Contrary to prevailing opinion, companies that sell products online may actually face less price competition and charge higher prices, especially for products that must be examined in stores before purchase, according to a study published in a journal of the Institute for Operations Research and the Management Sciences (INFORMS®).
"While the Net allows consumers to save shopping time and effort, it can make it costly for them to try new products like clothes that have to be evaluated in person," says Professor Rajiv Lal, the Stanley Roth Sr. Professor of Retailing at Harvard Business School. "As a result, companies that do a good job establishing brand loyalty should face less price competition and be able to charge higher online prices. This can lead to higher profits for these firms."
The study, "Is the Internet Likely to Decrease Price Competition?" is written by Prof. Lal and Miklos Sarvary of Harvard Business School. The authors used operations research and other techniques to reach their conclusions.
Digital and Non-Digital
The study challenges the conventional wisdom, which claims that by lowering the cost of distribution and making it easier for consumers to search online, the Internet will always intensify price competition.
The authors developed a mathematical model that tests when online price competition declines. The researchers found that the introduction of the Internet might lead to higher prices when (1) the proportion of Internet users is high enough; (2) "non-digital" attributes are relevant but not overwhelming; (3) consumers have a more favorable prior experience with a brand they currently own; and (4) when consumers must do "destination shopping."
Digital attributes of products, like recordings, are those that can easily be communicated online. Non-digital attributes are those, like clothing size or style, that require personal inspection of a product at a store. Destination shopping takes into account the time and effort of shuttling between stores to compare an item.
More surprising, the study also shows that in such cases, the use of the Internet not only leads to higher prices but can also discourage consumers from engaging in product searches.
Convenience of the Internet
With the presence of the Internet, the researchers suggest, consumers who have a favorable experience with a product they've examined at a store are more likely to purchase that same brand online in subsequent visits. The result is increased consumer loyalty, which induces firms to increase their prices. Given the convenience of the Internet, consumers may continue buying a favored product even if the online price is higher than the store price.
The findings suggest that companies that operate both retail stores and Internet sites should improve the personal service they provide to customers shopping for certain products in their stores to ensure that these customers make subsequent purchases online.
The study also guides retailers in the process of deciding whether to begin using the Internet as a complementary channel to their stores. These retailers may be able to distribute some product lines online, even if the online price is higher due to shipping, handling, and special return policies.
The researchers tested their theory mathematically by constructing an operations research model that takes into consideration digital and non-digital characteristics of products, consumer decisions about searching or staying with a familiar brand, companies that distribute merchandise only at stores, and companies that sell both in stores and over the Internet.
Because of similarities between catalog and Internet sales, the researchers' model also takes into account many aspects of mail order catalogs.
"When and How Is the Internet Likely to Decrease Price Competition?" appears in the current issue of Marketing Science, an INFORMS publication.
The Institute for Operations Research and the Management Sciences (INFORMS®) is an international scientific society with 12,000 members, including Nobel Prize laureates, dedicated to applying scientific methods to help improve decision-making, management, and operations. Members of INFORMS work in business, government, and academia. They are represented in fields as diverse as airlines, health care, law enforcement, the military, the stock market, and telecommunications. The INFORMS website is at http://www.