An overview of practical exchange design

THERE is a large literature on the design of selling mechanisms, which has led to a practical methodology for guiding sellers in the choice of selling methods (see note 1). This methodology is related to the theory of mechanism design in the same way that engineering is related to physics: the practical methodology includes not just theoretical insights, but also the results of experimental and practical tests and a growing body of evidence from deployment, including the sale of over $100 billion in radio spectrum, primarily for cellular telephony, as well as in medical residencies, school assignment, electricity, pollution permits and natural resources. While the literature on practical selling and matching is rich indeed, little has been written on the methodology of exchange design, a hole this article begins to fill. Exchange design differs from selling method design in a number of ways. First, in the design of selling methods, competition between sellers is generally ignored. Ignoring seller competition is reasonable when selling radio spectrum, which is offered by a government monopoly, but unreasonable in many other settings, such as eBay auctions. Selling methods typically favour the seller, while exchange design should balance the needs of both sides of the market. Second, there are few articles on the theory of exchange design; a methodology must therefore piece together the principles from one-sided design theory and rely more heavily on insights developed either through selling method practice or through experimental insights. Third, some selling methods simply do not apply: an ascending auction is not a sensible design in a two-sided market. Fourth, some issues relevant to an exchange environment, such as whom to charge, are moot in the one-sided auction environment. To focus our ideas, we consider exchanges in which a group of sellers sell a sequence of differentiated goods to a group of buyers. A typical eBay exchange of, say, a specific model of Apple iPod would serve as an illustrative example. In this case, some sellers appear once to sell one iPod and others run businesses and repeatedly come to the market with new iPods. Sellers differ in the value they place on the items and potentially on how they discount the future. Some items, like tickets for seats in baseball games or advertising impressions on web pages, expire at a fixed time, whereas others, like baseball cards, remain valuable indefinitely, but may be costly to store. Many buyers purchase a single unit, but some buy many units or be repeat buyers. Buyers may need the item by a specific time – a camera for a vacation – or may be flexible. Broadly speaking, an exchange is a mapping from expressed preferences of participants into an allocation of goods and money. Thus, buyers and sellers will express their preferences or valuations, through a process that may be iterative and reactive, and a rule will determine who gets what and who pays whom how much. The process and methods of expressing preferences and the mapping into allocations is exchange design.