Analyzing Information Intermediaries in Electronic Brokerage

Robert J. Kauffman Mani Subramani Charles A. Wood

Associate Professor Assistant Professor Doctoral Program
Information and Decision Sciences, Carlson School of Management
University of Minnesota, Minneapolis, MN 55455
{rkauffman, msubramani, cwood}@csom.umn.edu; 612-624-8030
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 Analyzing Information Intermediaries in Electronic Brokerage
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ABSTRACT
In the past, full-service stock brokerage firms had a
strategic advantage over discount brokers because of the
control full-service brokers had over the information
provided to the customer. Full-service stockbrokers act
as information intermediaries in that they capture
residual value from the transfer of information to make
a profit. Information intermediaries differ from
transaction intermediaries, who provide information
freely to the customer and rely solely on selection,
efficiency of production and delivery, and the
relationship with the customer to make a profit. New
Web-based information technologies allow information
to flow more freely and offers customers other sources of
information, reducing the strategic advantage enjoyed
by the information intermediary. Strategic vulnerability
occurs when information intermediaries are challenged
by competitors who use employ the new innovations
(e.g., electronic commerce technologies) to establish
themselves as alternatives to market leaders. This
research explores how strategic vulnerability differs
when the market leader is an information intermediary.
We develop a model of the phases of strategic
vulnerability and discuss three propositions that involve
strategic vulnerability, stalling of technological
adoption and value creation that show how information
intermediaries differ from transaction intermediaries.
1. INTRODUCTION
The information technologies (ITs) associated with
the World Wide Web give people unprecedented access
to information. These technologies can change the
nature of the competition and transform industrial
structure. This transformation can occur in multiple
industry contexts when market leaders become
strategically vulnerable to competitors who exploit Web
technologies to successfully establish market share. In
this paper, we argue that this transformation occurs in
two different ways: by enabling links between buyers
and suppliers for transactions in physical goods and
services; and by enhancing the flow of information
between counterparties in a transaction. This distinction
is useful; it allows us to understand how different types
of intermediaries create different kinds of value, how
intermediaries become vulnerable to competitors using
these new technologies, and how intermediaries react to
competitive threats from firms using Web technology.
Definitions of Key Terms. We use the term
strategic vulnerability to describe a reduction in market
power due to a competitor's use of technology. Strategic
vulnerability can result in a competitive disadvantage if
the vulnerable company does not address the
competitors' use of technology by imitating the
competitor’s actions or developing alternatives for the
consumer that reduce the competitor’s threat. Strategic
vulnerability can result in several situations. First,
competitors may deliver superior execution of the same
set of value-creating processes. For example, E*Trade
(www.etrade.com), a recent entrant to the electronic
brokerage services market, made it easier for customers
to place orders electronically and thus eliminated the
need for the large staff that is typical of a traditional
brokerage firm. Second, competitors may use more
efficient reconfigurations of their business processes.
For example, Charles Schwab (www.schwab.com)
recently began to provide access to research from third
parties -- something that makes firms with dedicated
research capabilities in-house more vulnerable.
We define transaction intermediaries in terms of
their reliance upon capabilities to efficiently deliver
products to customers and to communicate with the
customer. For example, the main function of discount
stockbrokers is to match stock sellers with stock buyers.
By doing so, they facilitate transactions that would be
difficult or impossible without their intermediation.
Transaction intermediaries can experience strategic
vulnerability when competitors use technology to
become more efficient. For example, E*Trade and
Ameritrade (www.ameritrade.com), among other new
firms, have emerged as viable alternatives to traditional
discount brokers by providing services to consumers
over the Web and over online services such as
CompuServe. These new competitors are able to
leverage new technology to provide services
electronically that were usually performed in person or
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over the phone. As a result, they are able to provide the
same services more efficiently than traditional discount
brokers. Discount brokers like Charles Schwab were
forced to imitate these new entrants to remain
competitive.
We define information intermediaries as firms that
profit from controlling information flows. They need not
do so by relying on IT solutions, as we will illustrate in
Section 3 of this paper. Information intermediaries
control information that is either desired by the
consumer, or information that a supplier would like the
consumer to have, or both. An information
intermediary's control over information enables it to
charge a premium for information access. Competitors
cause strategic vulnerability for the information
intermediary by using IT to communicate needed
information to the customer, reducing the value of the
information provided by the information intermediary.
The Intermediation Problem in Brokerage. In the
brokerage industry, discount brokers are classified as
transaction intermediaries while full-service brokers are
classified as information intermediaries. (See Table 1.)
