The Impact and Implications of On-Demand Services on Market Structure

This paper considers on‐demand services and its impact on market structure, firm profitability, and consumer welfare. The unique properties of on‐demand services are the conversion of fixed costs to variable costs, removal of capacity constraint, and fast setup time (which enables quick entry by any firm at any time when there is opportunity), whereas privacy and security concerns and switching costs have been noted as the biggest barriers from adopting on‐demand services. With a stylized model capturing these benefits and barriers to using on‐demand services, we establish several results. First, we show that conversion of fixed cost to variable cost enables new and small firms to enter existing markets and leads to the creation of new markets. Second, we show that competition and the threat of new entrants can be an important driver of a firm's decision to switch to on‐demand services. In addition, a firm's barriers to using on‐demand services can influence another firm's entry decision. Third, we show that two identical firms may employ different technologies in equilibrium. Fourth, we show that fast setup time and removal of capacity constraint associated with on‐demand services make it impossible for firms to make supranormal return and would lead to a perfect competitive market, even when there is only one firm, under very general conditions. Such a result still holds even when there exists an economy of scale (e.g., quantity discount) from using on‐demand services. On the other hand, when there are barriers preventing firms from offering similar products and products are substantially differentiated, on‐demand services can amplify this advantage of entry barriers by enabling firms to further increase prices and enhance their profitability. Therefore, contrary to the common belief that offering on‐demand services is best for firms offering commodity products, we show on‐demand services to be more profitable for firms with differentiated products.