3 Electronic Market System Framework
3.2 The Organizational View on Electronic Markets
3.2.2 The Product of the Market Firm
3.2.2.4 Application to Electronic Markets
As aforementioned, the provision and operation of an electronic market is a service. The core service basically denotes the determination of a market-based price (transfer payments) and corresponding allocation (choice). The electronic market service is thus defined as follows:
Definition 12: Electronic Market Service
The electronic market service basically comprises the price determination and allocation according to the institution of the electronic market.
Complementary services are mainly concerned but not limited to information services (e.g.
real time information about the actual demand and supply situation via the orderbook). The electronic market service is apparently generated along the market process. Within the market process the participating agents – the customers of the electronic market – submit offers to buy or sell according to the institutional rules. Those offers subsequently determine the price and the allocation. Consequently, the participating agents are also co-producers of the elec-tronic market service. The quality of the service is also dependent on the co-producers. In other words, the market firm has not control over the whole market process and can accord-ingly not assure good performance. Control over the whole process can be misleading. Surely, the market firm has perfect control over the message flow; what the market firm cannot con-trol is the behavior of the agents. In analogy to services the market firm cannot guarantee good quality of the market process but the best possible prerequisites for the market process.
Another particularity of the electronic market service is that at least two co-producers are in-volved. Co-production of the market participants basically comprises the submission of offers.
For a transaction to take place it needs two corresponding offers that can be executed against each other. A transaction is thus termed composite good; one offer has no value without the corresponding (Economides 1996).122 Moreover, as the co-producers of the composite goods are independent firms, coordination of the service that creates the transaction becomes diffi-cult. As a consequence, the market firm tries to attract as many submitted offers as possible.
Figure 11 illustrates in analogy to Figure 9 the electronic market service. The prerequisites of this electronic market service basically refer to providing a trading facility. Over this trading facility the participants negotiate about their demand and supply within the lines of the institu-tional rules. The market outcome of this service comprises the prices and allocations, which are discovered according to the trading rules (choice and transfer rules). More precisely, the market outcome is formed in the encounter of the market participants with the electronic mar-ket facility, the service prerequisites, of the marmar-ket firm. Apparently, the marmar-ket firm can only
122 For the submitting agent, the offer is assumed to generate no value, as no transaction occurred. However, it can be possible that the offer generates value for other agents. In financial markets payment for order-flow demonstrates that unmatched offers have a value and can be sold. Due to space restrictions, it is re-ferred to Harris (Harris 2003).
influence the market outcome and thus the quality of the service by the way the electronic market is provided. By the deliberated design of the institutional rules as primary setscrews, the behavior of the co-producers – the market participants – is directed in a way that good outcomes are generated.
Provision of an
Electronic Market Market Process Market Outcome
Price Determination Allocation
Define Infrastructure and
Institutional Rules
Application of Institutional Rules Behavior
of the Market Participants
Figure 11: A Service View on Electronic Markets
As with any other service, the design and implementation of the right prerequisites is essential for the success. The right prerequisites are under full control of the market firm and thus sub-ject to careful design. Recall that service development consists of the three primary compo-nents being service concept, service procedure and service system.
Transferred to the particular service of an electronic market, the service concept embodies the value proposition of the electronic market. Or differently stated, the service concept describes the coordination problem the electronic market seeks to solve. The process with which the service concept is implemented is actually confined by the service procedure. In the electronic market context the institutional framework, in particular the trading rules, constitutes the ser-vice procedure. The serser-vice system, defining the available resources to the serser-vice procedure consists of the market participants, the infrastructure, and the organizational structure of the market firm. Figure 12 visually clarifies the components of the prerequisites for electronic market provision.
Electronic Market Provision
Value Proposition
Systemic Framework Institutional Framework
Figure 12: Components of Providing an Electronic Market
Value proposition as service concept
The service concept is a concise description of the customers’ needs and the service that are intended to meet these needs. In the electronic market context the customers’ needs are over-laid by coordination problem the electronic market is actually devoted to solve.
Example 3.2-2: Coordination Problem in the Electricity Context
From an abstract level trading electricity creates a coordination problem that is character-ized by its inherent incompleteness and imperfect competition. Incompleteness is to a large extent inevitable as power is a flow of energy. A perfect monitoring of the flow is difficult; the storage is expensive. Furthermore, those flows on transmission lines are con-strained by operational limits and environmental factors. Comprising, supply of electricity is subject to fluctuations. On the other hand, is demand extremely variable and is largely insensitive to price changes of the spot market (Wilson 2002). The coordination problem of bringing demand and supply into balance is thus very difficult.
Apparently, the coordination (or allocation) problem is the most urgent (primary need) of the potential customers. This primary need can be matched by adequate institutional rules embed-ded in an infrastructure. The particular stress is on the trading rules again, as they define the original allocation problem and further a procedure to solve it. Nonetheless, primary needs are not limited to the allocation problem (e.g. trading over electronic media can also reason pri-mary needs). If the resource allocation solving capacity of an electronic market represents the core service, there are usually supplementary services bolstering the core functionality. For example, an electronic market can offer its customers a call center. Those supplementary ser-vices satisfy, however, secondary needs. A market firm must tackle both needs primary as well as secondary needs such that the customers are satisfied. Frequently, the supplementary services are the factors that make the wide difference in the customer satisfaction.
