Ajit Kambil on the inevitable, strategic use of electronic markets and auctions.
Ajit Kambil is a Senior Research Fellow and Associate Partner at the Accenture Institute for Strategic Change where he leads diverse research initiatives in electronic commerce, supply chains and innovation. He is co-author, with Eric van Heck, of the book "Making Markets: How Firms Can Design and Profit from Online Auctions and Exchanges."
UBIQUITY: John Seely Brown has said that your new book "provides an extremely readable, comprehensive, and intuitive account of the different kinds of auctions, exchanges, and price discovery mechanisms. It also offers insights into when electronic markets are apt to succeed or fail. I highly recommend this book. It has already helped me see the world differently." When someone says that the book has helped him "see the world differently," one concludes that there's some Big Idea in the book. What is that idea?
KAMBIL:: Actually, there are a number of Big Ideas. One idea is that electronic markets and auctions will become much more prevalent -- for both trading across organizations and trading within organizations. Managers will use markets and auctions to acquire supplies, reach out to new customers through new channels and respond to reverse auctions hosted by a customer. They will also leverage markets within firms as a tool to improve decision-making and find the most profitable ways to allocate their resources. British Petroleum created an electronic market to trade emission rights and find the lowest cost ways to reduce emissions.
UBIQUITY: And other Big Idea in the book?
KAMBIL:: Another key idea is that markets are complex and fragile theaters where buyers, sellers and market makers act out a trade. Markets also bring many inter-related processes together. You have to align the interests of all parties across all of the different processes to make markets work. If you make a technological change in just one process and don't think through its impact on all other process and the different market stakeholders -- the buyer, the seller, or the auction intermediary -- then the consensus or basis of the market could be undermined and the market may fail. The book articulates in a very crisp way the different processes of markets and how to make them work. It also sets out a vision for how to use markets in the future. Every manager must now begin to think about utilizing markets.
UBIQUITY: Could you give Ubiquity readers an abbreviated taxonomy of markets?
KAMBIL:: Sure. Every market creates value for buyers and sellers by solving a number of different problems. It provides a place where they can search for goods and services. It provides the mechanism to arrive at a price. It provides information, capabilities or logistics for transferring goods from one party to the other. It provides ways of authenticating the counter party to the trade and the quality of the material transacted. Most importantly to most people, it manages the flow of money. At the same time, a market provides other value-added functions. It provides a way to resolve disputes that may arise when parties are trading between each other. It may provide a context to assure trust so that the cost of trading is reduced. It provides a consensus on how to represent something that is to be traded. There is a range of different value-added activities that markets provide in totality. Sometimes when people bring technology to markets, they focus on one area and don't think about how all of the value-added processes interact with each other.
UBIQUITY: With regard to those kinds of interactions, has any electronic market ever killed off a physical market?
KAMBIL:: I would not say killed, but the London Stock Exchange went from a physical marketplace where people came together to an electronic marketplace where people trade remotely. In that sense, yes, you could say that there has been a transformation from a physical marketplace to an electronic marketplace.
UBIQUITY: So how does technology interact with the social dimensions of a market?
KAMBIL:: Technology improves a range of activities quickly. For example, searches, payments and logistics can be transformed quite easily. On the other hand, in terms of the social dimension, the impacts can be quite surprising. For example, in the book we talk about our studies of the Dutch farm market. There was quite a bit of resistance when technology was initially introduced into the market. The growers felt that online images didn't represent their product well. It changed the way they interacted with the marketplace. The same thing occurred with buyers. When trading online they didn't immediately trust that they were getting all the information that the physical marketplace would provide in terms of the expressions on people's faces and so forth. One has to be careful about the social context by which people already trade before introducing a new technology. People make use of all kinds of physical signals that exist in traditional trading places. The electronic market should account for the existing social arrangements.
UBIQUITY: Do people eventually get used to not having those physical signals and agree to accept the electronic market?
