INTERMEDIATION IN NETWORKS

Abstract. We study intermediation in markets with an underlying network structure. A good is resold via successive bilateral bargaining between linked intermediaries until it reaches one of several buyers in the network. We characterize the resale values of all traders in the network. The seller’s profit depends not only on the number of intermediaries involved in trade, but on the entire set of competing paths of access to buyers brokered by each intermediary. Local competition shapes the outcomes of intermediation. A decomposition of the network into layers of intermediation power describes the endogenous structure of local monopolies and trading paths. Local competition permits full profit extraction in transactions within the same layer, while hold-up problems impose intermediation rents on exchanges across layers. Layers delimit monopoly power from intermediation power. Only players who serve as gateways to lower layers earn significant profits. Resale values decline exponentially with each progressive layer. Trade does not maximize welfare or minimize intermediation. We provide comparative statics with respect to the network architecture and the distribution of intermediation costs. The elimination of a middleman and vertical integration increase the seller’s profit, as does the transfer of costs downstream; horizontal integration has ambiguous effects. 1