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Portal Economics and Business Models:

Pitfalls, Lessons Learned and Outlook

Christoph Schlueter Langdon (*)

USC Center for Telecom Management, Los Angeles

Alexander Bau
NetGiro Systems A.B., Redondo Beach

Abstract
New information technology (IT) is constantly enabling new ways of doing business. Channel
systems have been a particularly successful application domain and have seen the emergence of
many new business models, such as Web portals. Portals facilitate effective and efficient
interaction between sellers, advertisers and buyers. At the core of Web portal success is a set of
superior economic mechanisms, including, but not limited to transaction cost savings, economies
of scope and positive network externalities. These advantages are rooted in how structure and
competition have evolved in digital channel systems, which is discussed based on organizational
theory in a separate article titled “Digital Interactive Channel Systems and Portals: Structure and
Economics.” This article is exploratory and focused on portal strategy and key lessons learned.
Despite favourable economics, portal success is not guaranteed, and pitfalls can be avoided.

Keywords
Channel system, digital interactive service, business ecosystems, transaction cost, economies of
scope, network externalities, two-sided market, matchmaking, electronic retailing, cross-selling,
customer relationship management (CRM), remote tele-diagnostics, vehicle relationship
management (VRM)
 Portal Economics and Business Models:
Pitfalls, Lessons Learned and Outlook

Christoph Schlueter Langdon

USC Center for Telecom Management, Los Angeles

Alexander Bau
NetGiro Systems A.B., Redondo Beach

INTRODUCTION
In late 2005, the market capitalization of Google was the envy of every major media and telecom
company. More than any other Web portal, Google had succeeded in benefiting from the superior
economics inherent in digital interactive channel systems. At the core of Web portal success is a
set of economic mechanisms, including, but not limited to transaction cost savings, economies of
scope and positive network externalities. These advantages are rooted in how structure and
competition have evolved in digital channel systems, which is discussed based on organizational
theory in a separate article titled “Digital Interactive Channel Systems and Portals: Structure and
Economics.” One subcategory of transaction cost – lower search cost – has played a particularly
important role in the success of portal business models.
In the late 1980s information technology had evolved to inspire the development of online
services and the first digital interactive channel systems. Of the many companies that entered the
new business space (Prodigy, CompuServe, America Online, etc.), few survived and succeeded in
creating a sustainable business. The failure of the many and success of the few became the focus
of many studies. One of the early empirical investigations highlighted one category of business
models, originally labelled as Online Networks, the predecessor of today’s Web portals (see
Figure 1; Schlueter Langdon, 1996; Schlueter Langdon and Shaw, 1997, 2002).

Digital Interactive Channel Value System with

Online Networks

Content

Delivery
Infrastructure

Key characteristics:
 Reduction of buyer and seller transaction cost (i.e., search cost)
 Integration of community services, delivery technology, full
service spectrum and competing products
 Example: America Online
Source: Adapted from European Commission. 1996. Strategic
Developments for the European Publishing Industry towards the Year
2000: EuropeÕs Multimedia Challenge. BrusselsŠLuxembourg: 318.

Figure 1: Strategic Roles in Emerging E-Channels (Schlueter Landon, 1997)

The study identified search cost savings as a key advantage and foundation of the portal business
models. Google has evolved as one of the strongest verifications of this finding.
However, despite favourable economics, portal success is not guaranteed, and pitfalls can be
avoided.

