:: The Park Paradigm ::

Markets for the Digital Generation

It would seem obvious to anyone who has ever boarded an airplane that weather is a primary factor in determining whether or not any given flight will take-off and/or land on schedule. The impact of adverse weather conditions is even more acute for commercial flights using increasingly congested major airport hubs, with the complexity of managing thousands of co-dependent paths within the network. This weather-driven uncertainty has a real and measurable financial impact on carriers and air travelers including (but not limited to): extra fuel, maintenance and staff costs, customer compensation (or at the very least poor customer satisfaction); and for their customers lost time and productivity (not just on delayed flights as customers are forced to ‘build-in’ the uncertainty implicit in the flight schedules to their planning.)

In the past, there was no practical way to price and manage this risk; the transaction costs and computational intensity of trading and managing such a granular and complex set of weather risks would have certainly outweighed the potential benefits. Today however thanks to accelerating technological advances in computing and communications, and taking inspiration from the creative application of technology to pricing, managing and distributing risk derivatives pioneered by innovative young companies like Weatherbill, this is clearly no longer the case. I would go so far as to posit that any CEO and/or Board of a commercial air transport business is at risk of breaching their fiduciary duty if they are not seriously contemplating how they can manage and mitigate weather risk in their operations. At the very least, it should be quantified and reported - much in the way fuel-price risk now is - and any hedging (or deliberate decision not to hedge) strategy articulated and explained to shareholders and any relevant regulatory bodies.

To help get this Boardroom debate started, Weatherbill has helpfully just published a white paper framing the problem and at a high level quantifying the risk of weather-induced delays for US commercial airlines (from the report summary:)

Between June 2003 and April 2007, over 25% of all flights in the United States were disrupted
(either cancelled or delayed). More than 55% of those disruptions (almost three million) were
due to weather- the leading cause of flight disruptions in the U.S. In an effort to educate airlines,
airports, and consumers about their weather risk, WeatherBill has identified the most sensitive
airports and airlines to adverse weather to facilitate reliable estimates of future flight disruptions.
Fifty-four major airports and sixteen larger airlines were studied. There are three main results:

1. WeatherBill can statistically quantify the relationship between weather delays and
observed temperature and precipitation at major U.S. airports and airlines
2. The study shows that disruptions are more common with precipitation than temperature
3. Temperature-linked delays are seasonal

We have included a list of the top five airlines and airports with the highest & lowest
percentages of weather disruptions at the end of this summary. Those lists are already widely
available. What follows immediately are lists of airlines, airports, and their delay sensitivity to
precipitation and temperature, in minutes. WeatherBill hopes this new data will help the flight
industry and travelers better understand their weather delay risk.

I would suspect that most (all?) of the airlines would have there own detailed data on this, so it is unlikely (I would hope!) that anything in this report will come as a big surprise but I would be curious to know how (if?) they apply this data in managing their business (setting schedules, pricing, etc.) Having quantified the risk, you might think the next logical step would be to initiate a risk management program to monitor and potentially manage (through trading granular weather derivative contracts) this risk dynamically. While I think this is a sine qua non for anyone managing an airline, I believe there is a much more exciting opportunity (than simply mitigating downside risk) that arises from the ability to measure and manage economic sensitivity to weather: the opportunity to build such an advanced knowledge of operational risks into the customer proposition. So what exactly am I talking about? Well, at the simplest level to illustrate, an airline could sell ‘weather-protected’ tickets: tickets offering for example a full or partial (or variable) refund for weather related delays or cancellations. Not only would this improve the customer experience, but would be very helpful in offering a differentiated price based on time-sensitivity of the traveler: a business person going on a day-trip for a critical client meeting vs a university student traveling home for the vacation probably have a different sensitivity to the ‘cost’ of a delay or cancellation. Or maybe not. The point is, let the customer pay accordingly. It wouldn’t be perfect - there is basis risk involved - and I suspect that from a marketing/adoption point of view there would be an optimal level of complexity (accuracy) vs simplicity in structuring these sorts of deals; and obviously it wouldn’t necessarily ‘change’ the outcome (weather is weather) but those customers who most valued their time would be compensated accordingly.

