Aalsmeer Introduces Electronic Platform for Online Trading - Case Study Example

PROPOSAL ON NEW INFORMATION SYSTEM TO AALSMEER FLOWER AUCTION  Background The largest flower auction center in the world Aalsmeer, is also known as the flower capital of the world. The government of Netherlands has developed good infrastructural facilities in this center to cater to the marketing, warehousing, transportation, financial and communication needs of the centre.  It is said the flower auction building is the largest commercial building in the world.  Flowers are associated with weddings, sports, birth days, Valentine’s Day, funeral and number of occasions, representing culture and tradition.   To understand the importance of the business and its reach, it is important to analyze growing importance of ‘flowers’ in the international trade.  In fact in air travel there are certain routes referred to as ‘flower traffic’.    According to Dr. Terri W. Starman, Associate Professor, Department of Horticultural Sciences at Texas A&M University, in 2000, the wholesale value of the global flower market came to $24.68 billion, which translated to a retail value of $77 billion (Seideman P, 2004.) 14. Surprisingly, agriculture has been the leader in derivatives market volume with a compound annual growth rate of 29 percent between 2001 and 2005.7 In general, the most successful commodity operations have taken place in countries with the fastest economic growth such as China and India. …   Scope Within the floricultural value chain, growers are the initial suppliers. Demand comes from exporters, importers, wholesalers, cash and carry stores, and retailers. Within this chain, auctions play a mediation role - they bring together suppliers and buyers and so determine prices. Ever increasing floral trade, perishable nature of the product, emergence of new suppliers and new types of customers, changes in distribution patterns, customers’ preferences, etc. have brought about multifarious changes in the industry.  There is a need for breaking large consignments from growers into smaller amounts for buyers, and meeting the requirements of the retailers who are concerned about the tastes and fashions of the customers. According to Armellini, "There certainly has been a big change in the market in the last 10 years, " (Seideman 2004) Therefore, the focal point of the international flower trade, Aalsameer has to continuously improve the standards of infrastructural facilities and the information systems to meet the growing needs of trade as a part of their survival strategy, and maintain its leadership in the industry. Commodity exchanges in various countries are thriving well, though their reach is not international, and restricted to the indigenous needs.  Infrastructural facilities including transportation and warehousing are in place for the smooth functioning of the exchanges.  Information technology is the back bone for these exchanges.   Communication is blended into the operation of the business. Methodology It is in this backdrop, the paper considers the development of the new information system. As per the guidelines given by the board ‘the initial objectives of these e-business activities were to enable innovation, redefine the value chain reduce transaction costs, strengthen the link with wholesalers and retailers, and to increase market share.’ Identification and development of a new information system depends upon several factors that could be broadly divided in to communication specific and operation specific.   These factors are also inter-dependant, and not exclusive to each other.  The criteria in the selection process, requirements and implementation aspects are analyzed.   The technology used should be flexible enough to cater to the growth and expansion needs in future.   Technology involved for the information, communication and operation converges, and this convergence card should be effectively played for the optimum and efficient utilization of the resources. This option is also considered and analyzed. System Management The Board is of the view that ‘three developments threatened the comfortable position Aalsmeer. 1) The emergence of alternative, electronically driven flower markets. 1) The auction met the needs of growers, but not those of retailers. To satisfy changing consumer tastes the retailers asked for fresher products, more varieties, smaller quantities and multiple deliveries each week. They felt demand should have more influence on supply. 2) Mergers and acquisitions among retailers increased their size and power. At the same time growers became more professional, which led to a more formal way of doing business and interest in new, perhaps electronic, ways of selling.’ In view of the above situation, any system that is proposed in connection with the new information should take into account the above aspects, and integrate the proposal to meet the challenges that Aalsmeer face in this respect. Also, the system should be effective in maintaining the leadership of Aalsmeer in flower trade by providing facilities to growers and retailers worldwide. Projects differ according to size, budgetary guidelines, priorities of the project, decentralization factor, and interface with the regulatory authorities, priorities in implementation, etc.  In the present case, System management involves the following important aspects. Nature of Trading:  Flowers being perishable commodity time, consequently time is an important denominator in all the activities of the trade.  Therefore, any system which is proposed to be installed should take into account these two important issues.  