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When and How Is the Internet Likely to Decrease Price Competition?


Author Info

  • Rajiv Lal

    (Harvard Business School, Morgan Hall, Soldier's Field, Boston, Massachusetts, 02163)

  • Miklos Sarvary

    (Harvard Business School, Morgan Hall, Soldier's Field, Boston, Massachusetts, 02163)

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    Conventional wisdom seems to claim that, by lowering the cost of distribution and by making search easier for consumer, the introduction of the Internet is likely to intensify price competition. This paper intends to challenge this view by asking: When and how is the Internet likely to decrease the level of price competition between firms? To answer this question, we develop an analytic model with the following characteristics. On the demand side, consumers need to gather information on two types of product attributes: (which can be communicated on the Web at very low cost) and (for which physical inspection of the product is necessary). Consumers choose between two brands but are familiar with the nondigital attributes of only the brand purchased on the last purchase occasion. On the supply side, firms use traditional stores and the Internet to inform consumers about their products' attributes and to sell their products. In this setup, we show that the impact of the Internet on competition will be radically different depending on the relative importance of parameters describing the relevant shopping and distribution context. Specifically, we find that the introduction of the Internet might lead to monopoly pricing when (1) the proportion of Internet users is high enough, (2) when nondigital attributes are relevant but not overwhelming, (3) when consumers have a more favorable prior about the brand they currently own, and (4) when the purchase situation can be characterized by “destination shopping”. More surprising, we also show that in such cases, the use of the Internet not only leads to higher prices but can also discourage consumers from engaging in search. As such, an important message of the paper is that under some conditions the Internet might represent an opportunity for firms to leverage their brand loyalty and increase their profits. The intuition behind our results is the following. The Internet allows consumers to evaluate digital attributes easily, i.e., without visiting the stores. However, nondigital attributes can only be evaluated through physical presence. As such, for goods where both types of attributes are important, the introduction of the Net changes the effective cost of search for consumers. Without the Internet the cost of search is . With the introduction of the Net however, nonsearching consumers do not have to undertake the shopping trip at all because they can order products on the Net. Thus, in the presence of the Internet the cost of search is related to . In the case of destination shopping (i.e. when the fixed cost of undertaking the shopping trip is higher than the cost of visiting an additional store), the presence of the Internet creates higher effective search costs for consumers. Given this shift of paradigm in search costs due to the Internet, consumers may not take the risk of searching for products with better nondigital attributes, but instead, remain with the product they are familiar with. This results in increased consumer loyalty, which induces firms to increase their prices. Our results have important managerial implications. First, they provide guidelines for firms on when (i.e. for which product categories) they should consider expanding their distribution network to the Internet. In this respect, an important additional insight of the paper is that the Internet can lower price competition and lead to reduced consumer search if it is more expensive than the traditional distribution channel. This can easily be the case if distribution through the Internet represents additional costs such as the costs associated with shipping and handling and return policies. Second, the paper also provides guidelines on how to plan the firm's Internet strategy. Interestingly, the results suggest that with the general availability of the Internet the role of stores might actually become more important. While we do not explicitly model a dynamic market, our findings together with Klemperer's (1987) results suggest that stores might have a key role in consumer acquisition, while the Internet can help leverage the acquired customer base through demand fulfillment. This might imply that for certain product categories, firms should actually allocate additional resources to improve their in-store environment when considering the Internet as a complementary distribution channel.

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    Bibliographic Info

    Article provided by INFORMS in its journal Marketing Science.

    Volume (Year): 18 (1999)
    Issue (Month): 4 ()
    Pages: 485-503

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    Handle: RePEc:inm:ormksc:v:18:y:1999:i:4:p:485-503

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    Related research

    Keywords: Internet; Consumer Search; Digital/Nondigital Attributes; Competition; Game Theory;


