Sharing Rather Than Owning: How to Enable Collaborative Consumption?
Prof. Weber’s paper “Intermediation in a Sharing Economy: Insurance, Moral Hazard, and Rent Extraction,” to appear in the upcoming winter issue of the Journal of Management Information Systems, examines how intelligent transaction-design by an intermediary can solve a conundrum that has prevented market-based sharing for the better part of history. Using the example of collaborative housing it is shown how an intermediary can provide insurance to encourage good behavior on the part of both the borrower and the lender, and at the same time extract a portion of the gains from trade. The article is an extended journal version of a contribution on the “Collaborative Housing and the Intermediation of Moral Hazard,” presented at the Hawaii International Conference on System Sciences (HICSS) earlier this year.
The idea of sharing rather than owning an asset comes to mind whenever an item is expensive and rarely used. For example, a power drill, which tends to cost several hundred dollars, experiences an average active usage of only 10-20 minutes. This and many other expensive items in a typical household remain largely unused. Another, even more pertinent example is a house or an apartment. The owner may be away at times, which begs the opportunity for someone else to stay there, if only good behavior and trust could be guaranteed.
Actual Sharing may be Difficult. While sharing may come to mind almost immediately when learning about the lack of use for expensive goods such as a power drill or a house, there are practical details that may prevent transactions from taking place: matching and trust. First, a potential lender and borrower (or, in the case of housing: a host and a renter) have to find each other. Devices to help with this “matching process” have been available for a long time: bulletin boards, newspaper ads, and, more recently, internet platforms (such as eBay), or social networking sites (such as Facebook). Even with such tools, finding a suitable counterparty, given the specific needs or availabilities of individuals on both sides of the market, may be difficult but feasible if only the gain warrants it. In an increasingly networked society, matching cannot be ignored, yet it is unlikely to qualify as a serious obstacle. The second and perhaps more important issue is trust. For example, when renting out her apartment to a guest at short term, a host cannot really observe the renter’s behavior, and therefore faces the possibility that there may be damage, overuse, or other degradation caused by a lack of care. The guest, on the other hand, may not feel compelled to put in a lot of effort to keep the place intact. This is called moral hazard. One possibility of fixing the problem might be for the host to ask for a deposit. Yet in that case, the renter faces uncertainty about whether the money will ever be returned; this is compounded by that fact any legal recourse would need to take place in the host’s city, usually far from the renter’s residence.
Intermediary = Conduit for Transactions. A sharing intermediary is an entity, typically a business, which enables transactions between a host and a renter (or a lender and a borrower). Take peer-to-peer short-term rentals as an example. Since its founding in 2008, the San Francisco-based firm AirBnB has been enabling collaborative-housing transactions for more than 11 million guests in 190+ countries, with currently more than 600,000 active listings. As of April 2014, AirBnB’s investor valuation was about $10 billion. These numbers indicate that not only the market for shared peer-to-peer housing is working, but also that the intermediary is able to extract a significant fraction of the surplus generated by the transactions it facilitates. This means that the intermediary, by its presence, generates real value, helping to overcome the matching and trust issues discussed earlier.
Divide and Conquer: Separating Moral Hazard and Rent Extraction. In his recent paper, Prof. Weber shows that an intermediary can completely solve the moral-hazard problem, as long as the transacting parties are risk-neutral, that is, not especially sensitive to risk – a simplifying assumption. The optimal insurance terms are such that the intermediary asks the renter for a deposit equal to the expected damage (in case something happens) plus any verification cost in such an event. A host can claim back damage done by a renter from the intermediary, exceeding a minimum amount and subject to verification. The ensuing settlement is such that the renter pays for the damage, plus a surcharge, up to a total which at most equals the deposit. The host is given slightly more than the amount claimed in order to compensate ex ante for the fact that the host cannot file claims that are too small (below a defined minimum). In this way, the intermediary can “internalize” the concern a host feels about her property in the renter’s decision problem. The renter would therefore exert just as much care as the host would. With the insurance terms in place, and thus having resolved the moral-hazard issue, the intermediary can choose commission rates which divert a significant fraction of the gains from trade into its own pockets.
Transition to a Sharing Economy. In 2013-14, Professor Weber has been a member of an expert group by the Swiss Federal Ministry for the Environment for the optimization of product lifetime. The lack or excess of durability in many goods has come to the attention of regulators. One possible recommendation to respond to durability concerns is for the government to encourage sharing, via incentives and information. As the example of collaborative housing shows, private interests, as manifested by intermediaries such as AirBnB, Wimdu, 9Flats, and others (see, e.g., Botsman and Rogers 2011) can create functioning markets in which sharing becomes feasible and indeed desirable. The key for this exchange-based approach to work lies in a design which takes care of the imperfections that may otherwise cause a market failure.
- Botsman, R., Rogers, R. (2011) What’s Mine is Yours: How Collaborative Consumption is Changing the Way We Live, HarperCollins, London, UK.
- Weber, T.A. (2014) “Intermediation in a Sharing Economy: Insurance, Moral Hazard, and Rent Extraction,” Journal of Management Information Systems, forthcoming.
- Weber, T.A. (2014) “Collaborative Housing and the Intermediation of Moral Hazard,” Proceedings of the 47th Annual Hawaii International Conference on System Sciences (HICSS), IEEE Computer Society, Washington, DC, pp. 4133—4141.