By Meelis Kitsing, a lecturer at the Estonian Business School, Director of the Centre for Free Economic Thought
The European Union has adopted smart specialization strategy in its innovation policy, which emphasizes the importance of entrepreneurial discovery process. However, the importance of entrepreneurial discovery should not be limited only to the identification of domains where the EU structural funds will be allocated. The development of both real and digital economy depends on entrepreneurs.
The emphasis on entrepreneurs is particularly important because supply-side constraints matter more than demand constraints for the delivery of digital services and physical goods over online platforms. This is so because the demand for digital services and online purchases is derived demand. We don’t use digital services and online shopping for their own sake. There are substitutes available. If download speeds are too slow, then we will not read newspapers online and purchase a hard copy. If delivering goods from an online store takes too long and it is too expensive, then we drive to a store. If internet banking solutions are too complicated, then we will walk to a bank or call them up. In other words, the use of digital services depends on how they are delivered over online platforms. There is asymmetry between supply and demand. For some this constant disequilibrium between demand and supply may imply „market failure“ but this is how these markets work. It is naive to assume that imposing a masterplan in top-down fashion will make these markets somehow perfect.
Hence, we need to think how to unleash entrepreneurial discovery and how can innovative products and services be provided. The rules of the game governing the markets should not constrain but enable the process of entrepreneurial discovery to take place. The importance of entrepreneurial discovery was already recognized by Joseph Schumpeter in 1942 when he wrote about creative destruction and the role of entrepreneurs in breaking the routines in „Capitalism, Socialism and Democracy“.
Entrepreneurs are innovators who bring new services and products to the market. Often consumers do not even think and imagine what products and services are possible. Henry Ford once said that „If I had asked people what they wanted, they would have said faster horses.“ When internet banking was introduced in 1996 in Estonia, it was an innovation by a new entrepreneurial bank. In 2000, Estonia tax authority started to rely on identification methods offerd by internet banking to provide the possibility to submit tax declarations online. It is an example on how entrepreneurial discovery can lead to new digital services provided by both public and private sectors. Already in 2004 35 percent of Estonian internet users used internet banking while the EU average was 16 percent. In 2013, 73 percent of Estonian internet users used internet banking while the EU average was 42 percent. There are EU member states where only 4-5 percent of internet users use internet banking.
Most importantly, internet banking is not only about digital world. It is primarily about breaking routines in the physical world. The same way as cars broke our habit to rely on horses. Imagine if there would have been a regulation stipulating that financial services can only be used when consumers are physically present in bank premises. Or a law saying that only horses can be used for transport.
The complexity of rules governing every aspect of entrepreneurial activities in the EU has to be recognized in the development of digital single market. The barriers and path-dependencies for transforming services and product market are enormous. It is not just about rules governing telecom sector, consumer rights, intellectual property and privacy. For example, the EU digital single market communication has pointed out that high-prices and inefficiency in cross-border parcel delivery is an important barrier for online e-commerce. Flash Eurobarometer survey from 2015 shows that over 50 percent of companies engaged online activities find high delivery costs are most important obstacle for cross-border sales. Over a quarter of consumers finds that high delivery cost and almost quarter of consumers finds that long delivery times are the main obstacle for cross-border online shopping.
If we think about rules concerning parcel delivery, then service providers may be subject to EU and national postal, transport and freight regulations depending on their business models. There are different parcel services available depending on location, economies of scale and other factors. For instance, Amazon offers opportunity for small and medium size enterprises to use its logistics networks by using „Fulfilment by Amazon“ service in Europe.
However, most small online businesses with low volumes in cross-border parcel delivery rely on national postal operators. Usually, these government owned businesses were set up and regulated to provide letter mail services. They have to follow universal service obligations. They may also be constrained by number of other rules ranging from work hours to safety. Since these incumbent companies are not a springboard for entrepreneurialism and innovation, it is not surprising that parcel delivery is expensive and inefficient.
It may well be that low cost and more efficient parcel delivery service requires different business model from the delivery of letters. These models can emerge only by trial and error through the process of entrepreneurial discovery. Similarly with the introduction of internet banking and cars, it is about breaking routines in the physical world in order to create what can be called real digital economy. It is about new business and regulatory models – even more importantly, it is about our mental models – in overcoming supply side constraints in the emergence of new online and offline markets. Unfortunately, most European countries are more concerned with preserving existing business models and not eager to facilitate creative destruction.