Consumer Search Costs Research Articles

Shopbot 2.0: Integrating recommendations and promotions with comparison shopping

The current generation of shopbots reduce consumer search costs associated with determining the best purchase price and place to buy a product predetermined by the shopper. In order to provide better service to shoppers, the service horizon of these shopbots can be extended in several dimensions. In this paper, we suggest that shopbots can integrate retail promotions and incorporate recommender systems in order to provide greater values to their users. Although the majority of online retailers already provide recommender systems, we show that profit maximizing retailers may not always provide transparent recommendations and argue that shopbots are in the better position to offer such recommendations. We develop integer programming models for shopbots to integrate sales promotions and product recommendations. We validate our model by using product recommendation data from two popular online retailers, Amazon.com and Buy.com, to show that our model provides recommendations that offer better value to the price sensitive shopbot customers.

Competition in U.S. Petroleum Refining and Marketing: Part II - Review of the Economic Literature

This paper surveys the economic literature on competitive issues in domestic petroleum refining and marketing provides in order to provide some insight into the underlying causes of gasoline price dynamics. The survey examines the four major categories of economic literature: (1) the statistical significance of asymmetry between upstream and downstream petroleum prices; (2) causes of price asymmetry; (3) effects of forced deintegration through open supply and divorcement polices; and (4) price effects of mergers. The research generally indicates that asymmetry is statistically significant, but may be attributable to multiple causes such as consumer search costs, market power, and inventory adjustment costs. Divorcement and open supply policies tend to increase costs and prices, and petroleum mergers have, on balance, increased prices. Merger studies, in particular, have attracted criticism regarding the robustness of their results to differences in estimation technique and other parameters. Even with this caveat, the survey results are useful for addressing the merits of various policy proposals for dealing with competitive concerns and undesirable price dynamics.

Do retail gasoline prices rise more readily than they fall?: A threshold cointegration approach

This paper revisits the controversy over whether retail gasoline prices respond to increases in upstream prices more rapidly than decreases. Using threshold and momentum models of cointegration and daily data at different stages in the distribution chain, we find that transmission between upstream and downstream prices is mostly asymmetric in the momentum model: increases in upstream prices are passed on to downstream prices more quickly than decreases. We distinguish between small and large shocks and show that the asymmetry is more pronounced for small shocks, which may be due to consumer search costs.

The Effect of the Internet on Pricing in the Airline Industry

We examine the relationship between nonlinear pricing and consumer search costs in the airline industry during a period of increasing Internet use. We find that higher Internet usage increases the spread between unrestricted and restricted fares. We also find that the ratio of unrestricted to restricted ticket fares increases with more competition, but the effect is smaller as a result of a larger population searching for airline travel online, implying that the Internet is inducing more competitive firm behavior. The data support models of price discrimination through brand differentiation, but do not support standard consumer search cost models well.

Empirical Analysis of the Business Value of Recommender Systems

Online retailers are increasingly using information technologies to provide value added services to customers. Prominent examples of these services are online recommender systems and consumer feedback mechanisms that serve to reduce consumer search costs and uncertainty associated with the purchase of unfamiliar products. The central question we address is the business value of online recommender systems to online retailers. We develop a robust empirical method that incorporates indirect impact of recommendations on sales through retailer pricing, potential simultaneity between sales and recommendations, and a comprehensive measure of the strength of recommendations. Applying the model to a panel data set collected from two online retailers, we found that the strength of recommendations has a positive impact on sales. We also found empirical evidence for the reinforcing effect of sales on recommendations and for the positive impact of recommendations on prices. These results suggest that recommendations not only improve sales but also provide added flexibility to retailers to adjust their prices. A comparative analysis reveals that recommendations have a higher impact on sales than consumer feedback. Our study demonstrates the value provided by information technology to an online retailer and provides guidelines for integrating recommender systems into their overall marketing strategy.

Price Dispersion in the Grocery Market*

This paper provides an exploratory study of price dispersion in the grocery market and checks for the consistency of the evidence on this price dispersion with the existing theories of price dispersion due to costly consumer search, competition, and consumer heterogeneity in the context of the grocery market. Three dimensions of price dispersion are studied: price dispersion for a certain brand across stores, price dispersion within a category in a store across brands, and price dispersion over time for a certain brand. The results show that the standardized price dispersion is positively correlated with consumer search costs, competition, and consumer heterogeneity.

