Disintermediation

What Is Disintermediation?

Disintermediation is the process of cutting out the middleman. It may allow a consumer to buy directly from a wholesaler rather than through an intermediary such as a retailer, or enable a business to order directly from a manufacturer rather than from a distributor. In the financial industry, it is seen when an investor is able to buy stock directly rather than through a broker or a financial institution.

The purpose of disintermediation is usually to cut costs, speed up delivery, or both.

Understanding Disintermediation

The concept of disintermediation originated in the financial industry as investors were given the opportunity to directly buy stocks, bonds, and other products without an intermediary such as a broker or a bank.

The incentive, back in 1967, was clear: Consumers began to take their money out of bank savings accounts in order to seek a better return by directly investing in bonds or stocks. The government had placed a limit on bank interest rates for federally insured accounts.

The concept of disintermediation emerged in the late 1960s when many consumers, frustrated by low-interest rates on bank savings accounts, began investing directly in bonds and stocks.

Disintermediation Today

Disintermediation is now in use across industries and is a pillar of the internet model. In the online context, it is often called the B2C, or business-to-consumer, model.

Disintermediation can lower the overall cost of completing a transaction. Removing the intermediary may also allow a transaction to be completed more quickly.

Disintermediation can occur when a wholesale purchase allows an interested buyer to purchase goods, sometimes in large quantity, directly from the producer. This can result in lower prices for the buyer because the intermediary, a traditional retail store, has been removed from the purchasing process. This saves the buyer the cost of the markup that is associated with the transition of a product from a wholesaler to a retailer before it reaches a buyer.

Not all companies offer wholesale options directly to customers, as it requires a substantial investment in resources to fulfill and ship these orders.

Disintermediation and the Internet

The internet has the potential to be a powerful tool for disintermediation. Consumers and small businesses can in theory place orders directly with the producers of products.

In practice, new intermediaries such as Amazon, Etsy, and eBay have emerged as electronic middlemen. Even apps are sold through a third party such as Google Play or Apple's App Store.

Disintermediation at Work

The rise of online intermediaries may have been inevitable. Few producers can devote the resources to developing a retail platform and interface that could rival those of Amazon, eBay, or Etsy, and fewer still have the means to develop a professional marketing plan to promote their products.

Still, some products have been able to skip at least one middleman, the retailer. Electronics manufacturers such as Apple, Google, and HP are prime examples. Cosmetics brands, once sold only in department stores, now sell directly to consumers via their websites. Many small local businesses thrive by promoting their wares on their own websites and on social media.

Notably, many of these products are also available on retailers' sites.

Niche Disintermediation

Other internet giants took on disintermediation in specific niches. Google's Ad Sense platform has the potential to transform the marketing and advertising industry, allowing businesses to directly control their own messaging. Facebook gives local businesses a platform for communicating directly with customers and promoting their products.

That potential has been realized to some extent, particularly by small independent businesses and website operators. But online marketing specialists soon emerged to manage the message for businesses eager to outsource the work.

This process is sometimes called "reintermediation."

Cryptocurrencies and Disintermediation

The strategy of disintermediation is key to the development of decentralized cryptocurrencies that rely on blockchain technology, such as bitcoin. One feature of these systems is that users transact on a peer-to-peer (P2P) basis directly with one another, without having a bank or a monetary authority to facilitate or validate the transactions.

Instead of relying on a trusted third party, blockchain systems employ a distributed consensus mechanism such as proof of work (PoW) or proof of stake (PoS). These mechanisms rely on cryptographic functions and algorithmic processing to maintain security and fidelity.

Disintermediation is a critical component of the cryptocurrency business. Banks and governments are cut out. Transactions are peer to peer.

Advantages and Disadvantages of Disintermediation

The intermediary often does have a valuable part to play in the process of getting a product from the production line to the consumer. A producer has a network of wholesalers who preorder their products and ship them for distribution. They employ sales representatives to score orders for products from retailers. A retail store is needed to showcase the products properly, get the customers through the doors, and make the sales.

All of these roles would have to be duplicated by the producer who wants to cut out the middlemen.

The Middleman's Advantage

Disintermediation is inevitably associated with an increased burden on the company using the strategy. The company must dedicate more internal resources to cover the services that were previously handled by an intermediary.

Shipping costs, in particular, can be more expensive for a company that deals directly with the buyer. Specialized shipping companies have economies of scale that can substantially reduce their customers' shipping and handling costs.

Example of Disintermediation

The travel industry has been utterly transformed by disintermediation, mostly through the internet.

The process began well before the creation of the World Wide Web when American Airlines introduced direct flight bookings on its Sabre Global Distribution System (now Travelocity) and made the service available on early online sites including PRODIGY and CompuServe.

The travel agent now has to struggle to compete for consumers who can book hotel rooms, cruises, rental cars, and flights directly from the providers or through a travel site that allows them to compare an exhaustive list of options.

Online travel booking is not, however, a perfect example of disintermediation. A site such as Expedia is essentially an intermediary. It buys hotel bookings in bulk at a discount and resells them to consumers, earning an estimated 70% of its revenues on the markup.

Disintermediation FAQs

Here are the answers to some commonly asked questions about disintermediation.

How Do Consumers Benefit From Disintermediation?

In theory, consumers get a better price for a product when a step in its supply chain is eliminated. In practice, steps in the supply chain that are necessary still have to be done by someone.

Businesses and their customers benefit from disintermediation if the necessary tasks can be done as efficiently and more cheaply without the services of an intermediary.

When Does Disintermediation Occur?

Disintermediation occurs whenever a step in the supply chain is eliminated. A consumer calls a hotel directly to make a reservation rather than booking through a website or a travel agent. A retailer orders directly from a manufacturer rather than a sales representative for a distributor.

Or, on a vastly larger scale, Amazon builds up its shipping network in order to deliver directly to consumers rather than relying on FedEx or UPS.

What Is Disintermediation in E-Commerce?

From its beginnings, the internet has been seen as an ideal platform for disintermediation. It has the potential to remove the middleman and allow consumers and businesses to deal directly with producers and wholesalers.

It hasn't quite worked out that way. Most consumers most of the time go to new intermediaries such as Amazon in order to get a broad array of choices, customer service, and fast delivery all in one place.