We all have at sometime or other visited a famous online auction site called e-bay. The site very successfully uses an Online Auction business model. In an Online Auction business model the respondents bid for the product through on the internet. The entire bidding process is regulated by software that is called the auctioning software. It controls all the business processes involved in the auctioning.
There are two kinds of auctioning models. One is called the Dutch auction model while the other is English Auction model. In English business model, the bidders start bidding for a product or service with the lowest price, later on the bid goes up as more bidders join in. The methodology of a Dutch auction is a bit different, in this edition of the online auction, many identical items are auctioned at the same time, with all the bidders bidding simultaneously, the highest bid is the winning bid and the entire winning bidders end up paying the highest price. The products are sold at the highest price. These days all online auctions utilize English auction methods.
The strengths of this business model are presented as follows:
No problem of time constraints. All bids can be placed 24 hours a day, seven days a week. It gives the purchasers enough time for searching for information, deciding and then bidding. An increase in the number of potential bidders is noticed due to this convenience.
No geographical restriction. Bidders and sellers can auction or bid on items from anywhere across the globe through internet access. This increases the reach of the provider and also reduces the cost of auctions. The management and transportation cost is also reduced as there is no need to ship the items to any central location.
Good response due to extra advantage of social interaction. It increases lot of interest as well as enthusiasm in the bidders while they wait for the results and hope to win the bid.
Large numbers of bidders. A large number of bidders are attracted due to the very low price.
Large numbers of sellers. The clubbed advantage of larger numbers of bidders and low operational cost there are larger numbers of sellers auctioning on the site.
Network economies. Cascading effects of increased buyers due to increased sellers and vice-versa make this model highly economically efficient.
Online auctioning business has attracted a lot of people into this domain ranging from laid off workers to old people and ladies so this model is successful in providing employment to people who cannot find mainstream employment.
Network effect or externality can be described as an effect that a single user has regarding the value of the service or product to the other users. This can be very easily understood by applying its concept in the telephone network.
The network effect may have a negative externality or positive externality. For example the telephone network initially increases the value of network but as the number of subscribers increase, the externality tends to get negative as each user then begins to add on the congestion and as a result a network becomes less useful to other users leading to more hang –ups and busy tones.
The founder of Ethernet, Robert Metcalfe used the bandwagon effect of network model to popularize Ethernet and argued that the cost of each network card is equal to the number of users of Ethernet card but the value of network created by network card is equal to the square of the users of the Ethernet.
The proponents of this model use this effect to initially establish a business by propagating the value of the product and once the users of the product reach a stage referred to as critical mass i.e. when the benefit of the network of the product supersede the benefit of product, the product begins to be marketed by virtue of the strength of the network.
The key challenge here is to attract the users before reaching critical mass. A way to do this is to begin with fee –waiver, friend subscription, free sign up. However more prudent thing would be to build a product which is good enough to stand on its intrinsic value. For example the inventor of Del.icio.us, Joshua Schachter built it in such a way that even if no more users joined, it would be valuable still, at least to him.
Business examples of such a model can be found in following establishments
a) Foreign Exchange: Stock exchange feature network effect. Market liquidity is determined on the basis of number of people purchasing a particular stock and as the headcount increases the liquidity increases and transactional cost decreases.
b) Websites: Many websites feature network effect .Social networking sites like MySpace and Orkut thrive on the strength of positive network externality.
Negative externalities begin to become perceptible after a point of time when the cost and ease of maintaining the network and its efficiency overshoot the positives of benign network spread. These situations result in network fall-out as the users begin to wean away from the product due to dissatisfaction from the service.
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