An Economic Analysis of the Introduction of an Electronic Data Interchange System

Although electronic data interchange (EDI) holds the promise of significantly increasing the efficiency of business transactions, an installed base of proprietary implementations has been detrimental to the widespread acceptance of the technology. Thus, an important research issue involves strategies for facilitating EDI adoption. We analyze the introduction of an EDI system in a vertical market involving one manufacturer and two suppliers. The manufacturer initiates an EDI network, and penalizes a supplier for not joining the system by reducing its volume of business with the supplier. Along with a “stick,” the manufacturer can also use a “carrot” in the form of a subsidy to partially offset a supplier's setup cost. The competition between the suppliers is characterized by incentive types for joining the EDI system (“motivating” or “threatening”) and the Information Technology (IT) efficiency (“efficient” or “inefficient”). We show that regardless of its cost structure, a supplier may have to join the EDI network out of “strategic necessity,” due to the presence of an IT-efficient supplier. Our analysis further shows that depending on the supplier competition structure, the EDI system may prove to be a “beneficial” strategic necessity for a large supplier and an “unfortunate” strategic necessity for a small supplier. Another key result is that by increasing the severity of the penalty, both the manufacturer and the follower supplier can be worse off under certain conditions. The analysis of subsidy strategies reveals that unless leadership and followership positions are reversed due to a subsidy, subsidizing a supplier has no impact on the joining time of its competitor. Thus the EDI initiator cannot induce both suppliers to join earlier by subsidizing one supplier. Also, the larger the slack capacity of the leader, the higher (lower) the manufacturer's incentive to subsidize the leader (follower). These results offer insights for initiators and adopters regarding penalty and subsidy strategies, impact on competition structure, joining decisions and network growth.