KAMBIL:: The social aspect of markets must be accounted for when you're introducing a new technology because it could be a real source of resistance to change. Over time market participants will begin to accept technology. The key is to make sure that you don't create a situation where there is asymmetrical information. That is, where people in the physical market have different information from other people. If you introduce technology that allows people to trade remotely, and you also allow them to trade simultaneously in the physical space where they can get these other signals, the people in the physical space may feel like they have an advantage. To go from one format to the other, you must have a huge brace to make sure that there are no situations where one subgroup has a different set of information than the other. People do accept electronic markets, but one has to be very cognizant of the individual impacts, and thus, make sure that the information provided by the market itself to buyers is not asymmetrical across different buyers.
UBIQUITY: Do flowers for some reason present an especially good opportunity for developers of an electronic market?
KAMBIL:: In the case of the flower market, one of the key challenges is the physical logistics of moving the flowers closer to the buyer taking into account traffic and other factors. With electronic trading, you can locate a warehouse of the inventory that's closer to airports, has less traffic, and so forth. At the same time, by trading electronically you also get rid of the all the internal logistics within an auction hall. It's a very complex logistic process.
UBIQUITY: Explain the complex logistics of the flower auction and how technology addresses them.
KAMBIL:: The Dutch Flower industry has two major auction halls, each one about 10 football fields in size. Some 10 different auction clocks are running at each auction. Underneath the auction clocks, there are stacking carts of all the flowers going to the auction hall, probably 60,000 carts altogether. By running the auction electronically, you can separate the physical from the information about it. In terms of flowers, buyers have come to accept that if they have reasonable information about the color, the size of the head of the flowers, the stem life and so forth, they're willing to buy them electronically, which is quite remarkable. One would expect they'd want to be close to smell the flower. As long as you have a good rating system and a quality control system, the buyer can buy with confidence and minimize the cost of the transaction.
UBIQUITY: Do markets function mainly in terms of the goods or do they function equally well in terms of services?
KAMBIL:: Electronic markets traditionally work well with fairly standard physical goods. Increasingly, I think they're going to work more and more on intangible goods such as the trading of risks and futures.
UBIQUITY: The contemporary poster child for playing the risk trading game was Enron, which failed spectacularly.
KAMBIL:: Trading through commodities and futures exchanges is more regulated. Increasingly we're seeing early electronic markets or the B2B markets provide the capacity to do futures contract trades. For example, ChemConnect bought another company called CheMatch. They're exploring trading futures in chemicals that will help purchasers and sellers manage the risk of price fluctuations for critical inputs or outputs over time.
UBIQUITY: Have you observed much trading of knowledge assets within companies?
KAMBIL:: Very little of this is being done at this time. Most knowledge management systems like Lotus Notes provide few incentives for people to share know-how. One can envision the emergence of knowledge trading mechanisms within companies. But this will require executive commitment to new ways of knowledge management in firms.
UBIQUITY: How would a knowledge trading system within a company work?
KAMBIL:: One way that will initially emerge is by creating artificial markets, similar to a Hollywood Stock Exchange, that will enable companies to surface assumptions and make predictions. Charles Plott of Caltech ran experiments with a computer company in which he made sales forecasts using a market mechanism verses the traditional mechanisms. His results showed the market mechanisms performed better. These new information markets, if you like, give people an incentive to reveal information and express their beliefs by putting money behind those beliefs, which is a very compelling knowledge management tool. Envision a company that has uncertain assets -- such as ideas for new ventures -- using a market mechanism to ask, what do the people in my organization think about these ideas? Which ones are they putting their money on? Management can use that information in the decision-making process. By asking people to reveal why they put money on something, management can learn what motivates individuals to bet on one thing versus the other.
UBIQUITY: When people make bets like that -- when they effectively auction in that spirit -- must there always be some productization of what's being marketed?