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    Cited by:
    1. Wagner, Udo & Fritz, Wolfgang, 2001. "Tendenzen marktorientierter Preispolitik im "Electronic Commerce"," Working Papers 01/01, Technische Universität Braunschweig, Institute of Marketing.
    2. Lisa Klein, 2002. "Creating Virtual Experiences in Computer-Mediated Environments," Review of Marketing Science Working Papers 1-4-1001, Berkeley Electronic Press.
    3. King, Ruth C. & Sen, Ravi & Xia, Mu, 2002. "Impact of Web-Based e-Commerce on Channel Strategy," Working Papers 02-0123, University of Illinois at Urbana-Champaign, College of Business.
    4. Bhatnagar, Amit & Syam, Siddhartha S., 2014. "Allocating a hybrid retailer's assortment across retail stores: Bricks-and-mortar vs online," Journal of Business Research, Elsevier, vol. 67(6), pages 1293-1302.
    5. Robert J. Kauffman & Charles A. Wood, 2007. "Follow the leader: price change timing in Internet-based selling," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 28(7), pages 679-700.
    6. Choi, Tsan-Ming & Chow, Pui-Sze & Xiao, Tiaojun, 2012. "Electronic price-testing scheme for fashion retailing with information updating," International Journal of Production Economics, Elsevier, vol. 140(1), pages 396-406.
    7. Maarten C.W. Janssen & Rob van der Noll, 2005. "Internet Retailing as a Marketing Strategy," Tinbergen Institute Discussion Papers 05-038/1, Tinbergen Institute.
    8. Rea, Kenneth & Nwoha, Ogbonnaya John & Kennedy, Gary A. & Watson, Susan, 2006. "Website Usage Information for Rural-Based E-Commerce Start-Ups," 2006 Annual meeting, July 23-26, Long Beach, CA 21478, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
    9. Noble, Stephanie M. & Griffith, David A. & Weinberger, Marc G., 2005. "Consumer derived utilitarian value and channel utilization in a multi-channel retail context," Journal of Business Research, Elsevier, vol. 58(12), pages 1643-1651, December.
    10. Chris Forman & Anindya Ghose & Avi Goldfarb, 2006. "Geography and Electronic Commerce: Measuring Convenience, Selection, and Price," Working Papers 06-15, NET Institute, revised Sep 2006.
    11. Yuanzhu Lu & Xiaolin Xing & Fang-Fang Tang, 2008. "Retailers' Incentive to Sell through a New Selling Channel and Pricing Behavior in a Multi-channel Environment," Annals of Economics and Finance, Society for AEF, vol. 9(2), pages 315-343, November.
    12. Franziska Völckner & Alexander Rühle & Martin Spann, 2012. "To divide or not to divide? The impact of partitioned pricing on the informational and sacrifice effects of price," Marketing Letters, Springer, vol. 23(3), pages 719-730, September.
    13. Charness, Gary & Haruvy, Ernan & Sonsino, Doron, 2007. "Social distance and reciprocity: An Internet experiment," Journal of Economic Behavior & Organization, Elsevier, vol. 63(1), pages 88-103, May.
    14. Punj, Girish & Moore, Robert, 2009. "Information search and consideration set formation in a web-based store environment," Journal of Business Research, Elsevier, vol. 62(6), pages 644-650, June.
    15. Maarten C.W. Janssen & Rob van der Noll, 2005. "Internet Retailing as a Marketing Strategy," Tinbergen Institute Discussion Papers 05-038/1, Tinbergen Institute.
    16. Oksana Loginova, 2007. "Real and Virtual Competition," Working Papers 0715, Department of Economics, University of Missouri.
    17. Myung-Soo Lee & Brian Ratchford & Debrabrata Talukdar, 2001. "The Impact of the Internet on Information Search for Automobiles," Review of Marketing Science Working Papers 1-2-1011, Berkeley Electronic Press.
    18. Michael R. Baye & John Morgan, 2005. "Red Queen Pricing Effects in E-Retail Markets," Working Papers 2005-07, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
    19. Fahy, Colleen A., 2006. "Internet versus traditional retailing: An address model approach," Journal of Economics and Business, Elsevier, vol. 58(3), pages 240-255.
    20. Patricia Mokhtarian, 2004. "A conceptual analysis of the transportation impacts of B2C e-commerce," Transportation, Springer, vol. 31(3), pages 257-284, August.
    21. Häring, Julia, 2003. "Different Prices for Identical Products? Market Efficiency and the Virtual Location in B2C E-Commerce," ZEW Discussion Papers 03-68, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
    22. Charness, Gary & haruvy, Ernan & Sonsino, Doron, 2001. "Social Distance and Reciprocity: The Internet vs. the Laboratory," University of California at Santa Barbara, Economics Working Paper Series qt46r1282v, Department of Economics, UC Santa Barbara.
    23. Yan, Ruiliang & Ghose, Sanjoy, 2010. "Forecast information and traditional retailer performance in a dual-channel competitive market," Journal of Business Research, Elsevier, vol. 63(1), pages 77-83, January.
    24. Cai, Gangshu (George) & Zhang, Zhe George & Zhang, Michael, 2009. "Game theoretical perspectives on dual-channel supply chain competition with price discounts and pricing schemes," International Journal of Production Economics, Elsevier, vol. 117(1), pages 80-96, January.


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