The Difference between a “Market” and an “Exchange”
No surprise to those who know me, the area I spend most of my time thinking about during the workday is the online advertising business. In running a company that participates in this space and has some different takes on the existing ways of doing things (albeit many of these staid practices are all of 2, 5 or 10 years old), it often behooves me to have handy some analogies to help laypeople navigate our space and understand what it is that I am doing day after day and hour after hour.
Analogies and comparisons for online advertising are most often made with financial markets, and don’t always hold up. I did, however, stumble on some recent interesting information looking at the historical context in financial markets and talking about the difference between a financial market and a financial exchange. The text below is from a review of The London Stock Exchange: A History by Ranald C. Michie (1999) .
Michie begins his story, “From Market to Exchange, 1693-1801,” with an overview of the rise of an informal, unorganized, secondary market in government debt. This begins, in his view, in 1693 with the establishment of permanent debt that could be transferred. As the amount of debt increased with each successive war, so did the number of investors, encouraged by the government’s ability to continue servicing at least the regular interest payments promised on the debt issues. Gradually, specialists arose, both brokers and jobbers, both very important to the operation of an efficient secondary market for any set of products. Brokers made their money from commissions they charged to their principals, who desired to buy or sell an amount of a particular security within a specified price range. Jobbers provided the brokers the counterparties to their principals, offering to sell to their buyer or to buy from their seller the particular security. They made their money on the difference between the prices they bid or asked, and saved the broker the time and expense of finding a specific counter party to his original client. Both made more money, the greater the volume of transactions. Brokers made a commission charged to their principals; jobbers made a “turn” on the bid-ask spread always intending to buy low and sell high. By the end of the eighteenth century, the number of investors was large and a number of specialized brokers and jobbers seemed to be making a living from their respective trading activities. Nevertheless, asserts Michie, this was just a market, not an organized exchange that could affect by its own rules and enforcement decisions the way the security market would develop in the future. In 1801, however, the informal London stock market ceased to be shaped strictly by outside forces and henceforth could determine in part its own destiny through the decisions taken by its governing bodies.
Reviewed for EH.NET by Larry Neal, Department of Economics, University of Illinois.
The current state of the online display advertising market I think is quite similar to the above, with “brokers” and “jobbers” earning revenue by providing market access for varying amounts of commissions/fees that I am sure historically were quite volatile and in the absence of regulation might correlate with the particular client’s level of sophistication. The online ad space is a series of private markets loosely connected and as such, the connective glue that companies like ad networks provide definitely makes it stick together and these types of firms who already have been involved in these markets will play a role if shifts to one or more true exchanges take place. Again quoting the book review below, the LSE success was built on allowing access under controlled conditions, utilizing the skill and knowledge of the jobbers to help make markets and provide liquidity, and then the cycle of specialization with tight alignment of interests (specialization can only work well if motives of partners are in sync and measured/monitored by market and/or regulatory mechanisms… the relationships between entities becoming more important than the internal capabilities of one -> a market ecosystem develops…):
What accounts for this earlier success? Internally, one factor was that dual control by Proprietors and Members continued to be effective in offsetting tendencies towards restricting access to the exchange; another was the continued importance numerically of jobbers within the membership of the exchange. Externally, the most important factor was the central role played by the Stock Exchange in the money market of London. The ever-expanding joint stock banks in London found that their loanable funds could be employed profitably for short periods of time by lending to so-called money brokers who were members of the Stock Exchange. They, in turn, could lend on security of shares and stocks held by jobbers to allow them to settle differences at the fortnightly settlements or to continue their positions to the next account. Specialization in function within the Stock Exchange thus occurred that allowed further specialization in function among the financial intermediaries of Lombard Street. These nested specializations increased efficiency in the use of funds by all concerned. They also allowed, however, increased efficiency within the growing number of provincial stock exchanges, who could tap into the London money market easily through the branches of the joint-stock banks.
The development of stock exchanges is rich (sometimes eery) fodder for analogies for the development of new, electronic markets and exchanges. In the end, people and the incentives that connect them to one another and their institutions are the key underpinnings, but more about that later.