Disintermediation: Definition and Examples in Business & Finance

What Is Disintermediation?

The term disintermediation refers to the process of cutting out the financial intermediary in a transaction. 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

Disintermediation is used across various industries and is able to lower the overall cost of completing a transaction. Removing the intermediary may also allow a transaction to be completed more quickly. It is now a pillar of the internet model, where it is often called the business-to-consumer (B2C) model.

It can occur when a wholesale purchase allows an interested buyer to purchase goods, sometimes in large quantities, directly from the producer. This can result in lower prices for the buyer because the intermediary, such as a traditional retail store, is 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.

The concept originated in the financial industry, allowing investors to buy financial products directly without an intermediary, such as a broker or a bank. The government placed a limit on bank interest rates for federally insured accounts in 1967, so consumers began taking their money out of savings accounts in order to find better returns by directly investing in bonds or stocks.

Special Considerations

Intermediaries often play a valuable part 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 must be duplicated by the producer who wants to cut out the middlemen.

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.

Disintermediation and the Internet

The internet can be a powerful tool for disintermediation. Consumers and small businesses can theoretically 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 intermediary—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.

Many of these products are also available on retailers' sites.

Niche Disintermediation

Other internet giants took on disintermediation in specific niches. Google's AdSense platform transformed the marketing and advertising industry, allowing businesses to directly control their own messaging. Meta (formerly Facebook) gives local businesses a social media platform to communicate directly with customers and promote their products.

This potential was 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 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.

Example of Disintermediation

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

The process began 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 revenues on the markup.