The Simple Economics of Hybrid Marketplaces

• Citation: Vol. 30 No. 2
• Publication year: 2020
• Author: By Neil Dryden, Sergey Khodjamirian, and Jorge Padilla

THE SIMPLE ECONOMICS OF HYBRID MARKETPLACES

By Neil Dryden, Sergey Khodjamirian, and Jorge Padilla¹

ABSTRACT

This article explains that that the decision of a marketplace to operate its own reseller in competition with third-party sellers within the platform is likely to spur competition to the ultimate benefit of consumers. A marketplace will profit by supplying directly as a reseller when that duality is needed to (a) achieve selection parity with other distribution channels and/or (b) prod third-party sellers to compete more aggressively. The success of a hybrid marketplace (i.e., an online business that is both a marketplace and a reseller operating in that marketplace) may require it to support its retail operations in order to increase the appeal of its store vis-à-vis other stores. The effect of such strategy on the incentives to innovate of other sellers in the marketplace is in principle ambiguous but the available evidence suggests it may be positive.

KEYWORDS: antitrust, business models, hybrid marketplaces, regulation

JEL CODES: K21 (Antitrust Law), L13 (Oligopoly and Other Imperfect Markets), L40 (Antitrust Issues and Policies: General)

I. INTRODUCTION

Several authors and policymakers have expressed concern that a "platform"² that is both a service provider or a seller and an intermediary for other service providers and sellers may infringe the competition laws if, as an intermediary, it enjoys a dominant position and favours its own service provider or seller.³ Some have even proposed that dominant platforms be prohibited from adopting so-called "dual" or "hybrid" business models and demanded the structural separation of the most prominent digital platforms.⁴ This proposal is based on the belief that such duality creates a conflict of interest that can be exploited to further entrench the platform's alleged dominance, thwart competition, and stifle innovation.

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We do not dispute here that discrimination by dominant vertically integrated firms, including hybrid platforms, may distort the competitive process and cause consumer harm in certain circumstances. Instead, our main claim in this article is that not all hybrid platforms are identical. Differences in their business models and the dynamics of the markets where they operate are crucial to understand their incentives and the effects of their conduct. More specifically, we explain that e-commerce platforms (or "marketplaces"), which sell products and services to consumers, have no incentive to marginalise firms that distribute through them, restrict competition and/or thwart innovation by such firms.

Marketplaces seek to increase the volume that is sold through their stores over long periods of time. Such volume increases when consumers can find a wide selection of products at competitive prices upon visiting the store. However, third-party sellers using the marketplace to distribute their products may not have the incentive to offer as many varieties through that store as they do through other channels and, especially, their own direct distribution channels (their physical or online stores). Also, they may not have incentive to price competitively the varieties sold through the marketplace, especially when they possess market power. Likewise, they may not provide the right product quality or may fail to deliver promptly and satisfactorily the products acquired through the marketplace.

Firstly, distributing directly may save third-party sellers some commissions: not only because commissions are not paid on their own direct channels, but also because the simple existence of this channel may work as a credible outside option that naturally balances the bargaining power in favour of third-party sellers.⁵ Secondly, marketplaces increase consumers' ability to compare price and non-price terms and, therefore, may encourage greater competition. High prices, low quality and insufficient product variety reduce the marketplace's volume and profit.

Marketplaces may increase transactions and profits by adopting a hybrid business model, i.e., supplying directly as resellers in their platforms, adding the missing varieties with the aim of achieving selection parity with other distribution channels, and pricing competitively to make sure that its customers can see the best deal.⁶ They may do so by selling third-party brands through their own reseller arm or by selling their own (private) labels. However, this strategy may succeed only if the marketplace's own reseller arm is able to complement the marketplace's portfolio of product offerings by adding products that are sufficiently attractive to consumers.

Arguably, the marketplace's efforts to increase the appeal of the products or services offered by its reseller arm may be regarded as discriminatory and anticompetitive. However, that interpretation is in our opinion incorrect. Firstly, the goal of the hybrid marketplace is not to restrict competition but to make its own marketplace more competitive with other distribution channels. The marketplace enters as a reseller into those product markets where competition is limited, but to do so effectively it needs to offer attractive products at competitive prices without undermining the offers made by third-party sellers operating in the store. Secondly, consumers benefit from lower prices, higher quality and greater variety. Thirdly, a third-party seller's ability to innovate need not be diminished since the marketplace's entry only seeks to promote the success of the platform (which in principle could increase the third-party seller's profitability and, therefore, its incentive to invest in its product portfolio). Fourthly, increased competition increases the sellers' incentives to invest and, thus, consumers also benefit from more and more disruptive innovation. Finally, entry by the marketplace's own reseller arm expands the marketplace's customer base, which, in turn, incentivizes new sellers to join and existing sellers to invest in innovation.

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These findings have implications for policy. Hybrid marketplaces, such as Amazon (or El Corte Inglés in Spain, Selfridges in the UK, Walmart in the US, etc.), enter one side of their platforms with their retail arms to improve the appeal of their range of product offerings and promote their competitiveness with other marketplaces or distribution channels. This is procompetitive and consumer welfare enhancing.

The remainder of this article is organized as follows. In Section II we present three different online business models and investigate, on the one hand, why a marketplace distributing the products of third-party sellers may wish to supply directly as a reseller and, on the other, why a reseller may wish to operate as a marketplace to distribute the products of third-party sellers. In Section III we discuss the incentives of a hybrid marketplace to improve the appeal of its marketplace by increasing the value offered by its own reseller and consider the likely effects of such a strategy on competition and innovation inside its business and across marketplaces. In Section IV we consider an alternative theory—the "value capture" theory—which posits that both the marketplace's entry as a reseller and the potential bias in favor of its own reseller have the goal of free-riding on third-party sellers' efforts and the effect of discouraging innovation by these suppliers and making consumers worse off. We explain why the empirical evidence available to us is much more consistent with the procompetitive theory advanced in Section III than with the value capture theory presented in this section. The reason being that in practice the competition faced by marketplaces acts as a discipline device, limiting their incentives and ability to capture value while increasing their incentives to behave in a pro-competitive manner. Section V concludes discussing policy implications.

II. COMPARING ONLINE BUSINESS MODELS

We explicitly consider three different e-commerce business models in this article: the "reseller model," where the firm acquires products from suppliers and resells them to end-consumers; the "marketplace model," where it intermediates between sellers and buyers, and charges one or both sides; and the "hybrid model," where the platform acts both as reseller and a marketplace. The marketplace model is a pure intermediation model, whereas in the hybrid model the "platform" is both an intermediary and a seller.

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A. The Choice of Business Model

There is an extensive literature discussing the pros and cons of the three e-commerce business models described above.⁷ According to this literature, no business model universally dominates the others from a managerial or a social welfare perspective; it all depends on the facts.

One important consideration when assessing their relative profitability, for example, is who is better placed to choose the right way of marketing the product.⁸ It may be the reseller, because it can draw from the experience of selling many different products from many different suppliers. It may be the sellers distributing through an arm's length marketplace, because their products are highly differentiated or even rather unique. Or, if the answer varies from one product to another within the firm's product portfolio, then the right business model may be the hybrid model.

Another important factor to consider when choosing a business model is the possible existence of "cross-product market spillovers."⁹ Do higher marketing efforts for one product affect the demand for other products? If the answer is yes, then it is optimal to choose the reseller model, because the reseller can better internalize those externalities. Resellers may also be more efficient at selling incremental units to consumers due to economies of scale of stocking, distribution and marketing, especially when they are selling a narrow range of high demand products.¹⁰ In contrast, marketplaces may be more efficient when selling...