The role of intermediaries in the collaborative consumption economy

Sharing is a fast growing multi-billion dollar business. Firms like AirBnB, the global accommodation matchmaker, and share a ride company Uber, have demonstrated that collaborative consumption is both a viable business model and a lucrative one. Take AirBnB, founded in 2008, for example. With over one million listings in 34,000 plus cities in more than 190 countries, it has become a $20 billion business by enabling peer-to peer sharing of properties.
In many ways, collaborative consumption is the private rental market rewritten. Dispense with cosy notions of people sharing property out of the kindness of their hearts, though. This is about monetizing possessions. Owners make money. Intermediaries make a lot of money.

But how did this happen and why now? How have firms like AirBnB and Uber sparked a revolution in the use of private property, while bilateral private rental markets failed to expand in the same way? These are questions explored by Thomas Weber, chair of Operations, Economics and Strategy at EPFL, and an expert on the sharing economy, in his paper Intermediation in a Sharing Economy: Insurance, Moral Hazard, and Rent Extraction.

.

Innovating intermediaries

As Weber notes, it is the role of the intermediary that has provided a catalyst for increased use of the sharing model. Using an intermediary solves some of the problems that prevent the private rental market from gaining traction. For example, there is the matching problem. A person seeking accommodation needs to find someone willing to let an apartment in the place where they want to stay, at the time when they want to stay there. When intermediaries attract large numbers of potential renters to their website, it becomes worthwhile for potential lenders to make their property available for hire.

But as Weber shows, intermediaries also help solve a more intractable challenge facing host and renter - moral hazard. Generally speaking moral hazard is a situation that may arise when there is unequal information between two parties, and where one party takes a risk while the other party suffers the consequence of that risk taking. Knowing that the host is not watching them (the unequal information) a renter may feel able to misbehave, causing damage. A person hiring a car might thrash the engine and do donuts in the nearest car park.

For someone considering renting out their property short-term a lack of trust and doubt about the moral hazard issue become barriers to making that transaction. Unobserved, renters are less likely to be as careful as the owner or host. The owner could request a deposit, but the potential problems arising from resolution of damage disputes and return of deposit may still deter both owner and renter. The costs of the effort of engaging in the transaction are barriers for both host and renter.

Weber uses game theory to construct a model, mapping incentives, and showing how intermediaries can remove the moral hazard barrier and extract value from the transaction. The example is a host renting out short-term accommodation to a renter, via an intermediary – with the assumption that parties to the transaction are risk neutral, and hotels can be chosen as an external option. Although the example uses accommodation, the results should apply more generally to other types of peer-to-peer sharing.

.

Peace of mind

The intermediary sets the terms of the relationship. The idea is to incentivise renters to behave as if they were an owner. Consequently the intermediary provides what is effectively an insurance contract with a number of distinct elements: a renter's deposit, a surcharge, a minimum claims limit and a deductible.
If the renter damages the host's property above an agreed amount, the intermediary pays the host's claim for damage at the settlement amount agreed, less a deductible. The payment comes from the renter's deposit, and includes a surcharge over and above the claim amount. The renter receives their deposit less any claim amount and surcharge. The deposit amount caps the renter's outlay.

Thus the host is deterred from making spurious small claims. Equally the renter is incentivised to behave like the owner (not cause damage, for example) through having a financial stake in the damage related outcome of their stay - via the surcharge.
With the moral hazard problem solved in a budget-neutral way, the intermediary is free to maximise the value it extracts by charging commission on both sides of the transaction for services rendered: matching host and renter; codifying the process for host and renter by applying recommended rules and procedures; and removing the moral hazard barrier though insurance.
All parties benefit. Hosts extract value from property that would not otherwise have been rented. Renters gain both choice and a cheaper option than hotel alternatives. Intermediaries extract value from both hosts and renters for the services they provide. Society as whole may even benefit from more efficient use of economic resources.

In the long run, as Weber notes, other trust mechanisms such as, host ratings, and public comments, may increase the quality of information available, promote good behaviour, and render removal of the moral hazard barrier less important. But as Weber shows, it is the intermediaries' ability to solve market problems that has created a game changing revolution in property ownership and use.

.

Weber, T.A. (2014) "Intermediation in a Sharing Economy: Insurance, Moral Hazard, and Rent Extraction," Journal of Management Information Systems, Vol. 31, No. 3, pp. 35--71.