Capacity Expansion in Service Platforms: Financing vs. Employment

47 Pages Posted: 20 Apr 2020 Last revised: 20 May 2021

See all articles by Heikki Peura

Heikki Peura

Imperial College Business School

S. Alex Yang

London Business School

Date Written: May 11, 2021

Abstract

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

Peura, Heikki and Yang, S. Alex, Capacity Expansion in Service Platforms: Financing vs. Employment (May 11, 2021). Available at SSRN: https://ssrn.com/abstract=3564074 or http://dx.doi.org/10.2139/ssrn.3564074

Heikki Peura

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

S. Alex Yang (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

HOME PAGE: http://faculty.london.edu/sayang/

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