Flattening Supply Chains: When do Technology Improvements lead to Disintermediation?

TL;DR

The paper investigates how advances in production technology influence disintermediation in a digital-content market with one intermediary, multiple suppliers, and consumers. It develops a three-tier game where technology can be used by both the intermediary and consumers, with a convex production-cost function $g(w)$ and a fixed consumer fee $\alpha$, and analyzes the subgame-perfect equilibrium as technology-costs shift. The main results show disintermediation occurs at extreme cost levels, while the intermediary remains welfare-improving yet extracts all welfare gains; content quality is distorted and varies across regimes, and the range of intermediary viability depends on the fee structure and market size $C$. Extensions to a monopolist supplier, nonzero marginal costs, and alternative fees demonstrate robustness but emphasize the critical role of market design in determining the survivor status of intermediaries amid technology progress. Overall, the work contributes to understanding how production-technology innovations shape the survival and welfare effects of intermediaries in the digital economy.

Abstract

In the digital economy, technological innovations make it cheaper to produce high-quality content. For example, generative AI tools reduce costs for creators who develop content to be distributed online, but can also reduce production costs for the users who consume that content. These innovations can thus lead to disintermediation, since consumers may choose to use these technologies directly, bypassing intermediaries. To investigate when technological improvements lead to disintermediation, we study a game with an intermediary, suppliers of a production technology, and consumers. First, we show disintermediation occurs whenever production costs are too high or too low. We then investigate the consequences of disintermediation for welfare and content quality at equilibrium. While the intermediary is welfare-improving, the intermediary extracts all gains to social welfare and its presence can raise or lower content quality. We further analyze how disintermediation is affected by the level of competition between suppliers and the intermediary's fee structure. More broadly, our results take a step towards assessing how production technology innovations affect the survival of intermediaries and impact the digital economy.

Figures (8)

• Figure 1: Our model for a digital content supply chain with suppliers, a intermediary, and consumers (Section \ref{['sec:model']}). The supplier offers a technology to produce content, the intermediary produces content, and the consumers consume content. The suppliers also offer the technology to the consumers, so the consumers have the option to directly produce content and bypass the intermediary (the blue arrows).
• Figure 2: Production costs where disintermediation (red) vs. intermediation (green) occurs, for $g(w) = w^2$ (Theorem \ref{['thm:specialcasemiddlemanusageexposure']}). We vary the transfer $\alpha$ (left) and number of consumers $C$ (right). The intermediary only survives in the market when the production costs are at intermediate levels: the intermediary is driven out of the market when production costs are sufficiently low or sufficiently high. The range of values where intermediation occurs shifts lower when the fees $\alpha$ are higher, and the range expands when the number of consumers is larger. (We have generated these plots with a small number of consumers for ease of visualization, but our results apply for any number of consumers.)
• Figure 3: Analysis of social welfare, consumer utility, and content quality in this market in comparison to a hypothetical market where the intermediary does not exist, for $g(w) = w^2$. We show how the the intermediary increases (purple), decreases (blue), or does not affect (white) each of these metrics. The intermediary is always welfare-improving (left; Theorem \ref{['thm:socialwelfare']}). However, the intermediary does not increase consumer utility (middle; Theorem \ref{['thm:consumerutility']}), and instead extracts all of the surplus for themselves. The intermediary can increase content quality or decrease content quality (right; Theorem \ref{['thm:contentquality']}).
• Figure 4: Quality of the content consumed at a pure strategy equilibrium as a function of production costs, for $g(w) = w^{2}$ (Proposition \ref{['prop:contentquality']}) We vary the transfers $\alpha$ (left), and the number of consumers $C$ (right). The vertical dashed lines show the production costs at which disintermediation starts to occur. Observe that the quality is decreasing in production costs, and is discontinuous at the thresholds where disintermediation starts to occur (Theorem \ref{['thm:contentquality']}).
• Figure 5: Intermediary utility at a pure strategy equilibrium as a function of production costs, for $g(w) = w^{2}$ (Proposition \ref{['prop:middlemanutility']}). We vary the transfers $\alpha$ (left), and the number of consumers $C$ (right). The vertical dashed lines show the production costs at which disintermediation starts to occur. Observe that the intermediary utility is inverse U-shaped in production costs (Theorem \ref{['thm:middlemanutility']}).

Theorems & Definitions (83)

• Example 1
• Theorem 1
• Theorem 2
• Theorem 3
• proof : Proof sketch of Theorem \ref{['thm:specialcasemiddlemanusageexposure']}
• Theorem 4
• Theorem 5
• Proposition 6
• Proposition 7
• Theorem 8