TRANSACTION COST ECONOMICS: OLD WINE IN NEW

BOTTLES
Despite the attention that new technology receives, seasoned investors know that in the end, it is
all about economics. Specifically, how can new technology either improve the economics that
underlie current business models or enable entirely new models? Google’s success and high
market capitalization underscore the importance of economics, and its success is spectacular
considering the odds it faced. Firstly, it entered the portal game very late (see Figure 2 in the
related article on “Digital Interactive Channel Systems and Portals: Structure and Economics”).
Secondly, it dominates a business that had often been considered as subject to first mover
advantages, despite being a late entrant. One explanation for this success is Google’s singular
focus on the economics that are a pillar of any portal business model – transaction cost savings,
concept in economics pioneered by Coase (1937) and refined by Williamson (1975). Google
reduced search costs by focusing on the performance or “intelligence” of its search algorithms
and developed what is widely considered as the best search technology. In search there are
typically three ways to improving performance: First, by adding intelligence to the search
algorithm or agent (an experienced and more knowledgeable real estate agent is better than a
rookie); second, by providing structure to the search space (the phone book or yellow pages are a
good example); and third, by combining options one and two. Google focused on “intelligent”
search algorithms while Yahoo! tried to structure the search space using directories. Some
competitors even outsourced search altogether, essentially leaving the core or key pillar of the
portal business to third parties. This apparent misunderstanding of the fundamentals of the portal
business has been corrected as competitors have insourced search or formed strategic alliances
(AOL and Google in December 2005), but this strategic fumble has clearly aided Google’s
ascendance and stands as a reminder of the importance of understanding a business’ fundamental
economics.

BENEFITING FROM A TWO-SIDED BUSINESS

Google’s business or revenue model – the implementation of its exploitation of transaction cost
economics –also had an interesting twist. Any search has a dual outcome, and therefore can be
conceptualized as a simultaneous bi-directional process: a consumer/buyer finding a good and a
seller/advertiser finding a buyer/lead. Alternatively, Google can be viewed as operating in two
related markets: first, providing search results to consumers and second, providing leads to
advertisers (See Figure 2; another example of a so-called two-sided market is the credit card:
providers, like MasterCard, make cards and credit available to consumers; they also provide
terminals and processing for merchants to accept the cards; for an overview of two-sided markets,
see Evans 2002).
 Figure 2: Benefiting from a Two-Sided Market

While incumbents, such as AOL, were charging the consumer/buyer end of a search process (the
monthly, flat AOL fee), Google collected fees from the other side, from buyers/advertisers. In
other words, Google “free” search is in essence always advertiser/buyer paid search, which in
retrospect appears to be a more fitting model: Sellers are used to paying for customer acquisition,
which is then included in the sticker price and not broken out and charged to consumers
separately.

PROFILE POWER: NEXT GENERATION SEARCH AND

ECONOMIES OF SCOPE
In order to take search performance to the next level, portals have discovered user or consumer
profiles. The more that is known about a consumer’s wants and needs, the better a search result
can be. In short, knowing who is behind a click and why is key for a portal intermediary to match
clicks with sellers and vice versa. Knowledge about individual users or consumers is also a key
ingredient for exploiting another key economic foundation of portals: scope economies.
Broadly speaking, scope advantages in the portal context refer to benefits that accrue across
relationships (for a theoretic treatment of economies of scope, see Teece 1980). For example,
selling one type of product (e.g., paint) may make it worthwhile to sell another product (e.g.,
paintbrushes), because a buyer of paint may very likely need a paintbrush. In general, sellers
across vertical markets are spending money independently to acquire essentially the very same
consumer. Therefore, knowing a consumer’s wants and needs in two verticals A and B would
provide a cross-selling opportunity, selling A and also B. This is not a new insight; department
stores have been built on this implementation of scope economies: attract consumers or store
“traffic” and channel the traffic through different departments, which represent different vertical
markets (e.g., apparel, consumer electronics, toys). Key to success with this model is knowledge
of a customer’s wants and needs, which is often summarized as a “profile.” The success of a
scope-based business model crucially depends on the quality of these customer profiles. Hence,
portal competition is currently evolving to enrich the understanding of each visitor’s wants and
needs. Different companies are pursuing different strategies (e.g., MyYahoo!, Google’s
Personalized Home).

