Heterogeneous Firms and Cost Sharing in China's Marketplaces

IDE Research Bulletin

March 2016

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In this research project, we investigates the impact of cost sharing in a marketplace on heterogeneous firms’ sales strategy. Sharing costs means that firms in a marketplace do not need to build independent sales channels, can easily collect information on competitors and consumers, and share various services in the marketplace. As a result, less productive firms often prefer to locate in marketplaces, whereas more productive ones tend to locate outside of it.

To analyze the effects of cost sharing on a firms' sales choice, we develop a Melitz-style model in which firms share fixed costs only in the marketplace. To sell its products to consumers, each firm is required to locate in a marketplace or establish its own store outside the marketplace (modern distribution channels). While locating in a marketplace gives firms the advantage of share fixed costs, doing so also disadvantages them through higher transaction costs (North, 1991). A modern distribution channel, on the other hand, allows for lower transaction costs but higher fixed costs from independently establishing a sales channel.