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 / First Quarter 2000 / Issue 18(originally published by Booz & Company)


To Hal Varian, the Price Is Always Right

The dean of Berkeley's School of Information Management and Systems foresees a world in which everything is negotiable.

Jeff Bezos's eye; comfortably before Jeff Yang and David Filo ever uttered the exclamation, "Yahoo!"; and long before eBay Inc. was bid into existence, economist Hal Varian already knew that the Internet was a provocative marketplace for provocative ideas about marketplaces.

Way back in ancient, pre-World Wide Web 1989, he points out, a trio of academics created the "Santa Fe Double Auction," an Internet marketplace based on rules used by the Chicago Board of Trade. They decided to invite rival researchers to contribute software that would "compete" against others' programs in this digital auction house. The International Business Machines Corporation agreed to sponsor a $10,000 prize for the designer of the most successful software agent. Some 30 programs were entered: 15 from economists, nine from computer scientists, three from mathematicians, and one each from an investment broker, a team of cognitive scientists and a marketing professor. The virtual gavel for this auction tournament dropped in March 1990. Who won? A clever graduate student in economics, Scott Kaplan. "When I asked why he thought his program did so well," says Mr. Varian, dean of the School of Information Management and Systems at the University of California, Berkeley, and one of most world's most influential theorists on the Network Economy, "he responded that all the other contestants wanted to show their theory was correct. As a poor graduate student, he really wanted to win the $10,000!"

The prize-winning auction agent was, Mr. Varian says, "simple, non-adaptive, non-predictive, non-stochastic and non-optimizing." Its strategy was to lurk patiently in the background while others did the negotiating. But when the "bid" and "ask" prices got close, the program jumped in to steal the deal. It achieved this through a formula that waited until rival bids and asks came within 10 percent of each other, and then snuck in a bid slightly greater than the previous ask. After 28,000 plays, the graduate student's software strategy achieved almost total domination of the auction market.

But the victorious strategy had an unfortunate downside. Before long, the market crashed. "The reason," Mr. Varian says, "is that a 'wait-in-the background' strategy only works if there are many other active traders. When the student's strategy took over the entire market, it could no longer get a free ride on price discovery by other bidders."

Was the experimental auction software a model of ingenious simplicity, or a dark vision of the future of the Internet Economy? On such questions hangs the prosperity of little dot-coms and brand Goliaths alike.

No one doubts any more that the Internet has promoted a radical convergence in business. Distinctions between content and transaction have vanished; advertising and promotion have blurred; back-office activities and customer relationship management have become almost indistinguishable; it is no longer clear where "products" end and "services" begin. Bricks-and-mortar businesses are rapidly co-evolving into clicks-and-mortar business models. Even the General Electric Company - the last company from the original Dow Jones index - is reengineering itself around the Internet-facilitated convergence of customers, suppliers and business units.

But, Mr. Varian argues, there is another convergence going on - a convergence every bit as profound as the e-commerce revolution. This convergence entwines previously distinct strands of economic thought as disparate as the theory of the firm and behavioral finance.

This convergence brings simulation, empirical analysis, game theory, and evolutionary and experimental economics into a digital alignment that cannot help but enable future generations of business transformation. There are world-class economists who now view the Internet with the same lust for discovery and innovation that world-class molecular biologists bring to the human genome. Hal Varian is at the white-hot center of that intellectual convergence. Mr. Varian works from a Berkeley, Calif. office that is cluttered with the kind of books and technologies that make it indistinguishable from that of a computer scientist or an engineer. In fact, Mr. Varian is a mathematician-turned-economist with an intellectual appetite for "information" markets. He is the first person to hold the deanship at Berkeley's School of Information Management and Systems, and has positioned his institution as a conduit for technology, economics and business.

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