KAMBIL:: It doesn't always have to be productized. I'll give you an example. Say I'm in a biotech firm, and I want to know when a particular process will be solved in order to make my new medicine. I have a range of estimates and dates. I could find a solution in three months or in nine months. Different people in my organization have different components of the solution to the problem. Some may recognize difficulties; others may recognize potential breakthroughs. By having a market where a unique stock is defined for each quarter, people will say, "I believe it could be ready in one quarter and I'm willing to pay to buy that stock." The payout of that stock could be $10 if they're right. If people really believe it could be solved in one quarter, the price of the stock for the next quarter should go close to $10. Then most people would be expressing confidence that there's a pretty high probability the problem will be solved in three months. But if people believe the problem will be solved by the fourth quarter, then the fourth quarter stock will rise. Different people could reveal their beliefs using this market mechanism in terms of when they expect something to occur. Beyond that, at the same time, when they buy a stock we can also ask them why they believe it will be the fourth quarter or the first quarter. The answers to this surface the assumptions about their beliefs ï¿½ "eliciting" their real knowledge. Maybe then, management can focus and pay attention to the validity of different assumptions underlying the forecast to manage the drug development better. So, this is not about trading a product. It's trying to figure out when something might occur. The market becomes a way of getting a consensus or a snapshot of the beliefs of people and then soliciting their assumptions.
UBIQUITY: Whom did you have in mind as a reader when you wrote this book?
KAMBIL:: There are four audiences to this book. One is the information systems professional who thinks about what are the systems that they have to deliver and how can they move markets from a physical to an electronic space. It provides the roadmap for IS professionals and for faculty who teach students how to move markets from place to space. I was a former IS faculty member New York University's Stern School of Business, where I taught students how to transform an organization through electronic markets.
UBIQUITY: And the second audience?
KAMBIL:: The second audience is marketing. Marketing increasingly will deal with auctions as a way of distribution. With more than 45 million users eBay and auctions are a channel they cannot ignore. They should figure out how to capture value from resale markets by looking to them as a source of new product ideas, as a way of encouraging users to upgrade products. They must also estimate how increasingly friction-free resale markets will impact new product sales.
UBIQUITY: Let's pause for a second: Speaking of eBay, what can marketers learn from this type of resale auction?
KAMBIL:: Marketers can use a resale auction as a strategic resource. An auction gives you different ways of pricing. It creates different levels of effort for the buyer. It creates an opportunity for marketers to segment customers along different channels that perhaps they didn't think about before. The message for marketers is that they should understand the diversity and mechanisms of new auctions and how to use them strategically.
UBIQUITY: Okay, to continue, what are the other two audiences you had in mind as you and your co-author, Eric van Heck, were writing "Making Markets"?
KAMBIL:: The third audience is economists. Economists typically look at markets as a black box abstraction with very little attention to the richness of the institution and the social forces at play. The book focuses more on the social and technological forces rather than the boring textbook economic modeling of auctions. And, finally, the fourth audience is the supply chains where these markets are beginning to make a tremendous difference in procurement and sourcing activities.
UBIQUITY: Explain why you finished the book by urging people to go to their attics, find something, and put it for sale on an online auction?
KAMBIL:: There are many new opportunities available for individuals to participate in auctions. We felt it would be a way for people to engage with and learn the power of auction as a selling mechanism. We want people to go to an auction not only as a buyer, but also to learn how to become a better seller. We want people to say, "Somebody's going to pull a reverse auction on me and force me to be a seller. I'll have to know how to do that." Or, "I'm going to be a seller through an eBay, and it's going to make me a smarter buyer in the future." That's why we said at the end of the book; "Get out there and experience this." It's really important for managers to experience. Most managers are very busy and the auction is probably not the most convenient way to buy something. But with so many people using eBay and other auctions, it's something they cannot ignore. We are exhorting managers to experience it as more than an academic afterthought. Once they experience it, I think they'll begin to recognize just how important the channel is.