The Search For A Perfect Marketplace
Hemant Puthli
The last few years of this century - this millennium, actually - will probably be remembered in history as the most exciting, the most volatile, the most 'happening' years. When Christopher Columbus first set foot on the American continent, several centuries ago, it was a moment that forever changed the future of civilisation. When Neil Armstrong first set foot on the moon, some decades ago, it represented "...a giant leap for mankind". Achievements of almost the same magnitude are commonplace these days in the field of communications and information technology, if one were to consider a clutch of inventions and innovations as a collective whole.
Today, technology has made it possible for common people to receive electronic mail and listen to it being read out to them by a machine while trekking in the hills, or to purchase and experience the latest release by their favourite band while travelling, or to have a virtual meeting with associates across different continents without moving from their desks. On the flip side, the same technology has also given birth to issues such as the millennium bug (which has the potential to make one worry oneself to death, instead of partying likewise, on December 31, 1999). If there were no computers, we'd never have had a Y2K problem. If there were no Internet, we'd never have had cracking, hacktivism, spam, and large scale virus attacks. But then you always get it all in one integral package - you can't just keep only the good parts.
Of all these wonderful phenomena of the late nineties, Electronic Commerce (EC), however one chooses to define it, is probably the most outstanding, with an impact well into the time horizon as far as one's vision can possibly extend into the future. EC forms the pivot of the paradigm shift we are experiencing, in the way we live, learn, work and play. Of course, concerns over security, privacy, intellectual property rights, etc., may not have yet been fully and satisfactorily addressed. But then Free Enterprise can never wait for perfection; in fact, it will be free enterprise, more likely than anything else, that will eventually help us resolve these issues and put them behind us. Like all other outstanding phenomena which have proved to be turning points in history, EC too is surrounded by a lot of hype, myths, and, to put it mildly, over-expectation. Conservative businesses tread cautiously on the thin ice of EC, while the bold plunge into it - and sometimes win. Keenan Vision predicts that the Internet Economy will grow, from a little under US $40 billion in 1998, to over $446 billion in 2002, of which almost $129 billion will be traded through some form of 'exchange pricing' mechanism over the Internet, 32% of which (i.e. about $41 billion) is expected to be business-to-consumer. More conservative estimates by Jupiter Communications project that online business-to-consumer auctions will move $3.2 billion worth of merchandise annually by 2002. Regardless of the projections and forecasts, optimistic or realistic, aggressive or conservative, all observers and analysts of the EC phenomenon agree that it will significantly and permanently change our lives. Whatever the numbers, we are looking at exponential quantitative growth leading to major qualitative change.
These first few years of EC, then, should probably be looked at as the initial struggle of a new-born infant trying to deal with the extraordinary phenomenon of life, with all its sights and sounds and smells and tastes. Painful, exciting, scary, joyous ... in a word, unprecedented. The basic framework for the new business model in the new millennium has already been conceived and delivered, and is now undergoing its evolutionary journey the hard way - no guides, no parents, teachers, mentors - to tell it what to do, what to avoid: just plain old trial and error. What makes it more complex, in a way, is the knowledge that an experiment may fail only because it is too early for its time, and not because it is per se not workable. A baby puts its hand into a flame, gets burnt, and learns never to do it again. With EC, this may not necessarily be the lesson to learn. It does not rule out the possibility that the same activity, performed in the same manner (more or less), may lead to desirable results in a different context, a different time, a different space.
For instance, electronic cash (E-cash), at this point in time, seems to have failed as a business experiment, in spite of the hype surrounding it. Several banks, technology companies, merchants and retailers, toyed with a vast multitude of prototypes and variations on the theme, spending hundreds of thousands (even millions) of dollars. Some achieved limited success, while others burnt their fingers like new born infants touching a naked flame: the technology was ready, but lacked a strong business case. Does it mean that no other enterprise will ever touch this burning topic again? Certainly not. E-cash will re-invent itself when the time comes. The few who sustain themselves till that time will be heralded as pioneers - new age versions of Columbus - who believed in "being bold and going where no man has gone before", in the vast realm of cyberspace, the final frontier.
How can one be certain that E-cash will eventually prevail as the new form of money? A quick glance at the history of money itself - as a unit of account, store of value, and medium of exchange - will substantiate this forecast. From cattle to cowries, precious stones to metallic coins and paper currency to cheques, money has evolved in representation, in the overall context of technological advancement and economic growth. Being abstract in nature, money requires a suitable, concrete manifestation, in order to serve the useful economic purpose for which it was conceived. Money has always sought, and will continue to seek, the form best suited for it (in the technological context prevalent at the time), to enable commerce to be carried out smoothly and efficiently. It is only natural, therefore, that in the electronic age, when everything from text and numbers to sound and visuals is digitised, money too acquires an electronic form.
