Will the growth of multi-channel retailing diminish the pricing efficiency of the web?(study compares pricing behavior between online and traditional retailers)

Fang-Fang Tang [a,*]

Xiaolin Xing [b]

Abstract

In this study, we compare the pricing behavior between online branches of traditional retailers and pure Internet retailers. We seek to determine whether the pricing policies of these two types of online organizations differ, possibly because of the different competitive environments in which each operates. While both offer product over the Internet, traditional retailers must also taken into consideration the impact that such offers will have upon the business that they transact in their land-based stores. We anticipate that the constraint of a land-based store will cause such dual-channel operators to charge higher prices than Internet operators not so constrained. Focusing on standardized DVD brands, we gather a data set with of 4896 observations; we find that prices by pure Internet retailers are significantly lower than prices by online multichannel retailers by an average of $3.27 or 14%. The evidence also shows that the price dispersion is sharply lower among the pure Internet retailers than that among the multichannel retailers online. Price changes by both types are few, but adjustment magnitudes are large. This reveals that both types of online retailers do not change their prices frequently despite the claim that menu cost might be negligible for the online market. The evidence suggests that domination of multichannel retailing format may diminish the pricing efficiency of the Web. (c) 2001 by New York University. All rights reserved.

1. Introduction

The emergence and explosive growth of e-commerce through online trading have ushered in a new era of retail business. [1] Online trading promises the potentials of low barrier of entry, easy access to information, and low transaction costs. These features of online trading imply that the growth of e-commerce has the potential of realizing often stated economic ideals for a truly competitive market: low search costs, fierce price reactions, low margins, and weak market power. Such benefits bring might provide significant welfare benefits to consumers.

Empirical studies on online trading efficiency to date do not answer this question. Clay et al. (1999) compared prices of books sold by thirteen online and two physical bookstores. They found that prices in online and traditional stores were the same after controlling for book characteristics. In a more comprehensive study, Brynjolfsson and Smith (2000) examined prices of books and CDs sold through Internet and conventional channels in 1998 and 1999. They found that online prices were 9-16% lower than that in conventional stores. After weighting the prices by proxies for market share, Brynjolfsson and Smith found price dispersion to be lower among online retailers than conventional stores.

Morton, Zettelmeyer, and Risso (2000) compared prices of cars sold in online and conventional channels. They found that, on average, online consumers paid two percentage less than offline consumers. Both Bailey (1998a) and Brynjolfsson and Smith (2000) found that online menu costs were lower. Based on comparison between online retailing and traditional retailing, these various results lend support to the hypothesis of superior pricing efficiency in online markets to offline markets.

This study looks at multichannel retailers because we observe that with the rapid growth of e-commerce, more and more conventional retailers have initiated sales online. [2] Some traditional retailers have gained ground on the Web while the pure Internet retailers have been encountering economic difficulties and falling widely. [3] We seek to derive some insights as to why this may be the case. Partly following the methodology in Tang, Lu and Ho (2000) and Tang and Lu (2001), we explore the different pricing behavior between online-only retailers and online branches of multichannel retailers. In particular, we seek to contrast the pricing of multichannel retailers with those of online-only retailers and derive implications. As far as we know, this is the first and only study on the online DVD market from such a perspective.

What would happen if the online retail channel were to become increasingly dominated by multichannel retailers? Since both types of retailers will presumably be exposed to the same set of shopping pressures, one might anticipate that prices would tend to converge. Given that shoppers have typically looked for price savings when shopping on the Internet, retailers offering higher prices may not be viable in this market. In other words, there would be little chance for MCRs to dominate the Internet if they maintained higher prices.

However, since a multichannel retailer's pricing behavior would inevitably have influence upon demand in their conventional stores, given the early findings that traditional stores charge higher prices than online retailers, the consequence is that price differentials between the two will create internal competition and conflict between the two internal channels. Under this condition, it is not clear that multichannel retailers will compete closely on prices with online-only retailers even though this may leave them at a disadvantage. It is consequently not groundless to be concerned about creating a joint retail facility between Internet and land-based establishments for the interchange of customers and a cooperation, rather than competition across the two. [4] It may well be critical to keep prices similar in order to facilitate this synthesis and promote service to consumers. Scrutinizing this hypothesis by empirical evidence can substantially contribute to our understanding of the online pricing efficienc y.

If there were need for the multichannel retailers to coordinate prices across their multiple format channels, including the Web, would this dampen the pricing efficiency of the Web? To answer this question, we investigate prices of DVDs sold on the Web by both online-only retailers (henceforth referenced as DotComs) and the online branches of multichannel retailers (MCR). We test: (a) whether DotComs offer prices lower than MCRs; (b) whether the dispersion of prices exhibited by DotComs is smaller than that by MCRs; and (c) whether the two types of online retailers adjust their prices frequently and whether at similar frequencies or magnitudes. Our hypotheses are discussed in more details in Section 2. Section 3 describes our data collection methodology. Section 4 presents the results of our empirical analysis. Section 5 concludes.

2. Hypotheses

According to Smith, Bailey and Brynjolfsson (2000), "in retail markets where sellers set prices, efficiency occurs when prices are set equal to the retailer's marginal cost. Marginal cost pricing is the efficient outcome since pricing above marginal cost excludes welfare enhancing …