Table 1. Brokerage Classification
Broker Classification
Type
Full- Information Intermediaries – Full-service
Service brokers are information intermediaries
Brokers and are able to charge several times what
discount brokers charge because of the
information they provide.
Discount Transaction Intermediaries – Discount
Brokers brokers are transaction intermediaries and
exist solely to match a stock buyer with a
stock seller without providing stock
information or advice.
In the brokerage industry, full-service brokerage
firms over time developed capabilities that allowed their
financial advisory staff to aggregate company and
industry information in a timely manner to support better
purchase decisions by their customers. The full-service
stock brokers' control over company information
traditionally allowed them to charge several times as
much as discount brokers. Discount brokers, as
transaction intermediaries in this case, provided the same
basic service as full-service brokers (e.g., stock
purchases), but full-service brokers intermediaries)
would provide additional information to enable the
investor to make intelligent purchase decisions.
Today, however, electronic brokers such as Charles
Schwab and E*Trade use the Web to provide free,
searchable company and industry information. As a
result, some investors will be able to bypass expensive
full-service brokers by acquiring the online information
needed to make investments and trade at a discount.
Information intermediaries only reluctantly adopt these
technologies of the competitors. For example, in mid-
1999, with mounting strategic threats from online
discount brokers, several full-service brokers (e.g.,
American Express Financial Advisors and Merrill
Lynch) were just starting to commit to online trading and
unbundled servicing.
Information intermediaries in the brokerage business
also rely on the control generated by restricting
information flow as a basis for charging a premium. For
example, discount brokers such as Charles Schwab, a
transaction intermediary up till just recently, mostly
relied on efficient stock ordering to remain competitive.
The company was not in a powerful position with respect
to investment information relative to their competition.
Full-service brokers, meanwhile, have acted as
information intermediaries, and did not allow
information to be passed on to the consumer without a
fee or a contract.
These observations lead us to propose a number of
questions for research:
• What are the determinants of strategic vulnerability
for information intermediaries?
• How is the response to strategic vulnerability of
information intermediaries different from the
response of transaction intermediaries?
• What can an information intermediary do to create
new value to remain a viable competitor in its
marketplace?
The answers that we provide to these questions
about organizational strategy for intermediation in this
paper are applicable in a number of contexts (e.g., real
estate, the insurance industry, mortgage lending, and
more). However, we have chosen to focus on the
financial services industry, and electronic brokers in
particular because they provide a leading opportunity for
academic researchers to observe and explain the strategic
vulnerability of information intermediaries.
2. LITERATURE REVIEW
To examine these questions, we use three different
bodies of knowledge to develop our perspective on
intermediation:
• Economic theory (Biglaiser, 1993;
Demsetz, 1968; Rubinstein and Wolinsky,
1987) explains why intermediary exist in terms
of their role in increasing the likelihood of
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 transaction matching, and why sellers and
buyers are willing to subsidize these activities.
• Transaction costs theory (Coase, 1937;
Williamson, 1979; Malone, Yates and
Benjamin, 1987) is a subset of economic theory
that explains how firms use intermediaries to
reduce the costs of transactions. New
technology that facilitates the same transactions
causes strategic vulnerability.
• Social network theory uses the idea of
structural holes (Burt, 1992) to describe how
"disconnected" networks cannot share
information. Information intermediaries bridge
structural holes, profiting from members of
these networks who have to pay for information
originating from the other network.
Competitors use Web technology to communicate
information that was previously only available through
information intermediaries, thereby closing structural
holes. Organizational theory and the knowledge-based
view of the firm (Nonaka and Takeuchi, 1995; Seely
Brown and Duguid, 1998) define the firm as a set of
capabilities and collective knowledge. Information
intermediaries' vulnerability, to some extent, can result
from reductions in the value of their information. Hence,
firms that are strategically vulnerable must discover
ways to develop and bundle products and services that
customers find valuable.
2.1. Intermediaries As Transaction Facilitators
Intermediaries are vital to a smoothly functioning
market because they reduce the costs that buyers and
sellers incur in making transactions. Without them,
transactions would occur only if the transaction costs
(such as search costs, contract bargaining, risk of bad
transaction due to faulty knowledge, etc.) were less than
the total value of the transaction. Coase (1937) and later
Williamson (1979) reasoned that firms exist to decrease
the costs of transactions. Similarly, brokers exist
because they reduce transaction costs to an acceptable
portion of transaction value, thereby creating motivation
for buyers and suppliers to work with them. The profit
charged by an intermediary is less than or equal to the
buyer’s and seller’s utility of the services provided by
the intermediary. These services allow a timely
transaction match to occur (Rubinstein and Wolinsky,
1987).
