Economics of an Electronic Intermediary with Aggregation Benefits

Authors: Hemant K. Bhargava, Vidyanand Choudhary

Electronic intermediaries offer matching services that facilitate establishment of a buyer-seller agreement; and value-added services that either provide a stand-alone benefit or enhance benefits from matching services. This paper analyzes buyer-sided biased intermediaries (to simplify exposition; the results are applicable to seller-sided intermediaries also), and develops economic models of intermediation to examine their pricing and product line design strategies. Intermediaries provide aggregation benefits, and these benefits increase with the size of the network. In buyer-sided markets, the sellers' indirect contribution to the intermediary's revenue, through the aggregation benefit to buyers, gives the intermediary an incentive to subsidize sellers. In the case of intermediaries who provide stand-alone value added services, an increase in the level of the low-quality service reduces the intermediary's profits. Hence the intermediary's optimal strategy is to offer one product with only the matching service and a second bundle of the matching service and high quality value-added services. Intermediaries whose value-added services are useful only in conjunction with the matching function should offer a balanced set of features for matching and value-added services. An increase in service quality increases the surplus of all participants. For very high qualities, the intermediary allows all sellers to participate without any fees.