This dynamic (weather-) risk adjusted approach to pricing and management would also be relevant to airports and private charter or air taxi operators. Airports - especially those run ‘for profit’ - could build weather sensitivity into their landing and operational fees. For private aviation, while generally less subject to the negative weather-related knock-on effects endemic to the large commercial ‘hub’ airports, the relative importance of weather on flight disruptions is almost certainly higher than for commercial airlines (being less exposed to the other primary causes of flight disruptions (as defined by the US DoT): carrier delays, security delays, and late arrival of an earlier leg.) Also given the use of smaller aircraft, the sensitivity to adverse weather may also be greater in some cases (than for large commercial aircraft.) This approach would also be relevant for air cargo operators and given their concentrated hub operations and expertise in highly sophisticated logistical optimization, one could argue that implementation would be easier for companies like FedEx and UPS. (One problem however might be finding enough risk capacity on the ‘other side’ for Memphis…)

The Weatherbill study points out that (due to a lack of data and complexity beyond the scope of their paper) they did not consider ‘wind’ risk in their study, although they suggest that this is likely to some extent to be embedded in the temperature risk in some regimes (ie disruptions correlated with high summer temperatures may well reflect higher convective winds and/or thunderstorms related to these high temperatures.) However, there is no (technical) reason why over time sufficient (and sufficiently granular) relevant data on windspeed couldn’t be captured and used in pricing models up to and including in real-time. This would require data-capture not just at ground stations (airports) but in the air (aircraft) but the technology exists and the cost of transmission, storage and computation have (or will soon) declined sufficiently to make using what would be an incredibly vast and dynamic data set tractable (in a way that it would not have been even 5 years ago.)

You may recall I touched on this subject (dynamic outcome-driven air transport pricing) previously; and while weather risk management would be a good start in terms of bringing airlines into the 21st century, in my opinion a much deeper and more fundamental reappraisal of their business model is called for. Fundamentally, airline seats (or on any carrier for that matter) are substantially fungible - ie a ticket gives the right for one person to travel from point A to point B. Ok, Ok … before you get the pitchforks out - yes there is a difference in value between a seat on a Gulfstream V and the middle seat in row 34 on DiscountAirways… but the differences are relatively easy to understand and so I believe would be (mostly) efficiently priced in an open market. But ok, for the sake of simplicity, let’s set aside private or charter operations for the moment, and concentrate on scheduled commercial airlines. What you have today is a fragmented and reasonably opaque primary market* and no real efficient secondary market. (*Although the advent of the internet generally, and a number of innovative start-ups specifically has vastly improved the situation from that of a decade ago…) Why is this? Practically speaking it is because the airlines don’t want to allow transferability - they are unable or unwilling to embrace the fact that what they are selling is a commodity. That they are selling the transport of packets on a network. It’s an ego thing. They think they would lose out. Putting aside the fact that most of these companies have lost billions of dollars over decades (so I’m not sure what they think they have to lose), I am convinced that by encouraging a robust and complete secondary market in airline seats, not only would consumers win (through more transparent and rational (supply/demand) driven pricing) but the airlines - at least the well-managed ones - would be huge winners. First they would be able to save money by eliminating (or redeploying more productively) the boffins they currently pay to build ridiculously complex and customer un-friendly pricing schemes in the vain hope of optimising a priori load factors and revenues, and instead be able to focus on managing their assets, optimizing their routes and schedules and making their customers happy (insofar as they could see a return on this investment from a structurally higher secondary price for their seats.)

Stop for a moment and think how fundamentally this would change the paradigm of running an airline - load factor would disappear as a relevant metric because by definition, every seat on every flight would be theoretically ’sold’ - ie would have a market price (which in some cases may admittedly be zero…) - it would make explicit the fact that an airline is actually long a portfolio of options and could - using the feedback loop implicit in a robust secondary market - seek to manage this portfolio in such a way as to maximize the premium income. Part of this strategy would involve deciding when and how many seats to sell in the ‘primary’ market, and may in some cases involve also buying - yes buying - back seats in the secondary market as demand dynamics change. I sense that many of you are still uncomfortable with the heterogeneity of the market - ie the lack of fungibility - and the impact that would have on the liquidity of a secondary market. Perhaps this analogy will help: think of the (corporate) bond market - by definition it is much more complex and heterogeneous than the ‘equivalent’ market in common equity. Not only are there differences in the credit quality between companies (think different service levels, seat coverings, entertainment systems, airport lounges…) but even for the same company their are securities with different characteristics (maturities, seniority, coupons, etc.) (think flight times, class of service, changeability, etc.) - none of which inhibits the market from operating. Furthermore, the price signals this market sends with respect to these variables are important inputs for optimizing the management and balance sheet structure of these same companies. By allowing the CFO to see the relative cost and cost volatility of having a BBB vs a AA financial structure, she is much better able to make a decision as to which is best for her shareholders. In the same way, an airline executive would be able to better understand if his investments in customer service or in-flight entertainment provided positive returns to the shareholder (based on an average per-seat premium reflected in the market.)

