Econometrica, 2009, vol. 77, issue 2, pages 427-452
This paper looks at how online retailers interact with consumers using online search tools to find the lowest prices.
Online tools help lower prices, but online and offline sellers who keep costs down can use different pricing strategies to keep their prices above cost.
- Online consumers can shop using search tools like Pricewatch, which find products with the lowest price. Price competition is fierce and prices have fallen, but online sellers can survive and continue to price above cost.
- Retail sellers use loss leaders and other methods to obfuscate their prices and reduce the damage from price search tools.
- E.g., a seller will offer a computer part priced very low without a fan, then offer the fan for an additional price (add-ons).
- Shipping charges or free shipping can also frustrate price search tools.
- Search tools cannot sort by quality, so sellers can price a low quality product very low (loss leaders); consumers ultimately buy a higher quality product—often from the same seller--but use the search results as a starting point.
- Price search engines must not be so effective that they drive prices so low the sellers all go out of business. Or, if all sellers price the same, consumers will not need the search tool. Search engines can control such problems by charging per sale referral fees.
- The data clearly shows that loss leaders are effective marketing tools.
- Large online sellers face high costs of handling and sorting goods to send them to individual consumers compared to big retailers like Walmart, which only needs to deliver goods in bulk to one location.
- Small online sellers are more efficient than their large counterparts.