Capacity Expansion in Service Platforms: Financing vs. Employment
47 Pages Posted: 20 Apr 2020 Last revised: 20 May 2021
Date Written: May 11, 2021
Service platforms are now ubiquitous in industries such as ride-hailing, food delivery, and accommodation. Different from traditional business models where companies directly offer services, platforms connect consumers to independent service providers who own the asset capacity required to deliver the service (e.g., cars suitable for ride-hailing). Platforms seeking to expand their services have therefore trialled different mechanisms to attract prospective providers who do not yet possess the requisite assets. This paper examines the viability and relative performance of two such mechanisms. Under platform financing, the independent providers invest in assets using loans from the platform; subsequently it sets the service wage, and the providers decide whether to serve the platform. Under employment, the platform itself invests in asset capacity and offers the providers an exclusive employment contract. We compare these approaches using a game-theoretic model consisting of a platform, its existing providers, and potential new providers with uncertain labor productivity and outside options. We find that relative to conventional bank financing, simple platform financing with an interest-only loan fails to benefit the platform or the service providers unless the asset investment cost is very high. By contrast, more sophisticated platform financing with terms linked to on-platform activities can greatly improve platform profitability and efficiency even for lower investment costs. Compared to financing, the platform prefers employing providers when the investment cost is low, market demand is high, and when the providers' outside options are relatively unattractive. Stronger network effects and resource pooling further increase the relative performance of employment-like contracts.
Keywords: platform economy, OM-Finance interface, capacity investment, holdup, free-riding
Suggested Citation: Suggested Citation