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Over the past several weeks, almost a dozen exchanges have come to pitch . All of these companies offer efficiency gains to their respective markets by using technology to automate human brokering between buyers and sellers. Given such an influx, I wondered if there was some pre-requisite conditions for success for an exchange.

To develop such a list, I analyzed successful market places we’ve invested in such as RightMedia, Oodle and HomeAway, and the relatively newer market places, The Receivables Exchange and BlueKai. Additionally, I verified my hypotheses against the stories of Craigslist, eBay and others.

This is my current list:

  • Exchanges must trade fungible goods/commodities: the traded items must be known quantities so to speak and must be standardized to a certain degree.
  • Both supply and demand must be fragmented: there must be many buyers and sellers, none of which represents a significant majority of supply or demand.
  • A reputation or trust system must be created: Given the large numbers of traders on both sides of the transaction, the exchange must provide a framework for trust between two unknown parties.
  • The exchange must replace a high friction, long sales process with a low friction, high velocity process that benefits all key parties: Should any one major constituency suffer and in particular the purchasing party, the exchange will likely fail.
  • To generate significant revenue, the exchange must charge on a per transaction basis. Typically, charging for seats on the exchange represents a smaller revenue opportunity than a small tax on each transaction. Successful exchanges exact revenue by providing a payment mechanism with corresponding fees as a percentage of the value of traded items.
  • There must be some disruptive force in the environment to initiate a shift toward an exchange: This force may be the result of the creation of new kind of commodity, a new technological enabler, or a demographic or economic shift. For RightMedia, it was the massive growth in remnant impressions. For BlueKai, it was the ability to target and purchase ad inventory with fine grained control. For Receivables Exchange, it was the implosion of credit available to SMBs for factoring. 

Exchanges are wonderful businesses for disrupting markets. The market power they possess creates monopolistic conditions and consequently very large businesses. 

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