As with money, so with markets. The notion of a market is, in fact, older than that of money. Markets are where one went, in order to trade something which one had a surplus of, in return for something else which one had a deficit of - a kind of 'black box' into which one could put what one did not want so much, and pull out what one wanted very much. Needless to say, there is always an underlying urge to part with as little as possible (you can never really have a 'disposable' surplus of anything, especially if someone else wants that very thing), and yet get back as much as possible. The more easily and satisfactorily one can perform the task of exchanging what one has for what one doesn't, the closer to perfection one may consider the market to be. Now, what exactly might this involve? Firstly, the 'black box' should be within easy reach and be functioning when required (accessibility / availability); secondly, there should be takers for what one has to offer and offerers for what one wants to take (liquidity); thirdly, it must provide a price which represents the real value of the item for sale / purchase at that point in time - a 'fair' price, which anyone else in the same position at the same point in time would also obtain (fairness); fourthly, it must enable a transaction to be struck quickly for the agreed price (speed); fifthly, it must record and remember the details of the transaction exactly as it was struck, and not permit any change, intentional or otherwise (integrity); sixthly, it must guarantee consummation of the transaction in its entirety (freedom from settlement risk), meaning that the exchange of value must be complete - delivery against payment must be assured.
The first few markets in the history of mankind were based on barter or exchange of goods, where participants negotiated transactions on a case-by-case basis, and struck a bargain depending on individuals' circumstantial needs on either side of the deal. It was the advent of money, which provided a standard measure of value, that gave birth to the concept of a 'price' to a trade, and permitted various price-setting mechanisms to grow and proliferate. These could broadly be classified into 'fixed-price', where the price is pre-determined by someone (the party offering the goods or an entity with overall authority over commerce), and 'auctions', where the price is discovered when demand and supply meet. Across various parts of the old world, variations of the auction mechanism evolved side-by-side with fixed price markets. Given the imperial power structures of governance prevalent at the time (and the need for the ruling class to maintain the control of economic factors within their administrative machinery), fixed pricing was usually favoured for purchase and sale of common goods by common people, whereas the use of auctions was confined to high-value goods, such as slaves, land and livestock, where market participants were usually wealthy capitalists.
It was the advent of free trade, along with the growth of personal political freedom, which began to influence the use of market-driven pricing for goods of all kinds. In the evolving commercial environment, buyers and sellers were empowered to arrive at a mutually agreeable price and to transact at that price. Structured marketplaces - called 'exchanges' were set-up, where goods were auctioned regularly as per an agreed set of rules which would apply to various processes associated with price discovery, transaction, confirmation and settlement. Participants were registered with the exchange authority and needed to fulfill specific criteria before they were granted membership of the exchange. The 16th century saw the establishment of stock exchanges throughout Europe, and the first American exchanges were established in New York in the early 18th century. Gradually, thereafter, it has come to be accepted that the price of a good is best determined through a free and open auction-type system, rather than set at levels pre-determined by a governing authority.
It is interesting to note, however, that Man's instinct to negotiate the best deal (i.e., maximise what you get; minimise what you give), has prevailed right through history as an socio-economic reality - the essence of the trading process, and the basis of economic theory and business practice. While this may be taken for granted as a constant, everything else about markets has been subject to change. Over time, markets have been constantly evolving, maturing, seeking perfection. Up until the last decade of this millennium, the main impediment to the formation of markets has been the fact that participants needed to meet in physical space and at a pre-arranged time, in order to transact business. The advent of the Internet has removed this constraint - this network of networks, pervading all pockets of civilisation as we know it, already reaches a mass of people large enough in size to be considered a continent, albeit a virtual one.
Consider the proposition that the Internet qualifies as the world's first, and to date only known platform, to develop the perfect market for any good or service. We had earlier proposed 6 criteria for a perfect market. Let us now evaluate a hypothetical Internet-based market against these criteria:
Clearly, a perfect market cannot be formed on the Internet by just anyone with a web presence. In order to qualify for perfection, an Internet-based market not only needs to provide for the smooth and continuous functioning of the trading facilities, but also needs to ensure fair practices in price discovery and transaction execution, and to guarantee the settlement of transactions entered into by buyers and sellers. Two distinct roles may be envisioned here - one entrusted with the responsibility of making sure that the core 'engine' of the market is always up and running, and the other, entrusted with the responsibility of defining the rules of the game and also enforcing compliance by the players. The former may be played by a technology-driven organisation whose sole purpose is to maintain the platform on which the smooth and continuous functioning of the market is based. The latter may be played by a sovereign financial institution, whose sole purpose is to create and maintain a business system which defines the framework for a perfect market. Among other things, it must provide a guarantee that all valid transactions entered into by bonafide participants will definitely result in a successful settlement. This requires something more than mere technological capability to maintain a robust web-site - it requires a sound market design, and organisation and management skills to create and sustain a perfect market. These characteristics we posit in what may be called the 'Internet Exchange' - an enterprise equipped to play both the roles outlined above.
