Digital Economy of the 21st Century - Essay Example

INTRODUCTION The world’s economy has steered in to a new direction with the onset of the 21st century. Markets, consumers, producers and businesses have been redefined with the technological changes in the last couple of years. The most prominent change has been the inception of the “Digital Economy”, an electronically created market where business transactions take place electronically between the consumers and the producers. In other words, digital economy has necessitated the need for electronic commerce. Instead of on the spot trading; the Internet and Web technologies have made it easier for products and services to be sold online. With the recent technological boom, electronic businesses and markets have no doubt, flourished. The example of digital entertainment like MP3’s, e-books, availability of various soft wares for download and videos for streaming are only some examples of the phenomenal growth of the digital market. When markets come into play, whether they are digital or physical, price automatically becomes a crucial feature. It is important for consumers because they expect to buy at the least price, it is important for producers because they expect to sell at the highest price while maximizing profits and it is very important for the market as a whole in order to keep resource allocation efficient. One area of interest which scholars have long debated over, in relation to the digital economy, has been with respect to prices. A large amount of literature has been written in evidence of showing the presence/absence of price dispersions in online pricing, the reasons why such a phenomenon occurs and how significant it is in relation to modern retail outlets; traditional, pure-Internet based and multi-channel retail outlets (land based retail presence as well as an internet presence of the retailer). At this point it is important to define the phenomenon of Price dispersion. Pan, Ratchford and Shankar (2004, p.443) define price dispersion as “the distribution of prices (such as range and standard deviation) of an item with the same measured characteristics across sellers of the item at a given point in time”. In simpler words, it may be defined as the difference of prices among sellers of the same items. This concept has major implications for the retailing outlets as it acts as a cue for assessing their own pricing strategies and is reflective of what strategies their competitors have adopted. Be it the traditional, pure Internet or multi-channel retailer, the degree of price variances among the three retailers will be reflected in the prices. This is important to producers or retailers (as they may be able to manage to some extent the degree and narrowness of price dispersions) to take advantage of opportunistic pricing. They may be able to assess price dispersions and widen and narrow it by altering the factors behind price dispersions. The factors which cause price dispersions may be random or specific/unique to the retailer. For example, the price variances may be attributed to difference in services, product itself or to the particular features of the market at that point of time. The concept of price dispersions arising online is also important from the customers’ point of view. At the end of the day, consumers are the ones paying the prices and they can resort to different retail outlets if price dispersions in one become too great. The literature review that follows sheds light on previous studies which have tried to explore the dynamics of price dispersions; whether it is present or not and how narrowly or broadly it can be defined for online markets. The second part of the literature review will briefly discuss arguments from different schools of thought on why price dispersions take place in the first place. The final part of the literature review will discuss the impact of price dispersions on the various retail outlets for reasons mentioned above. LITERATURE REVIEW With the advent of the Internet, researchers had long thought that easy access and wider availability of information would give birth to a “frictionless” economy. Bakos (1997) suggested that the reduction in search costs was one of the most salient features of the electronic economy. These reduced costs combined with the assumption that consumers are fully informed about price and products would drive prices low until they converged to perfect competition market levels. He argued that in such a scenario, the market place would reduce inefficiencies, maximize consumer welfare and hinder sellers from charging monopolistic prices reducing their market power. However, much of the empirical research shows a different scenario. The situation of perfect competition does not prevail in digital goods markets. The numerous studies have confirmed time and again, not only differences in online retail price levels (as compared to offline retailing) but the consistent presence of the price dispersion phenomenon in online pricing. The degree of price dispersion however, has varied, in almost all studies. Some suggest that price dispersions in online retailing is higher (in comparison to offline retailing) while others are conclusive of price dispersions being comparatively low. Nonetheless, price dispersion does exist in a digital goods market. Brynjolfsson and Smith (2000) suggested that because it was relatively easier to make an entry in an online market than a traditional market, the reduced costs would contribute to lower price dispersions. The authors suggested that the cost of operating and managing a Website would be less than the cost of operating a traditional market setup. This would again lower costs for online retailers, giving rise to lesser price dispersions. In an experiment comparing prices of two homogenous product categories- CD’s and books, over a period of 15 months, in a conventional and online setting, the authors came to a conclusion that e-tailers had smaller price variances than offline retailers. Much of the later research published, also suggested likewise findings. In an online car retailing paper published by Morton, Zettelmeyyer and Risso (2001), the outcome was the same. When more cars were sold though the website Autobayel.com, price dispersion was lower; consumers had greater information and the prices that that they paid on average varied less. In an insurance study done of 30,000 insurance policies in a five year period, Brown and Goolsbee (2002) found similar results. They discovered that with introduction of internet research sites to shop for insurance policies, though the price dispersions initially peaked, later on the price dispersions decreased as information on the internet came widely available. Much of the empirical research work, however, also showed contradictory results. To start off with the earliest of the studies, Bailey (1998) conducted a series of research on the prices of homogenized CD’s, books and software sold through the Internet and offline channel. The study concluded that the price dispersions were not lower online; books and CD’s had more price variance on the Internet and thus more price dispersions. This study had limitations though as the authors themselves suggested; the Internet maturity had not reached a level which is seen now days and with more information and time maturity it was concluded price dispersion would eventually narrow down. In another research, Lee and Gosain (2002) compared the price