Rob Kauffman studies pricing strategies of Internet retailers and the expectation that the best prices are found online.
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."