Intermediaries are best suited to conditions in which
demand occurs in the presence of heterogeneous
consumers, where information must be discovered about
the nature of the transaction goods. Intermediary-
supported knowledge transfers tend to make financial
markets efficient, for example. In market situations
where everyone's needs are different, such as with
insurance, real estate, or investing, an intermediary can
use her knowledge to act as an expert, increasing the
likelihood that the consumer will find products that are
suited to his individual needs (Biglaiser, 1993). For
example, stockbrokers and customers discuss what
stocks to invest in. The broker acts as an expert to
provide information needed by the customer to make a
purchase.
An intermediary also facilitates transactions between
consumers and suppliers, using expertise to make the
supplier and consumer better off (Biglaiser, 1993).
Rubinstein and Wolinsky (1987) describe how
intermediaries facilitate transactions when it is
improbable or inefficient and timely consuming to match
a buyer and a seller. Consequently, if a match becomes
more probable or more efficient and less time
consuming, then the intermediary becomes vulnerable
since the intermediary’s services will not be as valuable
to the buyer and seller.
Advances in communication technology that
increases the ease of communication can reduce the
value of an information intermediary's services.
Consumers who have access to Web information can
avoid the premiums charged by the information
intermediary. For some consumers, the expertise of the
intermediary may still be of some use, but the marginal
value is decreased. Malone, Yates, and Benjamin (1987)
apply transaction costs theory to predict that firm
hierarchies will decrease in size and may dissolve into
self-organizing market structures due to advances in
communication technology. As competitors use the Web
to provide information, the information intermediary
becomes vulnerable.
2.2. Intermediaries As Bridges Over Structural Holes
Burt (1992) introduced the idea of structural holes, a
perspective associated with social network theory. A
structural hole occurs when two networks (e.g., suppliers
and consumers) are not connected. By "not connected,"
Burt means that actors (individuals, organizations or
industries) in one network are not reachable by any actor
in another network, because the two networks are
disjoint. No information can flow through the structural
hole, even though actors in both networks would benefit.
An information intermediary creates value by
bridging this structural hole and allowing information to
flow between networks. This intermediary can exert
some control over both networks by choosing what
information to transfer, and, therefore can profit from her
position as a bridge (Burt, 1992). Figure 1 shows how a
single intermediary (Actor A) bridges the structural holes
between Networks A and B, A and C, and B and C.
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Actor A controls the flow of information between the
networks, and can use her gate-keeping influence to
profit from any other participant (indicated by the black
circles) who requires information from a different
network. (See Figure 1.)
Intermediaries act as a bridge over a structural hole
between the network of sellers or information providers
and the network of buyers. For example, full-service
stockbrokers provide information to the consumer about
various securities and influence the consumer's purchase
decisions. In addition, the broker can often charge the
seller for providing such information to the buyer, such
as in the case of limited partnerships (Eichenwald, 1995)
or initial public offerings (Klein, 1998), thus profiting
from both the seller and the buyer.
Figure 1. An Information Intermediary Bridges a
Structural Hole
Although an intermediary provides a valuable
function in filling a structural hole, we stress that the
intermediaries' central position as a bridge over a
structural hole tends to give the broker control over the
consumer -- control that may not be in the best interest of
the customer (Arya, Fellingham and Young, 1993).
First, brokers may exhibit opportunistic behavior, taking
advantage of their position as a bridge over a structural
hole, to restrict the flow of information to the consumer.
For example, Eichenwald (1995) showed how
Prudential-Bache's tax shelter brokers, unknown to the
parent company and investors, manipulated transactions
and fraudulently used an investor's money to cover a
their own investment losses. Second, brokers may not
share the same values and priorities as the customer. For
example, a stockbroker may understand a given industry
better than other industries and therefore try to steer
customers toward her area of expertise regardless of the
investment needs of the customer.
2.3. Intermediaries as Experts and Sellers of
Knowledge
Nonaka and Takeuchi's (1995) knowledge-based
view of the firm represents the firm as a collection of
knowledge, not as a collection of transactions. The
theory states that firms are knowledge organizations, and
that profitability rests on the generation and synthesis of
organizational knowledge (Kogut and Udo, 1992).
Competitive advantage results from cultivating this
knowledge to develop core competencies. Seely Brown
and Duguid (1998) suggest that firms gather experience
and knowledge when firm members work together in
communities of practice. Communities of practice
combine explicit information with experience to develop
tacit information that is not easily transferred over an
electronic medium (Nonaka, 1994). Customers often
have access to data, consisting of facts without context,
but they may not have access to information or
knowledge, which create surprise value as facts take on
meaning within context (Cohen, 1999). Firms can use
tacit knowledge to help customers navigate through
complex situations in a way that communication via the
Internet cannot support.
