Some important markets feature intermediaries who offer a network of upstream suppliers to downstream consumers. Examples include general contractors, who assemble networks of skilled craftsmen and subcontractors, business-to-business web sites, which assemble networks of parts suppliers, and managed care organizations, which assemble networks of hospitals and physicians. These intermediaries take advantage of their expertise and purchasing economies to identify superior suppliers and to extract better terms than could consumers shopping on their own. In some cases, such as managed care, they also provide insurance against the risk of needing the network’s services.
Sometimes, consumers may know their specific needs at the time they select their intermediary. For example, homeowners may have detailed architectural plans at the time they select their building contractors. In other situations, consumers may select their intermediary prior to knowing their specific needs. Insurance markets are an important example. Automobile owners often commit to a network of auto repair shops at the time they purchase collision insurance, even though they do not know, in advance, what kinds of repairs their car might require. Similarly, patients commit to a network of medical providers at the time they purchase their health insurance, but before they know their specific medical needs. Non-insurance examples include manufacturers who sign long-term contracts with suppliers, which in turn outsource specific manufacturing tasks as the need arises. Following Dranove and White (1996), we call these option demand markets (or OD markets). In OD markets, consumers commit to a potentially restricted network of sellers prior to knowing their needs fully, but retain the option to visit any seller in the network once their needs are known. The value that any one consumer places on a given network depends on his expectation of how well the network’s members will be able to meet his needs. This contrasts with direct purchase markets in which consumers do not eliminate any potential sellers prior to learning their needs.