Speculation and hedging volumes, especially after the introduction of futures, constitutes major portion in the total trading volume of the commodities as in the case of equities. The price discrepancies attract arbitraging. Speculative activities and arbitraging increases liquidity, and aids hedging and price discovery process. Method of trading:  Trading on the floor of exchange has become history after Nasdaq came into existence. The trading on the floor of the exchange has become extinct for all practical purposes throughout the world.  Similarly the advent of ebay has rewritten the concept of ‘Auction’ in the world.  The trading community has reconciled to the changing environment and swiftly embraced the new technologies and developments. Commodities traded:  More and more commodities are brought into the trading list.  The new gradation and certification techniques enable the exchanges to standardize the commodities into the predetermined grades.  This enables trading in these commodities without any scope for disputes with regard to quality. Settlement of the transactions:  Electronic trading and clearing facilities makes the settlements easier.  Trading in commodity futures are settled in physical delivery or cash settlement.  Futures are standardized with reference to market lot, quality or grade of the commodity and period.  The prices may vary for the same commodity of the same market lot and grade, if the periods covered are different.  There are derivative ‘option’ products of calls and puts at different strike prices.  Therefore, permutations and combinations offer varieties of options in trading, and the markets are becoming deeper and wider in nature.  Margin requirements:   Levy of margin is a risk management tool to curtail over speculation in the commodities. Over speculation makes the commodity prices more volatile. Chandrashekhar G explains To safeguard the integrity of the market and its own interest, the exchange imposes what is called margin money. Different types of margins imposed on futures contracts include Ordinary/Initial margin; Mark-to-market margin; Special margin; Volatility margin; and Delivery margin. The purpose of the margin is to minimize the risk of default by either counter-party.  Other than the ordinary or initial margin, other margins are ad hoc measures to cool down the market activity in a particular or group of commodities. Delivery-in and delivery-out: In the case of physical deliveries, warehousing plays an important role, and the delivery-in and delivery-out should be recorded and updated online. Warehouse receipts or other documentations are standardized with reference to the procedural requirements of the industry, banks, financial institutions and other agencies involved.  Clarity and absence of ambiguity in documentation are the essential requirements in this process.  Project overview The concept of flower labeling, standards and certifications in the industry is growing and paving way for futures trading in the business.   ‘A California organization has begun offering a certificate of good farming practices called "VeriFlora." … Traders developed futures contracts, selling bulbs that were still in the ground, flowers that hadnt bloomed yet. Prices climbed and whats now called tulip-mania took hold.’  (CBC News 2007).   Chicago Mercantile Exchange offers wide range of commodity derivatives.  It includes Futures and options of grains, livestock, oilseeds, dairy, lumber, and other products, and traded around the clock on the CME Globex electronic trading platform.    If there is one center which is capable of introducing ‘futures’ in flowers successfully, it is Aalsmeer.  Futures could be introduced in select flower items initially, and the portfolio could be expanded slowly over a period of time as it is happening elsewhere in commodity exchanges.  We feel this is a pertinent issue for the discussion because, when we are planning to introduce new information system, all the future developments should be taken into consideration.  Aslsmeer should pursue various alternative courses to meet the emerging competition and challenges, and its outlook should be global in nature in this respect. Already there are signs of changes and consolidations taking place elsewhere in the industry.  ‘World Commerce Online and Eliance Corp. said they entered a strategic relationship to enable flower growers and wholesalers around the world to buy and sell fresh cut flowers online via Worlds FloraPlex system.’ (internetnews.com, 2009). The growth of Commodity exchanges in the developing countries is also phenomenal, and the time is ripe for Aalsmeer to go global by seizing the opportunity and use the awareness of the growth and developments in commodities trading already created in these countries.  ‘The multi commodity exchange of India (MCX) has launched the exchange of futures for physicals transaction facility for the first time in the Indian commodities market’ (Business Standard, 2009)  Project Implementation  The strategy involves development of the online information system covering online trading, online reporting, risk management mechanisms, back office operations with online instruction facilities to the members, warehouses, banks, depositories, clearing houses, etc. and reporting system for regulatory compliance, etc.   Efficiency in trading, transfers and movement of the consignments are dependent upon the transactions taking place in a seamless manner among the following points:   Bank account – Clients Account – Members Account – Dematerialized Account – Physical Deliveries  Modus Operandi:  When a client placed an order to buy a commodity with the broker, who is a member of the commodity exchange, the system verifies the amount available in his bank account linked to the system.  