors have realized that saving a small amount on a transaction isn’t worth much if the trade isn’t going to be executed properly or if they’re not getting good prices. A number of brands will survive, and some will be cut-rate. Right now, we’re in a shake-out phase.

TR: What’s the main problem facing old-line companies still struggling to understand Web commerce?
Varian: Incumbents in any industry have to grapple with their old business models. Take music retailing-record producers would love to sell directly to consumers, but they don’t want to alienate their traditional distribution channels. A company that comes along without a pre-existing distribution channel to preserve-like Amazon.com, for instance-can be much more flexible.

Shapiro: Of course, there’s nothing to bar conventional retailers from competing online as well. Look at the bookselling business. Barnes and Noble didn’t lead, but it pretty quickly followed Amazon.com. I think that’s a pattern we’ll see over and over: upstart entrants establishing a way to use the Net that works, and then the incumbents following along saying: This may cannibalize some of our existing business, but if we don’t do it, others will.

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