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Rob Kauffman
Information and Decision Sciences
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When the
Internet first arrived, knowledgeable observers thought it would
change the way companies compete and make profits, and that consumers
would turn to the Internet to get the lowest prices. However, outside
of shopping for airline and hotel tickets and rental cars, this
is not what marketing and information systems researchers have been
seeing.
"The promise of the Internet was that online retailers would
be able to change prices at a moment's notice to remain competitive,
and consumers could compare prices to get the lowest price,"
said Rob Kauffman, professor of information and decision sciences
at the Carlson School of Management. He is studying how
often prices change on the Internet.
"Most business people expected prices on the Internet to be
much more flexible, without the physical costs that a store must
endure to change price tags and update print media advertisements,"
said Kauffman. "The Internet was supposed to become a 'frictionless'
environment for prices. Internet-based sellers would use technology
to track their competitors' prices and products, shoppers would
consult 'shopbot' comparison tools, and the market would reach an
epic level of efficiency-like a financial market that trades stocks
and other financial instruments."
Kauffman said that many strategic pricing experts believed that
customers would be able to find better deals online for products
sold at stores like Target or Best Buy. This is because vendors
would have access to shopping data in real-time and be able to make
quick price adjustments.
However, the failure of early dot-com retail sites proved that the
actual costs of changing prices may be higher than just the physical
costs. Professor Kauffman, marketing professor and pricing expert
Mark Bergen, and information systems doctoral candidate Dongwon
Lee join other business school researchers now looking at online
pricing models for a variety of products, including automobiles,
books, computers, electronics, and insurance products. They study
price rigidity-how often prices change on the Internet-because markets
may behave differently based on the frequency of price changes,
Kauffman said.
Less frequent price changes may be used by sellers to signal higher
quality and avoid the impression in the marketplace that the
company is interested in serving consumers who are only "chasing
prices," Kauffman said. Frequent price changes may
confuse consumers, who are searching for appropriate prices, not
necessarily the lowest ones. Frequent price changes can even make
a retailer appear dishonest, as customers try to interpret the firm's
motives behind a price change. So consistency of a seller’s
prices over time-even in the presence of shopbots-may be desirable
from a consumer's standpoint.
According to Bergen, who studies pricing and branding, frequent
price changes don't necessarily work when a company is selling a
brand as much as a product. "Companies are increasingly savvy
about making sure Web surfers choose their products over the competition,"
Bergen said. "They know, in many cases, that price is not the
defining factor. Some people want to know they are buying high-quality
products so they seek information about the features, benefits,
and services being offered. Others want to know they will get their
products shipped on time or that the company will stand behind its
products if there is a problem. These factors lie at the heart of
a company's brand and image and are often more important than getting
the lowest price."
Bergen, Kauffman, and Lee researched the daily Internet pricing
patterns for Amazon.com and Barnes&Noble.com and found that
these retailers use several pricing strategies and theories. By
tracking the prices of 330+ books over 450 days in 2003 and 2004,
the research team uncovered a number of ways that Internet retailers
appear to be using to lure and retain their online customers, keep
ahead of the competition, and make a profit.
Their research, "Beyond the Hype of Frictionless Markets: Evidence
of Heterogeneity in Price Rigidity on the Internet," was published
in the October 2005 issue of the Journal of Management Information
Systems. "Prices on the Internet appear to be more rigid than
we ever might have guessed," said Kauffman. "Our results
should break the hype that surrounds expectations of 'frictionless
markets' and the idea that Internet technology somehow has fundamentally
changed strategic pricing. It probably hasn't."
Their findings come at a time when consumers are turning to the
Internet in increasing numbers to make their purchases. According
to the U.S. Department of Commerce, Internet sales rose nearly 25
percent over last year's sales, during the first quarter of 2005.
At the same time, brick-and-click retailers like Best Buy, Target,
and Barnes & Noble have been placing more emphasis on their
Internet customers and doing their best to figure out how to price
and market their products online.
To study the online book retail market, Lee, an expert in computer-based
analytics for e-commerce, developed a software program to cull data
from the two retail sites on the Internet, as well as BestWebBuy.com,
a price comparison site. After crunching the data, six findings
emerged:
1) Internet retailers appear to change prices on any day of
the week. This is in contrast to grocery stores and retailers, who
adjust prices with sale fliers and print and radio advertisements
to take advantage of greater demand that occurs around the weekend.
