Decision Support Systems 47 (2009) 105114

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Decision Support Systems

j o u r n a l h o m e p a g e : w w w. e l s ev i e r. c o m / l o c a t e / d s s

The sustainability of B2B e-marketplaces: Ownership structure, market competition,

and prior buyerseller connections
Kexin Zhao a, Mu Xia b,, Michael J. Shaw b, Chandrasekar Subramaniam a
a
Department of Business Information Systems and Operations Management, Belk College of Business, University of North Carolina at Charlotte, 9201 University City Boulevard, Charlotte,
NC 28223, USA
b
Department of Business Administration, College of Business, University of Illinois at UrbanaChampaign, 350 Wohlers Hall, MC-706, Champaign, IL 61820, USA

a r t i c l e

i n f o

Article history:
Received 12 May 2008
Received in revised form 24 October 2008
Accepted 27 January 2009
Available online 5 February 2009
Keywords:
B2B e-marketplaces sustainability
Ownership structure
Market competition

a b s t r a c t
B2B e-marketplaces alter the structure of buyerseller trading networks. To study the network-level
structural changes caused by the emergence of e-marketplaces, we develop a multiple-player noncooperative
game, where rational rms select optimal interrm connections and the network is endogenously formed
and evolved. We examine the conditions under which both neutral and biased B2B e-markets will sustain,
when previous buyerseller connections exist. We test our model in both the oligopoly market and the
oligopsony market. Our analysis explains how ownership structures and market competition interact with
each other to affect e-market sustainability. We also identify other critical factors for sustainable e-markets
and their social welfare implications.
2009 Elsevier B.V. All rights reserved.

1. Introduction
B2B e-marketplaces match buyers and sellers with automated
transactions, lower search costs, and increased process effectiveness
and efciency [5,6,18]. The emergence of such e-marketplaces represents one of the major market transformations brought about by the
proliferation of information technologies [14,24]. However, despite
rms' enthusiasm in Internet-based B2B e-marketplaces, the growth of
B2B transactions has fallen short of earlier expectations [10]. Most
notably, the shakeout of B2B e-markets1 during the late 1990s and early
2000s has spurred skepticism about the earlier high expectations about
the role of these e-markets. A large number of B2B e-markets, such as
Chemdex and Adauction, went out of business, while others, including
e-Steel and Covisint, changed their business model from e-market
operators to technology service providers. Nevertheless, there are still
hundreds of B2B e-markets, such as World Wide Retail Exchange and
SciQuest, that have survived and thrived [22]. It is thus intriguing why
some e-marketplaces have survived while others have failed and what
key factors lead to a sustainable e-marketplace.
In this paper, we try to answer the question by focusing on the
structural dimension of e-markets [12], which refers to the overall
pattern of connections between rms. The structural perspective
provides us insights into network stability, when individual rms
strategically establish interrm links. The resulting network and the
rms' relative positions in the network determine their bargaining
Corresponding author. Tel.: +1 704 687 7637 (K. Zhao), +1 217 333 2878 (M. Xia),
+1 217 333 5159 (M.J. Shaw), +1 704 687 7604 (C. Subramaniam).
E-mail addresses: kzhao2@uncc.edu (K. Zhao), mxia@uiuc.edu (M. Xia),
mjshaw@uiuc.edu (M.J. Shaw), csubrama@uncc.edu (C. Subramaniam).
1
In this paper, we use the terms e-marketplaces and e-markets interchangeably.
0167-9236/$ see front matter 2009 Elsevier B.V. All rights reserved.
doi:10.1016/j.dss.2009.01.005

power and performance. When equilibrium is reached, both participating rms and the market operator are willing to keep their existing
connections. This implies the emergence of a sustainable B2B emarket. Otherwise, the e-market will fall apart and evolve into other
business models or exit the market.
We develop a multiple-player non-cooperative game to simulate
the endogenous formation of public B2B e-marketplaces (many-tomany connections). In the model, we describe the overall network
structure as a graph, in which rational and self-interested rms are
nodes and their business relationships are the edges between
corresponding nodes. Buyers and sellers select individual connections
in the game, and their payoffs are determined by the overall network
structure and their relative positions in the network. We focus on
three major factors that affect the endogenous formation of B2B emarkets (Table 1). The rst factor is the ownership structure of the emarket. An e-market can be either neutral or biased [30]. A neutral emarketplace, such as EC21 and Alibaba, is owned by an independent
intermediary, while a biased one is operated by a group of buyers (e.g.,
World Wide Retailer) or sellers (e.g., iSteelAsia) [30]. For the biased
type, we focus on buyer-biased e-marketplaces and then show that
seller-biased e-marketplaces demonstrate similar properties.2 Since
previous studies suggest that neutral and biased e-markets have
difference properties [30], we also examine whether the ownership
structure will affect e-market sustainability. The second factor is the
type of market competition faced by both participating rms and the
market operator. An e-market can be established in either an oligopoly
market or an oligopsony market. In an oligopoly market, there are
2
Yoo et al. [30] also nd that biased marketplaces, no matter whether buyer-biased
or seller-biased ones, have similar economic properties.

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Table 1
The endogenous formation of B2B e-marketplaces.

