What drives self-regulation in the nascent P2P “ride-sharing” industry?

First published on IPdigIT.

uber The American company Uber has been all over the news in Belgium over the last three weeks. Uber connects passengers with drivers of vehicles for ride-sharing services; it appears therefore as a typical two-sided platform. As Evans (2011) explains it, a business opportunity emerges for a two-sided (or multi-sided) platform when three conditions are met:

  1. There are distinct groups of customers.
  2. A member of one group benefits from having his demand coordinated with one or more members of another group (i.e., there are indirect, or cross-side, network effects).
  3. An intermediary can facilitate that coordination more efficiently than bilateral relationships between the members of the groups.

Uber meets the three conditions. First, the two groups are passengers and drivers. Second, indirect network effects are clearly present; as one can read on Uber website:

By seamlessly connecting riders to drivers through our apps, we make cities more accessible, opening up more possibilities for riders and more business for drivers.

Finally, drivers and passengers would have a hard time to find each other if they could not use the Uber app on their smartphone. Uber made the headlines in Belgium recently because it first launched its service (UberPOP) in Brussels, then was requested to stop this service by the Brussels authorities, and finally counterattacked by modifying its offering and by making it freely accessible for one week. To justify its decision, the Brussels government invoked the fact that Uber service is illegal because it violates several regulations (the drivers do not pass any exam, they do not follow the tariffs and vehicles do not exhibit the required marks). Brussels is by far not the only city in the world where Uber is in conflict with the regulators (Seattle just added its name to the list today); and the same goes for similar peer-to-peer transport platforms such as Lyft, Sidecar, or Turo. One can easily understand that taxi drivers feel threatened by these new business models, which make it possible for you and me to compete with them. It is thus logical that they lobby their local authorities to have these services shut down. One can also understand that regulators take sides with taxi drivers, not only because a taxi strike is a nuisance that any reasonable city council is glad to avoid, but more importantly because these platforms are relatively new and it is therefore not clear whether they correctly protect the interests of all the parties involved (passengers and drivers). In an excellent piece recently published in the Economix column of the New York Times, Arun Sundararajan explains that the current misalignment between newer peer-to-peer business models and older regulations is dangerous because it may impede economic growth.

This is unfortunate, because the emerging peer-to-peer, collaborative “sharing economy” will be a significant segment of the country’s future economic activity, stimulating new consumption, raising productivity and catalyzing individual innovation and entrepreneurship.

In the face of this “regulatory conundrum”, Arun Sundararajan recommends a combination of self-regulatory measures taken by the platforms themselves and some redesigned government oversight:

The solution is to delegate more regulatory responsibility to the marketplaces and platforms while preserving some government oversight, by creating new self-regulatory organizations like those that have succeeded in other markets and industries. (…) the government should recognize that the new peer-to-peer marketplaces have sophisticated controls naturally built in. (…) The platforms have voluntarily adopted additional nondigital safeguards. (…) Self-policing isn’t a universal panacea. We’ll still need government mandates to prevent effects like congestion, or for, say, providing accessible vehicles and ensuring disaster preparedness — things that markets don’t easily self-provide.

I fully subscribe to this view (and, apparently, so does the State of California as it is the first State that made peer-to-peer transport services legal under a dedicated regulatory framework). As noted above, Uber and the other peer-to-peer transport services are typical examples of two-sided platforms. I have already explained in a previous post that

On such platforms, intermediaries have to design various strategies to induce agents on both sides to participate. This might be tricky because of the “chicken-and-egg” problem that pesters all these platforms: to attract one group, you need to attract the other one, but were should you start?

A first role of these platforms as intermediaries is thus to act as platform operators by providing a platform where passengers and drivers are able to interact. Yet, a precondition for having both sides on board is that they can trust each other, which is far from obvious in the presence of asymmetric information. Hence, the intermediaries must also play the role of trusted third-parties; that is, Uber, Lyft, Sidecar and the likes must act as certification agents, mainly by revealing information about the drivers’ reliability or quality. They do so through reputation systems and active supplier screening; another cooperative initiative in this direction is the Peer-to-Peer Rideshare Insurance Coalition, which aims “to build a foundation of insurance best practices, policies and information for P2P Ridesharing.”

trust

Source: creatinemarketing.com

If they want to be considered as trusted intermediaries, platforms have to become bearers of reputation and effectively certify the quality and reliability of the drivers that they take on board. It is indeed in the platforms’ best interest to screen drivers carefully so as to keep only the high-quality ones. Why? Because a driver selected by the platform is believed to be of high quality by a passenger unless she previously experienced low quality of some other driver contacted through the platform. Hence, to avoid any stain on its reputation, the platform will directly discontinue the operation of low quality drivers. Understanding that, drivers do not find it profitable to provide a low quality service, implying that only high quality services are eventually provided on the platform. In a nutshell, the platform can be trusted simply because it suffices to have one rotten apple in the bag to spoil the rest of them in no time, something that a two-sided platform simply cannot afford. As many Internet-based platforms share this problem of establishing trust, I would like you to find and discuss some specific mechanisms that they put in place in order to achieve this goal.

