NATURAL OLIGOPOLY AND CUSTOMER NETWORKS IN INTERMEDIATED MARKETS

The industrial structure of an intermediation industry is analyzed, in brokerage markets, where intermediaries help to reduce search frictio ns. The aspect of competition in intermediated markets is analyzed in an 'island economy', in which intermediaries invest in information net works, which allow them to inform the market about their price offers. Larger networks allow them to reach more markets and potential custom ers. This enhances trading probabilities. Thus the size of the informa tion network may be viewed as a quality attribute by market participan ts. Price competition among intermediaries therefore exhibits features of imperfect price competition in markets of vertically differentiate d products. It is shown that the number of intermediaries active in a symmetric equilibrium is bounded independently of the size of the mark et, as long as investments are costly. Thus, the market constitutes a natural oligopoly in the sense of Shaked and Sutton (Econometrica, 198 3, 51, 1469-1483), and convergence to a fragmented industrial structur e does not obtain as the economy grows large. In particular, we find a natural oligopoly consisting of generally three larger intermediaries of similar size and smaller intermediaries occupying niche markets. N evertheless, as the number of islands increases, spreads shrink to zer o and almost competitive allocations arise.