K. Zhao et al. / Decision Support Systems 47 (2009) 105114

K. Zhao et al. / Decision Support Systems 47 (2009) 105114

107

more buyers than sellers and buyers face more intensive competition.
Examples include natural resource markets and major distributors,
such as Ingram Micro, who transact with a large number of resellers/
buyers. In the oligopsony market, there are fewer buyers than sellers.
Contrary to the oligopoly market, buyers have a major advantage over
sellers in the oligopsony market. For example, the market in which
major retailers, such as Wal-Mart and Target, deal with a large number
of suppliers can be characterized as an oligopsony market. Will market
competition affect the equilibrium of e-markets, since buyers and
sellers have different bargaining powers in an oligopoly market
compared to an oligopsony market? Prior theoretical work is limited
in this area. The third factor is the impact of preexisting buyerseller
connections prior to the emergence of e-markets, as rms often have
direct exchanges for doing business in the absence of e-marketplaces.
For example, the defense contractor Raytheon had used in-house
developed tools to connect with its own suppliers before it joined
Exostar, an e-market cofounded with other large manufacturers in the
aerospace and defense industry [31]. A B2B e-marketplace can either
bring prior disconnected rms together or substitute previously
existing direct buyerseller connections. To the best of our knowledge,
this is one of the rst papers to investigate the process of how B2B emarkets supersede direct buyerseller networks.
Our analysis yields several insights on the sustainability as well as
social welfare impacts of B2B e-marketplaces. First, it demonstrates the
interactions between market competition and ownership structures of
e-markets. The emergence of a neutral e-market does not change
market competition, and the sustainability conditions are the same in
either the oligopoly market or the oligopsony market. By contrast, the
emergence of a biased e-market changes market competition by leading
to the formation of a buyer or seller consortium. We nd that a biased emarket formed by the more competitive side is less likely to survive than
one formed by the less competitive side. Second, our analysis underscores the importance of considering prior buyerseller connections,
which determine rms' incentives to join the e-market and the
efciency gains provided by e-markets. Third, sustainable e-marketplaces require low e-market connection costs to attract rms'
participation. Furthermore, the impacts of the number of buyers and
sellers on the e-market sustainability are different depending on the
ownership structure. Lastly, we show that social welfare is improved
with the emergence of a neutral e-marketplace, but the change in social
welfare is ambiguous in the case of biased e-marketplaces.
The rest of our paper is organized as follows. We rst review the
related literature in network economics and B2B e-marketplaces. In
Sections 3 and 4, we present our model and apply it to study direct buyer
seller networks and to establish the pre-e-market equilibrium structures
in both the oligopoly market and the oligopsony market. In Sections 5 and
6, we study the formation of a neutral B2B e-marketplace and a buyerbiased e-marketplace, respectively. We then discuss theoretical contributions, policy implications, and future research opportunities.

investigates how the emergence of e-markets changes its structure. Our

work is related to Kranton and Minehart [21], who introduce a basic
model of buyerseller exchange network. In our paper, we consider a
few additional factors. First, we study the oligopsony market in addition
to the oligopoly market. Second, we explore the dynamic process by
which a direct buyerseller network evolves into a B2B e-marketplace.
While it is agreed that advanced information technologies stimulate
new B2B connections from prior stable network structures, the
transition has yet to be analyzed in the literature.
Prior electronic markets studies also have analyzed the impact of IT
on market transformation by discussing macro trends towards
electronic markets, electronic hierarchies [24], or the move to the
middle hypothesis [9], without examining in a micro context how
rms would change their relationships with their trading partners in a
network. Our work offers a more focused examination of the structures of B2B relationships in an exchange network. While previous
literature has looked at an individual rm's choice among alternative
electronic connections [8,19], we examine structural changes happening at the network level.
There exist extensive studies analyzing the design and implementation of electronic market mechanisms [2,11]. In the present paper,
we assume that a price discovery mechanism has been established;
yet transactions can only be conducted between buyers and sellers
who are connected. Therefore, rms have to, ex ante, determine
optimal linkage patterns in order to maximize their ex postpayoffs
from a bilateral exchange constrained by the network structure.
Yoo et al. [30] study rms' participation in both neutral and biased
B2B e-marketplaces. They nd that biased e-marketplaces bring a
greater surplus to participants than neutral e-markets do. We study
how ownership structures inuence the endogenous formation and
sustainability of B2B e-markets. The difference in our model is that
there are direct and stable buyerseller connections before the
formation of e-markets. Yoo et al.'s model [30] represents a special
case of our model, when an e-market brings previously unconnected
buyers and sellers together.
Kleindorfer and Wu [20] survey contract structures in both B2B
spot markets and long-term markets in capital-intensive industries.
Along the same line of research, Wu and Kleindorfer [29] propose a
game between one buyer and multiple sellers to study integrated
contracting and spot market options. They characterize market
equilibrium conditions and analyze how market structures affect
B2B transactions. We only focus on B2B spot markets, and we nd that
the market competition structure plays a critical role in determining
the stability and efciency of bilateral exchanges.

2. Literature review

3.1. A buyerseller exchange network

Economists have used the game theoretical approach to model

network formation for over a decade [4]. This line of research suggests
that network structures are important in determining the outcomes of
economic and social interactions, such as bilateral product exchanges
and technology adoption [16,27]. Previous studies also identify typical
network structures and their stability conditions under various circumstances [7,21]. In this paper, we consider B2B e-markets as an
exchange network and study their stability conditions based on a
similar approach.
While many studies of network economics focus on an abstract
network in which players are homogenous and anonymous [7], recent
developments have begun to examine networks in more concrete social
or economic settings, such as co-author networks and buyerseller
networks [17,21,28]. Our study focuses on a buyerseller network and

We consider an exchange network between m buyers, Bi, iaM{1,,m},

and n sellers, Sj, jaN{1,,n}. Assume each buyer demands one unit of a
good with a reservation value, vi, and each seller produces one unit of a
good by incurring a production cost, cj.3 The bilateral exchange can occur
in either an oligopoly market or an oligopsony market. In the oligopoly
market, there are more buyers than sellers, i.e., mNn, and market
competition is primarily on the buyer side. For example, large distributors,
such as Ingram Micro in the technology section and iSteelAsia in the steel

3. Model framework
In this section, we introduce our basic model framework and our
assumptions.

3
While the unit demand assumption may seem restrictive, it does represent
industries where sellers are exible specialists [25], who deliver small batches of
goods (considering each batch as an aggregated unit of good) to buyers in each
production cycle. Many industries, such as apparel, electronic components, and
professional services, feature demands of this type [21].

