Retailing on the Internet, it is said, is a almost perfectly competitive. Really?
THE explosive growth of the Internet promises a new age of perfectly competitive markets. With perfect information about prices and products at their fingertips, consumers can quickly and easily find the best deals. In this brave new world, retailers' profit margins will be competed away, as they are all forced to price at cost.
Or so we are led to believe. And yes. studies do show that online retailers tend to be cheaper than conventional rivals, and that they adjust prices more finely and more often, But they also find that price dispersion(the spread between the highest and lowest price) is often as wide on the Internet as it is in the shopping mall-or even wider. Moreover, the retailers with the keenest prices rarely have the biggest sales.
Such price dispersion in usually a sign of market inefficiency, In an ideal competitive market, where products are identical, customers are perfectly informed, there is free market entry, a large number of buyers and sellers and no search costs, all sales are made by the retailer with the lowest price. So all prices are driven down to marginal cost. Search costs on the Internet might be expected to be lover and online consumers to be more easily informed about prices. So price dispersion online ought to be narrower than in conventional markets. But it does not seem to be.
A recent paper*, by Michael Smith and Erik Brynjolfsson of the Massachusetts Institute of Technology's Sloan School of Management and Joseph Bailey of the University of Maryland, looks at the main research on this topic. One study it cites, by Mr Bailey, finds that price dispersion for books, CDS and software is no smaller online than it is in conventional markets. Another, by Messrs Brynjolfsson and Smith, finds that prices for identical books and CDS at different online retailers differ by as much as 50%, and on average by 33% for books and 25% for CDS. A third, by Eric Clemons, Il-Horn Hann and Lorin Hitt of the University of Pennsylvania's Wharton school, finds that prices for airline tickets from online travel agents differ by an average of 28%.
There are many possible reasons for this price dispersion. One is that the studies are not comparing like with like. Not so Even after controlling for differing arrival and departure times or connections, the study of online travel agents finds that prices for airline tickets vary by an average of 18%. The study of books and CDS deliberately focuses on physically identical products. Indeed, it finds that pricier retailers offer service terms, such as flexible returns rules, that are no better-and sometimes worse-than cheaper ones.
Convenience could also explain the price dispersion. Some websites offer better search tools, product reviews and samples, such as book chapters or audio clips. But in a frictionless market, consumers could use these services to choose what they want to buy and services would explain price dispersion only if there were significant search or switching costs online.
For all the talk about the Internet eliminating search costs, a prominent site may be as important to online retailers as it is to conventional ones. Why else do web retailers spend a fortune advertising their web addresses on Internet portals, such as yahoo!, as well as in the conventional media? Search engines are not always much use: Yahoo!'s book retailer section lists 6,219 sites. Searching for online bookstores at Altavista returns 5,173,884 possibly relevant web pages. So, rather than rooting out the cheapest deal, most consumers go directly to Amazon.com or CDNOW, even though, the research shows, they charge 7~12% more on average than such lesser-known retailers as Books.com and CD Universe.
Switching between online retailers can also be costly. Many sites have loyalty programmes. Moreover, once consumers are familiar with a site, they may be reluctant to try another, especially when their usual site is customised to suit them, for instance through "one-click" shopping.
Search and switching costs are clearly important. But perhaps the biggest reason for price dispersion is the biggest reason for price dispersion is that consumers are willing to pay a premium to shop at sites that they trust. According to the paper, even people who use "shopbots", or computer programs that search many websites for the best deal, usually buy from the market leader-even if it is not quoting the lowest prices. A trusted brand may be more important on the Internet than on the high street, since online consumers pay upfront and cannot be sure whether or when their purchases will be delivered.
For all these reasons, some online retailers are able to charge more than others. Moreover, individual retailers can discriminate in their pricing. For, as well as enabling consumers to collect better information about prices, the Internet allows retailers to gather better information about consumers. Online retailers can more easily offer different consumers different prices, since customers do not know what price others are being quoted.
The study of online travel agents, for instance, found that the lowest-priced and the highest-priced sites were owned by the same company. But the pricier one was easier to use, allowing the parent company to charge busy customers more.
Consider too a site such as shopping.com, where shoppers can either pay list prices or bid less in an auction. On average, bidders get lower prices. But they have to spend time placing bids and monitoring the auction's progress, and they may not end up with the goods. Shopping.com can thus discriminate between bargain hunters and regular customers.
To bo fair, the Internet is still in its infancy. The degree of price dispersion may fall as consumers become cannier. But it is a good bet that retailers will come up with new wheezes too, and that those with strong brands will retain their pricing power. Perfect competition is some way off.
.....................