Do you believe in sharing or in owning? Do you rely on commons or on private property?

First published on IPdigIT.

An article in the Financial Times (Tim Harford, ‘Do you believe in sharing?’, F.T., August 31/Sept. 1 2013) reminds us of an eternal debate: shall we believe in the ability of humans to adequately share and reasonably use the resources offered by our planet? Or do we have to define property rights so that over-consumption of natural resources, such as fish in the sea, is avoided?

That all persons call the same thing mine in the sense in which each does so may be a fine thing, but it is impracticable; or if the words are taken in the other sense, such a unity in no way conduces to harmony. And there is another objection to the proposal. For that which is common to the greatest number has the least care bestowed upon it. Every one thinks chiefly of his own, hardly at all of the common interest; and only when he is himself concerned as an individual. For besides other considerations, everybody is more inclined to neglect the duty which he expects another to fulfill” (Aristotle)

The outcome is crucial for solving various environmental problems, including probably the most ever challenging issue for mankind: how to address climate change?

tragedy_of_commons

 

Relying on commons might be suicidal. So goes “The Tragedy of the Commons”, a seminal article of Garrett Hardin from 1968 (see here). The tragic story is about a common pasture that everybody can use for grazing livestock:

“It is to be expected that each herdsman will try to keep as many cattle as possible on the commons…the rational herdsman concludes that the only sensible course for him to pursue is to add another animal to his herd. And another; and another… But this is the conclusion reached by each and every rational herdsman sharing a commons. Therein is the tragedy. Each man is locked into a system that compels him to increase his herd without limit–in a world that is limited. Ruin is the destination toward which all men rush, each pursuing his own best interest in a society that believes in the freedom of the commons.”

For Hardin, the ruin of the commons is inevitable as individuals cannot internalize the negative consequence that their consumption might have on the resource. But society could find a way out and establish private property rights.

In addition, in a state of commons free for all to use, no one has the incentive to invest in cultivating the land and assuring its long-term sustainability. Because of the lack of exclusivity, there is under-investment in the production. The existence of this negative externality of the market requires the State to intervene, for instance by mandating some enclosure of the commons.

Not everybody would buy the idea popularized by Hardin’s article. One of his most tenacious opponent won the Nobel prize for economics in 2009: Elinor Ostrom. For her, “The tragedy of the commons wasn’t a tragedy at all. It was a problem – and problems have solutions” (T. Harford in the F.T.). Ostrom found that, all over the world, similar environmental problems were solved, again and again, by local communities. For instance, she found that the Swiss farmers of the village of Törbel, in the 13th century, had developed a system of rules, fines and local associations to avoid the over-utilization of Alpine pasture and firewood. In other regions, a lottery system had been designed to adequately allocate the rights to fish. Far away from the grand theory of Hardin that she openly opposed, Ostrom discovered many instances throughout the world where a bottom up approach had developed an effective monitoring system, graduated sanctions for those who break the rules and even some alternative dispute-settlement mechanisms.

Ostrom died last June, but her encouraging message remains. Especially in relation to climate change, a global problem for which global responses are tried, without much success, at regular meetings under the auspices of the UNFCC (already the acronym of this United Nations Framework Convention on Climate Change is scary!). Ostrom believed that focusing on those global agreements was a mistake as the common pool problems are too complex to be solved from the top down. And what about enforcing those global instruments without the support of local communities?

commons588px

 

Now, is the ‘tragedy of the commons’ something useful for the justification of intellectual property rights? Hardin’s seminal article focuses on the rights in land. Is it justified to apply his analysis to intangible or informational goods? There is a compelling argument already put forward by H. Demsetz in a leading article of 1967:

“Consider the problems of copyright and patents. If a new idea is freely appropriable by all, if there exist communal rights to new ideas, incentives for developing such ideas will be lacking. The benefits derivable from these ideas will not be concentrated on their originators. If we extend some degree of private rights to the originators, these ideas will come forth at a more rapid pace” (Toward a Theory of Property Rights).

