A Model of B2B Exchanges

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.