Términos y Definiciones

Figure 5.1 Continuum of product homogeneity.

Out to the left of the continuum, price is relatively steady and the other 3Ps are used to facilitate trade. It is clear that as one moves from left to right, price becomes an increasingly more important variable in the marketing mix. On the extreme right hand side of the continuum where the products are standardized, price is the only variable in the mix used to facilitate trade. Also, out to the right, price moves all over the place because the other 3Ps have little to no influence on facilitating trade.

Auctions

Refer again to Figure 5.1. There is another observation which must be made with respect to how the goods on the continuum are offered for sale. As we have seen

throughout history, markets have arisen in response to individuals seeking to improve their lot by exchanging any surplus they have produced. This is true whether the transactions took place via direct (i.e., barter), or indirect (i.e., via money) exchange.

People either sold their goods at a local auction, put them on display and haggled with potential buyers until they settled on a price, or left them with small shop keepers to sell on consignment at a stipulated price. Either way, the goods were being auctioned;

the only question was whether the goods sold in a passive auction or an active auction. To this day, products are sold in the same way.

In a passive auction, the buyer chooses from a range of available prices for a good or service, with each price representing a certain degree of quality. For instance, consider a jewelry store display case with a wide array of watches: Some have calendars built in, others do not; some have leather bands, others have metal bands;

some are made by companies with well-known names, others are made by lesser known companies. Prices for the watches range from $50 to $500. In this environment the consumer is essentially faced with a passive auction. Price is set. Seeing the choices laid out before him, he merely "picks his poison," so to speak, paying the posted price for the watch which meets his wants or needs. Either the customer pays or passes, but there is generally no active role in determining the price.

In an active auction, buyer and seller (or their representatives) actively negotiate the price at which a transaction will take place. Typically, the word "auction" conjures up the one-way bidding process witnessed in an auction house like Sotheby's or Christie's. Rare pieces of art or collectibles are put on display and an auctioneer starts the bidding at a "suggested" price. Then, in an attempt to arrive at as high a selling price as possible for the item, he begins a process of offering successively higher prices in an attempt to reduce the number of active bidders until only one remains.

Again, this is an example of a market where the goods flow in one direction. Another example of a one-way auction is a livestock auction. However, cattle are more common and more numerous than most of the items sold at Sotheby's. Therefore, high prices received for cattle at a local auction can attract the attention of other cattle owners who may bring their herds to the next auction. This additional supply may result in a lower price for cattle at the next auction.

The same phenomenon exists to some degree with Van Gogh paintings. In the mid-to-late 1980s the Japanese paid extremely high prices for paintings from the Renaissance masters. In response, private collectors of similar types of paintings began to put them up for sale. So the phenomenon of price-moving to attract buyers and sellers occurs in all markets, but not nearly to the extent that it does in markets in which the product is standardized; higher prices tend to attract producers (sellers) to the market. In the airline market, any airline can offer service between virtually any pair of cities simply by renting gate space and notifying the respective airports of the new service. Prices in the form of high fares offered by competitors are usually the factor which attracts an airline to a market in the first place; and it uses a lower price to gain customers. Nevertheless, the principles of auctions are the same, even though the outward operational procedures of the individual markets may differ.

A Sotheby's auction is an example of one-sided competition among buyers. The mirror-image of a Sotheby's-type auction is, for example, a municipal government considering bids from private contractors to provide goods or services. When the municipality announces its plans for a sewer project, private contractors submit the price at which they are willing to sell their services. This auction is a one-sided competition among sellers.

The financial markets combine these two types of auctions into an active, two-way dual auction; a two - two-way competition among buyers and sellers; not just sellers as is the case in most consumer markets and not just buyers as is the case in

Sotheby's auction house. There is a two-way flow of goods and everyone is a potential

"consumer" and "producer," so to speak. (Since the product is never truly consumed, the participants are more accurately described as "buyers" and "sellers," respectively.) Moreover, this dual auction process is continuous in nature as opposed to coming to an end when the auctioneer raps his gavel at Sotheby's or when the city accepts a contractor's bid. All of these features combine to make price extremely important, and its movements more exacerbated, for the products on the right hand side of the continuum.

Price becomes even more important as a means of segmenting participants into STFP and LTFP when, as is the case in the futures markets:

1. The goods are completely standardized.

2. Anyone can create supply (i.e., not limited to producing firms), which enables prices to rise and fall attracting both sellers and buyers, as opposed to basically falling to attract buyers in the real economy markets.

3. The product is never consumed, per se - every buyer can become a seller and vice versa.

Moreover, these characteristics of the futures markets make price extremely important in terms of facilitating trade by segmenting the time-frame participants in the market, but they also make price fluctuate more than is the case in other markets. In a standardized product market which relies solely on price to facilitate trade, the interplay between short and long time-frame buyers and sellers creates what can only be accurately described as a dual auction.

In the futures market, goods do not flow only one way as they do in the consumer markets; rather, anyone can be a seller (producer) and anyone can be a buyer (consumer). With the combination of a standardized product and two-way flow of the product where virtually unlimited numbers of buyers and sellers can enter the market with ease, price is the single item promoting trade. This creates a sale when price is offered lower than it has been of late and the opposite of a sale when price is offered above what it has been.

Who Trades with Whom?

Before going any further, a key observation needs to be made about the interplay between the LTF buyers and sellers. LTF participants do not exchange with each other at the same price at the same time. In the housing market, for example, LTF buyers are looking for a "deal" on their purchase and LTF sellers are looking for an

"attractive" price to sell their house. Since neither participant is pressed by a time constraint to execute a transaction, trade with each other is probably not going to happen. The LTF buyer has a price in mind which he is willing to spend for the house and is trying to get an advantageous price—a "price below value" situation. The LTF seller, on the other hand, also has a price in mind and his price is "above value." The LTF participants will not be able to agree on price for transaction. It will take a STF buyer, who is willing to "pay up" for the house, for a transaction to occur. The STF buyer's time-frame perspective is short for some reason (i.e., he was just transferred to town and must buy a house, or his children are starting school in a month and he must live in that neighborhood for his children to attend a certain school) and he is willing to pay the LTF seller's price for the house. The ideal situation for the STF buyer would have been to find a STF seller who was moving out of town on short notice and was willing to part with his house at a price less than the LTF seller was. In this ideal situation the STF participants are transacting at a "fair price."

So here are the combinations of who will, and who will not, trade with whom:

STF buyers and sellers trade with each other. STF buyers and sellers will exchange with LTF buyers and sellers. LTF buyers will not exchange with LTF sellers at the same price at the same time.

The reason LTF buyers and LTF sellers don't exchange with each other is because they are both trying to secure an advantageous price. The LTF buyer wants to buy at a bargain price and the LTF seller wants to sell at a premium price. Thus, they will never be able to agree on a price at which to transact with each other. As you will see shortly, the futures markets are no different in this regard.

Since there is a buyer and a seller in every transaction, prices going higher or lower do not necessarily mean there is "buying" or "selling," respectively, in the market. We know that the reason the two participants take opposite sides of the trade is either the result of simply conducting routine business as consumer and producer, or the result of the speculative element in the market and therefore a function of expectations about the future. The $64,000 question becomes: How does one determine whether there is "buying" or "selling" in the market? The answer is the subject of the next chapter.

Chapter 6