I imagine that a further argument against such a market would be ’security’ (ie ‘identity’): the airlines (and various government agencies) need to know who is travelling in any given seat. Well again - thanks to technology - this is a red herring argument. There is no reason to believe that in a world of ubiquitous mobile phones, electronic payments and fulfillment that this ‘problem’ is not entirely tractable. Indeed, to take the securities markets as an example - due to various ‘know-your-customer’ and anti-money laundering statues - the days of anonymously trading bearer certificates are long gone; and yet the number of participants and transactions in financial markets has never been higher. So yes, any secondary market would need to robustly and accurately identify the ultimate ticket holder but this would not be a problem. (Additionally, in the first stage I would imagine it would probably make sense to start with a market that ended T-1 - ie not allow trading in the last 24hrs before a flight - which would significantly remove or mitigate a number of potential operational risk factors arising from such a market. Once these risks were better understood and engineered around, one could imagine eventually allowing trading up to the moment the flight closes for boarding.)

You may recall that in my earlier post, I mentioned Farecast as one of a variety of companies innovating intelligently in this space. This is a company that was on my “IRWIWHHTOTI” (I-really-wish-I-would-have-had-the-opportunity-to-invest) list (for reasons I hope would be clear to my regular readers…) Unfortunately, they have just sold themselves to Microsoft. Why do I say unfortunately? (1) There is now no chance to invest in or buy the company. (2) Microsoft has a long and not-so-illustrious reputation for buying really interesting and innovative companies (good) and then having their own big-corporate antibodies attack and often kill said innovation and energy (not so good.) (See here for more thoughts on Microsoft.) I hope this doesn’t happen to Farecast (in the same way I hope CBS won’t kill last.fm) but let just say I’m cautiously pessimistic. I am entirely sympathetic to the founders - liquidity is important (you can’t pay mortgages with ‘potential’ upside) and understand how the structural constraints of the mainstream VC business model drives the logic of this kind of exit. But the combination of these factors leads from time to time to what I would consider excellent opportunities to deploy smart, unconstrained capital. Since this is something I personally have limited amounts of (alas) I will be working to convince others of the merits of this view, with the goal of being able to act on a small number such opportunities when they arise in future…

Many of the issues that would be faced in creating such a market are very similar to those faced by secondary markets in live event tickets. Whilst, I wouldn’t want to distract the founders and executives of the companies pioneering in this space (against much hysterical and illogical reactionary resistance from some of the incumbent market participants,) I wonder if they might be available in a year or two’s time to sit down with me and my partners and construct a plan to turn this vision into a reality. Or I wouldn’t be surprised if someone were already working on it. If so I’d love to know more.

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…would seem to be an interesting question to put to the various ‘prediction markets’ that seem to be proliferating. (see Jed’s blog for a reasonably comprehensive round-up) Ironically most of these are US based - as is much of the ‘academic’ activity surrounding these new information markets - and so are limited (mostly) to play-money and fantasy leagues. (Rather than repeat myself, I refer you to this previous post as to the hypocrisy and inanity of the US legislation in this regard…)

My cynical take is that it will only happen when the corporate incumbents (with their big beltway lobbying armies) figure out how to capture these markets, ideally without cannabalizing their existing rents. It will be interesting to see who moves first on this - the Wall Street/Chicago (financial) trading complex or the Las Vegas gambling cabal; indeed one of the biggest psychological barriers is that these new information markets would - if legitimized - by their very existence, break down the illogical sematic barrier (between gambling and trading) that both sides seem so keen to preserve. But at some point the opportunities created (for providers, users and the economy generally) by legitimate traded markets in outcomes will simply become too big for either industry (or politicians) to ignore.