Here are the questions:

  1. Do you believe that most creations protected by intellectual property rights would not exist without those rights? Can you give examples? Are there some types of intangible goods that would probably never come to the fore?
  2. There are at least two main differences between the commons in land and the “commons in ideas”, what are they? How would you call the commons in the area of ideas?
  3. Those who advocate the commons for ideas and criticize the “second enclosure movement” (resulting from the creation of IP laws) believe that there is no need to provide additional incentives to create. Is this convincing in the field of copyright? What other interests would not be protected if no copyright (IP) exclusivity would be granted by the law?
  4. Relying on chapitre 10 of the book of B. Coriat (sous dir. de, Le retour des communs, Les Liens qui libèrent, 2015) authored by S. Dusollier, can you explain how copyright rules tend to weaken the public domain? Can you give three examples?

These are just a few questions to think about in order to further compare the ‘proprietary’ approach with the ‘sharing’ approach of the commons.

 

 

 

Online banking, switching costs and competition: a complex story

First published on IPdigIT.


(Updated February 7, 2013)
In an article published in October 2012 in the New York Times, Nelson D. Schwartz suggests that online banking creates switching costs and, thereby, reduces competition in the US banking sector. The title of the article summarizes the argument in a forceful way: “Online Banking Keeps Customers on Hook for Fees”. Mr. Schwartz illustrates his point with the following anecdote:

“Tedd Speck, a 49-year-old market researcher in Kent, Conn., was furious about Bank of America’s planned $5 monthly fee for debit card use. But he is staying put after being overwhelmed by the inconvenience of moving dozens of online bill paying arrangements to another bank.”

You probably use online banking yourself to pay your bills, to transfer money across your accounts or simply to access your account information, whenever and wherever it pleases you. You will then agree with me that these services are conveniences that you are willing to pay for. For the sake of the argument, say that you value these services up to 100 euros per year.

Lock and wheel

However, whether or not you have already tried to do so, you can easily imagine the hassle of switching your accounts from one bank to another. On top of learning to use another interface, you might have to create a new list of payees, of direct debits, etc. Again, for the sake of the argument, say that you estimate at 50 euros the value of the time and energy that you would spend when switching online banking services.

Such switching costs clearly put your bank in a strong position. Instead of charging you its online banking services at 100 euros per year (i.e., the value that you attach to the services), your bank can increase the fee up to 150 euros (i.e., the value + the switching costs) without fearing that you would leave. In economic terms, switching costs decrease the price-elasticity of demand; it becomes harder to substitute one service for another, which reduces the consumers’ sensitivity to price increases. Consumers are indeed “kept on hook”.

Yet, does the latter — undisputed — fact necessarily mean that online banking services (and the switching costs they create) reduce competition and make customers worse off? The New York Time article follows this line of argument:

“With 44 million households having used the Internet to pay a bill in the past 30 days — up from 32 million five years ago and projected to reach 55 million by 2016 — it’s a shift that has major ramifications for competition. There’s even evidence that fewer consumers are switching banks, with 7 percent of them estimated to be moving their primary account to a different institution in 2011, down from 12 percent last year, according to surveys by Javelin Strategy and Research.”

Mr. Schwartz sees thus a causal relationship between the increase in the adoption of online banking services, the reduction in the level of consumer switching and lower competition in the US banking sector.

Personally, I would be much more cautious before drawing any conclusion from the previous facts. First of all, as well known in economics, correlation is not causality! Second, I would like you to think about some causal effects that Mr. Schwartz may have ignored or underestimated. In particular, I propose as food for thoughts the following two quotes taken from a report published by the Office of Fair Trading (the competition authority in the UK) in 2003:

“As firms realise that they can price above cost to customers once they are locked-in, then these customers become extremely valuable. As a result, competition can mean that firms price very low, even below cost to attract new customers.”

“If switching costs are very low then prices may adjust to prevent customers from switching. So a low level of switching need not imply that switching costs are high.”

You may also want to look at the current advertising campaign of Deutsche Bank in Belgium, which is precisely focused on switching costs. The ad starts with these words: “What would happen if your supermarket behaved like your bank does?” It then shows a cashier asking customers to pay, on top of their bill, additional charges for renting the shopping trolley, for using the conveyor belt, for not having a loyalty card, etc. The ad ends with this question and this ‘suggestion’: “You don’t accept unnecessary charges in your supermarket; why do you in your bank? Switch now to deutschebank.be.”

(You can find below and here the previous comments on this post; you are certainly welcome to read them but what I am really after is that you form your own opinion.)