Opinion | An online platform’s low-price strategy need not be predatory | Mint
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Business News/ Opinion / Views/  Opinion | An online platform’s low-price strategy need not be predatory

Opinion | An online platform’s low-price strategy need not be predatory

Such a business could be using low prices as a way to crack a chicken-and-egg problem and gain a critical mass for viability

Photo: Ramesh Pathania/MintPremium
Photo: Ramesh Pathania/Mint

We have a minister who, whilst welcoming Amazon’s investments in warehousing, has suggested its pledge to invest $1 billion would fund losses resulting from predatory pricing. In this context, it is worth pointing out that for two-sided online platforms such as Uber and Amazon, prices offered below marginal cost do not indicate predation.

Platform markets are characterized by the presence of externalities such that the value of the platform to a user from one side of the market increases in the presence of actors from the other side. What ride hailers care about is having more drivers on the ride-finding Uber app, as that increases the chances that a cab will be available nearby. Such a phenomenon makes the service more attractive to people using the ride-hailing app and shifts the app’s demand curve outward. Similarly, drivers benefit from more users of the app. More cabs on Uber’s platform means more riders, and more riders means more cabs.

If there are not enough users on one side of the platform, participants on the other side will not join, and this might lead to its membership eroding to zero on both sides because of a lack of critical mass. Below-cost prices are thus used to generate a surplus by attracting those users on one side of the platform who provide the greatest benefits to the network of other users on the other side. Such price structures may grant greater market share to a firm, but a price below marginal cost cannot be considered predatory. Negative margins, or subsidies, may be necessary to overcome the starting chicken-and-egg problem by convincing one group of agents to join the platform when they hold pessimistic expectations on the participation of the other. The losses on that side of the market must then be recouped much later, once demand on both sides has stabilized.

An inability to fathom the nature of two-sided platforms has resulted in policies that are distortionary. Some time ago, regulations were introduced that restricted foreign-owned platforms from selling inventory from their own subsidiaries. Platforms were reduced to pure marketplaces , where suppliers sell directly to buyers via a platform, and faced restrictions on reselling products from subsidiary suppliers to buyers—the inventory model of platforms. In reality, e-commerce intermediaries make choices between these two set-ups. Amazon began as a pure reseller of books and held inventory, but now operates as a marketplace as well. Netflix operated as a reseller, but now also produces its own films and TV serials. Zappos, the leading online shoe retailer in the US, began in 1999 as a marketplace, but then turned into a pure reseller by the mid-2000s.

We see this in brick-and-mortar department stores as well. Department stores such as Shoppers Stop offer cosmetic products through dedicated counters where sales staff are exclusively assigned and displays are designed by individual brands—a marketplace organizational form. Other products such as mass-market products are serviced by generalist sales personnel in the store operating in its reseller/inventory mode. When a brand has specialized knowledge of how its products are to be marketed that is not easy to transmit to retailers, then it operates in the marketplace as a direct seller. When there are marketing activities that generate spillover effects across products, then coordinating their sale and delivery for the same consumer creates value for the latter. This also results in the inventory model of delivery.

In platform markets, if more suppliers attract more buyers-per-supplier, and if expectations are low of the participation of those on the demand side of the market, then, operating as a reseller in the inventory mode allows a platform intermediary to skirt the chicken-and-egg problem that is endemic to early-stage platforms. Platform intermediaries such as Amazon do much of the legwork for retailers, such as help them upload product descriptions, fill out tax forms, handle phone orders on their behalf, and pick up, pack, as well as deliver using durable packaging. It is not for policy to pronounce that a platform should not run in the inventory mode. It should be left to the intermediary to decide on its operational mode as a business decision, keeping in mind the internalization of spillovers from one side of the market to the other, and the need for a critical mass of participants to make the platform viable.

The Confederation of All India Traders and other like-minded organizations have caught the attention of policymakers. It is worthwhile to recall that India had a policy of small-scale reservations that was implemented in the belief that it would generate employment. The economic reality, as last year’s Economic Survey pointed out, is that small firms find it difficult to sustain employment and that large firms via economies of scale are the better source of employment growth. The economic potential of the country was set back by many years because of that faulty policy.

Errol D’Souza & Astha Agarwalla are, respectively, professor, IIM Ahmedabad, and associate professor, Adani Institute of Infrastructure Management

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Published: 22 Jan 2020, 09:34 PM IST
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