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K. Zhao et al. / Decision Support Systems 47 (2009) 105114

section, sell to a large number of small and medium-sized resellers/

buyers. The oligopsony market has more sellers than buyers, i.e., mbn. For
instance, in the aerospace and defense industry and automotive industry,
the bilateral exchanges happen between several large original equipment
manufacturers (OEMs) and their suppliers. Our analysis reveals that in
both the direct buyerseller networks and the neutral e-markets, the
oligopsony market is only the reverse case of the oligopoly market.
Therefore, we skip the discussion of the oligopsony market in Sections 4
and 5. Instead, we examine the oligopsony market in detail in Section 6 in
the case of a buyer-biased e-market, when the market competition has a
profound impact on the sustainability of B2B e-markets. In the current
section, we focus our model description on the oligopoly case.
We assume that buyers' reservation value, vi, in an oligopoly
market is independently and identically distributed on a uniform
distribution between 0 and 1. The actual realization of vi is only known
to
to the buyer Bi himself. Sellers' production cost, cj
, is also assumed

m n 4
with the
be independently and identically distributed on 0; m
+ 1
commonly known uniform distribution. Again, only seller Sj privately
knows his own production cost cj.
3.2. Bilateral exchange constrained by the network connection
Our model's distinct feature is that a linkage is required for two
parties to trade. That is, the bilateral exchange can only occur between
buyers and sellers that are linked via either a direct, one-to-one,
buyer-seller connection, or through an e-market. Such a link, or a
business relationship, can be broadly dened as anything that facilitates the bilateral exchange [21,28]. The link reects the constraint
that rms need to locate potential trading partners and establish
certain connections before they can conduct business transactions
[13,19]. For example, to purchase from its suppliers, Raytheon either
needs to initiate one-to-one connections by itself or go to the emarket, Exostar, to get in touch with the participating network of
suppliers. Only after a connection is established can the physical exchange of goods or services occur. We use a graph, G, to represent rms
and their connections. Firms within the network are nodes and their
business relationships are undirected links, g, in between. If gBi Sj = 1,
there is an established connection between buyer Bi and seller Sj, and
the future exchange of the good between them is feasible. Otherwise, if
gBi Sj = 0, buyer Bi cannot obtain the good from seller Sj. The connection is
undirected in G, that is gBi Sj = gSj Bi.
We use the generalization of a second price auction to represent the
competition for goods. The auction model is similar to a Walrasian
auction and can be used to describe typical competition between
multiple, interconnected buyers and sellers. The second price auction is
a commonly used auction model and has several desirable economic
features. First, second price auction induces truthful bidding from
bidders [15]. Second, rms have the right incentives to build connections
as the prices themselves reect the social opportunity costs of
exchange [21, pp. 490]. Third, the auction enables an efcient allocation
of goods, where buyers with highest valuation will obtain the goods in
the oligopoly markets. The efcient allocation leads to the highest total
payoffs, or social welfare, from the exchange. The efcient structure
serves as a benchmark case, in which it is most difcult for e-markets to
stabilize and sustain. The reason is that if the pre-e-market structure has
already been efcient, the emergence of e-markets can only reduce
connection costs without enhancing trade efciency.
In the oligopoly market, sellers hold simultaneous ascending price
auctions with the going price being the same across all sellers. The prices
rise until enough buyers drop out for the demand to match supply, and
4 m n
m + 1 is the market clearing price, where the second price auction determines the
exchange between the entire set of m buyers and n sellers. By assuming the sellers'
production costs to be lower than the market clearing price, we ensure that all n units
of goods will be sold. Otherwise, if some of the sellers' costs are higher than the market
clearing price, they cannot sell. The situation is then analogous to the case in which
less than n sellers participate in the exchange.

all competing buyers pay the same price. Overall, the auction
mechanism and the network structure jointly determine the nal
transactions between buyers and sellers. Due to the connection
constraint for trade, the model is fundamentally different from a
traditional second price auction. The bilateral exchange constrained by
the network connections also exhibits double-sided network effects
[30]. A buyer enjoys positive network effects as more sellers establish
connections with it. Meanwhile, the buyer faces negative network
effects as more buyers establish relationships with its linked seller set.
3.3. Network equilibrium: pairwise stability
We use the concept of pairwise stability to dene network equilibrium [16,17]. Pairwise stability reects the fact that a relationship in
an exchange network must be mutually benecial, since linkage
formation inherently requires that not only must a rm be desirous of
forming a linkage, it should also be attractive to potential partners [1,
pp.317]. Thus, mutual consent is necessary for establishing a connection between a pair of partners (e.g., both Raytheon and its suppliers), but severing a link needs only a unilateral decision from either
party involved (e.g., either Raytheon or its suppliers).
We use the value function, f (G), to denote the expected payoffs of
any rm f in the network G. f ' represents any other rm in the network G. Pairwise stability requires that links in the equilibrium network G satisfy:




For all gff 0 aG; f G z f G gff 0 and f 0 G z f 0 G gff 0 : 1




For all gff 0 gG; if f Gb f G + gff 0 then f 0 G N f 0 G + gff 0 ;
and vice versa:

Condition (1) means that for a link to be in the equilibrium

network, it has to be benecial for rms at both ends of the link to
maintain the connection when the network G reaches pairwise
stability. Condition (2) requires that if one rm wants to add an
additional link to an equilibrium network, its target partner will reject
the request since its payoff will be worse. These two conditions
indicate that any link, g, which belongs to a stable or sustainable
exchange network, should be mutually benecial. Otherwise, any one
of the rms can discontinue the link unilaterally.
3.4. Two-stage game
We use a two-stage game to model the formation and transition of
exchange networks. In Stage 1, rms simultaneously choose their
potential customers by establishing links within the exchange
network. Each rm only knows the distribution of its valuations or
costs. Firms have an incentive to connect to multiple trading partners
in order to have more trading opportunities and to keep a strong
bargaining position in competition for goods. Only those links that
benet rms on both ends will be established. After the rst stage, the
resulting network structure is observable to all rms. Stage 2 is the
trading stage, in which rms know their private information and
compete with each other in the auction constrained by the network
structure. The two-stage assumption reects the fact that rms need
to be connected with their partners before they can trade, as well as
the often rapidly changing market conditions, such as style preferences and technology developments, which lead to the uncertainty of
buyers' valuations and sellers' production costs.
4. Direct buyerseller networks: the pre-e-market structure
We rst study the pre-e-market structure, where buyers and
sellers exchange goods via direct network connections. Later, we will
show that the emergence of B2B e-markets not only alters individual

