So much for removing the middleman
When we order takeout from a neighborhood restaurant, we are less and less likely to call the restaurant directly. Instead, we can order through Uber Eats or DoorDash, which take a cut of the sale and charge us a delivery fee. When summer rolls around and we go online to find new swimwear and stock up on sunscreen, we can turn to Amazon, which now relies for the majority of its retail sales on independent sellers who use its e-commerce platform. Even when we try to buy directly from the manufacturer, Internet-enabled intermediaries still play an important role. The wave of direct-to-consumer companies of the 2000s, for example, ended up paying huge sums to Facebook and others for the targeted ads they depended on to reach new customers.
This is not what was supposed to happen. The Internet, people like Bill Gates insisted, would be a disruptive force that would shift power into the hands of manufacturers and consumers. In his 1995 book, The road to follow, the Microsoft co-founder predicted that the Internet would become “the universal middleman” and that “often the only humans involved in a transaction will be the actual buyer and seller.” In other words, why pay a middleman to help you find what you need when you could find it yourself?
The Internet has swept away some intermediaries. The number of travel agents has declined as Americans have grown accustomed to booking their own flights, hotels and rental cars online. But the fate of travel agents is the exception, not the rule. Far more common is the persistence of intermediaries that technology should have rendered obsolete and the rise of new types of intermediaries, draining even more money and power from creators and their customers.
Surprisingly, some long-established intermediaries whose role seems comparable to that of travel agents have found ways to persist. Traditionally, buyers needed real estate agents to help them identify available homes. Sellers relied on their knowledge of recent sales to figure out how to price their homes. All of this information is now readily available online. Yet buyers and sellers continue to use full-service real estate agents and continue to pay very high fees – an average of around 5% of the value of the house sold. Because real estate – not stocks – is the primary store of wealth for a typical family, the Internet’s failure to render these expensive intermediaries obsolete is a real loss for the American middle class.
Meanwhile, the Internet has transformed some traditional intermediary industries, especially retail, in ways that empower a small number of large middlemen. More online shoppers start their search on Amazon than on any other website, including Google. Amazon, which was initially only a virtual version of the classic bookstore, has become an intermediary among intermediaries; rather than setting up their own e-commerce systems, small producers and resellers are selling on Amazon, but it’s costing them money. According to the Institute for Local Self-Reliance, Amazon’s reduction in sales to third parties increased from 19% in 2014 to 34% last year. Yet the number of sellers using Amazon also continues to grow.
DoorDash and Uber Eats, which dominate food delivery, show how the internet has contributed to the emergence of new types of intermediaries, disrupting direct connections instead of facilitating them. When I was growing up, when we wanted to take out, we would call the local pizzeria and their delivery guy would bring our food to us. Today, many people order through one of the few apps, even though the high fees these apps charge erode restaurant profitability. Economists attribute the power of these intermediaries to the nature of what they do: once they attract a critical mass of sellers, buyers follow, and vice versa. As more restaurants join DoorDash, for example, the growing range of options attracts many hungry customers. These customers in turn persuade more restaurateurs that they have no choice but to sign up, and the cycle continues.
Similar network effects are at play in Amazon’s marketplace and in the Multiple Listing Service (MLS) databases – controlled by traditional real estate agents – of homes for sale. Understanding these dynamics helps explain the high degree of concentration among online intermediaries.
Another reason intermediaries have flourished is that they have used their economic and political influence to distort the evolution of the markets in which they operate. My research on intermediaries in finance and beyond reveals a vicious cycle. Intermediaries first rise to power by providing a valuable service, helping to facilitate the flow of goods from sellers to buyers or, in finance, the flow of money from savers to entrepreneurs. But all the infrastructure, expertise and relationships that intermediaries develop to be good connectors also give them inordinate power in the marketplace and in legislative and regulatory chambers. Then, in the future, these intermediaries will use this power to put their interests before those of the customers they serve.
Real estate agents, for example, created MLS to help sellers get their homes in front of a large number of buyers and to give buyers an easy way to learn about potential homes that meet their needs. Yet once MLS inclusion became essential to selling a home, traditional agents were able to use the threat of MLS exclusion to penalize anyone who wanted to sell a home cheaper and more creatively. Real estate agents have also used their expertise and deep pockets to successfully lobby for public policies that suppress competition, such as entrenching laws that prohibit banks from offering real estate services. Far from challenging the power of real estate agents, sites like Zillow have MLS as their hidden backbone.
For many intermediaries, dominance simply breeds more dominance. Amazon controls the most advanced and extensive order processing system in the United States. This allows Amazon to deliver goods quickly and efficiently, but Amazon also uses this network and the promise of seemingly free and fast delivery to entice customers to join Amazon Prime. However, once customers pay the membership fee, they come back to Amazon again and again because it seems more expensive to go elsewhere. And the more customers search for Amazon Prime, the more sellers feel compelled to pay Amazon to store and ship their wares so they can earn that tag, which helps explain and accentuate Amazon’s growing discount on sales at some thirds. DoorDash and Uber Eats offer similar subscription services, resulting in similar dynamics. These three companies have also used their insights into their evolving markets to buy out competitors who may pose a future threat and to further expand the reach of their domain.
I and other critics of middleman economics must recognize that many middlemen help consumers save time. As a working mother of two young girls, I don’t just sympathize with the many other time-pressed Americans who prioritize convenience; I regularly join their ranks. Forgoing the use of dominating intermediaries may mean waiting longer for a package to arrive, walking down the street to get dinner, or making numerous phone calls to arrange house calls. Such efforts can sometimes have hidden rewards, like helping us cultivate more patience and fostering a sense of connection, but many are just burdens.
Yet Gates and others rightly understood the value of cutting out the middleman; the convenience they provide may give way to the initiate. The decades since have shown just how much the price we pay for the convenience they provide continues to rise. For too long, policy makers have remained on the sidelines as these intermediaries have grown in size and influence. Congress and regulators are beginning to tackle the massive power these middlemen have accumulated, but the rules of the game continue to favor middlemen over manufacturers, restaurants and door-to-door sellers, and their customers.