Pricing and Product Design: Intermediary Strategies in an Electronic Market

Hemant K. Bhargava, Vidyanand Choudhary, and Ramayya Krishnan
International Journal of Electronic Commerce,
Volume 5, Number 1, Fall 2000, pp. 37.

Abstract: Electronic intermediaries play an important role in many Web-based electronic markets, adding value for participants by offering such services as matchmaking and trust. This paper presents an economic model of intermediation where the intermediary offers services to two types of actors: consumers and providers. When consumers are heterogeneous, differentiated by their willingness to pay for intermediation, the intermediary can potentially offer two (or more) levels of service quality to target different consumer segments. The analysis in this paper highlights the aggregation benefit that consumers derive from having access to multiple providers through the intermediary. According to prior research on vertically differentiated digital goods, it is optimal to offer only one quality level in the market, because segmentation causes cannibalization and lowers profits. In the case of intermediation, however, the aggregation benefit makes it optimal for the intermediary to offer both levels of service. The intermediary’s profits increase when the quality of the lower-quality service is decreased, suggesting that the two quality levels should be differentiated as much as possible. If the aggregation effect is intense, the intermediary should make the service free for providers.

Key Words and Phrases
: Electronic markets, intermediation, price discrimination, pricing of software services, network effect, vertical differentiation.