K. Zhao et al. / Decision Support Systems 47 (2009) 105114

buyerseller connections but also changes the overall network structure [26]. In this paper, we will not discuss the case in which e-markets
supersede physical markets and the network structures remain the
same before and after the formation of e-markets (see Bakos [7] for an
excellent discussion about this case).
In direct buyerseller networks, the link costs include, but are not
limited to, search costs to locate potential trading partners, negotiation
costs to exchange information and establish business procedures, and
setup costs to link two internal information systems. We distinguish the
link costs between buyers and sellers, as they incur different activities in
general, but assume all buyers have the same cost, and so do the sellers.
That is, it costs a buyer lB(KBi) to establish and maintain direct buyer
seller links, while it costs a seller lS(kSj) to build and keep such connections. kBi/Sj represents the number of link the buyer Bi/Seller Sj has.
l(0) = 0, l(k) N 0, l(k) 0, indicating that rms incur either a linear or a
concave link costs. In the case where rms could benet from economies
of scale, they will face lower marginal cost as the number of links
increases. For example, it may become easier for a rm to establish an
interorganizational system with a new trading partner if it has used
similar systems before with existing business partners.
Specically, the network formation process is modeled in the
following two-stage game:
Stage 1: Buyers and sellers simultaneously determine whether to
maintain a link with one another. A link is established only
when both the buyer and the seller want to connect with
the other party. All can observe the consequent network G.
Stage 2: Firms' private information is revealed; then they compete in
the second price auction restricted by the structure of the
network G.
Under different ranges of link costs, multiple equilibrium network
structures exist. Here, we focus on least link complete (LAC) networks
[21], dened in the next paragraph, and use it as a benchmark case for
all pre-e-market structures. If the pre-e-market structure is a LAC
network and thus already enables efcient good allocation, it is most
difcult for e-markets to emerge since e-markets can only reduce
network connection costs without increasing the efciency of good
exchanges. If pre-e-market structures are not efcient, the formation
of B2B e-markets not only changes network structures, but can also
enhance exchange efciency. A special type of the pre-e-market structure is a null network with previously unconnected buyers and sellers,
when direct buyerseller links are prohibitively expensive due to
causes such as geographical dispersion. For instance, it is difcult for
many small Chinese suppliers to meet global buyers without the help
of global B2B e-markets, such as EC21 or Alibaba. In this case, rms'
pre-e-market payoffs are zero, and B2B e-markets are more likely to
emerge. We focus on the analysis of LAC networks without loss of
generality.5
In the oligopoly market, n goods will be sold when the market is
fully cleared. An exchange network is allocatively complete (AC) if and
only if, for every subset of n buyers, there is a feasible allocation in
which every buyer in that subset can purchase successfully. Therefore,
for any realization of buyers' private valuation, the n buyers who have
the highest valuation in AC networks can all obtain products from the
constrained auction game. Obviously, when all buyers and sellers are
connected with each other, the network is AC. An LAC network is an AC
with a minimal number of links, which we regard as an efcient
network since the connection in the network is costly. If the most
efcient networks can move to a market, it will be easier for the less
efcient ones to change as well.

5
We can extend our analysis to other pairwise stable structures of direct buyerseller networks. Firms' pre-e-market payoffs will be different, and the sustainability
conditions of e-markets will change accordingly. However, the properties of network
transition processes still hold.

109

Fig. 1. A LAC network with 5 buyers and 3 sellers.

The structures of LAC networks share several characteristics [21].

Based on the Marriage Theorem, a network is AC if and only if every
subset of buyers is connected with at least sellers, 1 n. As a
result, in LAC networks, each seller is linked to exactly m n + 1
buyers and each buyer has anywhere from 1 to n links in the oligopoly
market (see [21] for the detailed proof). Buyers are in heterogeneous
positions (i.e., their number of connections or bargaining positions are
different from one another) due to demand side competition. Fig. 1
gives an example of LAC networks.6 We explore the LAC network
characteristics in the following discussion.
Proposition 1 provides the condition under which the only efcient
direct buyerseller network, an LAC network, is stable as rms strategically select links in the endogenous network formation process.
Later, we use properties to discuss important ndings that can be
directly derived from the main propositions.
Proposition 1. (Equilibrium of LAC networks in the oligopoly market):
and 0 V flS m n + 1
When lB and lS satisfy 0 V lB 1 V  m  1
n

lS m ng V  m  1
n

m + 1

m + 1

, LAC networks are the unique stable direct

buyerseller exchange network.

Proof. LAC networks ensure that the network structures are efcient
and any additional link is redundant. Therefore, we only need to show
that removing any link from LAC networks is not feasible given the
conditions shown in Proposition 1.
Let Xh:m denote the random variable that is hth highest valuation
among m buyers', whose valuations are drawn
a [0,1] uniform
 from

distribution. The expected value of Xh:m is E X h:m = m m+ +1 1 h. Since
LAC networks are efcient, for any realization of (v1,vh,vm), sellers
can sell goods to buyers with highest valuations. Thus, the expected
m n
market clearing price in a second price auction is E X n + 1:m = m
+ 1.
For a LAC network in the oligopoly market, each seller has m n + 1
links, while each buyer has from 1 to n links. We dene H(B) as the set
of n buyers with the highest reservation value, which are X1:m, X2:m,
Xn:m. Suppose we remove a link gij between buyer Bi and seller Sj.
Seller Sj is no longer able to sell a good to H(B). It implies that the other
m n buyers connected
with seller Sj happen to be the set B / H(B),
 
1
. After removing the link gij, buyer Bi has
and the probability is mn
to pay at least EX n:m = m m+ +1 1 n and seller Sj can at most sell at


n 1
E X n + 2:m = m m
+ 1 . Consequently, both buyer Bi and seller Sj expect

m 1
if the link gij is severed.
n  1
1
If a buyer's links cost lR(1) is lower than mn
m + 1 and a seller's link
 1
1
cost difference {lS(mn+1)lS(mn)} is lower than mn
m + 1,

1
to lose at least m +
1 with the probability

then both the buyer and seller are willing to add the link. Therefore,
removing any link from LAC networks is not feasible given the
condition in Proposition 1.

Please note that the layouts of LAC networks are not unique.

