E-Commerce market model: Intermediation as a value creator, but very different from banks

Banking is a good example where intermediation between savers of capital and those who require it creates enormous value. This intermediation works in both vertical channels and horizontal channels. It is the vertical channel where they are closer to E-Commerce platforms, but I will come to this later.

The commercial banks do not own the capital they help to transfer, but they are the biggest creators of capital. With financial innovation this has become far too complex and appears to have masked the risks it actually carries, but banks have a way to work around risks and there are Basel norms from the Bank of International Settlements that have to be complied with as well.

The market model of E-Commerce or the platform model is a distant proxy of the same intermediation between buyers and sellers. These platforms do not own the products they help to exchange between buyers and sellers. For some service platforms they have no remote linkage with the service that actually attracts people to it, the examples could be taken from hotels and restaurants to taxi service or from Lawyers and doctors prescribing for the clients of all kinds.

The power of the commercial banks have grown without owning capital; from the smallest saver to the biggest corporation, the money seamlessly flows and no one has any way of understanding how this connection physically happened as money is indistinguishable.

E-Commerce platforms differ from the banking example in this as products are distinguishable and the value it creates stems from creating the segmentation not merely from making the flow happen. The power of E-Commerce platforms stem from finding those connections between buyers and sellers which otherwise could not have happened without incurring a sizeable transaction cost.

To put it in the language of Economists, E-Commerce platforms actually create value by minimizing transaction costs further by replacing the existing models in firm supply chains. Ronald Coase (Nobel Prize in 1991) made us aware of the reason why firms exist, which is to minimize transaction costs, otherwise without them buying and selling would have become so expensive that there would have been no social value.

E-Commerce platforms make additional sales to happen in the first place, they make allowance for a very remote buyer to get connected to a seller or they make it possible for attention to be drawn towards goods or service which otherwise would not have happened.

Imagine buying a simple book that is getting published somewhere in the world today. Twenty years back, if you were in Timbuktu and the book was coming up in New York, you would not have known the existence of such a book in the first place. Today you could be the first buyer of that newly published book thanks to E-Commerce.

The banking example differs with E-Commerce in many different ways although both could be engaged in intermediation and transaction cost minimization.

The difference comes from the power that buyers and sellers impose on the platforms against the power that banks can impose on the debtors and creditors. The power of the platforms are driven by the number of clients it could attract to the platform but also it is driven by the number of platforms there exists. The asymmetries in power we see in platforms stem from the presence of too few platforms and the speed of acquisition of clients.

The platforms we see in E-Commerce who are household names already, are too few and they have progressed this far because their progress have been too fast due to the advancement of technology and the ability of these technologies to make the progress happen. Their models have been supremely scalable that proliferated geographies and boundaries of all kinds. They envisaged local problems too early and had a way to get around these problems well before they could cascade into bigger events.

Banks, whatever they are, are not monopolies. There is enough regulation to make that happen.

E-Commerce platforms are already monopolistic (not taken in the negative sense of the term, just by sheer market share); at least the biggest players in their operating spaces are all monopolies if we go by their market share. Regulations to regulate E-Commerce platforms have not progressed much as competition itself is so weak against these platforms.

So we see a huge difference in the banking industry where regulation has progressed for the simple oversight to see that banks could not end as monopolies. Whereas in E-Commerce platforms we see the exact opposite, they are monopolies to start with before regulation is even conceived of.

Banks have two types of intermediation, one chain is vertical, which directly channelize funds from savers and buyers and provide a very efficient retail banking service as pointed out by John Kay today in Financial Times. The E-Commerce platforms do exactly that.

There is the second kind of intermediation that banks do, which is horizontal intermediation, where a series of players start to trade with each other as intermediaries. We have seen this channel in the last financial crisis, when horizontal intermediation created a plethora of bank products from CDS to the more esoteric items that finally ended increasing risks for all the intermediaries in the horizontal channel.

Horizontal intermediation is the root of the all the problems in the actual retail sector, where traders starting from the distributor, wholesaler and retailer all trade with each other and partially destroy value between the original seller and buyer.

The E-Commerce platforms eliminate such horizontal intermediation. That is where they excel. Retail channels are yet to figure out a way to get around this problem and supply chain designs are woefully inadequate to create economies in a model where horizontal intermediation is eliminated.