Economics of an Information Intermediary with Aggregation Benefits

The widespread use of the Internet has led to the emergence of numerous information intermediaries that bring buyers and sellers together and leverage their knowledge of the marketplace to provide value added services. Infomediaries 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 develops and analyzes economic models of intermediation to examine their pricing and product line design strategies. Intermediaries provide aggregation benefits: buyers find an intermediary’s service more valuable if it provides access to more sellers, and sellers value it more if it provides access to more buyers but also when they compete with fewer sellers. Due to this unique combination of network effects, we find that an intermediary has stronger incentives to provide quality differentiated versions of its service relative to other information goods sellers. When buyers have constant marginal valuations for service quality, the intermediary should offer only two levels of service. While it is optimal for the intermediary to offer two levels of service, increasing the quality of the low level service reduces the intermediary’s profits due to increased cannibalization of the premium service. Hence the optimal menu consists of a basic matching service and a premium service that includes matching and value added services. The intermediary’s profits are larger when positive network effects are stronger and lower when negative network effects are stronger.