A Model of B2B Exchanges
Abstract
B2B exchanges are revolutionizing the way businesses will buy and sell a variety of intermediary products and
services. It is estimated that most of the roughly $7 trillion worth of business transactions are likely to go
through these new institutions within the next decade. This paper tries to understand the economics
governing the transactions within B2B exchanges and analyze their likely evolution over time. In doing so, we
start by providing the rigorous definitions to a number of critical concepts broadly used in the context of B2B
exchanges including "market fragmentation", "critical mass" and buyer-seller "connectivity". We describe
equilibrium behavior in the exchange and analyze it as a function of these critical concepts. Next, we study the
evolution of the exchanges in a dynamic system where buyers and sellers enter (exit) the exchange based on
the relative economic surplus (loss) they receive inside vs. outside the exchange. Our results have important
implications for practice. For example, we show that equilibrium prices within the marketplace may not
always decrease with lower search costs. However, buyer surplus rises with lower search costs even if prices are
higher in the exchange. We also show that the general view that demand and supply (so-called "liquidity")
either grows or shrinks in the marketplace may not always hold and it is quite possible to have a marketplace
that is stable even though only a relatively small proportion of the market participants transact in it. Finally, we
also provide conditions under which the exchange should subsidize buyers or seller in order to achieve critical
mass.