Illustrative services of an Internet Exchange include participant credit verification, participant registration, information dissemination, order entry and management, order matching and transaction confirmation, collateral management, and trade settlement. In a nascent EC environment, various models are likely to evolve, for both order matching (typical Stock Exchange functions), as well as settlement guarantee (typical Clearing Corporation functions). It is envisaged that a wide variety of implementations would emerge, and the more appropriate models will develop on a 'survival-of-the-fittest' basis.
In a free universe, a plethora of 'perfect market' models can and will emerge, and struggle for at least a small mention in the story of the evolution of markets, if not for institutional immortality or perpetual existence. We may find not just one but several Internet Exchange implementations, each aspiring to be the dominant player in the game of running the world's most perfect market. While it is certainly possible that one such leader emerges in the long run, the short-term scenario, while we have a multiplicity of Internet markets, will bring out the need for specific participant-oriented services, such as finding the best deal for a good or service ('agent'), across various Internet Exchange instances. (This is probably where at least one strain of next generation search engine technology is headed.) In the business-to-consumer space, with vendors happy to offer goodies in return for information about consumers visiting their site, there would be a need for someone to represent the participant ('proxy') in negotiating deals to the participant's advantage. This could also be a free market answer to the privacy issue - withhold information about yourself that you treasure; part with the rest in return for gain. With increasingly heavy advertising on the Internet, consumers may want someone to shield them from irrelevant commercial messages ('filter') and allow only relevant ones to reach them so as to pick-up just a wee bit of that commodity so precious to marketers - attention span / eyeball share / mind share, whatever. Vendors, on the other hand, are constantly looking for the most effective target segment to hit on, and would like to have someone pointing them out ('audience brokers') or directing most-likely potential buyers to their site ('lead generators'). Research by McKinsey & Co. has identified five stereotypes of what are called 'infomediaries' (for information intermediaries) described above: consumer-oriented agents, proxies and filters; vendor-oriented audience brokers and lead generators.
For a moment, ponder - could an Internet Exchange provide these (and other such) services? While one may continue to attribute more functionality and features to the Internet Exchange, pragmatism reminds us that it may not be possible for a single organisation to successfully play the role of caretaker of a perfect market, and also provide its participants with customised services designed to serve their interests, such as the ones described above. Efficiency apart, we have distinctly possible conflicts of interest, intrinsic to such a structure. Besides, there is a need for even more services in an Internet market - someone who guarantees / underwrites the credibility of a direct participant, someone who checks the authenticity of, and vouches for the trustworthiness of, a common buyer or seller. Clearly, the principle of segregation of duties would dictate that the Internet Exchange not be involved in providing such services. Enter the infomediary who could play any of these roles, and serve either the consumer-participant or the vendor-participant in the Internet Exchange. This new role also provides an escape hatch to traditional intermediaries, who will not have anything to offer to participants of a perfect market if they continue to stick to their original role definition - a third party who introduces buyers and sellers and earns a commission proportionate to the value exchanged. By reducing the economic distance between buyer and seller, the Internet has challenged the role of the broker as has been traditionally defined and established. Transaction execution on behalf of the buyer or seller is no longer relevant, since buyers and sellers are now empowered to directly meet and transact.
To summarise, I submit that the Internet has already provided a platform for the perfect market to establish itself. With appropriate technical expertise and adequate managerial capabilities, near-perfect markets will emerge, each developing its own variant of an auction pricing model. Brokers with foresight will morph into infomediaries, serving consumers and/or enterprises that sell to consumers, all of whom will participate in these markets. Over time, natural evolution - competition and survival of the fittest - will ensure the establishment of a perfect market in a stable, flourishing economic ecosystem, consisting of the Internet Exchange, various types of infomediaries, and various types of participants, individuals and businesses, small medium and large.
You ask: Is all this really going to happen?
I reply: You hear a knock at your door. It is Opportunity.
Wanna bet?