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K. Zhao et al. / Decision Support Systems 47 (2009) 105114

Property 1a. LAC networks are less likely to sustain in the oligopoly
market as the number of buyers increases.
Based on Proposition 1, we nd that if the number of buyers
increases, the link costs have to be smaller for LAC networks to reach
equilibrium. When there are more buyers in the exchange network,
the competition for goods becomes more intensive and rms expect
less marginal gain from any additional network connection. Consequently, rms have less incentive to keep multiple links, and it is more
difcult for LAC networks to reach equilibrium. In other words, as the
buyer side becomes more fragmented, the resulting stable direct
buyerseller networks are less likely to be efcient.
nn + 1
2mm + 1

Property 1b. In LAC networks, buyers' expected payoff is

X

lB kBi kBi a1; :::; n; and
kBi = nm n + 1 , sellers' expected

iaM

n + 1, and the expected social welfare is

payoff is 2mm + n1 lS mX

n
lB kBi .
2 nlS m n + 1
iaM
m n
mi+ 1.

Proof. In LAC networks, the expected market clearing price

h is
Since each seller has mn + 1 links in LAC networks, ELAC Sj G =
m n
m + 1

2mm + n1 lS m n + 1 =

m n
2m + 1

lS m n + 1.

The number of buyers' links range from 1 to n. For buyer Bi with kBi
links,
h
i
ELAC Bi G







 
 n:m
1
mn
mn
mn
1:m
2:m
E X
+ E X
+ ::: + E X
lB kBi

=
:

m
m+1
m+1
m+1


 
 
1
n
n1
1
nn + 1
+
+ ::: +
lB kBi =
lB kBi :
=
m m+1
m+1
m+1
2mm + 1

Social welfare is the sum of rms' individual payoffs in the network. In our paper, we use W to indicate social welfare. The expected
social welfare in the LAC network is:
h
i
h
i
X
X  
n
nlS m n + 1
ELAC W = nELAC Sj G +
ELAC Bi G =
lB kBi :
2
iaM
iaM

As we have discussed before, LAC networks are used as a benchmark for all pre-e-market structures. In the following analysis, we use
LAC networks to represent the equilibrium prior to the emergence of
e-markets.
5. The emergence of a neutral B2B e-market
In direct buyerseller networks, rms have to keep multiple links
in order to maintain a strong bargaining position and achieve efcient
good exchanges. With the entry of a neutral e-market, a large number
of buyers and sellers can be connected to the other side with only a
single link to the intermediary (Fig. 2). Buyers and sellers want to link
to a neutral e-market to save on individual link costs.
Neutral e-markets, such as EC21 (http://www.ec21.com/) and
Texileweb (http://www.textileweb.com), match buyers and sellers
and facilitate information exchange, physical deliveries and payment
between them [7]. To be able to facilitate transactions among multiple
participants, a neutral e-market has to invest I, to build the IT infrastructure and maintain the exchange platform. Its prots come from the
entry fees, eB and eS7, charged to buyers and sellers, respectively. For
instance, EC21 charges $450 for its Trade OK members. Buyers and
sellers incur setup costs, sB and sS, when they adopt e-market connections. Setup costs may include costs to post/check information on emarkets and improvement of internal connectivity to meet the requirement of e-marketplaces. If rms join a neutral e-market, their new
link costs are the sum of the e-market connection costs and the entry fee

7
For the unit demand exchange, the entry fee can also be considered as transactionbased.

Fig. 2. A buyerseller network with a neutral e-market.

paid to the e-market. The network transition triggered by the entry of a

neutral e-market can be described as the following two-stage game,
which is similar to the two-stage game in an exchange network:
Stage 1: A neutral e-marketplace enters a direct buyerseller
network. Buyers and sellers simultaneously determine
whether or not to change to an e-market-centered connection by paying entry fees and incurring e-market
connection costs. The network G is observable to all
participants.
Stage 2: Firms' private information is revealed; and they compete in
the second price auction restricted by the overall linkage
pattern.
We study the complete participation case8, in which buyers and
sellers connect with each other only through a neutral B2B e-market.
At the second trading stage, rms realize their payoffs from the
bilateral exchange facilitated by a neutral intermediary. Using the
backward induction, at the rst stage, rms decide their network
connection channels based on expected payoffs obtained from the
trading stage. When a neutral e-market enters the buyerseller
trading network, it needs to charge fees that motivate both buyers and
sellers to participate. Therefore, the fees should be low enough that
buyers and sellers receive the same payoffs or more compared to those
in direct buyerseller trading network. Proposition 2 presents the
equilibrium conditions under which the efcient direct buyerseller
network (i.e., a LAC network) evolves into a neutral e-market, after a
neutral intermediary enters the exchange network.
Proposition 2. (Sustainability of a neutral e-market in the oligopoly
market): If a neutral e-market charges at fees for buyers and sellers,
when I n{lS(m n + 1) sS} + m(lB(1) sB), it will replace a LAC
network and is sustainable.
Proof. A neutral e-market with complete participation facilitates
efcient
Thus, the market clearing price is

good mallocation.
n
E X n + 1:m = m
+ 1. The number of buyers' links in LAC networks
ranges from 1 to n. If the buyer with only one link in LAC networks has
the incentive to join, all other buyers will choose to switch to e-marketcentered connections too. The marketplace's objective is to maximize its
prot. In order to motivate all buyers and sellers to participate, a neutral
B2B marketplace owner should charge the entry fees eB,, eS, such that:
max meB + neS I
s:t: eB + sB V lB 1
eS + sS V lS m n + 1:
Therefore, eB = lB(1) sB, and eS = lS(m n + 1) sS.
A neutral e-market owner is willing to invest only if meB +neS I 0,
that is I n{lS(m n + 1) sS} +m(lB(1) sB), and all buyers and sellers
are willing to join.

8
For the incomplete participation cases, we can only study individual cases by
specifying idiosyncratic network structures.