When the requirement is covered with balance available in the client’s bank account, the order is executed and his account debited simultaneously, and on delivery his commodity account is credited with the quantity of the commodity bought.  Similarly for sale, the stock in his account is verified and the sale order is executed and simultaneously his commodity account is debited with the quantity sold.  On the payout day as per the settlement, his bank account is credited with the sale proceeds. The above example is simplified for better understanding with certain assumptions.  Actually, in the commodity exchanges futures are predominantly traded.  For example, in the Indian Commodity markets earlier there was no option for physical delivery at all initially, but introduced only later.  ‘. .. only a relatively small percentage of LME contracts actually result in delivery, as the vast majority of contracts prove to be hedging contracts bought or sold back before falling due for settlement.  As a result, the deliveries that do take place either in or out of warehouse will reflect the physical market demand and supply…’ (London Metal Exchange, 2010) The transactions are carried out by paying margins rather than by payment of full consideration, and the differences adjusted on settlement.  Therefore, the clients’ accounts are debited to the extent of margin requirements or credited on reversals.  The debits or credits on account of losses or profits respectively to the clients’ accounts take place on settlement. For the purpose of analysis with regard to the development of new information system, the system is broken down to several modules and the modules are integrated to establish cohesiveness and seamless interaction.   Though the detailed systems analysis is beyond the scope of this paper, major modules covered are given below:   1. Trading:  Trading involves buying and selling. We consider a platform compatible with futures trading also.   Flowers - Physical  Flowers - Futures  Price data and charts (for Regular trading & Futures separately, here and in other modules)  Connectivity to Members - Dealers codification – for execution of trades: This is the primary module establishing link to all the clients through the members of the exchange, and to the exchange.   2. Back Office Operations: Back office operation means all other activities involved in the business other than actual trading, (i.e. bids and offers or buy and sell) which are mostly the consequences of trading in the primary module.  Risk management tools –  Exposure – Limits Margin requirements (various types of margins for various commodities and for varying periods) –  Mark to market debits and credits Depository – Warehousing – Warehouse Receipts - Stock Statements and movements  Warehouse receipt is a legal document and its accounting is very important. ’A warehouse receipt is a legal document of  title that shows the quantity and quality of commodity sitting in a secure warehouse facility licensed and regulated by the Uganda Commodity Exchange under the Warehouse receipts systems act 2006’ (Uganda Commodity Exchange) Clearing House operation –  Banks – Financial institutions  Instructions – Members – Clients – online transfers of payment, consignments  Contract Notes, Debit or Credit Notes, Statements  3. Others:  Other than trading and back office operations there are multifarious activities involved with reference to dissemination of information, functioning of the exchange or auction house, other details related to trading, information about arrangements with the warehouses, financial institutions, statistical information, archives, messages for the members, investor education, exchange timings, holidays and so on.    Notifications – Record dates, Settlement details, government notifications, trading limits, margins.   Voice recording - scanning  Documentations and compendium  Documentation is important in any system and hence organizing and updating the collected information for later retrieval on a continuous basis is very important.  Fundamental Principles:  The fundamental principles are based on the conventional wisdom.  Guide to the System Administrator  User Manuals  Installation Guide  Customization Guide  Checklists   Means of storage CD-Rom, HTML, Backup, etc.,  Means of External storage   Indexing:  The documents must be indexed for easy referencing and retrieval.   Basic Requirements: A good system facilitates,  Timely reporting  Referencing  Process: Storage with types, categories, chronological listing/alphabetical listing or both for major and subsidiary headings for locating the data with minimum efforts    The number of users at any given point of time depends on so many factors.  Therefore, the access to the system should not be hampered by the number of users.  In fact this is the major advancement in the evolution of the information technology.  ‘Multiple Users’ or ‘Multiple Access’ is one of the most important features of the developments in the information technology.    Security: Needless to elaborate under the conditions of multiple users, security is an important factor in the gamut. Access only to the authorized personnel, with minimum number of steps involved, without any delay and incorporating checks to avoid misuse, is a very critical issue as on date.  The latest techniques use various methods including thumb impressions, voice recognition and so on. Risk Management Risk management assumes greater significance in the implementation, if the system of trading is switched to online and with the introduction of derivatives.  