I’ve thought for some time that this would happen sometime in the next 2-6 years (post-Bush) and would probably need to happen under a Democratic administration (due to the Republicans now seeming to be institutionally incarcerated by the evangelical flat-earth constituency) although either a McCain or Giuliani administration might be able to buck this trend (if by miracle either managed to find himself in the Oval Office in the first place.) And I wonder if seeing mainstream media like the WSJ finally acknowledging the usefulness of prediction markets in their election coverage (teaming up with intrade to show political markets on their home page and creating their own - albeit fantasy - market) isn’t a harbinger of changing winds. And it can’t hurt either when the New York Times reports on Google’s internal use of prediction markets (an initiative run by Bo Cowgill)…

…hey maybe the Valley lobbyists might get behind this one? Although probably not as they have enough on their plate with Net Neutrality, wireless spectrum, biotech, greentech, …

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Maybe it’s just confirmation bias, but I seem to be noticing a lot more news and commentary on secondary markets for tickets to live events.

The Sports Economist draws attention to an editorial over at ESPN:

TMQ’s Gregg Easterbrook, after a sensationalized introduction, asks an interesting question:

On Monday, sellers on StubHub were asking from $750 up to a rather comical $164,710 for tickets to the Ohio State-LSU game (the latter price is for a prime luxury-box seat). The season finale Giants-Patriots NFL game might be historic; on Monday, sellers on StubHub were offering tickets for $200 up to $26,000, depending on seat location or box quality. Once the NFL playoff pairings are known, scalper Web sites will come to life for those contests, too. The asking price is not always the selling price, of course. But bowl committees and NFL teams must be saying to themselves — if these seats really are worth hundreds or even thousands of dollars on the free market, we should be the ones pocketing that scratch. How long will it be until professional teams cut out the middle person and simply auction off tickets for whatever the market will bear?Any day now, the NFL is expected to announce a deal to affiliate all its teams with one online reseller, probably Ticketmaster or StubHub, formally acknowledging reselling as legitimate and bringing the NFL an expected annual fee in the $20 million range. This might be just the first step in converting sports-ticket selling into StubHub World.

If one thinks of tickets like shares of stock, it is unlikely that franchises will initially place 100% of each season’s seats by an electronic auction mechanism. But what percentage will be “placed,” and what percentage will be auctioned?

I think rich people in particular are willing to pay to sit in the same spot (”their” seats in some sense) near others that they recognize. The latter component may be modest, but it might also account for the some of the interest in prosecuting scalpers in the old days. Legal reselling increasingly puts that component at risk. This is a stretch, but one way of interpreting laws against scalping is that clubs didn’t mind you selling tickets to your friends, just any old high bidder.

Meanwhile, Fortune recently did a profile piece on Live Nation’s CEO Michael Rapino:

But Rapino isn’t satisfied with dominating the concert business. He is mounting an audacious attack on the record labels and seeking to poach their most important assets - their stars - by turning Live Nation (Charts) into a one-stop operation that handles their every musical need. His offer: We already operate your tours. Why not let us make your albums, sell your merchandise, run your website, and produce your videos and a range of other products you haven’t yet thought of? This is the age of the empowering Internet, after all. Artists are in charge. Who needs a record label?

Depending on whom you believe, Rapino’s strategy will either reinvent the ailing music industry and turn Live Nation into a powerhouse - or cripple his company. Certainly it’s brash talk for a concert promoter whose toddler-aged company has never put out a single record. But artists have been listening closely since Rapino landed a giant catch. In October he struck a first-of-its-kind deal with Madonna, who bolted her longtime label Warner Bros. and signed a ten-year contract estimated at $120 million to let Live Nation handle every part of her business except publishing.

For what it is worth I think they’ll make money on the Madonna deal, even without attributing a value (which is certainly non-zero) to the marketing/business development angle of this innovative and high profile deal.

For more of my thoughts on how I see these markets developing over time, I refer you to a few earlier posts:

• This Just In: Google pre-IPO shareholders owed upwards of $35 billion
• Tickets & Markets, Part 1 (On the shoulders of investment banks)
• Tickets & Markets, Part 2 (Copy, Paste…embrace the inevitability)

Now, I just need to figure out how best to get involved…

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One of the core tenets of the sixth paradigm will be the migration of value from transaction execution and (to a lesser extent) processing to data. In this context, Markit Group is in my opinion an excellent example of the kind of company that will emerge and be successful in the coming decade(s):

Markit was founded in 2001 as the first independent source of credit derivative pricing. Today, our data, valuations and trade processing services are regarded as the market standard in the global financial markets, helping our clients to reduce risk and improve operational efficiency.

