When you look for a digital camera or LCD TV on Amazon, often you can’t see the price till you add it to the shopping cart. This is a little bit on an inconvenience so why does Amazon do it?
It turns out the producers force Amazon to do it. Adding the extra step to shopping has two effects.
First, the prices do not turn up on comparison shopping sites like Pricegrabber.com so it is harder to search for a good deal. Second, every time you search you incur an extra cost to discover the price at another internet retailer. These small differences can make a huge difference.
The classic logic for how small search costs can have a dramatic impact on prices is offered by the Diamond search model. Suppose stores are selling a homogenous good but you do not know the price they set till you visit the store. Each visit costs you a few pennies in search cost.
If there is no search cost, the unique equilibrium has all stores setting price equal to cost and making no profits on sales. But this cannot be an equilibrium with positive search costs. Then, one store can raise its price secretly by a few cents. Once the customer has entered and sunk his cost of search, he will buy anyway knowing that taking the cost of search into account for his visit to another store, it is not worth it to search. It is easy to see what any equilibrium must be symmetric, otherwise all consumers will go to the store with the lowest prices and the store with the lowest prices has an incentive to raise them. So, what is the symmetric equilibrium? It is the monopoly price! Only at that price does no store have the incentive to raise the price as it will choke off too much demand.
So, a small search cost leads to a dramatic change in prices from zero profit to monopoly profit. This conclusion is too stark and it can be made less dramatic by adding product differentiation but the core idea remains the same. Search costs give firms some degree of market power and allow them to raise prices. This is the strategy being attempted on Amazon. It will be interesting to see how it plays out.
10 comments
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February 10, 2010 at 10:04 pm
Michael
The question remains though, why would a firm want market power downstream from them?
February 10, 2010 at 10:52 pm
David
I refuse to consider the offerings of brands that want to make me jump through hoops before they’ll tell me what they’re actually offering. Also, because I’m a vindictive bastard, I refuse to buy *any* of their products for a while, even if the price is disclosed up front.
February 11, 2010 at 7:22 am
alex
Glenn Ellison has a couple of papers about this: “A Search Cost Model of Obfuscation” with Alexander Wolitzky, and “Search, Obfuscation, and Price Elasticities on the Internet” with Sarah Fisher Ellison (published in econometrica)
February 11, 2010 at 8:46 am
Noah Yetter
“It will be interesting to see how it plays out.”
Well it’s been standard practice for 7 or 8 years at least so it must be working.
Also it’s not ALL prices that are concealed only SALE prices. The manufacturer doesn’t want it to be easy to find a sweet deal on their item. Why, I presume is the standard Retail Price Maintenance bullshit, or something. Whatever the real reason is it’s ineffective against savvy shoppers so I care little.
February 12, 2010 at 11:39 am
Tim Randall
It does have a certain elegance: The only thing that can compete with Modern Western Virute #1 (cheapness) is Modern Western Virtue #2 (convenience).
February 12, 2010 at 7:36 pm
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February 13, 2010 at 4:09 am
Leigh Caldwell
Related and also annoying Amazon habit: I sometimes have to put in my credit card details before I can see the delivery charges. They don’t charge it until I confirm again, but still…this is a big cognitive barrier and I’m sure it has a similar effect.
In fact, I would my example put in the category of sunk costs/endowment effect rather than search costs. The delivery costs might put me off if I see them before making the choice to purchase; but once I’ve gone through this hassle, I’m more likely to resign myself to pushing the final button and place the order.
February 17, 2010 at 12:16 pm
billpetti
While there is certainly a cost to search, the digital medium significantly reduces that cost (I would imagine near zero in some cases). In the case of online shopping, it is exceedingly easy to uncover the hidden price and then quickly search a comparison site for the same item and determine which is the better deal. I have never felt the pull of sunk search costs by visiting Amazon and going through the extra few clicks to reveal the price. I have, however, decided to look elsewhere as a result (user experience is the main issue here).
March 18, 2010 at 5:30 am
eddie
nice and very informative writeup keep it up.
May 6, 2020 at 3:18 pm
antarvasna
Also it’s not ALL prices that are concealed only SALE prices. The manufacturer doesn’t want it to be easy to find a sweet deal on their item. Why, I presume is the standard Retail Price Maintenance bullshit, or something. Whatever the real reason is it’s ineffective against savvy shoppers so I care little.