When an insufficient amount of useful knowledge is
accrued, according to Seely Brown and Duguid (1998),
the value of the knowledge provided by the firm over
time is reduced and the firm loses competitive
advantage. The Internet exacerbates this problem by
allowing faster information dissemination and sharing,
often making existing knowledge obsolete. Firms must
develop and retain tacit knowledge, and develop
techniques to market and package their unique
capabilities for customers.
Strategically vulnerable firms need to decide how to
create and bundle knowledge products in ways that are
difficult for competitors to duplicate. A bundling
strategy can be profitable when marginal production
costs are low, there is much return business, and
consumer needs are homogeneous (Bakos and
Brynjolfsson, 1998). For instance, a stockbroker may
charge $2100 per year for unlimited online trades,
advise, and financial statements. Such bundling may be
easy to implement using existing Web technology, but
hard to duplicate. An unbundling strategy can be
profitable when customer needs are heterogeneous,
repeat sales are minimal, or production costs are high
(Bakos and Brynjolfsson, 1998). For example, brokers
can unbundle their services into fee-based-per-service
products, calibrating their customers' willingness-to-pay
for advice and services. Such unbundling removes
implicit subsidies and allows firm knowledge to be
leveraged.
3. THEORETICAL FRAMEWORK AND
PROPOSITIONS
We next use these theoretical perspectives to
develop a framework for analyzing strategic
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vulnerability and intermediation that supports the
specification of three propositions.
3.1. A Strategic Vulnerability Framework for
Intermediation
The three perspectives -- economic analysis of
intermediation, social network theory, and the
knowledge-based view of the firm -- each comment on
different aspects of the information intermediary. The
first explains why intermediaries are formed, and how
their existence makes buyers and suppliers better off.
The literature suggests ways in which newly efficient
high technology intermediaries can destabilize market
structure, leading to the vulnerability of the information
intermediary. The latter two perspectives offer
Table 2. Phases of Strategic Vulnerability
Phase Transaction Intermediaries
I: Intermediation Intermediation is accomplished through
the traditional economic role of efficiently
matching sellers and buyers in a way that
reduces transaction costs. (TC)
II: Vulnerability Vulnerability exists when a competitor's
more efficient processes reduces or
eliminates the relative economic
efficiency of the transaction intermediary.
(EA)
III: Resistance There is usually no resistance. Transaction
intermediaries rush to develop knowledge
to copy the success of the competitor who
is challenging them. (EA)
IV: Adoption, Transaction intermediaries develop
Extinction, knowledge to successfully duplicate the
or Successful innovation and are, once more,
Resistance competitive, or they fail and become
extinct or at least reduced in importance.
(EA, KBV)
Legend: EA = economic analysis; TC = transaction cost theory; SN = social network theory; KBV = knowledge-base view of the firm
3.2. Propositions
Strategic vulnerability elicits different responses
from information intermediaries than it does from
transaction intermediaries. Information intermediaries
derive revenue by bridging the structural hole and
controlling information. Information intermediaries are
vulnerable when communication technology reduces the
premium that information intermediaries charge.
Consequently, information intermediaries resist the move
to new technology, often issuing press releases
describing how the new technology is bad for the
consumer. This resistance to adopt the new technology
normative guidance about how firms should develop
knowledge that would "fill" a structural hole, creating
opportunities for competitive advantage and improved
appropriability of value. The knowledge-based view of
the firm also argues that firms must constantly add value
in customer relationships by developing new knowledge
that results in new products and services that are highly
valued in the marketplace. It emphasizes that sustainable
competitive advantage is a by-product of continuing
innovation.
We formalize our use of the theory in Table 2 by
defining four phases of strategic vulnerability for
intermediaries. We indicate the distinctive differences in
the likely experiences of transaction intermediaries and
information intermediaries. (See Table 2.)
Information Intermediaries
Intermediation is accomplished by bridging a
structural hole and controlling the level of
information between two networks. (TC, SN)
Vulnerability exists when technology allows
competitors to use communication innovations (e.g.,
the Web) to close the structural hole bridged by the
information intermediary. (EC, SN)
There is usually strong resistance as information
intermediaries struggle to maintain profits and
position over the structural hole. (EC, SN)
Information intermediaries must develop knowledge
to compete in the new environment. New products
or unbundled products may be necessary that let
them add value in the new competitive environment.