K. Zhao et al. / Decision Support Systems 47 (2009) 105114

111

Property 2a. In a neutral e-market, buyers' expected payoff is

nn + 1
m n
2mm + 1 sB eB , sellers' expected payoff is 2m + 1 sS eS ,
the neutral intermediary's expected payoff is n{lS(m n + 1) sS} +
m(lB(1) sB) I, and the expected social welfare is n2 msB nsS I.
In order to compare e-markets with direct buyerseller connections, we keep the same trading mechanism. The emergence of a
neutral e-market changes the overall structure of exchange networks.
By enabling rms to reach a large number of potential trading partners
via a single link, a neutral e-market reduces the link costs to achieve
the efcient good exchange among buyers and sellers.
Property 2b. The lower the e-market connection costs incurred by both
buyers and sellers, the easier it will be for a neutral e-marketplace to
sustain.
This result is straightforward since rms' intent to adopt a new
interorganizational link is directly affected by the associated costs. A
neutral e-market, by enhancing technical functions, simplifying operational procedures, and establishing a trustful exchange environment,
can make the connections worthwhile for both buyers and sellers [7].
Property 2c. The more buyers and sellers in the network, the easier it
will be for a neutral e-market to sustain.
Proposition 2 indicates that the threshold value of I becomes larger
in a network with m + a buyers and n + a sellers than in a network with
m buyers and n sellers, where a is any positive integer. Thus, a neutral
intermediary is more likely to achieve equilibrium or sustainability of
an e-market if there are a large number of potential participants on both
the buyer side and the seller side. Many successful neutral B2B emarketplaces have a sufciently larger number of participants on both
buyer and seller sides [3]. For example, EC21 has more than 1.5 million
buyers and sellers and GHX has over 250 suppliers and over 3600 health
care providers.
Proposition 3. (Underinvestment of the neutral intermediary): The
network evolution caused by the entry of a neutral e-market is socially
benecial. However, the neutral intermediary's feasible investment
level is lower than the level at which it achieves optimal social benets.
Proof. In the oligopoly market, a neutral e-market will join
=
the network if, and only if, its investment cost is lower than IInter
n{lS(m n + 1) sS} + m(lB(1) sB).
At the same time, in order to increase the social welfare, we need
to ensure that the intermediary's investment is less than the reducn
n
tion of overall connection
X  costs: i.e., 2 msB nsS I z 2
lB kBi . We denote the investment level
nlS m n + 1
iaM

under which the entry of a neutral

is socially optimal as:
X e-market


= nflS m n + 1 sS g +
lB kBi msB . Comparing those
ISoc
iaM
X 

IInter
=
lB kBi mlB 1 N 0.

two equations, we nd that ISoc

iaM

The intuition behind the enhanced social welfare with the emergence of a neutral e-market is that it reduces the total number of links
required for efcient good exchange. Buyers and sellers voluntarily
switch to e-market links only if doing so can lead to better payoff.
However, buyers' positions in direct buyerseller networks are asymmetric, since some buyers have fewer links and can save less from
switching to e-market connections. In order to motivate all rms to join,
the independent intermediary has to lower entry fees and share part of
the increased social welfare with less-motivated rms. Consequently,
the neutral intermediary will invest less than the socially optimal level.
In this section, we discussed the conditions under which an efcient direct buyerseller network will migrate to a neutral B2B emarket. We identied factors such as double-sided fragmentation and
low e-market connection costs that lead to the sustainability of a
neutral e-market. Our analysis implies that market competition has no

Fig. 3. An exchange network centered on a buyer-biased e-market.

impact on the emergence of a neutral e-market. Thus it is common to

see neutral e-markets in both the oligopoly market (e.g. GHX) and the
oligopsony market (e.g. EC21). Our analysis can be easily extended to
apply to the oligopsony market case, which shares similar properties
with the oligopoly market case. In the next section, we will study the
network dynamics triggered by a biased e-market. We will show that
market competition has a profound impact on the formation of a
biased e-market.
6. The emergence of a biased B2B e-market
In addition to neutral intermediaries, e-markets can also be
initiated by either the buyer or seller side of the market. For instance,
a group of buyers can aggregate their purchasing power by organizing
a buyer-biased e-market (also called buyer consortium) and charge
entry fees to participating sellers. A seller-biased e-market is the exact
mirror case of a buyer-biased e-market, thus we discuss only the
buyer-biased case in this paper. In a buyer-biased e-market, such as
World Wide Retail Exchange and Endorsia, buyers can increase their
bargaining power with consolidated demand, while sellers can reach a
large number of buyers with only a single connection. As the owners
of the biased e-market, buyers will share the cost, I, to establish and
maintain the trading platform. However, they can benet from
operating the e-market through the enter fee, eS, charged to sellers.
For example, suppliers/manufactures need to pay an annual subscription fee in order to join World Wide Retail Exchange. To switch to
the e-market centered connections, buyers and sellers incur setup
cost, sB and sS. The next two-stage game illustrates the network
transition triggered by the formation of a buyer consortium:
Stage 1: Buyers decide whether to join a biased e-marketplace, and
incur operation costs as well as e-market connection costs.
Sellers determine whether to connect to the biased emarket, and incur e-market connection costs and entry
fees. The network G is observable to all participants.
Stage 2: Firms' private information is revealed, and they conduct
bilateral exchanges restricted by the overall linkage pattern.
Similar to the neutral e-market analysis, we focus on the complete
participation scenario, in which all buyers and sellers join the biased
e-market (Fig. 3). We can extend our analysis to incomplete participation cases with different specic network structures.9
In the oligopoly market, the rms' bargaining power is changed
signicantly after the emergence of a biased e-market. In the prior direct
buyerseller networks, buyers compete with each other to obtain the
goods. In the buyer biased e-market, buyers increase their business
benets from both link costs reduction and additional prots from
increased bargaining power. When all buyers participate in the biased emarket, they are able to gain monopoly power and appropriate to
themselves all sellers' prots. In the oligopoly market, the equilibrium
condition of a buyer biased e-market is shown in Proposition 4.
9
It is more challenging for e-markets to succeed if not all rms in the network join
e-markets in equilibrium. The reason is that buyers' bargaining power cannot increase
as much as in the complete participation scenario, and gains from e-market formation
are lower with fewer participants.