As a private company with privileged relationships with 16 shareholder banks, Markit has unparalleled access to a valuable dataset spanning credit, equities and the broader OTC derivative universe. Our unique relationships with the bank shareholders give us the opportunity to work closely with these leading market makers to develop innovative solutions for the marketplace.

With close to 1,000 institutions as clients - including investment banks, hedge funds, asset managers, central banks, regulators, rating agencies and insurance companies - we provide round-the-clock support from our offices in London, New York, Chicago, Toronto, Amsterdam, Brussels, Luxembourg, Tokyo and Singapore.

The founders - led by Lance Uggla and Kevin Gould, seasoned capital markets traders and managers both - understood that having good clean, well-packaged data was essential to the growth of any traded market and that this was not a given in (many) OTC markets, picking one in particular - credit - that had great growth potential but particularly poor data availability as a natural starting point for their business. Since then they have grown the business impressively both organically and through judicious acquisitions which focused on bringing their management, distribution and platform strengths to smaller companies focused on certain market niches. I was privileged to serve as a founding Director on their Board (representing DKIB) and so when I saw that they had recently closed on the acquisition of International Index Company (on who’s Board I also served) I must say I was pleased, having first floated the idea of this deal to Lance when I was Chairman of IIC a few years ago. The strategic fit is very good and with Markit’s resources behind it, IIC will be able to continue to improve and strengthen its leading franchise in fixed income indices.

I enjoyed tremendously my time working with Markit and fully expect them to continue to be leaders in the development of modern markets data services in the years to come. They are definitely someone to keep an eye on.

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In a leader this week on banking in Africa, the Economist asks the question “A bank in every pocket?” making the point that “banking on mobile phones holds promise, provided regulators are willing to be flexible”:

Leonard Waverman of the London Business School has estimated that an extra ten mobile phones per 100 people in a typical developing country leads to an extra half a percentage point of growth in GDP per person. To realise the economic benefits of mobile phones, governments in such countries need to do away with state monopolies, issue new licences to allow rival operators to enter the market and slash taxes on handsets. With few exceptions (hallo, Ethiopia), they have done so, and mobile phones are now spreading fast, even in the poorest parts of the world.

I wholeheartedly agree with their point - indeed my post a year ago (!) A Trinity: Finance, Mobile Phones & Africa (from November 11, 2006) made many of the same observations:

It seems clear that mobile phones (as opposed to personal computers) will be the most important device for access and connectivity in the developing world, and probably everywhere eventually. But access to the internet and computing will become more and more common everywhere, with many different initiatives - both technological and financial - focused on bringing down the cost and expanding the market for computing in the developing world.

As has been written many many times before, mobile phones are changing everything. From politics to business to culture. The digital generation is but a subset of the connected generation, a worldwide phenomenon. Again, this is probably being felt more strongly in developing countries - not so much because the effect is greater or different - but because the contrast with what came before is that much more marked. This extension of connectedness enabled by mobile telephony taps into something that is inate in humans; it extends our ability to form communities unbounded by geographical or even political constraints.

The Economist goes on to highlight the flexible, adaptive regulatory approach to mobile banking being taken in the Philippines (something I was not aware of) as a model to emulate:

Rather than trying to work out the best rules in advance, which could hamper innovation, the regulator is working closely with the banks and operators behind the country’s two m-banking schemes. That way the regulator can see what is going on, so the schemes’ operators get more flexibility. The experience will feed into new banking regulations. Rules that are too tight will hinder adoption; rules that are too lax could allow fraudsters to bring the whole idea of branchless banking into disrepute. But if regulators strike the right balance, m-banking may provide the next example of the mobile phone’s transformational power.

In the same edition, “On the frontier of finance” gives a good overview of the state of the banking industry on the African continent, highlight that while recent growth and investment is encouraging, the opportunity remains vast with most of African’s - even in the richest countries like South Africa - remaining unbanked and having no or poor access to even basic financial services.

A couple weeks ago, in a special report in the FT on Tanzania, Tom Burgis wrote a very good article “Crops are starved of lending” on how the lack of access to basic financial services, working capital and markets hold back improvements in agricultural productivity and essentially trap much of Tanzania’s population in a vicious cycle of poverty:

Four in every five Tanzanians live in rural areas; most are subsistence farmers. Eighty-five per cent of cultivated land is still worked with hand-held tools, 10% with animals and just 5% with machines. For a decade, the sector’s growth has failed to match the overall expansion of the economy. Without a transformation in agriculture, Edward Lowassa, prime minister, admitted in a recent speech, there will be no escape from poverty.