If the company stalls too long, it will be hurt. The
information intermediary may successfully
reestablish the structural hole and its position as a
bridge over it, but this is unlikely since any such
attempt would be met with resistance from both
competitors and customers. (EC, SN, KBV)
can change the dynamics of competition by giving
competitors who employ the technology more time to
gain a foothold or reach critical mass in the new
competitive landscape. As well, information
intermediaries can become vulnerable if certain elements
are in place, including enabling technology and
competitors that would benefit if the structural hole were
closed.
Our research question "What are the determinants of
strategic vulnerability for information intermediaries?" is
addressed by:
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 • The Strategic Vulnerability Proposition: Table 3. Three Propositions for Analyzing
Information intermediaries are subject to strategic Intermediary Strategies
vulnerability from competitors when: Three Transaction Information
(a) an information intermediary profits Propositions Intermediaries Intermediaries
because of its position as a bridge over a Strategic Intermediaries are Intermediaries are
Vulnerability vulnerable because vulnerable because
structural hole and its competitors would profit competitors competitors can bypass
if that structural hole were closed; become more customer's dependence
(b) communication technology exists that efficient due to on the intermediary's
technical information.
can provide information previously only
innovation.
available via the information intermediary; and, Stalling Intermediaries Intermediaries usually
(c) the information intermediary's Adoption often try to stall, trying to protect
duplicate their their profitable position
customers use this communication technology.
competitor's as bridge over the
Using observations from different industries, we success. structural hole.
illustrate differences in behavior between Value Intermediaries try Intermediaries need to
transaction and information intermediaries in Creation to duplicate the find new product
their reactions to technical innovations that competitor's value bundling options that
allow more efficient communication. to maintain their add value for the client
market share. and leverage the
The research question "How is the response to Intermediary's
strategic vulnerability of information intermediaries knowledge that is not
different from transaction intermediaries?" is addressed available to the
by: competitor.

• The Stalling Adoption Proposition: Unlike

transaction intermediaries that rush to duplicate an
innovation, if an intermediary's main source of
profit is through the control of information, then
that intermediary will "stall" and resist imitation of
competitors’ technological innovations that
enhance the transfer of this information.
As an industry is transformed and structural holes
are closed by competitors, information intermediaries
will no longer be able to charge merely for information.
They will need to develop new products and services that
are a combination of components of existing products
and newly developed products that are valued by the
firm's customers. Our final proposition addresses the
research question, "What can an information
intermediary do to create new value and stay a viable
competitor with respect to long-time customers?"
• The Value Creation Proposition: A firm that
acts as an information intermediary but is now
vulnerable due to advances in communication
technology will eventually be forced to change the
bundling their products to be more knowledge-
intensive, specialized, and competitively-priced to
attract more customers.
We next compare these propositions from the
perspective of the transaction intermediary and the
information intermediary. As Tables 2 and 3 illustrate,
there is reason to believe that transaction and information
intermediaries are quite different.
3.3. Other Examples of Stalling and Imitating
We assert that when intermediaries profit from
controlling information, and competitors use technology
to provide the same information, the information
intermediaries will first stall to imitate the competitors
because such imitation may make it difficult for current
customers to differentiate between the information
intermediary’s products and the competitor’s products.
When competitive pressure continues to increase, the
information intermediary will eventually try to rebundle
products and services in an attempt to stop the erosion of
their customer base and to reclaim lost market share.
In the interest of clarification, three points must be
understood regarding the predicted phases of strategic
vulnerability shown in Table 2. First, we recognize that
information intermediaries often perform value-added
functions, such as filtering, customization, or
aggregation. However, while these services are valuable,
if the information intermediary commands a higher price
for controlling information -- as well as offering these
services -- then the price it can charge for its services
will be reduced. This is because the information
intermediary’s clients derive a portion of the products’
value from information that is now available at a fraction
of the cost.
Second, it is obvious that competitors are necessary
to generate strategic threat. If no competitors are
attempting to close a structural hole that is bridged by an

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information intermediary, then the information
intermediary will not feel threatened and may adopt new
communication technology, such as the Web, to make its
current business processes more efficient.
Third, being an information intermediary that is
threatened by competitors is not the only reason to stall
to adopt a new technology. For example, if new
technology causes a high degree of change to existing
business practices, a firm may stall while trying to
incorporate this new technology. For example, Dell
computers primarily sold mail-order computers over the
phone. For Dell, the move to the Internet simplified
some of its business processes. Compaq, on the other
hand, had a network of resellers and chains. Compaq
saw no need to rush to the Internet to sell computers and
was more concerned about the effect that direct sales
would have on existing value chain relationships.
