Desperately seeking liquidity

Roberta Kowalishin, vice-president of technology ventures at chemical exchange, explains why "liquidity" has become...

Roberta Kowalishin, vice-president of technology ventures at chemical exchange, explains why "liquidity" has become the hottest issue in electronic marketplaces

B2B markets often claim that they have the most "liquidity" by trumpeting the number of members, or volume of transactions. Transactions and members, however, do not measure liquidity - one of the most misused terms in marketplaces today. A market is only liquid to the extent that a buyer can easily find and transact with a seller willing to take the other side of a transaction or vice versa.

The single largest issue in B2B markets today is how to get enough liquidity so that when buyers and sellers come to a marketplace, they find what they are looking for and can complete a transaction. B2B marketplaces that don't find the secret to building liquidity quickly won't survive - and those that do have already made a respectable start to the complex "chicken and egg" issue of building liquidity. Successful B2B liquidity building has five principles:

  • Domain expertise is essential in understanding customers, processes and transactions today and helping move them online
  • Creative incentives are needed to lure halfhearted traders into the marketplace
  • A human "swat" team needs to monitor activity and provide personal real-time service while the market is running
  • Products need to be described and launched in a thoughtful, orderly way
  • Technology must provide a simple, satisfying experience.

    You can't set up a chemical exchange without knowing something about chemicals or having a relationship with at least some of the major manufacturers, buyers, traders, distributors, speculators or resellers of chemicals.

    Understanding the dynamics of the industry will determine whether to recruit buyers or sellers first. Focusing first on the group and processes with most pain means understanding the industry well enough to know the pressure points. Domain expertise is the reason that identified lack of price transparency and the ability to manage risk as pressure points in the bulk chemical market.

    Back in the early 20th century, the Chicago Board of Trade used creative incentives, like a daily free lunch of cheese, crackers and ale, to lure traders when "weeks could go by without a single transaction taking place".

    Today, large companies recognise their power and know that the liquidity they bring to marketplaces is very valuable, often requesting equity in return for their liquidity. This means it is now essential to develop a plan for rewarding selected marketplace participants with private incentives like equity, aggressive early pricing, or volume discounts.

    In the early B2B days, equity was given freely, often not even tied to liquidity metrics. The right incentives today need to target selected companies and be tied to achievable transaction-based metrics so that both the marketplace and the participant share in value creation.

    Real-time human "swat" teams are another essential ingredient. Human relationships are needed to build liquidity, particularly in markets whose participants are used to transacting this way. The liquidity swat team qualifies members and knows their trading preferences personally. Throughout the day, the swat team monitors activity and fair trading practices and its members regularly make phone calls, or provide in-person training. Above all, the swat team has first hand knowledge of how the most active participants - the early adopters - are using the tools and provides frequent input to product development teams.

    Helping buyers and sellers find what they are looking for is a complex, underrated problem for many marketplaces. Without standard classifications or product specifications, a marketplace becomes a bulletin board, where similar products can be entered freeform, making search and comparison almost impossible.

    Experience suggests that it is best to define and deliver on liquidity for a small number of products first before broadening the set of products and services offered. A marketplace needs to present a clear message for the industry about the liquidity today and strategy for the future, so that expectations are met when buyers and sellers enter the market.

    Finally, a fatal error for B2B marketplaces is implementing elegant, sophisticated technology tools that can create highly-engineered, theoretically pure market designs that are well beyond current industry practices. For highlytraded products, a central liquidity pool will form to create some kind of electronic exchange. For less liquid products, other types of systems that allow attribute matching, "crossing" or auction formats are needed. In any case, simple processes and uncluttered interfaces are best. As the sophistication of participants grows, so can the technology.

    Liquidity equals domain expertise plus technology, where domain expertise includes creating the right incentives, human swat teams and product definitions for the market.

    Companies that are developing e-services like logistics, credit and payments would be well-advised to partner with marketplaces that understand and are delivering liquidity - because without liquidity, nothing else in the marketplace matters, including worrying about which e-services to offer and how to integrate into a company's back office.

  • Read more on IT risk management