Pricing Strategies of Electronic B2B Marketplaces with Two-Sided Network Externalities

B2B electronic commerce has become an important issue in the debate about electronic commerce. How should the intermediary charge suppliers and buyers to maximize profits from such a marketplace? We analyze a monopolistic B2B marketplace owned by an independent intermediary. The marketplace exhibits two-sided network externalities where the value of the marketplace to buyers is dependent on the number of suppliers, and value to suppliers is dependent on the number of buyers and suppliers. When these two-sided network externalities exist, we find that the optimal price for buyers and the fraction of buyers in electronic market are dependent on the switching cost and the strength of the network effect of both types: buyers and suppliers. The same is true for the optimal price for suppliers and the fraction of suppliers in electronic markets. In other words, the parameters that define the buyers also affect the optimal price for suppliers and the fraction of suppliers in electronic market and vice versa. Our results also point to some counterintuitive optimal pricing strategies that depend on the nature of the industry served by the marketplace. 1. Research questions The rapid growth of electronic commerce led to high expectations, some of which were too unrealistic to hold true. The struggles of famous dot-coms such as Amazon.com and Buy.com in business-to-consumer markets have cast doubt on the future of electronic commerce. While much attention was focused on business-to-consumer firms at the outset, far greater volumes of transactions were conducted in business-tobusiness markets. According to Forrester Research, the amount of business-to-business (B2B) sales is several times that of business-to-consumer (B2C) sales and will be even greater in the near future. However, in the context of designing B2B marketplaces on the Internet, there are several unanswered questions. How to attract buyers and suppliers to B2B marketplaces? How can intermediaries 0-7695-1435-9/02 $1 nual Hawaii International Conference on System Sciences (HICSS-35’02) 2002 IEEE extract revenue from suppliers and buyers in the marketplaces? Many practitioners have speculated about these questions, but there is little academic research in this area. Some B2B market intermediaries have successfully created marketplaces. One common factor among them is that, along with transaction services, they have provided information services such as industry-related news services for the industry (Citadon), consulting services (FreeMarkets), and other services. For example, industryrelated news services can attract suppliers and buyers and help form a community to disseminate new information related to the industy. This, in turn, attracts more buyers and suppliers. Such information related services are valuable to buyers and suppliers irrespective of the level of network externalities. Then, the marketplace can make efforts to transform the community into a customer base. An important question facing intermediaries is how to price their services? How will network externalities affect the strategy of the intermediary? In this research, we study the strategies of intermediaries including their pricing of services when the impact of network effects is significant. Usually network externalities affect a consumer's valuation of a product depending on the number of compatible products being used by other consumers. The network effect in a marketplace is different in that the value of a marketplace to a buyer depends on the number of suppliers and vice versa. We discuss the nature of the network effect in marketplaces in detail in subsequent sections. This article is organized as follows: Section 2 briefly reviews previous studies related to B2B marketplaces. Section 3 discusses the basic marketplace model. Section 4 discusses the impact of market conditions on the optimal prices and level of participation in electronic markets. Finally, Section 5 presents our conclusions. 2. Theoretical foundations There are two main benefits of electronic B2B marketplaces. The first one is the speed and efficiency of transactions enabled by information technology. Using advanced information technology, suppliers and buyers 7.00 (c) 2002 IEEE 1 Proceedings of the 35th Hawaii International Conference on System Sciences 2002 Proceedings of the 0-7695-1435-9/02 $ can reduce transaction costs. The second benefit accrues from the larger number of participants. By bringing together a large number of buyers and sellers, electronic marketplaces increase choices. Because of the ease of searching for suppliers in electronic marketplaces, buyers have a greater chance of finding cheaper prices or better transaction conditions. Also suppliers can find buyers that better match their requirements when they want to sell their products. When the value of a product depends on the number of users, we consider the product to exhibit externalities. The benefits from having a large number of participants are called ‘positive network externalities’. As an example, a telephone is only valuable if there are other people with compatible telephones that a user wishes to call. In earlier research, Katz and Shapiro [8] discussed the strategies for products with positive network effects. They showed how network externalities can affect the decisions of companies, especially those relating to the compatibility of their products to industry standards. Brynjolfsson and Kemerer [2] empirically showed that the network externalities of spreadsheet software programs can increase the price of these programs. In this paper, the characteristics of network externalities of the marketplace are quite different from the characteristics of network externalities of products in previous studies. We call the network externalities of products one-sided to differentiate it from the network externalities of the marketplace. For each player, the value of the marketplace is dependent on the participation of the other party. As we can see in Fig.1, for buyers in the marketplace, the number of suppliers is the main concern and for suppliers, the number of buyers is the main focus. B2B Marketplace (Intermediary) Supplier1