Thus, we assert that there are many reasons why
firms may react differently to new technology.
However, if a firm is an information intermediary, it is
our observation that it will stall rather than adopt
technology that its competitors use to close structural
holes. Furthermore, rather than using a high level of
imitation of their competitors (such as Compaq Express
did when it finally started imitating other online
computer vendors like Dell), when the information
intermediaries finally adopt the new technology, they
will rebundle their products to differentiate them from
their competitors.
4. INFORMATION INTERMEDIATION IN THE
BROKERAGE INDUSTRY
The brokerage industry provides an appropriate context
for the study of the effects of competitors' Internet-
focused business models on traditional full-service
brokers as information intermediaries. In this section,
we will show why full-service stockbrokers can be
considered as information intermediaries, and how their
reactions to the efforts of online discount brokers are
different than those of transaction intermediaries.
4.1. Methodology
Our methodology in this research is an industry case
study. It is appropriate for two reasons. First,
case studies aid the exploration of evolving areas,
enabling the construction of new explanatory
theoretical perspectives. With the recent arrival
of Internet-focused business models, empirical
methods are often suitable; few data exist for the
kinds of phenomena we address here. Second,
case studies offer an opportunity to identify
settings in which significant future research
efforts -- analytical, empirical or experimental --
are likely to provide useful normative guidance
for management.
Eisenhardt (1989) and Tsoukas (1989) remind us
that in-depth analysis of a single system does not
preclude arriving at valid explanations and relevant
conclusions, though they may be subject to concerns
about external validity. Moreover, the case study
method enables us to examine responses of information
intermediaries in detail and to use information from the
brokerage industry as a lens on firm behavior in other
industries. To address generalizability issues from the
study of a single case, we examine other industries in the
next section that employ information intermediaries to
see if they share common elements.
4.2. The Brokerage Industry
Discount brokers charge little but provide less
information than full-service brokers, who often charge
many times more. We next analyze intermediation in the
brokerage industry from the point of view of our
framework.
Full-Service Brokers. Full-service brokers provide
investors with valuable information for investment
decision-making. Aggregating and interpreting
information for the investor requires a complex network
of sources that are dedicated to constantly monitoring
company information. Full-service stockbrokers convey
this information to the investor at a premium. Figure 2
shows how the full-service broker bridges a structural
hole between the investor and information sources. (See
Figure 2.)
Figure 2. Brokerage Market Network Structure With
Full-Service Broker Intermediation
8

The full-service broker is an information
intermediary that is positioned over a structural hole --
the investor has no connection to the other network
actors (e.g., firm and industry analysts, the stock
exchanges and the firms themselves). Therefore, the
full-service broker can exert some influence over
investor decision-making, and will have the ability to
charge a premium for information.
Discount Brokers. Investors who have access to
needed information or refuse to pay premium prices use
discount brokers to buy stock. Discount brokers charge
less than full-service brokers but don't provide
information to the investor that full-service brokers
provide. Although they provide stock exchange access,
they do not provide advice or additional information
about companies or industries. (See Figure 3.) Often
their business model precludes them from bearing the
risk of lawsuits that might arise due to investment
recommendations to their clients.
Figure 3. Brokerage Market Network Structure with
Discount Brokers
4.3. Strategic Vulnerability in Brokerage
Discount brokers can use Web technology to
provide terabytes of easily searchable data available
about companies to the investor, without taking any
fiduciary responsibility for its contents. Through their
use of the Web, discount brokers allow individuals to
find information they need for investment decision-
making, threatening the full-service broker, who builds
this capability into its service bundle for a fee.
Electronic Brokerage on the Internet.
Communication technology changes the information
intermediary's position. Discounters who remain
reluctant to give advice directly (for liability or
availability reasons, for example) can use the Internet to
provide consumers with a new spectrum of information.
This decreases the full-service brokers' control. One
observer remarks that electronic brokers are "giving
away so much free data and research to attract traffic that
they're making once-valuable information virtually
worthless" (Lux, 1997, p. 92). As discount brokers give
investors access to corporate financial information (via
SEC EDGAR or Yahoo Finance), aggregated industry
information (from Bloomberg or Bridge), and analysts'
reports (from FirstCall), the need for a full-service
broker is diminished. In this sense, technology closes
the structural hole. (See Figure 4.)
Technological Innovation and Stalling Adoption.
Full-service stockbrokers have existed not only to match
buyers and sellers of stocks, but also to advise the
investor. Full-service stockbrokers acted as a structural
hole between networks of analysts, companies and
investors. Investors needed stockbroker information, but
could not be sure if the stockbroker gave them good
advice.
