Following Shapiro and Varian (1999), I contend that the Internet does not so much change the fundamental characteristics of the general negotiation process, as the economic principles behind negotiations are still valid. Yet it does enable trading mechanisms to be implemented that were previously unknown or infeasible. This book has analyzed a broad range of negotiation protocols for electronic markets while focusing largely on auction mechanisms.

Auctions have proven to be very effcient negotiation protocols that converge to an equilibrium very quickly, which is important in situations where transactions need to occur at a rapid rate. Considering political contexts, auctions are also widely perceived as fair. In fact, they reflect the general shift of power towards the consumer, as sellers who do not offer some form of negotiation might be in danger of falling behind or being considered consumer-unfriendly. Aside from theoretical arguments, auctions have a number of practical advantages for both seller and buyer:

• An auction mechanism releases the bid taker from having to negotiate with several bidders individually, thus saving time.

Electronic markets are breaking new ground in old industries by providing them with a wealth of supply chain information via the Internet. The way that net market makers match buyers and sellers is key to the success of a marketplace and the design of electronic marketplaces has become a million-dollar business. This is a challenging field for both the business and the academic community.

This book introduces a framework of negotiation protocols for electronic markets. In particular, I will focus on multi-dimensional auction mechanisms which allow automated negotiation on multiple attributes and/or multiple units of a product. The findings and analyses should be useful to an audience of scholars as well as practitioners involved in the business of electronic market design. Through this book a reader should be able to understand the multitude of technical and economic issues involved in the design of electronic marketplaces. In contrast to purely economic treatments of this topic, the book combines aspects of both economics andcomputer science. The book provides a detailed description of the various negotiation protocols, which will be a valuable resource for systems engineers and designers. It also covers the relevant theoretical concepts in this multi-disciplinary field and should, therefore, be of interest to the wider academic community.

Information systems and their application play a major role in today's business. In addition to the introduction of new technologies which help to streamline processes within companies, electronic commerce has become the most recent trend. Electronic commerce has been described as “commercial transactions occurring over open networks, such as the Internet” (OECD, 1997). These new information technologies provide new opportunities and mechanisms to cooperate or to compete, taking advantage of computer power, the communication possibilities of the network, and the fact that millions of people and businesses are simultaneously online.

Though only a few years old, electronic commerce (e-commerce) has the potential to radically alter business-to-business, business-to-consumer as well as consumer-to-consumer transactions. For instance, electronic communication between businesses and suppliers via Electronic Data Interchange (EDI) has recently been enhanced by web-based front-ends for the placement of customer orders. Inter-organizational systems, efficient consumer response, and supply chain management are only a few of the challenges that future businesses will have to meet.

The current success of electronic commerce and the creation of billions in market capitalization and revenue is based on fundamental work done in the past in various disciplines.

This book analyzes a variety of market mechanisms for electronic marketplaces. “Electronic brokerage” is a metaphor for information systems facilitating the matching of buyers and suppliers in an electronic market; and, therefore, these mechanisms are key to the success of an electronic brokerage system. Before market mechanisms are analyzed, this chapter will give an overview of electronic brokerage systems on the Internet, and classify the various services being provided by electronic brokerages.

The Role of Electronic Brokers

The current state of Internet commerce is a far cry from what an electronic marketplace is envisioned to be. Although a growing number of suppliers, manufacturers and retailers offer their goods and services, in many markets there are no scalable and integrated methods for

• suppliers to reach customers

• customers to reach suppliers

• introducing new products, services, and offers efficiently

• negotiating, billing, and accounting

• creating limited, structured electronic marketplaces.

Electronic commerce depends on the emergence of capabilities that empower buyers to obtain all the product data they need to make informed purchase decisions quickly and easily.

Utility theory and decision analysis have a long tradition in microeconomics, operations research as well as in business administration. The following sections will introduce the basic concepts of both disciplines. Understanding these is important to the conceptual design ofmulti-attribute auctions and to the practical implementation of these mechanisms.

Basic Ideas of Utility Theory

The theory of utility dates back to over a century ago. “Utility” and “value” are synonyms for many researchers, therefore, the term “utility” is used throughout the text. Microeconomists were the first to analyze consumers' preferences and utilities. This research has a long, complicated and controversial history and is as old as economics itself. At the present time economists still do not agree on the real meaning of utility and the way in which it should be defined (Metha, 1998).

