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Disintermediation (Strategy) Explained

Disintermediation Defined

In simple words, disintermediation means removal of the intermediaries or middlemen from a supply chain (sales) or transaction (finance). These intermediaries include brokers, agents, wholesaler, distributor, banks and other finance houses.

Disintermediation in Finance

In finance, investment companies, banks, and savings and loan associations are the intermediaries between the supplier and the user. A saver or investor invests their funds in such institutions and borrowers receive the funds. Disintermediation is withdrawing the funds from banks and other financial institutions and investing them directly in mutual funds or in securities. It is generally done to get more return. It also eases the process of the transaction and makes it quick.

The companies often issue bonds to secure additional financial support. It supplements the traditional ways of collecting capital, and a company directly works with the buyers of the bond omitting the intermediary.

Disintermediation in Distribution Channels

Traditionally, producers distribute their goods to intermediaries (generally, distributors). These intermediaries supply those to the end customers. In a disintermediated system, the consumer directly deals with the producer, thus removing the intermediaries or middlemen from the supply chain. There may be more than one level of intermediaries in a supply chain.

In a traditional retail system, the retail stores work as the intermediaries. They purchase the products from the producers and sell those to the end customers. In other situations, buyers can directly buy the products from the producer. When these middlemen are removed from this supply chain and the manufacturers directly deal with the customers, it is an example of disintermediation.

Disintermediation often results in lowering the prices of the products as the middlemen are removed from the distribution channel. Customers often share in the lower cost structure. It also helps in increasing the profit margin of the producing company in long run. Unfortunately for consumers, all companies do not opt for disintermediation as it involves more investment in resources for distributing the products.

A Little More About Disintermediation

Disintermediation often reduces the price of the products. Online shopping is one such system where the consumers buy directly from the company’s website. In the retail market, it is commonly known as “factory direct”, where the consumer receives the goods directly from the factory or company’s warehouse.

In finance, the investors may withdraw their funds from the intermediary financial institutions like banks or other savings and loan association and may invest the money directly to a company’s bond and equity shares. It is done in an attempt to receive a higher return.

Advantages of Disintermediation

This system is considered to have many advantages for both the producers and customers. As direct communication can be established with the customers formulating a better marketing strategy becomes easier. As the producer is directly interacting with the consumers, it eases the process with a lesser number of transactions between them. It may also help in developing a better understanding of the demands of the customers. The customers can report issues regarding a product or service directly to the service provider or manufacturer and may register their dissatisfaction or appreciation. This process saves money, time and energy of both the parties.

Why Does the Disintermediated System Remain?

Even after all these advantages, many companies, as well as customers, still prefer the traditional system of distribution and investment. Removing the intermediaries puts an extra burden on the manufacturing companies. They may need to invest more money and manpower in-house to run the supply system without intermediaries. It also means much more responsibilities which are otherwise taken care of by the middlemen. Investors often find it more comfortable and safer to invest their money in banks and other financial houses. Investing money directly into the market needs skill and more research. One needs to plan their investment thoroughly in order to get a guaranteed and higher return.

Problems with Disintermediation

Removing the intermediaries from the supply chain causes more burden on the internal resources of the company. In a traditional system, the intermediaries take care of several services. After disintermediation, the companies need to handle those services. To do so, the companies need to invest more money and manpower to run the system efficiently. In wholesaling, they need to send the products directly to the individual customers instead of sending them to the retail outlets.

In the context of finance, managing funds becomes more complicated (requiring more expertise and time from the investor). For the investors, it poses new challenges as they need to take every decision on their own. They need to invest more cautiously as they are responsible for every transaction made. Further, they need to be more aware of the market scenario at all times to strategize their investments properly.

This system also poses some challenges in the economy as removing the middlemen leads to job loss. It may also lead to lack of transparency in the market and arbitrary price hike by the producers.

