Platform Liability and Innovation

Abstract

Sales of counterfeits in online marketplaces have received large attention from both press and policy makers in recent years. We study an online marketplace platform’s choice between restricting entry to brand owners only and allowing entry of imitators (including counterfeits), how that choice affects brand owners' innovation decisions, and how imposing platform liability influences both the platform’s decision to restrict entry or not and brand owners’ innovation. We isolate the effects resulting from the platform’s lack of commitment power. Absent platform liability, lack of commitment induces the platform to allow excessive entry of imitators even if this reduces brand owners’ incentives to innovate (by creating a hold-up situation), and can reduce the platform's profit. This happens because the platform’s choice is distorted towards buyer participation. When platform liability is introduced, a compliant platform delists all counterfeits. This helps the platform to mitigate the hold-up problem. However, liability may generate an overshooting problem, with the platform restricting entry too often, even when the entry of legitimate sellers would be socially desirable.