Cutting Out the Middleman: The Structure of Chains of Intermediation

Abstract

Distribution of goods often involves multiple intermediaries engaged in sequential buying and reselling. Why do these chains of intermediation exist, and what are their implications for consumers? We show that multi-intermediary chains arise in response to internal economies of scale in trade costs. This suggests that chains will be longer on average in developing countries, and can account for empirical patterns in firm size and prices that we document using original data on imported consumer goods in Nigeria. While policy wisdom often calls for shortening chains, we show that this has ambiguous welfare implications. Equilibrium distribution structures are not generally efficient, and policies and technologies that lead to shorter chains will not necessarily benefit consumers, even when intermediaries hold market power. Instead, there is a fundamental trade-off: shorter chains have lower marginal cost but also fewer sellers, which can reduce competition, product availability, and access to retailers. We embed this insight in a quantifiable model of endogenous intermediation chains, which we calibrate for distribution of Chinese-made apparel in Nigeria, and describe changes in chain structure in response to counterfactual changes in regulation and e-commerce technologies. We find that cutting out middlemen has heterogeneous welfare impacts but may harm remote consumers.

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