Existence of a Utility Function

In the nineteenth century economists saw “utility” as an indicator of a person's overall well-being or happiness. The first explicit and systematic use of the concept of utility to explain value of commodities can be found in Jevons' classical Theory of Political Economy (1871). Jevons did not, however, distinguish between preference and utility.

The experimental analysis of multi-attribute auctions in chapter 6 provides a good understanding of the relevant issues and causalities. This chapter will focus more on the theoretical underpinnings of multi-attribute auctions. So far, game-theoretical models have focused on cases in which agents' private information is one-dimensional. The consideration of multidimensional types poses substantial technical difficulties and results of any generality seem restricted to a few papers. The complications are not merely technical: many economic insights in single-dimensional theory do not necessarily extend in any natural fashion.

Section 7.1 will provide a summary of spare game-theoretical literature in this field. Section 7.2 will compare the results of conventional and multiattribute auctions using a simulation model. This section will also consider the particularities of OTC trading of financial derivatives, which have been the focus in chapter 6. Up until this stage quantity was assumed to be fixed in advance and all items to be purchased from a single bidder. Section 7.3 will provide a classification framework for multi-attribute auctions where quantity is an issue, and introduce a model which shows the impact of economies of scale on the outcome of multi-attribute auctions.

Subsection 5.2.2 introduced negotiation support systems, which are used to support bilateral negotiations on multiple attributes. This section introduces multi-attribute auctions, a generalization of reverse auctions. Multiattribute (reverse) auctions combine the advantages of auctions, such as high efficiency and speed of convergence, and permit negotiation on multiple attributes with multiple suppliers in a procurement situation.

Multi-Attribute Procurement Negotiations

Several authors have analyzed tenders and reverse auctions (Dasgupta and Spulber, 1989; Laffont and Tirole, 1993). Previous game-theoretical models of reverse auctions have generally assumed that the qualitative attributes are fixed prior to competitive source selection – hence, bidding competition is restricted to the price dimension. While such an approach may be appropriate for auctions of homogeneous goods, this assumption does not necessarily apply to most procurement situations.

In reverse auctions, bidders often provide very different kinds of goods and services in their bids. An example is the procurement of large food retailers (Bichler, Kaukal and Segev, 1999). The suppliers in the market consist of large companies as well as a large number of small and mediumsized enterprises (SMEs) such as bakeries and breweries. The buyers are a small number of large food retailers who aggregate the demand and distribute it to the consumer.

Markets evolve, but they are also designed by entrepreneurs, economists, lawyers and engineers. Market design creates a meeting place for buyers and sellers and a format for transactions. Recently, economists and game theorists have begun to take a direct role and designed different kinds of market mechanisms.

An area in which market design is well developed is in the study of auction-based protocols. Although this is criticized by some authors (Kersten and Noronha, 1999a), auctions will be considered as a special type of negotiation. Leading economists such as Preston McAfee, John McMillan and Robert Wilson, among others, have successfully deployed game-theoretical analysis in order to design the bidding process in the case of the US Federal Communication Commission's (FCC) spectrum auctions as well as the design of energy markets. However, auction design is also an area in which there is a need to supplement the standard microeconomic theory.

Game theory is an important methodology, but it is not by any means the only technique necessary for successful market design. Market design practice is in its early stages and comprises methodologies such as equilibrium analysis, game theory, mechanism design theory, experimental economics, and computation. These techniques will be described in subsequent sections.

Most companies are faced with the problem of pricing their products. This problem has been a focal research question of microeconomics and marketing. Microeconomists have developed a sound framework of markets which is a good starting point for an analysis of electronic markets. This section will provide a brief overview of microeconomic theory and the morphology used to describe different market structures. This framework provides a useful terminology for thinking and communicating about markets, and describes the basic ideas of price-setting.

Section 3.1 will focus on a number of market structures which are well analyzed in microeconomic theory. Of course, this can only be a rough description of the microeconomic theory, and by no means complete. (For a more rigorous discussion see Varian, 1992, 1996c; Mans field, 1996; Browning and Zupan, 1999.) Section 3.2 will describe differential pricing, which is of particular importance to electronic commerce.

Market Structures

An economic environment consists of individual economic agents, together with an institution throughwhich the agents interact (Browning and Zupan, 1999). The agents may be buyers and sellers, and the institution may be a particular type of market.