Figure 4. Broker Market Network Structure with the
Internet
Although full-service stockbrokers would charge a
commission that was several times higher than the
discount broker, many investors would pay this higher
commission since stockbroker advice could lead to
higher profits. Unlike discount brokers, no full-service
stockbrokers rushed to embrace the Web as a viable
channel:
True, full-service stockbrokers and their online
competitors are converging. Wall Street's retail
powerhouses are ramping up new electronic
offerings. But out on the Web, the two camps are
still living in different worlds. Visit even the most
advanced of the traditional brokers' Web sites, and
you'll come away thinking that investing is still a
dark art best practiced under the tutelage of trained
professionals. None yet offer online trading.
Virtually every link you pursue leads sooner or later
to one message: call your broker. Over at the
online brokers' sites, however, the democratization
of investing is in full swing … (NcNamee, 1999, p.
120).
9
 Full-service stockbrokers resisted moving online
because electronic transactions decrease the value of
their brokers' activities. However, even though full-
service brokers control most of the assets in the
brokerage industry, online trading is beginning diminish
full-service brokers' market share. Market leader Merrill
Lynch has been a leading naysayer on online investment
till just recently (Merrill Lynch, 1999), when the
pressures it has experienced in its retail brokerage
business led to its first money-losing quarter since 1989.
Although investors are trading shares in record numbers
and the Dow-Jones Industrial Average has jumped to
over 10,000, Merrill had to lay off over 4,000 employees
between October 1998 and April 1999. Meanwhile,
online discount brokers (e.g., E*Trade, Ameritrade,
Charles Schwab, etc.) were handling about 340,000
trades per day (nearly one in seven that occur on the
exchanges), an increase of 34% over the prior three
months, and nearly 125% beyond the volumes that
occurred in 1997. By the end of 1999, this volume will
amount to about 14% of all stock trades that occurred on
the market, nearly double from 1998, with more than
$500 billion assets now controlled by electronic brokers.
(This information was from news by Reuters on the
World Wide Web, various dates (www.reuters.com).)
Online competitors have taken advantage of
Merrill's reluctant to be a full participant in the online
trading made, and are capturing market share at the
expense of the full-service broker:
... Merrill's [7%] percentage increase pales
compared with Internet brokers. Transaction
revenue (composed mostly of brokerage
commissions) soared nearly 2.4 times in the first
quarter at E*Trade Group Inc., to $90.5 million. …
Those investors aren't just using "play money" for
cyber-trading. … 22% of the online households
had more than half their portfolios with the
Internet-investment firms, instead of their full-
service brokers (Gasparino and Buckman, 1999a,
C1).
Framework Application. In years now past, the
full-service brokers occupied the position that bridged
the structural hole. Discount brokers have benefited by
closing the structural hole bridged by the full-service
brokers, such that latter no longer have such an obvious
competitive advantage. This follows the logic of our
strategic vulnerability proposition. Many investors use
the Web and can retrieve information provided by
discount brokers, thus enabling investors to forego the
cost of a full-service broker.
Full-service stockbrokers have so far resisted the
move to online trading, a situation that is described by
our stalling adoption proposition. However, they are
starting to develop new products and new business
models based on core competencies, for example,
describe new business models and bundling techniques
for knowledge-based brokerage services:
• Prudential Securities will charge $24.95 for online
or full-service broker trades via an account that
charges investors an annual fee of roughly 1% to
1.5% of assets (Gasparino and Buckman, 1999a)
• Salomon Smith Barney contemplates online trading
for its "Asset One" (minimum $100,000) accounts.
Investors will pay fees ranging from 0.5% to 2% of
assets, and get online trades and "free" advice.
(Gasparino and Buckman, 1999a)
• Merrill Lynch now offers trades for $29.95 per trade
plus a minimum annual fee of $1,500 that allows
clients to seek advice and use Merrill’s online
resources like financial planning, research reports,
pre-approved mortgages, and free access to ATM
machines (Gasparino and Buckman, 1999b; Merrill
Lynch, 1999)
Full-service brokers are at a point were competition
has damaged performance. In response, these firms are
bundling products to be more knowledge-intensive,
specialized, and competitively priced to attract
customers. This outcome is illustrative of our value
creation proposition.
5. TRANSFORMATION OF OTHER INDUSTRIES
Do we see similar processes occurring in other
industries where information intermediaries are
prominent? Does the theoretical perspective that we
offer seem to be borne out elsewhere in American
industry? In this section, we consider three other
industries that appear to offer supportive evidence.