In electronic markets the value propositions of the market epitomize the service concept.
Value propositions are generally defined as the statements of benefits that are delivered by the firm to its customers (Bagchi and Tulskie 2000). As electronic markets are competing with non-electronic markets, they must create real value in a sense that they offer superior (e.g.
cheaper or faster) services than the non-electronic ones. Electronic markets are frequently pulled together with the following value propositions (Bailey and Bakos 1997):
• Aggregation
In pursuing new opportunities firms engage in a search process identifying potential trans-action partners. An electronic market can aggregate submitted offers and thus ameliorate the problem as well as the associated costs of search (Geertz 1978; Bakos 1997).
• Facilitation
Facilitation aims at two primary issues. Firstly, the electronic market place facilitates trade by standardizing the traded object. This standardization reduces the uncertainty over the quality of what is to be exchanged and likewise the associated chunk of the deliberation costs123 (Rangan 2000). Secondly, the electronic market facilitates 1-to-many, many-to-1, or many-to-many interconnections. The electronic market can thus tremendously reduce the coordination costs via a standardized process with standardized data formats (Bailey and Bakos 1997).
• Trust
Part of the deliberation costs concerns the trustworthiness and reliability of the partner in transaction. As electronic markets typically facilitate short-term relationships even
123 Broadly speaking deliberation costs denote costs of the making decisions (Stigler and Becker 1977).
shot transactions, trust plays a major role. The electronic market can build up trust by a sound enforcement mechanism.
• Matching and Pricing
Matching denotes the capability of electronic markets to efficiently match buy with sell offers via the price mechanism. The institutional rules of an electronic market presumably yield better matches than the participants would do without them (Malone, Yates et al.
1987; Bailey and Bakos 1997). However, a proper matching requires sufficient partici-pants because otherwise the matching is less predictable.124
• Anonymous trading
By means of electronic markets, it is also possible to trade anonymously. Agents are often reluctant to reveal their identity. For example, in procurement settings the manufacturers may want to conceal the price they have to pay for the inputs, because their customers may abuse this information in subsequent transactions. Anonymous trading can hence constitute the value proposition (Kambil and van Heck 2002).
The sample of value propositions addresses questions concerning the core functionality, which refers to the coordination mechanism.125 Apparently, they can all be expressed in terms of transaction costs. The market participants eventually evaluate the electronic market in terms of how well those value propositions are fulfilled.
Institutional framework as service procedure
Formulating the value propositions is a first step on the way to develop a sustained electronic market. But those propositions must be put to work. The institutional framework comprises the totality of all institutional rules the market firm can set (recall chapter 3.1.2.3). Those rules characterize the service procedure in detail.
Systemic framework as service system
The systemic framework is actually a composite that proxies for the resources that are avail-able to the service. As the previous discussion showed, the service system comprehends physical and technical equipment, customers and the organizational structure. In the electronic market context the technical equipment, i.e. the infrastructure, assumes a focal position126. The infrastructure is the foundation of the electronic market, being in charge of processing the offers. The infrastructure imposes media rules on the behavior of the agents and has thus an anchor in the system procedure.
Employees and organizational structure are naturally important assets. Employees of the mar-ket firm are only rarely involved in the marmar-ket process.127 Usually the knowledge and the ex-perience of the employees help in providing the service, but also in designing it.
124 For example if a Vickrey auction with a single participant will be initiated, this one participant will be awarded with the good and pays 0. Accordingly, this type of auctions is from the sellers’ point of view suspicious leaving the seller with no payment. The question of how many participants are necessary to ensure a proper matching is dependent on the type of auction, which is being used.
125 Note that these value propositions are fairly general. For design they must be described in much more de-tail.
126 Chatterjee, Pacini et al., give a vivid definition of infrastructure “ IT infrastructure consists primarily of physical assets, intellectual assets, and standards. Whereas the physical components include hardware and software related to computing, communications, and database management, the intellectual and standard components of IT infrastructure refer to the human skill set, policies, and procedures required to combine the physical components to create shared IT services like network service, database man-agement, video conferencing, electronic data interchange (EDI), hypertext publishing, and electronic messaging” (Chatterjee, Pacini et al. 2002, 8).
127 In the case of biased electronic markets the market firm is actively trading over the own market facility.
As such there is a direct encounter between the customers and the (employees of the) market firm.
The customers of the service – the market participants – are the primary factor that determines the quality of the market process. Basically, the market firm can train their customers con-cerning how to use the electronic market adequately. Frequently, stock exchanges offer train-ing programs for traders as complementary service.
In summary, a market firm is a service company that provides the electronic markets for elec-tronic market services. As any other service company market firms cannot determine the qual-ity of their service. By carefully designing the provision of electronic markets, the market firm can nonetheless indirectly affect the quality of their service.