* "understanding Digital Markets: Review and Assessment". July 1999. Available from http://ecommerce.mit.edu/papers/ude
THE explosive growth of the Internet promises a new age of perfectly competitive markets. With perfect information about prices and products at their fingertips, consumers can quickly and easily find the best deals. In this brave new world, retailers' profit margins will be competed away, as they are all forced to price at cost.
Or so we are led to believe. And yes. studies do show that online retailers tend to be cheaper than conventional rivals, and that they adjust prices more finely and more often, But they also find that price dispersion(the spread between the highest and lowest price) is often as wide on the Internet as it is in the shopping mall-or even wider. Moreover, the retailers with the keenest prices rarely have the biggest sales.
Such price dispersion in usually a sign of market inefficiency, In an ideal competitive market, where products are identical, customers are perfectly informed, there is free market entry, a large number of buyers and sellers and no search costs, all sales are made by the retailer with the lowest price. So all prices are driven down to marginal cost. Search costs on the Internet might be expected to be lover and online consumers to be more easily informed about prices. So price dispersion online ought to be narrower than in conventional markets. But it does not seem to be.
A recent paper*, by Michael Smith and Erik Brynjolfsson of the Massachusetts Institute of Technology's Sloan School of Management and Joseph Bailey of the University of Maryland, looks at the main research on this topic. One study it cites, by Mr Bailey, finds that price dispersion for books, CDS and software is no smaller online than it is in conventional markets. Another, by Messrs Brynjolfsson and Smith, finds that prices for identical books and CDS at different online retailers differ by as much as 50%, and on average by 33% for books and 25% for CDS. A third, by Eric Clemons, Il-Horn Hann and Lorin Hitt of the University of Pennsylvania's Wharton school, finds that prices for airline tickets from online travel agents differ by an average of 28%.
There are many possible reasons for this price dispersion. One is that the studies are not comparing like with like. Not so Even after controlling for differing arrival and departure times or connections, the study of online travel agents finds that prices for airline tickets vary by an average of 18%. The study of books and CDS deliberately focuses on physically identical products. Indeed, it finds that pricier retailers offer service terms, such as flexible returns rules, that are no better-and sometimes worse-than cheaper ones.
Convenience could also explain the price dispersion. Some websites offer better search tools, product reviews and samples, such as book chapters or audio clips. But in a frictionless market, consumers could use these services to choose what they want to buy and services would explain price dispersion only if there were significant search or switching costs online.
For all the talk about the Internet eliminating search costs, a prominent site may be as important to online retailers as it is to conventional ones. Why else do web retailers spend a fortune advertising their web addresses on Internet portals, such as yahoo!, as well as in the conventional media? Search engines are not always much use: Yahoo!'s book retailer section lists 6,219 sites. Searching for online bookstores at Altavista returns 5,173,884 possibly relevant web pages. So, rather than rooting out the cheapest deal, most consumers go directly to Amazon.com or CDNOW, even though, the research shows, they charge 7~12% more on average than such lesser-known retailers as Books.com and CD Universe.
Switching between online retailers can also be costly. Many sites have loyalty programmes. Moreover, once consumers are familiar with a site, they may be reluctant to try another, especially when their usual site is customised to suit them, for instance through "one-click" shopping.
Search and switching costs are clearly important. But perhaps the biggest reason for price dispersion is the biggest reason for price dispersion is that consumers are willing to pay a premium to shop at sites that they trust. According to the paper, even people who use "shopbots", or computer programs that search many websites for the best deal, usually buy from the market leader-even if it is not quoting the lowest prices. A trusted brand may be more important on the Internet than on the high street, since online consumers pay upfront and cannot be sure whether or when their purchases will be delivered.
For all these reasons, some online retailers are able to charge more than others. Moreover, individual retailers can discriminate in their pricing. For, as well as enabling consumers to collect better information about prices, the Internet allows retailers to gather better information about consumers. Online retailers can more easily offer different consumers different prices, since customers do not know what price others are being quoted.
The study of online travel agents, for instance, found that the lowest-priced and the highest-priced sites were owned by the same company. But the pricier one was easier to use, allowing the parent company to charge busy customers more.
Consider too a site such as shopping.com, where shoppers can either pay list prices or bid less in an auction. On average, bidders get lower prices. But they have to spend time placing bids and monitoring the auction's progress, and they may not end up with the goods. Shopping.com can thus discriminate between bargain hunters and regular customers.
To bo fair, the Internet is still in its infancy. The degree of price dispersion may fall as consumers become cannier. But it is a good bet that retailers will come up with new wheezes too, and that those with strong brands will retain their pricing power. Perfect competition is some way off.
.....................
* "understanding Digital Markets: Review and Assessment". July 1999. Available from http://ecommerce.mit.edu/papers/ude
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