112

K. Zhao et al. / Decision Support Systems 47 (2009) 105114

Proposition 4. (Sustainability of a buyer-biased e-market in the

m n
oligopoly market): When I V n2m
+ 1 nsS + mlB 1 sB , a LAC
network will evolve to a buyer-biased e-market that is pairwise stable
as well as efcient.
Proof. When all buyers join the consortium, sellers have to connect
to the biased e-market as long as their expected payoffs are nonnegative
at the second stage, that is: 2mm + n1 sS eS z 0: Thus, buyers can
charge the entry fees as high as 2mm + n1 sS . Buyers' expected payoff
from forming the biased e-market is:

nn + 1
2mm + 1

n
m eS

I
m

sB . In

order to convince allbuyers to participate

in the consortium, we need to

nn + 1
nn + 1
n
m n
I
have: 2m
m + 1 + m 2m + 1 sS m sB z 2mm + 1 l1. From
m n
which we can obtain the equilibrium condition: I V n2m
+ 1 nsS +

mlB 1 sB .
We can extend our analyses to the oligopsony market, where the
market competition is on the seller side (m b n). In the oligopsony
market, sellers' production costs are assumed to be independently and
identically distributed on [0,1] with the commonly known uniform
distribution. We assume that buyers' reservation value, vi, is independently and identically distributed on a uniform distribution be+ 1 10
tween 1 and mn +
1 . In the oligopsony market, the equilibrium condition
of a buyer biased e-market is shown in Proposition 5.
Proposition 5. (Sustainability of a buyer-biased e-market in the oligopsony market): When I V m2nm ++ 11 nsS + mlB n m + 1 sB ,
a LAC network will evolve to a buyer-biased e-market that is pairwise
stable as well as efcient.
Proof. In the oligopsony market, sellers' expected payoff from the
second trading stage is
h
i
EBiased Sj G





 n:n
1 m+1
m+1
n m + 1:n
=
+ ::: +
E X
E X
sS eS
n
n+1
n+1
=

mm + 1
s S eS :
2nn + 1

With the monopoly power enabled by the biased e-market, buyers

mm + 1
can charge the entry fees as high as 2n
n + 1 sS . In order to convince
all buyers to participate in the consortium, we need to have:
n m
n
I
n m
2n + 1 + m eS m sB z 2n + 1 lB n m + 1. From which
we can obtain the equilibrium condition: I V m2nm ++ 11 nsS +
mlB n m + 1 sB .

Property 3a. It is more challenging to form buyer-biased e-markets in

the oligopoly market than in the oligopsony market.
Market competition has no impact on the formation of neutral emarkets, as e-market sustainability conditions are the same in both
the oligopoly market and the oligopsony market. However, biased emarkets have different economic properties in the oligopoly market
than in the oligopsony market. First, the emergence of biased emarkets changes rms' bargaining power to different levels in two
markets. In the oligopoly market, buyers compete with each other in
direct buyerseller networks and their bargaining positions are
different prior to the formation of biased e-markets. After the
emergence of a buyer-biased e-market, the buyers enjoy monopoly
power by aggregating their purchase power. By contrast, in the
oligopsony market, it is sellers who compete with each other in the
pre-e-market network. Thus, consequent to the formation of buyer10

Similar to the oligopoly market case, we assume that buyers' reservation value is
higher than the market clearing price, where the second price auction determines the
exchange between the entire set of m buyers and n sellers. Thus all m buyers will
participate in the nal good exchange. If some buyers' reservation value is lower than
the market clearing price, then they cannot obtain goods. The situation is then
analogous to the case in which less than m buyers participate in the exchange.

biased e-market, the sellers' bargaining power declines more in the

oligopoly market than in the oligopsony market. Second, buyers'
positions in the pre-e-market network are heterogeneous in the
oligopoly market, which leads to their different incentives to join the
consortium. Widely-differing payoffs from switching to e-market
links make it difcult to convince all buyers' to participate [18]. In the
oligopsony market, buyers' positions are homogeneous in the pre-emarket network, and they share similar interests in forming the biased
e-market. Therefore, it is more challenging to form buyer-biased emarkets in the oligopoly market than in the oligopsony market. Sellers
will resist the formation of buyer-biased e-market due to the significantly reduced bargaining power and buyers are also reluctant due to
their heterogeneous incentives. This conrms our observation that
most successful and surviving biased e-markets, such as World
Wide Retail Exchange and Endorsia, are initiated by the side that
has less competition prior to forming the e-markets. It is rare to see
sustainable biased e-markets formed by the more competitive side.
SupplyOn, a B2B e-market formed by automotive suppliers may look
like an exception. However, to stay in the market, SupplyOn acts more
like a neutral intermediary and invites both automotive OEMs and
lower tier (e.g. 2nd tier and nth tier) suppliers to join.
Property 3b. It is uncertain how the number of buyers/sellers affects
the sustainability of biased e-markets.
The number of buyers has two opposite impacts on the e-market
sustainability conditions. When more buyers join the consortium to
initiate the biased e-market, the e-market operation costs shared by
individual buyers are lower. However, each buyer will also expect less
shared payoff due to the entry fee. The number of sellers also affects the
e-market sustainability in two different ways. Buyers can save more
connection costs if there are more sellers in the network. However,
buyers will expect fewer benets from increased bargaining power with
more sellers in the network. The number of sellers will intensify the
seller side competition in the pre-e-market network. That is the market
clearing price in the direct buyerseller network becomes lower when
the number of sellers increases. Consequently, in biased e-markets,
buyers' payoffs from purchase price reductions become less.
Property 3c. In a buyer-biased e-market, rms' expected payoffs and
expected social welfare are shown in Table 2.
Proposition 6. (Uncertain social welfare change of a buyer-biased
e-market): In the network migration process caused by a buyer-biased
e-market, the improvement of social welfare is uncertain due to
involuntary participation on the seller side.
Proof. In the oligopsony market, a buyer consortium is formed if and
f
=
only if the total e-market operation cost is lower than IBiased
mm + 1
2n + 1 nsS + mlB n m + 1 sB .
At the same time, in order to increase the social welfare, we need to
ensure that the
  investment is less than the socially optimal
Xe-market
f
=
lS kSj nsS + mlB n m + 1 sB . Comparing
level ISoc
jaN

#
those two equations, we nd that I#
Soc IBiased.
The proof of the oligopoly case is similar and is omitted.
During the network transition to a buyer-biased e-market, buyers
want to join the consortium only if their payoff is better than in pre-emarket structures. However, after all buyers participate in the
consortium, sellers have to switch to e-market-centered connections