…[in a village dependent upon cashew farming] The 1,006 vilagers are unable to bypass what officials say are illegal cartels of traders who keep prices cripplingly low, depriving farmers of capital to reinvest in raising quality and productivity. Their predicament is worsened by the near impossibility of borrowing.

I know that solving problems like these is not easy; that there are many social, cultural, institutional hurdles to overcome (on top of the operational and technological challenges) but it would seem to me that in the next decade or so, there really is a chance to ‘leapfrog’ using cheap, ubiquitous mobile communications and devices as a substrate and deliver the power of modern financial services and markets to every corner of the planet. Even the poorest. Especially the poorest. Indeed the maxim “go where the pain is highest (with respect to introducing new products and services)” means that it is not ridiculous to think that some of the earliest adopters of sixth paradigm markets and techology may well be found in some of the poorest and challenging regions on the globe.

Imagine these villagers armed with mobile phones giving them access to markets, risk management tools (weather, commodity risk), payment systems, and ultimately capital - breaking free from the bottlenecks and information barriers currently trapping them in a vicious circle of poverty. How is that for a big idea? We’re (I’m!) not quite there yet (in terms of being at the inflection point) but we are getting very close. Hey maybe this is worthy of a TED Prize wish in 2 or 3 years from now!

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In 1971 Intel unveiled the world’s first commercial microprocessor, a technological revolution that heralded the Age of Information and Telecommunications - the fifth techno-economic paradigm since the dawn of the industrial revolution in the 18th century.* Although it is almost impossible to identify the core elements of each successive technological revolution without the distance of historical perspective, I wonder if Betfair’s recently announced Flywheel trading engine might be an analogous revolution at the dawn of the sixth paradigm - the Age of Markets. Will Moore’s Law be joined by Yu’s Law? (or Devine’s Law?):

“The number of transactions per second per $1000 of hardware increases by X every Y months…(!)”

(Remember future wikipedia contributors, you read it here first! )

To put this into context, and using Carlota Perez’ framework, let me outline some of the elements I believe will characterize the Age of Markets. Firstly, new technologies and new or redefined industries will emerge:

• truly global financial markets (including ‘developing’ countries)
• entirely new concept of risk management and insurance: “outcome” markets
• convergence of retail and wholesale risk markets
• ubiquitous worldwide realtime trading in “digital goods and services”

These will be supported by new or redefined infrastructures:

• cheap electronic exchange software
• digital transaction costs converging on free
• abundant (almost free) computing power and communication bandwidth
• worldwide dissemination of mobile networked computers (phones)
• vast social networks (breaking institutional monopoly on trust)

Indeed, unleashing the potential for ubiquitous traded markets in heretofore “inaccessible” products, services and outcomes depends on a number of foundation elements: essentially free transaction mechanisms (allowing high frequency, low value transactions), vast distributed digital communication platforms, robust and secure trust frameworks, and intuitive (ideally invisible, at least in the conscious sense) and painless trade capture and risk management interfaces. It would seem that Flywheel has the potential to meet at least the first of these requirements (from BusinessWeek):

Betfair CEO David Yu set the company’s R&D team the task of increasing throughput by 100 times for free. Project 100X took two years to develop and was run both internally and with three other partners, in what Carter calls a “bake out” - whichever team came up with the best prototype would get the investment for the rollout.

The budget for the entire project was less than £1m over two years.

In the end, the R&D team came up with a betting engine, called Flywheel, that could demonstrate a throughput of almost 100,000 transactions per second, while also reducing the cost per transaction by 200 times.

Even with a traditional betting engine, Betfair processes five million transactions per day - much more than the London Stock Exchange’s transaction processing system is capable of.

The R&D team expects one million trades per second to be possible through Flywheel, which it estimates is the equivalent of the entire combined annual global equity trading volume being processed in a matter of hours.

However, for Carter, the key achievement is the cost levels. He explained the whole system runs on two servers with an approximate cost of £25,000. This, he said, is in comparison to a high street bank with a similar throughput load that will typically use a mainframe costing many millions of pounds.

Ok, just in case you skimmed over that last bit, it probably bears repeating:

ONE MILLION TRADES PER SECOND. ON £25,ooo OF HARDWARE.