THE ADVERTISING MONEY ECONOMY

It is in the quest for generating the richest consumer profiles that the move to “free” search has
powerful implications far beyond the portal business. The threat is not so much about portals
giving search results away for free but Google’s success with the concept of giving something
away for free to one side of a market while collecting revenue from the other side. It has been
done before, but at a much smaller scale. For example, giving away free Internet access used to
be a successful method for banks to acquire customers for online banking services. It worked for
banks, because paying for Internet access was cheaper than other customer acquisition measures,
plus online self-service banking was cheaper than counter service. It was bad for Internet access
service providers, because suddenly consumers could get Internet access for free, which firstly,
took customers away and secondly, depressed prices in the residential Internet access market.
Also, this threat appeared quite unexpectedly: banks and Internet service providers were not
related businesses.
Today, one scenario could be that portals give away phone service for free to attract users and
learn more about them in order to enrich user profiles and to ultimately benefit from search
results and cross-selling opportunities. Adding phone service to a portal is not far fetched; phone
companies have used the phone business to succeed in the yellow pages or directory services
business, one analog ancestor of today’s digital portals. Therefore, adding free phone service
would probably work well for portals. At the same time it would be a terrible threat for telecom
providers, because many still rely on the revenue and cash flow from fixed line traffic. It would
force traditional telecom providers to pursue new revenue opportunities, probably seeking the
same sources that portals pursue, such as advertising money or other marketing expenditures.

WHO OWNS THE CUSTOMER CONNECTION?

Usage and visitor numbers suggest that portals have already emerged as an important gateway to
many products and services. If portals succeed in improving their matchmaking performance,
such as through the use of rich user profiles, then it is conceivable that a portal’s user
relationships could rival a vendor’s customer connection. This could be problematic for many
vendors. For one, customers are the most important ingredients in any business. Without
customers there is no revenue. For another, many vendors have only recently discovered how
tight customer relationships can also help lower cost. In some areas it is a return to the pre-mass
production age when goods were made to order and vendors owned the customer connection.
With the introduction of mass production techniques vendors typically lost the relationship with
the end customer and became reliant on specialized channel partners, such as wholesalers,
brokers and retailers, to distribute and sell their goods. Since the success of the Internet, many
vendors have begun to use the Web to link with customers and to involve customers more
actively as participants in a company’s business operations (Schlueter Langdon, 2003b). Just as
Ikea, the Swedish furniture maker, is “outsourcing” final product assembly to its customers (Ikea
sells its furniture unassembled in flat boxes), so are many companies using the Web to let their
customers customize products, update and maintain customer records, check orders, provide
advise to fellow customers, install and update products, etc. Some companies, such as Dell
computers, have perfected this customer involvement to the extent that a push system is reversed
into a pull system, in which a customer’s order is pulling the product through the production
system (Gershman, 2002). This switch from push to pull reduces inventory and other costs.
Portal-type intermediaries could challenge a vendor’s customer relationships, which could affect
revenue as well as cost savings opportunities.
However, customer connection struggles across vertical stages of an industry system are not new.
The Internet and mobile technologies have made it easier to cause channel conflicts. Today, many
original equipment makers (OEMs) are struggling to take advantage of a direct and interactive
link with each customer while maintaining good business relationships with existing retailers.
The auto industry provides a very recent example. Automakers have discovered how the use of
telematics and telediagnostics technology can improve customer and vehicle relationship
management (VRM). In a BMW television commercial, a driver receives a call and is reminded
to schedule an oil change. Surprisingly, the call is not coming from the BMW dealership that sold
the car or from the service station that maintains it. Instead the call comes directly from the OEM,
BMW. This is possible, because once again, the power is with the profile. In this example,
technological progress has given automakers the opportunity to establish a direct, interactive
channel with every single vehicle and customer and to collect data on vehicle usage. Just as in
other industries this “profile” can be used to improve the customer experience and satisfaction,
and to better match customers’ wants and needs with future products.
As rich profile data is quickly emerging as an important “raw material” in many industries the
only losers in this new game are companies without it. Portal businesses are uniquely positioned
to benefit from profile data as it reinforces the existing advantages that it can offer to the many
different users: consumers, buyers, sellers, and advertisers.

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