Online marketplaces: Digitizing small businesses can boost economy but ‘platform neutrality’ is critical

March 12, 2020 12:42 PM

Technology for MSMEs: Apart from larger volumes of trading activity and better price discovery, there would also be benefits arising from innovation in product offerings of online marketplaces resulting from competition among vendors.

Marketplaces are best understood by looking at stock exchanges, as an example.
  • By Suma Damodaran

Technology for MSMEs: Thanks to the huge investments by players like Amazon, revolts and protests by restaurants against food delivery apps, and the really deep discounts on offer across categories, online marketplaces for goods continue to remain in focus and grab headlines. It is obvious that when there is a disruption of this scale not everyone is going to emerge as a winner. There will be players who prosper and there will be others who bleed, and maybe die. It is also obvious that in the desperate melee to gain pole position, the fight will be aggressive and might not always be seen as being free and fair by all concerned. So, the questions to be asked are first, prima facie, will the economy as a whole benefit? and second, will the aggressive competition run the risk of causing harm that outweighs benefits?

Online Marketplaces vs Stock Exchanges

Stripped of all complexities marketplaces are just physical spaces (almost predominantly so in the earlier days) or (increasingly) electronic platforms that aggregate demand and supply. Marketplaces are best understood by looking at stock exchanges, as an example. Modern stock exchanges are electronic market places that allow a large number of members to buy or sell units of identical assets (say SBI shares). This unfettered meeting of large numbers of buyers and sellers results in throwing up – or ‘discovering’- of equilibrium prices. The stock exchange itself does not enter the arena as a trading party. Instead, it makes its money by charging fees from members for access to the marketplace. It also ends up being the owner of a valuable by-product of the trading activity: the trading data.

In a market place such as this, the rules that govern the routing of an incoming order to one of the members becomes all-important. For example suppose a new order to buy an SBI share arrives at the marketplace, to whom should this order be routed? A fair system would be to route it to the trader willing to sell at the lowest price. This is what most exchanges do: they follow a ‘price-priority’. But what if, at the lowest price, there are two traders willing to sell at the same price? A ‘fair’ system might be to route it to the trader whose order arrived first. That is what most exchanges do: they follow a ‘price-time’ priority. But then, marketplaces could potentially also use other routing rules (other than time) to break the tie on prices: for example the ‘status’ of the traders; the quantities that they are willing to trade, and so on.

The primary difference between online goods marketplaces and stock exchanges is that unlike the shares traded on stock exchanges, the goods being traded on online marketplaces are not super-standardized. And this difference makes (almost) all the difference! Since the goods traded are not standardized (for example, it could be a dinner set), the price cannot be the sole determinant for routing orders. For example, now, the routing of a buy order for a dinner set to a particular seller-vendor cannot easily be challenged; because there could be myriad other features other than price that can form the basis for the routing.

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Playing Favourites

The problem is that the goods marketplace can now potentially play favourites by deciding which seller to route an incoming order to by putting a preferred seller in the precious ‘buy’ tab on an online marketplace or by many other means. The problem becomes serious because unlike stock exchanges, many of these marketplaces are themselves, players, in the marketplace. They could be one of the vendors on its own platform, competing with other vendors for order fulfilment! The online goods marketplace can potentially route orders preferentially to its own ‘labels’.

Moreover, online goods marketplaces are not tightly regulated like stock exchanges. While the contracts between the members of a stock exchange and its trading members are standardized and transparent, the rules by which orders are routed to ‘preferred’ sellers by online goods marketplaces need not be made transparent. Plus, the contracts entered into by the online goods marketplace with various vendors can be different from each other. This lack of transparency means that the marketplaces could be routing orders preferentially to its own labels, and doing so surreptitiously.

The story does not end here. Remember the precious by-product of trading that both stock exchanges and online goods marketplaces come to own — the trading data? The data that an online goods marketplace owns is far more valuable than the trading data that stock exchanges own because of the insights into consumer behaviour that it can provide. These insights are far less valuable when the traded product is a standardized, one like equity shares. And because the online goods marketplace is also often itself a player, it can use the access to this valuable data to gain a competitive advantage over the other vendors.

Are marketplaces bad?

Does this mean that the mushrooming of online goods marketplaces are decidedly bad for an economy? Obviously not. On the contrary, prima facie, wider access for buyers and sellers to a marketplace increases trading activity and facilitates efficient price discovery. The exponential increases in trading volumes on stock exchanges across the world after digitization afforded easier access to traders bears witness to this. In the case of online goods marketplaces, apart from larger volumes of trading activity and better price discovery, there would also be benefits arising from innovation in product offerings resulting from competition among vendors. And if some of the investments are of a developmental nature and help small businesses to digitize and offer their goods on the online marketplace it would provide a huge fillip to the economy.

But then, the dangers also are very real. And therefore it is important that the data that is co-created by all players on the marketplace is not used by the owner of the marketplace against the very same players who have helped create it. Ensuring “platform neutrality” is important. The conflict arising from the dual role played by the platform as an owner of the marketplace and as a competitor in the very same marketplace was in fact highlighted by a study by the Competition Commission of India (2020).

Suma Damodaran is the Economics Faculty at IIM Udaipur. Views expressed are the author’s own.

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