I’m talking my own book sure, but honestly who’s stock would you rather own? The NYSE Euronext? Nasdaq? how about Deutsche Borse? or OMX? or the LSE? …or Betfair???

In Amazonbay, I suggested that someone like eBay might move into financial markets, leveraging their technology and associated low transaction costs by buying a financial exchange, leading electronic agency brokers and ultimately Betfair (in the summer of 2010!) With a market capitalization of c. $44bn eBay could probably afford NYSE Euronext (at c. $21bn plus a takeover premium) but the real prize would be Betfair. By 2010 they should still be able to afford it but it’s far from clear it will be for sale and one imagines it will be a far sight more expensive than the £1.5bn valuation Softbank acheived when it took a private stake in April 2006. Speculating about big brand name corporate deals is obviously fun but risks confusing the real point.

Any business predicated on charging a significant ‘metered’ transaction fee for matching or facilitating a (digital) trade is likely to see it’s business model washed away like a sand castle at high tide and needs to be ready to compete in a world where marginal transaction costs are zero and value is derived ‘because of’ the trade, not ‘with’ the trade.

Oh, and one more thing… ONE MILLION TRADES PER SECOND. MILLION.

…this is not your father’s oldsmobile…

(* see Technological Revolutions and Financial Capital, p. 11)

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Working to bridge the disconnect between the socio-institutional paradigm and the techno-economic paradigm, which as Carlota Perez so eloquently writes will lead to a golden age for the emerging digital generation:

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So first Stan, now Chuck. Who’s next?

I don’t know these gentlemen, and obviously I am not privy to the internal workings of the financial behemoths that they were charged with piloting, but I wonder if the problem isn’t so much who is at the helm but the ship they were trying to steer. As Mr. Prince said, taking personal responsibility was the “honorable thing to do” as a leader (I’m reminded of the immortal words of Hopper - “The first rule of leadership: everything is your fault”) and I would tend to agree. And there is no reason to cry for these men - they were amply rewarded for their efforts and will - I’m sure - land on their feet so to speak, so don’t misunderstand what is to follow as sentimental apologia for their failings (real or perceived.) However I wonder if these giant firms are manageable at all - at least under the current constructs of managerial science - and ask honestly if any one individual however smart, charismatic or experienced (Mr. Rubin would seem to have all these qualities in excess) can realistically succeed in steering the turn-of-the-21st-century financial megafirm through the oceans of Extremistan (Mr. Taleb’s metaphorical “province where the total can be conceivably impacted by a single observation.”)

For some years now, I have been interested in trying to understand how the corporate ecosystem would change under the effects of the onslaught of accelerating social and economic change driven by the revolution in information and communication technologies. Applying Coase’s Theory of the Firm to a world where communication and transaction costs move unrelentingly towards zero (at least in many contexts) must in my mind lead to a fundamental - quantum - shift in the optimal organizational dynamics of companies and the economy more broadly speaking. The vision I seem to be ineluctably drawn towards is one that looks like the classic map of a network, containing millions (or billions) of nodes and interconnections, with a fractal geometry. So yes I do think that ’super-nodes’ (read mega-corporations) will continue to exist and even grow, but I think that complexity will migrate away from any particular node to the network. So in my mind, bigger is only sustainable if ’simpler’. Today’s financial behemoths are anything but ’simpler’.

If we look back from a vantage point twenty years hence, I suspect that the period between 2002 and 2012 (or so, I’m not hung up on exact dates…) will be seen as a transitionary period - when the one wave (of linear giganticism) crested, and another of specialization and the migration of organizational complexity to the network (the “edge”) emerges. Will the takeover of ABN Amro be the last of the mega-mergers (although and perhaps fittingly the 3-way break-up involved added an element of deconstruction to the transaction…)? If I had to guess, probably not but it will more likely be ‘one of’ the last of its kind. Of course, I am far from alone in wondering if these giants have passed the point of diminishing returns on scale (from the BBC article on Mr. Prince’s resignation:)

“The actual structure of Citigroup is broken - it’s too big, it’s too bloated and we think it should be broken up into three of four pieces,” added Bill Smith from Smith Asset Management in New York.