Trademark Dilution, Search Costs, and Naked Licensing

Trademark dilution needs to be rethought to ensure that it enhances social welfare. Blurring should only be considered harmful when it increases consumer search costs. The fact that a trademark calls to mind two different products should not itself be considered actionable. Blurring only causes real harm when it interferes with consumers' ability to remember brand attributes. The Coase Theorem suggests that anti-dilution statutes will not block beneficial, non-competing uses of a mark, because, if transactions costs are low and the use is socially beneficial, the trademark owner will license the use. Unfortunately, the "naked licensing" rule, which forbids unsupervised licenses, adds unnecessary transactions costs and blocks potentially beneficial uses. Some commentators think free riding is or should be the essence of dilution. If free riding causes no harm - no consumer confusion, no blurring, and no tarnishment - then it is socially beneficial and should be allowed.

Search and Collusion in Electronic Markets

We examine the impact of reduced search costs on prices of commodity products in electronic marketplaces. Conventionally, reduced consumer search costs may be expected to engender stronger price competition between firms, resulting in lower prices and improved consumer welfare. This notion was formalized in Stahl (1989, “Oligopolistic pricing with sequential consumer search,” American Economic Review, Vol. 79, No. 4, pp. 700–712) in a model of static firm competition. In this paper, we show that these standard welfare conclusions may be neutralized or reversed in a dynamic environment. We focus on self-enforcing collusion by firms and characterize the conditions under which collusive equilibria exist. We show that less costly consumer search can facilitate firms' abilities to collude, resulting in higher prices and reduced consumer welfare, even with imperfect or no monitoring by sellers of each other's prices. If the same technology that eases consumer search also allows firms to monitor each other's prices more easily, then firms can more easily detect cheating on a collusive price arrangement, allowing an even greater scope for collusion. This raises antitrust concerns with respect to the electronic marketplace and suggests that at least some of the anticipated competitive gains from electronic market systems may be difficult to realize.

Advertising, search costs, and social welfare

Analysis of the welfare effect of advertising depends critically upon the effect of advertising on market prices. In many circumstances, advertising that leads to higher (lower) market prices is overproduced (underproduced) from society’s perspective. This paper demonstrates that these predictions may not hold when consumer search costs are important. A model is developed to show how advertising affects equilibrium prices, search costs, and social welfare in monopoly and imperfectly competitive markets. When informative advertising leads to a sufficient reduction in consumer search costs, both consumer and producer welfare may increase even though market prices rise. This conclusion has important implications for policy analysts, because it demonstrates that one cannot test the welfare effect of advertising by determining the impact of advertising on market prices alone. One must investigate the impact of advertising on both market prices and search costs to fully understand the welfare effect of advertising.

Trademarks and Consumer Search Costs on the Internet

In theory, trademarks serve as information tools, by conveying product information through convenient, identifiable symbols. In practice, however, trademarks have increasingly been used to obstruct the flow of information about competing products and services. In the online context, in particular, some courts have recently allowed trademark holders to block uses of their marks that would never have raised an eyebrow in a brick-and-mortar setting - uses that increase, rather than diminish, the flow of truthful, relevant information to consumers. These courts have stretched trademark doctrine on more than one dimension, both by expanding the concept of actionable confusion and by broadening the classes of people who can face legal responsibility for that confusion. And they have based their decisions not on the normative goals of trademark law, but on unexplored instincts and tenuous presumptions about consumer expectations and practices on the Internet. We argue that this expansionist trend in Internet trademark cases threatens to undermine a central goal of the Lanham Act - to promote fair and robust competition through reducing consumer search costs.

Causes of retail price fixity: an empirical analysis

There are many plausible theoretical explanations for retail price fixity, but few empirical tests. This study develops a general theoretical model that nests several explanations within a real options framework. One unique implication of this model is that retail prices will exhibit greater fixity the more volatile are wholesale prices. Our empirical example supports the real options hypothesis as well as price rivalry, flat marginal cost curves, and consumer search or goodwill costs.