References for Disintermediation

Academic Research on Disintermediation

  • · Disintermediation and the role of banks in Europe: An international comparison, Schmidt, R. H., Hackethal, A., & Tyrell, M. (1999). Journal of Financial Intermediation, 8(1-2), 36-67. This research seeks to find out if the banking systems of France, Germany, and the UK are becoming less relevant as individual consumers have the ability to directly participate in capital markets. Using data created from national account statistics, the authors show that while banks aren’t becoming less important in the European markets, non-bank entities are beginning to play a larger role. Specific market effects in each country are discussed, and future financial pressures are predicted.
  • · Credit derivatives, disintermediation, and investment decisions, Morrison, A. D. (2005). The Journal of Business, 78(2), 621-648. This article shows that the existence of a credit derivatives market might cause banks to engage in risky behavior and issue low-grade bonds. Credit derivatives might reduce the importance of traditional banking entities and standards. The author argues that stronger reporting requirements can help prevent the side-effects of these markets.
  • · Disintermediation, disintegration and risk in the SME global supply chain, Ritchie, B., & Brindley, C. (2000). Management Decision, 38(8), 575-583. This research shows that the models currently used to examine supply chain relationships will be replaced by more modern, adaptive models. These quick-changing models will respond to a more dynamic workplace where good managers will be able to quickly create flexible alliances. This paper focuses on small to medium-sized enterprises and highlights potential opportunities and provides guidelines for strategic management, relationship marketing, and risk management in such organizations.
  • · Deregulation, disintermediation, and agency costs of debt: evidence from Japan1, Anderson, C. W., & Makhija, A. K. (1999). Journal of Financial Economics, 51(2), 309-339. This research uses stock price and accounting data to show that many Japanese fims in the 1980s relied less on traditional banks after widespread deregulation. The authors show that companies with more bond debt had lower growth opportunities while firms with more bank debt were more likely to experience positive growth.
  • · Disintermediation in question: new economy, new networks, new middlemen, Jallat, F., & Capek, M. J. (2001). Business Horizons, 44(2), 55-60. At the beginning of the internet revolution we were promised that consumers would interact directly with producers, and this paper examines the reality of these predictions. By examining real-life players like Amazon and Dell, modern chains of communication and customer interaction are examined. The assumptions about an information-driven marketplace are challenged with the recognition of cyber-intermediaries and the truth about the willingness of customers to devote their time to these new markets.
  • · Supply management under high goal incongruence: An empirical examination of disintermediation in the aerospace supply chain, Rossetti, C. L., & Choi, T. Y. (2008). Decision Sciences, 39(3), 507-540. This research shows that if there is going to be a separation between the original equipment manufacturer’s (OEM) and the firms that produce the after-market parts for that original equipment, the best-case solution is for both parties to have aligned goals. Using archival date and an internet-based survey, these hypotheses are examined in the aerospace industry. The lucrative after-market parts segment of the market is analyzed and insights about these new relationships are offered.
  • · Financial disintermediation and policy, Hester, D. D. (1969). Journal of Money, Credit and Banking, 1(3), 600-617. This research shows that past research on credit flows wasn’t entirely successful because they fail to recognize the decreasing importance of traditional financial institutions in the credit markets. In light of these new assumptions, this paper also analyzes the effectiveness of monetary policy on the financial markets.
  • · Agent‐based supply chain disintermediation versus re‐intermediation: economic and technological perspectives, Nissen, M. (2000). Intelligent Systems in Accounting, Finance & Management, 9(4), 237-256. This research examines the real-world application of information technology as it changes the connection between the consumer and the supplier. It questions if emerging technologies are actually bring suppliers and consumers closer together as we were promised, and if so, will these conditions always be the case? Economics literature is used to create the foundation for the discussion, then supply chain models that use these new connections are created and examined.
  • · Disintermediation through policy loans at life insurance companies, Schott, F. H. (1971). The Journal of finance, 26(3), 719-729. This research uses an examination of the rise of policy loans at life insurance companies to shed some light on the decrease of importance in traditional financial institutions and the conditions that leading to this situation. The rapid growth of such loans have serious underpinnings for the predictability of the financial markets at large.
  • · The disintermediation of financial markets: Direct investing in private equity, Fang, L., Ivashina, V., & Lerner, J. (2015). Journal of Financial Economics, 116(1), 160-178. By comparing the results of solo transactions versus similar transactions undertaken by large funds, this research examines disintermediation in the equity markets. 20 years worth of transaction data by large institutions is also used to establish a benchmark for comparing public transactions in buyouts as compared to those transactions undertaken by seven large institutions.

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