Table 2
Firms' expected payoffs and expect social welfare in the biased e-market.
Oligopoly market
Buyer's payoff
Seller's payoff
Social welfare

n
2m

n
m sS

I
m

sB

0
n
2

Oligopsony market
1
2

n
m sS

I
m

sB

0
nsS I msB

m
2

nsS I msB

K. Zhao et al. / Decision Support Systems 47 (2009) 105114

even if their payoffs are worse, as they have no choice. The change of
social welfare can go either way depending on the extent of sellers' total
payoff adjustment. If not all buyers join buyer-biased markets, buyers
cannot fully capture the benet from enhanced bargaining power, since
there is still competition between them. Sellers' connection choice
becomes much more complicated, depending upon the fraction of
buyers who join the biased market.
7. Discussion, managerial implications, and concluding remarks
In this paper, motivated by the e-commerce shakeouts a few years
ago, we studied the conditions for B2B e-markets sustainability. We
developed and solved a multi-player noncooperative game to examine
the emergence and dynamics of B2B markets. Our paper makes several
theoretical contributions. First, we provide a model of the network-level
analysis of e-markets and demonstrate the structural changes brought
by new B2B connections. Second, our analysis reveals the interaction
between e-market ownership structures and market competition.
When a neutral e-market emerges as an intermediary, we expect to
observe similar properties in both the oligopoly market and the
oligopsony market. However, the sustainability of a biased e-market is
different under the two market conditions. For example, a buyer-biased
e-market is less likely to succeed in an oligopoly market than in an
oligopsony one, since the buyer-biased e-market signicantly reduces
the sellers' bargaining power. Thus, it is not surprising that many emarkets formed by small buyers (called as reverse aggregators in [18]),
such as FOB, have failed. Meanwhile, those buyer-biased e-markets
formed in oligopsony markets, such as World Wide Retail Exchange,
have survived the e-commerce shakeouts. Another successful example
is Exostar, an aerospace-defense e-market formed by manufactures, BAE
Systems, Boeing, Lockheed Martin, Raytheon and Rolls-Royce. It has
attracted tens of thousands of suppliers since its inception [31]. When
buyers form an e-market consortium to connect to their sellers, the
buyers can consolidate their bargaining power and the sellers have no
choice but to connect to the e-market. The buyers in the consortium
appropriate the benets from reduction in link costs and also by driving
down the sellers' prots. This leads to an interesting situation where it is
uncertain whether a biased e-market can enhance the overall social
welfare in the exchange network.
The third contribution of our paper is showing the importance of
examining network structures that existed before the emergence of the
e-markets. Those prior e-market structures are critical in determining
the outcome but have often been overlooked in previous theoretical
analysis. In particular, benets created by B2B e-markets are two-folded:
link cost reduction and efciency gains, both of which depend on the
prior e-market structures. Since rms only need one link to connect with
a group of buyers/sellers in the e-market, their savings are greater if they
have more pre-e-market connections. However, rms' heterogeneous
positions in prior exchange networks lead to different incentives in
joining e-markets. The efciency gains brought about by e-markets also
depend on the structure of prior exchange networks. If prior buyer
seller connections are limited, e-markets can bring more trading partners for a rm and create efciency gains in addition to link cost
reduction. Our model focuses on LAC networks, which are the most
challenging for an e-market to emerge, since LAC networks already
enable efcient product allocations and e-market can only offer link cost
saving benets. Our model can be applied to other non-LAC networks
and when doing so, the conditions for e-markets to emerge and sustain
in such networks will be easier to satisfy.
Our work also offers several managerial implications for e-market
initiators and operators. First, our results suggest that it is important to
keep e-market connection costs low enough to attract rms' participation. It explains why it is important that Exostar spares its members
from buying added technologywhether hardware and softwareto get
a job done; technologies are purchased as a variable cost service and are
included in the platform, rather than being downloaded to clients the

113

way hosting services (ASPs) work. [31] Second, e-market operators

need to keep in mind that ownership structures, market competition
and previous buyerseller connections jointly affect the sustainability of
B2B e-markets. If the e-market is launched by a neutral intermediary, it
does not matter whether it faces an oligopoly market or an oligopsony
market. Nevertheless, sufcient number of rms is needed on both the
buyer side and the seller side. If the e-market is launched by either the
buyer side or seller side, the challenges it will face differ in the oligopoly
market and the oligopsony market. It is much more difcult to organize
biased e-markets by the previously more competitive side.
B2B e-markets are still evolving [12,23]. More empirical studies
can help in better understanding the relationships among e-market
characteristics and their performance [22]. These e-markets can
include private e-markets formed and owned by individual rms such
as Wal-Mart and Cisco. Future studies can also explore the case where
not all buyers or all sellers participate in a biased e-market.
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Michael J. Shaw is the Hoeft Endowed Chair in Information Technology Management

and Director of the Center for Information Technology and e-Business Management at
College of Business. He received his Ph.D. from the Krannert School of Management at
Purdue University. Professor Shaw is the editor-in-chief of the journal Information
Systems and e-Business Management, and he has published extensively in leading
academic journals. Among Professor Shaw's recent books are the Handbook in
Electronic Commerce, Information-Based Manufacturing, and e-Business Management.
Currently, Professor Shaw works in the areas of e-business strategy, humancomputer
intelligent interaction, IT management, and knowledge management.

Kexin Zhao is an assistant professor of MIS at the Belk College of Business at the University
of North CarolinaCharlotte. She received her Ph.D. degree from the University of Illinois at
Urbana-Champaign in 2007. Her research interests are economics of information systems,
development and adoption of e-business standards, and game theory in information
management. She has published one book chapter and several peer-reviewed journal
papers. Her teaching interests include introduction of business computing, system analysis
and design, electronic commerce.

Chandrasekar Subramaniam is an assistant professor of MIS at the Belk College of

Business at the University of North CarolinaCharlotte. He received his PhD at the
University of Illinois at UrbanaChampaign in 2003. His research projects have been
funded by corporations such as Caterpillar, Motorola, and State Farm Insurance and the
Center for e-Business and IT Management at the University of Illinois. He has published
in several leading journals in information systems and contributed chapters for two
books on electronic commerce.

Mu Xia is an assistant professor of Information Systems in the Department of Business

Administration in the College of Business at the University of Illinois at Urbana
Champaign. He received his Ph.D. in Management Science and Information Systems in
2001 from the University of Texas at Austin's Graduate School of Business (now McCombs
School of Business), in addition to a Bachelor's degree in Automatic Control from Tsinghua
University, China. His research interests are the economics of online communities, the
economics of open source and collaborative e-business standards development and
adoption; business-to-business e-commerce and combinatorial auctions.