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Red Queen Pricing Effects in E-Retail Markets

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Author Info
Michael R. Baye (Department of Business Economics and Public Policy, Indiana University Kelley School of Business)
John Morgan (University of California at Berkeley)

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Abstract

A standard “solution” offered to the deleterious effects of all-out price competition is for firms to engage in differentiation strategies. This solution, however, depends critically on the inability of rivals to imitate a successful differentiation strategy. With imitation, we show how “Red Queen” pricing effects can arise: All firms have an incentive to vertically differentiate and increase markups, yet imitation by rivals drives prices down toward pre-differentiation levels. Thus, the price premia arising from differentiation strategies in eretailing critically depend on the number of other firms that imitate the strategies. Based on data from Shopper.com, we find that an online firm that unilaterally differentiates itself from its rivals by participating in CNet’s Certified Merchant program enjoys a 5 to 17 percent price premium. However, when other firms also follow this strategy, the price premium vanishes.

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File URL: http://www.bus.indiana.edu/riharbau/RePEc/iuk/wpaper/bepp2005-07-baye-morgan.pdf
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Publisher Info
Paper provided by Indiana University, Kelley School of Business, Department of Business Economics and Public Policy in its series Working Papers with number 2005-07.

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Date of creation: 2005
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Handle: RePEc:iuk:wpaper:2005-07

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Related research
Keywords: Pricing; Product Differentiation; Red Queen Effect; Internet; Reputation;

Find related papers by JEL classification:
D4 - Microeconomics - - Market Structure and Pricing
D8 - Microeconomics - - Information, Knowledge, and Uncertainty
M3 - Business Administration and Business Economics; Marketing; Accounting - - Marketing and Advertising
L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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  1. Clay, Karen, et al, 2002. "Retail Strategies on the Web: Price and Non-price Competition in the Online Book Industry," Journal of Industrial Economics, Blackwell Publishing, vol. 50(3), pages 351-67, September. [Downloadable!] (restricted)
  2. Kathy Baylis & Jeffrey Perloff, 2001. "Price Dispersion on the Internet: Good Firms and Bad Firms," Institute for Research on Labor and Employment, Working Paper Series 1019, Institute of Industrial Relations, UC Berkeley. [Downloadable!]
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  3. Smith, Michael D & Brynjolfsson, Erik, 2001. "Consumer Decision-Making at an Internet Shopbot: Brand Still Matters," Journal of Industrial Economics, Blackwell Publishing, vol. 49(4), pages 541-58, December. [Downloadable!] (restricted)
  4. Michael R. Baye & John Morgan, 2001. "Information Gatekeepers on the Internet and the Competitiveness of Homogeneous Product Markets," American Economic Review, American Economic Association, vol. 91(3), pages 454-474, June. [Downloadable!] (restricted)
  5. Glenn Ellison & Sara Fisher Ellison, 2004. "Search, Obfuscation, and Price Elasticities on the Internet," NBER Working Papers 10570, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Gary E. Bolton & Elena Katok & Axel Ockenfels, 2003. "How Effective are Electronic Reputation Mechanisms? An Experimental Investigation," Working Paper Series in Economics 3, University of Cologne, Department of Economics. [Downloadable!]
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