Real Estate. In the real estate industry, real estate
brokers' main source of profit lies in controlling
residential multiple listing service (MLS) information
that the seller cannot update and that a buyer is unable to
access. Strategic vulnerability arises from new
competitors like Owners.com (www.owners.com), which
provides "for sale by owner" (FSBO) listings of
properties, thereby bypassing the expensive MLS realtor.
While many realtors have web sites where potential
buyers can view homes (without addresses) for sale, no
realtor has yet made the move to allow addressed listings
or transactions to occur electronically. In this sense,
realtors are currently stalling until the industry can
determine how to rebundle services to face the strategic
10
vulnerability brought about by competitors' threats of
online services.
Automobiles. Automobile dealers also can act as
information intermediaries; they provide car buyers with
information that can help them to make a purchase.
Historically, dealers were in a position of information
control. They would only reveal car information that
was in their best interests. For example, defects,
evidence of poor performance, and manufacturer price
information were hidden from the consumer. Now,
traditional dealers face online competitors (e.g.,
AutoByTel (www.autobytel.com) and Microsoft's
CarPoint (carpoint.msn.com)), who provide information
about manufacturers' models and dealer costs,
performing intermediation at fraction of the cost and
overhead of traditional car dealers.
According to the Boston Consulting Group
(Middlemiss, 1998), one of every six people shopping
for an automobile uses the Web to get information or to
make a purchase. And, by 2000, 50% of U.S. auto sales
will be to people who used the Web to research, buy, or
lease their cars. All the determinants of the strategic
vulnerability proposition are present:
• the dealers span a structural hole;
• technology that is used by car buyers is being
employed by traditional dealers' competitors to
eliminate their competitive advantage;
• although car dealers have web sites, these sites
convey mostly advertising information, but still do
not provide the extensive information that car buyers
have come to associate with the Internet car sales
websites.
Clearly, car dealers have been stalling. They have
avoided providing information or allowing online
purchases, because it has been in their interests to do so.
It remains to be seen how car dealers can rebundle their
products to make them more attractive, and maintain
their brick-and-mortar margins.
Initial Public Offerings (IPOs). Investment
bankers (e.g., Goldman Sachs, Morgan Stanley, etc.)
charge significant premiums based on value created in
the capital formation process. Their competitive
advantage lay in controlling information about firm risk
and value, and investors' risk profiles. Upstarts such as
Wit Capital (www.witcapital.com) and E*Trade
(www.etrade.com) make investment banks vulnerable by
creating new electronic financial markets over the
Internet (Klein, 1998). Investment bankers are stalling to
continue profiting from the structural hole that they
bridge, but already they are making arrangements with
Wit Capital and other Internet-based investment banks to
exploit this new channel for capital subscription.
6. CONCLUSIONS
In this paper, we have made three contributions
towards developing a better understanding of the
strategic issues associated with information
intermediaries. First, we identified different phases of
reactions to strategic vulnerability that differ for
information intermediaries and transaction
intermediaries. Information intermediaries are reluctant
to use communication technologies because it weakens
their competitive advantage as bridges over structural
holes. In contrast, transaction intermediaries reduce
vulnerability by copying the innovations of their
competitors. Second, our strategic vulnerability
framework shows how information intermediaries differ
from transaction intermediaries, especially in terms of
their control of information as a means of adding value
in their marketplaces.
Third, we developed a strategic framework that
shows how information intermediaries can create value
that is difficult to duplicate through Web technology.
Web technology enables the transfer of information and
reduces the value of information intermediaries' services
and capabilities. We described several industries in
which information intermediaries profit from bridging
structural holes. Our theory predicts that information
intermediaries in these industries have a higher
probability of becoming vulnerable: communication
technology allows competitors to transfer information to
the consumer, thereby allowing competitors to threaten
the information intermediary's traditional strengths.
Although a single industry case study of the
brokerage industry limits our ability to generalize, and
offer a broad-based theory, nevertheless, we have
provided exploratory evidence of information
intermediary vulnerability and stalling technological
adoption in other industries. As we move into the 21st
century, these competitors -- and the traditional
industries that they represent -- may be blind-sided by
new competition with new business that involve direct
links in the social networks in which they control the
flow of information. The multiple theoretical
perspectives that we have offered in this paper offer a
starting point for more in-depth analysis, and expansion
to other application areas when more complex instances
of information intermediation occurs.
11
 17. Merrill Lynch, "Merrill Lynch Sets New Industry
Standard for Advice, Access, and Choice in Personal
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