Internet retailers-perhaps due to their high technology prowess-are
capable of being more flexible than traditional bricks and mortar
retailers. Yet they don't take advantage of this new capability,
choosing instead to change prices very infrequently-on average every
222 days for Amazon.com and every 56 days for Barnes&Noble.com.
2) Price adjustments for books occur less frequently than every
day-every 90 days on average for the companies they studied. One
possible explanation, according to Lee, is that demand for books
is fairly constant over time and books are non-perishable, unlike
airline or hotel tickets, so prices don't need to change as much.
3) On some days of the year, price change activity is great.
According to the data, prices changed most frequently on tax day,
April 15 (when many consumers are focused on paying their taxes);
followed by June 2, which is around the time that the summer reading
season begins and school lets out. Other price change days included
the first days of January, February, June, and September.
4) Surprisingly, none of the top 10 price change days occurred
in the Christmas holiday shopping season or around other holidays. The
exception is the New Year’s holiday period of January 1 and
2, 2004, which ranked seventh and ninth in their price change
data. "Physical stores have to increase their staffing levels
around the end-of-the-year holidays or encourage their customers
to wait for the week’s bargains to be found in the newspaper
ads," said Lee. "Internet book sales are probably inelastic
around the holiday season. People buy books as gifts, and so the
retailers' keep their prices high, reflecting this inelastic demand,
even though they may advertise more aggressively during this period.
In addition, Internet booksellers probably also have smoother sales
levels across the entire year, unlike traditional retailers who
generate larger portions of their revenues between Thanksgiving
and New Year's Day. If these retailers don't reduce prices in the
face of very high demand, they risk missing the market at a crucial
time."
5) Price change activity varies by book category. Their data
show a high of one change on average every 61 days for bestsellers
to a low of one change every 184 days on average for steadysellers,
classic books by authors such as Hemingway or Faulkner. "This
seems to be based purely on supply and demand," Lee said. "Steadysellers
seem likely to have more stable and better understood demand structures
than either new books or bestsellers." In addition, media hype
surrounding bestsellers may change demand and also affect prices.
6) Amazon.com changed its book prices every 222 days, while
Barnes&Noble.com changed its book prices every 56 days on average.
There could be a number of reasons for this, including the fact
that Barnes & Noble entered the online market later than Amazon.com
and may be relying on pricing expertise from its traditional store
operations, said Lee. Barnes & Noble also offers a fee-based
service called "Reader's Advantage," which entitles the
buyer to 10 percent discounts on all in-store and Internet-based
purchases, and builds a basis for affinity purchasing-though they
may not have lower prices than Amazon.com. Another interpretation
of Amazon.com's relatively stable online pricing may lie in the
negative media reports that resulted from Amazon.com's brief (and
unsuccessful) foray into computer-based price discrimination for
its existing customers. In this case, Amazon.com briefly charged
different segments of its customers higher or lower prices, before
its customers rebelled. Yet another theory is that people think
a store is of higher quality if its prices are higher, so prices
are less flexible for higher-priced, higher-quality stores, Lee
said. In addition, these stores typically offer more customer service
and more product choices, so they may face higher costs and seek
higher margins and keep their prices higher for longer periods of
time.
The bottom line is that new capabilities that Internet technology
offers do not seem to impact other factors central to making pricing
decisions-like a company's quality and service profile in the marketplace,
its own understanding of pricing strategies relative to its brick
operations, the sophistication of its competition, consumer impressions
of reasonable pricing, and overall demand. Still, online retailers
must make sure they are taking advantage of current technologies,
since their capabilities are increasingly at the heart of a modern
firm’s abilities to effectively set prices.
"To be successful in the online marketplace, today's retailers
must align their pricing strategies with their brands and ensure
that their operations are in line with the current capabilities
that information technology offers for competitive advantage,"
Kauffman said. "Our next step will be to compare these price
change findings with other product categories and industries, in
order to build the basis for a more complete understanding of the
most advantageous pricing strategies of Internet retailers."
Reprinted with permission from the July 2005 edition of Insights
@ Carlson School, a publication of the Carlson School of
Management.
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