Ronald Coase, the economist, famously observed that private companies are different, because they are not the only place to do business. An alternative to costly and complex banks is an atomised market, where individuals and institutions do business without a large financial intermediary. Banks may merge to survive this inevitable transition; but in the long run many of their functions will disappear…the core functions of any Wall Street Bank cannot remain inside the same complex and costly shell forever.

Given this is probably a topic worthy of a doctoral dissertation (and if done well perhaps a Nobel prize in 25 years), there is no way I can even start to do it justice in a short blog post, but I hope I have been able to give at least a taste of how I think this might play out and why it is likely to be a core consideration in any investment thesis for financial services over the coming two or three decades.

Update: Link to WSJ article on Citi’s troubles.

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Thanks to Boing Boing for the pointer to this article on using game theory and mathematical models to predict event outcomes:

Predicting the future is not very hard, according to Bruce Bueno de Mesquita: a little mathematics is all you need. Figuring out how to manipulate a situation to achieve specific aims is a bit less straightforward, but Bueno de Mesquita says his mathematical tools can usually do that, too.

The New York University political science professor has developed a computerized game theory model that predicts the future of many business and political negotiations and also figures out ways to influence the outcome. Two independent evaluations, one by academics and one by the U.S. Central Intelligence Agency, have both shown that about 90 percent of his predictions have been accurate. Most recently, he has used his mathematical tools to offer approaches for handling the growing nuclear crisis with Iran.

Bueno de Mesquita provides the computer tools, but he relies on political or business experts to identify specific issues, their possible outcomes, and the key players. He asks experts narrow, carefully delineated questions about which outcome each player would prefer, how important the issue is to each player, and how much influence each player can exert. But he does not ask about the history of the conflict, the cultural norms of the area, or what the experts think will happen.

Another example of the emerging potential of algorithmic business strategies? Come by next Tuesday at 5pm at Web 2.0 Expo in Berlin if you are interested in hearing more!

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Well done to Bank of America for seizing the opportunity enabled by advancing mobile tele-computing appliances. Of course I’m talking about the iPhone, and when I predicted back in January that the possibilities created by such mobile and user friendly (at least for those who don’t have giant digits) hardware would lead to an opening up of a whole new frontier in mobile markets and commerce, I have to admit I was too cynical to think that a giant like Bank of America would be leading the way:

In a move sure to set a precedent, Bank of America is the first banking application featured on Apple’s iPhone App directory.

Here’s their intro:

Bank of America Mobile Banking is available to all Online Banking customers. With Mobile Banking you can use your iPhone or iPod touch to easily and securely check your balance, pay your bills, transfer funds, or find a nearby ATM or banking center. It’s easy, fast, and convenient — just use the Safari browser on your iPhone or iPod touch to go to www.bofa.mobi and you can get started.

Although other banks have mobile banking Websites that work equally well on the iPhone, they’re the first to proactively promote it as an iPhone app. It’s a smart move given that many sites still need to tweak their interface code to be optimized on the iPhone screen. As a result, iPhone users are often frustrated with their experience on sites that are not optimized.

In time I think any service - certainly any financial service - that is time sensitive (all trading services and many others) will need to be offered conveniently (!) on and optimized for mobile devices. This is certainly true of ‘retail’ services but I’ll go out on a limb and say that it will be equally important for institutional (wholesale) financial services as well. As people get a taste of not being tied to their desks or workstation, they will come to demand this functionality (just as once they got a taste of mobile email via the blackberry, they would no longer live without it.)

Secondly (and in my view much more important and interesting), the very existence of the possibility of easily ‘trading’ in any market anywhere is both a sine qua non and will be a driver of (in a virtuous circle) the development of traded markets in anything and everything (that is worth trading) - in particular anywhere there is a need to allocate a scarce resource or a need to assign a probability to any given outcome. The Age of Markets will be made possible by the very low barrier to market participation that comes as a result of: (1) the ability to trade electronically (either the informational goods themselves or derivatives of real physical goods and services), (2) massive and cheap computing power driving marginal transaction costs to zero, (3) abundant wireless data bandwidth, and (4) powerful and intuitive mobile computing devices (combining state-of-the-art hardware with innovative and easy-to-use user interfaces.) The ability for billions of people to express their preferences through a market as easily as they can state their opinions aloud will allow these thousands of markets to bloom.

I know I’m skating over a lot of the details, but I think many regular readers will be able to fill in the blanks and get my meaning. And for those that don’t, you’ll just have to trust me - check back in 20 years and we’ll see if I’m right.

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