There are two important issues in this connection.  The first one is security factor involved in the process.  The second and the important issue from the long term point of view is disaster recovery management.  In other words, there should be business continuity plan.  A business impact analysis considers financial as well as intangible implications and justifies the required course of action.  The measures involve prevention, detection and correction.  Some of the exchanges plan for back up sites to continue the operations without any break, considering the importance of time value in the business. Evaluation of the effectiveness of an information system for its users The system proposed introduces an element of convenience in trading both for the growers and retailers. On line transactions saves time, eliminates human errors and avoids ambiguity both for the growers and the retailers. The price recovery process would be efficient in the proposed system. When the size of the market lot is fixed for the online trading system, the aspect of breaking up of the bulk consignments into smaller lots is taken care of. Options Apart from establishing infrastructure and new information system in this regard on its own, it can also enter into strategic alliance with the leading commodity or stock exchanges which have expertise in derivatives markets as well.  However, there are many drawbacks in this option due to its dependence on an external agency.   In spite of this alliance, the Aalsmeer in any way has to revamp its information system because, in the new strategy warehousing, transportation and communication would be global in nature, and effective control could be established only when the entire system is in complete control of Aalsmeer.   This is because, in this changed scenario warehousing near the growers and the users, consequently transportation arrangements for transfers from warehouses to warehouses comes into picture.  However, these predictions are beyond the scope of the present study.  But, its implications on information system are needed to be considered.   Assumptions  We assume that the Aalsmeer introduces electronic platform for trading online. Irrespective of some technical differences, the ‘Auction’ in the lines of Ebay and online trading in commodities are similar in nature.  The proposal is made for a new information system replacing the existing system with suitable provision for online trading.  The system also takes into account the introduction of futures, consequently warehousing and transportation, in order to strengthen and develop the business, but keeping the options open for up-gradation in the event of the management taking decisions in these lines.   Transition   The System to be installed should take into account all the above factors keeping in mind the problems associated with the transition phase.  Smooth transition from the existing system to new system without affecting the regular activities is of paramount importance.  It is like maintenance of blood circulation in the body when surgery in heart is undertaken. Proper training to the staff, dissemination of information to all the parties and agencies connected to the business should be planned well in advance and set into the motion. Conclusion The information system proposed should be sound and balanced with reference to the following, considering the assumptions made in the proposal. The existing Document Management System should be integrated with the new system or replaced in phases without affecting the current operations. Disaster recovery plan should be finalized with foolproof arrangements made for continuity. This is only pilot study to give a bird’s eye view of the situation, and the recommendations preliminary in nature. The decision of the management with regard to its firm future business plan, financial backup with budgetary allocation, decision on implementation of electronic trading system and introduction of futures, geographical spread, etc. are very important for selection of the suitable technology, configuration of the equipments and detailed systems analysis for implementation. References Tony Seideman, 2004, Reference: Despite Globalization Traumas, Flower Industry Blooms, viewed 8April 2010, http://www.worldtrademag.com/Articles/Feature_Article/4e61cf5149af7010VgnVCM100000f932a8c0____ Chndrashekhar G, 2007, Role of margin money, The Hindu Business Line Newspaper, Aug 05, 2007             CBC NEWS, 2007, Flower power: A blooming movement for change, viewed 8April 2010, http://www.laborrights.org/creating-a-sweatfree-world/fairness-in-flowers/news/11037   World Commerce Online, 1999, FloraPlex Partner With Eliance, http://www.internetnews.com/ec-news/article.php/33321   Ravi Muthreja, 2007, MCX Coffee Robusta posts record Physical Delivery of 120 tonnes, India PRwire, http://www.indiaprwire.com/pressrelease/food/200704052462.htm UGANDA COMMODITY EXCHANGE, Uganda Commodity Exchange and Uganda Coffee Development Authority Joint Press Release, http://www.docstoc.com/docs/27286357/UGANDA-COMMODITY-EXCHANGE/ London Metal Exchange, 2010, Warehouse approval -  physical delivery of LME contracts, http://www.lme.com/what_warehouse_physicaldelivery.asp   Business standard, 2 Dec 2009, MCX launches Futures with physical delivery UNCTAD, Market information in the commodity area, http://www.unctad.org/infocomm/exchanges/ex_overview.htm COMMITTEE ON COMMODITY PROBLEMS, 2007, COMMODITY EXCHANGES AND DERIVATIVES MARKETS, EVOLUTION, EXPERIENCE AND OUTLOOK IN THE CEREAL SECTOR, http://www.annberg.com/papers/UN-FAOC-Paper.pdf Read More