Credit card rates and consumer search

Credit card rates have tended to be higher and stickier than other loan rates but have fallen over the past decade. Some argue this decline is due to a reduction in consumer search costs. Our evidence suggests search costs are not the best explanation for the decline. We test whether consumer search models explained credit card pricing in the 1980s when search costs were thought to be significant. We find that the distributions of rates were inconsistent with those derived from many models of search. Proposals for stricter disclosure requirements may have less effect on equilibrium credit card rates than intended.

Search and Product Differentiation at an Internet Shopbot

We estimate the magnitude of consumer search benefits and costs using data obtained from a major Internet shopbot. For the median consumer, the benefits to searching lower screens are $6.55 while the cost of an exhaustive search of the offers is a maximum of $6.45. We are also able to estimate price elasticities and find that they are relatively high compared to offline markets (-7 to -10 in our base model). Our results suggest that consumers face fairly high costs to search for information online, even in the nearly perfect market of the shopbot.

The Impact of Shopbots on Electronic Markets

Internet shopbots are automated tools that allow customers to easily search for prices and product characteristics from online retailers. Some market observers have predicted that shopbots will benefit consumers at the expense of retailers. In this view, shopbots will radically reduce consumer search costs and reduce retailer opportunities to differentiate their products; as a result, they will drive retailer margins toward zero. However, a review of the literature suggests that while shopbots may place pressure on retailer margins in some circumstances, retailers retain numerous opportunities to differentiate their products, leverage brand names, set strategic prices, and reduce the effectiveness of consumer search at shopbots. The article closes by identifying significant questions for future research.

PRICE, QUALITY, AND SERVICE ON THE INTERNET: SENSE AND NONSENSE

Faster, frictionless, cheaper, better: these are said to be the hallmarks of economic activity on the Internet. Search theory suggests use of the Net could reduce the prices consumers pay, but product branding, price discrimination based on data mining, and auctions may raise prices. The Net has lowered most prices, but raised others, even when shop bots are used. Price dispersion is greater on the Net, and Net sellers change their prices more often. The role of intermediaries has not been reduced. The quality of service is idiosyncratic and highly variable. The Net is a new and distinctive avenue of commerce, but those who argue it has invalidated conventional economic principles are well off base.

When Shopbots Meet Emails: Implications for Price Competition on the Internet

When Shopbots Meet Emails: Implications for Price Competition on the Internet

Effectiveness of Trade Promotions: Analyzing the Determinants of Retail Pass Through

Trade promotions are temporary price cuts that manufacturers offer retailers to encourage them to reduce retail prices. While trade promotion spending as a percentage of marketing budget has increased dramatically, the inefficiency of trade promotion represents the “number-one concern” among manufacturers, as indicated by recent trade surveys. At the heart of this dissatisfaction lies manufacturers' concern regarding widespread retailer opportunism with low retail pass through. Our objective is to develop a simple game-theoretic framework to examine the strategic considerations that underlie a retailer's decision to pass through a trade deal. In particular, we are interested in answering the following questions: What and how do product-market characteristics impact the extent of retail opportunism? How can the manufacturer alleviate the retail pass-through problem by strategically supplementing trade promotions with advertising trade deals directly to consumers? To address these issues, we consider a stylized channel with a single manufacturer who serves two customer segments through a single (focal) retailer. We implicitly capture the essence of retail competition by allowing customers to have an outside option: other retailers that customers might search if they deem the price at the focal retailers to be “too high.” Customers differ in their valuation for the manufacturer's product and in the costs they incur when searching for a better price at other retailers. While customers are unaware of the existence of a trade deal in any particular time period, through prior experience they know the frequency of such deals and, furthermore, they update their beliefs about the occurrence of a deal by observing the posted retail price. The retailer decides whether to pass through a deal or not, recognizing the impact of his pass-through policy on customers' search propensity, and hence, their willingness to pay. The main message of the paper is that in an environment where manufacturer offers trade promotions, a retailer may not have the incentive to pass a low wholesale price onto consumers because consumers do not have perfect information about ongoing trade promotions. When consumers observe a high price at the focal retailer and yet are not sure if a trade promotion is on, they may not look around for a low price. Therefore, the retailer can price opportunistically to gain a higher margin by not passing a low price to consumers. However, if the retailer never passes savings on, consumers can infer opportunistic pricing based on prior knowledge of trade promotion frequency and have a higher tendency to shop elsewhere, thus reducing sales volume. The retailer resolves the conflicting incentives by occasionally charging a low price when a trade promotion is on, while posting a high price on other occasions. We find that the extent of retail opportunism depends on product-market characteristics, such as the retailer's clientele and the heterogeneity in consumer search costs, as well as on the characteristics of the manufacturer's trade promotion policy, such as the frequency of trade promotion and the depth of discount offered. When the low-valuation consumers have search costs that make them exit the market when the focal retailer posts a high price, the manufacturer will intervene by advertising his trade promotion directly to consumers, thus performing a channel coordination function. We consider several extensions of the base model—explicit retail competition, differentiated retailers, and heterogeneity in consumers' knowledge about the frequency of trade deals—and show that our results still hold.

