Designing Online Platforms for Offline Services: the Bigger, the Better?

Leon Chu (University of Southern California)
Brian Wu (University of Michigan)

Abstract: Empowered by information technologies, online platforms enable service providers to offer customized services that Chinese consumers have increasingly desired. Despite its tremendous value-creation potential, offering customized services encourages greater opportunism from the service providers. While reputation-based mechanisms have been proposed to foster trust, their effectiveness is limited by the disadvantageous initial state of the Chinese industries. To address this problem, we propose a novel platform design where, from its inception, the platform deliberately limits the number of service providers below a certain threshold, even if they are homogenous. Without imposing this threshold, the competition among the service providers may lead to a unique equilibrium under which all the service providers shirk. In contrast, by imposing the threshold, the platform may induce a welfare-enhancing equilibrium where (i) the service providers on the platform enjoy higher capacity utilization than those outside and are motivated to exert effort by future concerns, and (ii) customers prefer service providers on the platform and are willing to pay a premium. We evaluate the implications of our proposed approach on platform profitability, specifically by comparing different payment schemes. We generalize the model regarding imperfect monitoring signals and the entry and exit of service providers. Our work sheds new light on how platform design can help reduce market frictions in economic exchanges and potentially influence the evolution of industries.

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