Effectiveness of Trade Promotions: Analyzing the Determinants of Retail Pass-Through

Trade promotions are temporary price cuts that manufacturers offer retailers to encourage them to reduce retail prices. While trade promotion spending as a percentage of marketing budget has increased dramatically, the inefficiency of trade promotion represents the number-one among manufacturers as indicated by recent trade surveys. At the heart of this dissatisfaction lies manufacturers' concern regarding widespread retailer opportunism with low retail pass-through. Our objective is to develop a simple game-theoretic framework to examine the strategic considerations that underlie a retailer's decision to pass-through a trade deal. In particular, we are interested in answering the following questions: (i) What and how product-market characteristics impact the extent of retail opportunism? (ii) How can the manufacturer alleviate the retail pass-through problem by strategically supplementing trade promotions with advertising trade deals directly to consumers? To address these issues, we consider a stylized channel with a single manufacturer who serves two customer segments through a single (focal) retailer. We implicitly capture the essence of retail competition by allowing customers to have an outside option: other retailers that customers might search if they deem the price at the focal retailer to be too high. Customers differ in their valuation for the manufacturer's product and in the costs they incur when searching for a better price at other retailers. While customers are unaware of the existence of a trade deal in any particular time period, through prior experience they know the frequency of such deals and, furthermore, they update their beliefs about the occurrence of a deal by observing the posted retail price. The retailer decides whether to pass-through a deal or not, recognizing the impact of his pass-through policy on customers' search propensity and hence, their willingness-to-pay. The main message of the paper is that in an environment where manufacturer offers trade promotions, a retailer may not have the incentive to pass a low wholesale price onto consumers because consumers do not have perfect information about ongoing trade promotions. When consumers observe a high price at the focal retailer and yet are not sure if a trade promotion is on, they may not look around for a low price. Therefore, the retailer can price opportunistically to gain a higher margin by not passing a low price to consumers. However, if the retailer never passes savings on, consumers can infer opportunistic pricing based on prior knowledge of trade promotion frequency and have a higher tendency to shop elsewhere, thus reducing sales volume. The retailer resolves the conflicting incentives by occasionally charging a low price when a trade promotion is on while posting a high price on other occasions. We find that the extent of retail opportunism depends on product-market characteristics such as the retailer's clientele and the heterogeneity in consumer search costs as well as on the characteristics of the manufacturer's trade promotion policy such as the frequency of trade promotion and the depth of discount offered. When the low valuation consumers have search costs that make them exit the market when the focal retailer posts a high price, the manufacturer will intervene by advertising his trade promotion directly to consumers thus performing a channel coordination function. We consider several extensions of the base model - explicit retail competition, differentiated retailers and heterogeneity in consumers' knowledge about the frequency of trade promotions ? and show that our basic results still hold.

The Internet and the Reshaping of the Music CD Market

In this paper we examine the market for music CDs to see how it is different from physical markets in terms of characteristics such as pricing, price dispersion and price dynamics, and what emergent market structures are taking shape. We find that the Internet market continues to show price dispersion despite the apparently near zero search costs for consumers. Retailers tend to have a different set of pricing strategies for mainstream and niche products thereby catering to distinct customer segments. Price dynamics alter over time with Internet retailers offering cheaper prices for niche products and employing more frequent and finer price changes. With growing support for digital distribution and peer-to-peer connectivity illustrated by the Napster community, it appears that value chain structures will evolve and market roles change over time to reflect the changes in value creation competency requirements.

When Shopbots Meet Emails: Implications for Price Competition on the Internet

When Shopbots Meet Emails: Implications for Price Competition on the Internet