dispersion of music CD’s of nine online Internet retailers with five traditional retailers. This study was important as it showed distinct price dispersion patterns for two distinct product categories, “popular” and “niche”. Lower price dispersions were noted for current albums, but higher online price dispersions were discovered for old ones. One important conclusion drawn, therefore, was that sellers could also employ maximum price strategies in case of old CD albums to their advantage. Because “niche” albums could afford to have higher price dispersions, sellers could charge higher prices In a cross border study done by Clay and Tay (2001) data on textbooks sold in different online markets across Germany, US, UK and Turkey was gathered. The research showed that price dispersions across the countries were significant and US had the highest price dispersion. Also, if shipping costs were included the price dispersions grew fairly. Studies have also been done with products as diverse as vitamins. In the study done by Erevelles, Rolland, and Srinivasan (2001), five forms of retail outlets were compared to see which had the highest degree of price dispersion. The Internet, ware house retailers, discount retailers, supermarkets and drug stores were compared and it was found out that the Internet retailers compared to traditional retailers had higher price dispersions, and in addition had higher prices. In the airline industry, research done by Clemons, Hann and Hitt (2002) compared the prices of online airline tickets controlling for product heterogeneity, the results showed higher price dispersions via the online internet agencies ; as high as 18% even after controlling for the differences in services that might skew the results. Comparisons of price dispersions have also been made for everyday household items like deodorants, hair spray, hand creams and medicine like aspirin. Scholten and Smith (2002) compared traditional retail outlets of the 1970’s to the internet retailers outlet of 2000 and showed that the price dispersions of the online retailers was higher for the above products; a variance co-efficient of 14.5% for Internet retailers as compared to a 12% for traditional retail outlets. The most exhaustive research on online price dispersions was done by Ancarani and Shankar (2004) who compared price levels and price dispersions along the three modes of retailing; online, traditional and multi-channel retailing. The results showed that multichannel retailing showed the highest price dispersions as compared to online retailers who only had higher price ranges otherwise but lower standard deviations. The above part of the literature review indicates that price dispersion in online retailing is pretty much consistent. Though different studies show the degrees of how wide and narrow these dispersions can be, the finding that it is present, is an all important concern in its self. This is because it shows that there is high level of price competition online, discarding older theories about the Internet being a place of perfect competition and buyers possessing full information. The next part of the literature review explains why these price dispersions take place in the first place. This is an important discussion as it will link how price dispersions affect the retailers pricing strategies and how it different retailers can take advantage of varying the degree of price of dispersions. In the study of why price dispersions take place in electronic markets, one study concluded by Pan, Ratchmond and Shankar (2002) suggested that the differences merely arose because of variance in the quality of “services” provided by online retailers. However, when the heterogeneity of services was controlled for, it did not affect the degree of price dispersions. It meant that attributes like services of online retailers did not account for variances in prices, reinstating the theory that the electronic market is imperfect and full of information asymmetries. When the same study took into account e-tailor characteristics like services, website convenience, customer support etc , along with market characteristics( product popularity in the market, number of retailers available) and category uniqueness of the products and concluded that the interaction of all the three generated price dispersions. The study also found out that e-tailors or Internet retailers with a good and deep knowledge of the product did not always charge higher prices. This was consistent with another study done by Beyloff and Perloff (2002) which also attributed to price dispersions owing to bad (higher prices and lower services) firms and good firms (lower prices and higher services). Another theory which is seen as being a crucial one suggests that consumers take notice and are aware of retailer names. Thus Chen and Hitt (2003) suggest that if the consumers are a little conscious of brand names and only a few consumers are aware of all the available retailers online then retailers play a game of mixed pricing strategies. It was found out that well known brand of retailers would set higher prices on average, than lesser known retailers. Thus, this would in turn create the phenomenon of price dispersions. The former section of literature review has discussed some of the factors that may contribute to price dispersions being present in digital goods market. Various theories and reasons have been outlined as possible causes. Now that the discussion above has established the presence of price dispersions in digital goods or Internet markets, the rest of the literature review will focus on why the issue of price dispersions is receiving growing concern by various retail outlets. By knowing that it exists and having prior knowledge of what may contribute to such dispersions, the different retail outlets can assess the price dispersions in relation to each other and build on strategies to minimize or maximize the degree and significance of price dispersions accordingly. One very significant study on price dispersions in relation to different retail outlets, which has already been mentioned above, has been conducted by Shankar and Ancarani (2004). The study is a discussion on how three different retail outlets have a varying price level and varying price dispersion level. The three retail outlets which are considered are pure –play Internet retailers, bricks and clicks (multi-channel retailers) and bricks and mortars (traditional retailers). According to the authors it is essential to know if price dispersion levels vary across the three retail outlets. This is because ultimately multi-channel retailing would reflect both the prices of traditional and pure internet based retailing. When price dispersion is measured of the three ( in terms of standard deviation and ranges) a very significant outcome is found. Multi- channel retailers have higher price dispersions than the pure Internet or traditional retailers. This in turn has other important implications for the three retail outlets. The greater variability in prices of multi-channel retailers suggest that they can differentiate more and have more opportunities to distinguish themselves as compared with the other two retail outlets. The authors therefore find crucial evidence that retail outlets with multiple channels can charge higher prices and can have higher dispersions owing to the simple fact that they operate online and have a land presence. In a study done by Xing and Fang -Tang (2001) on the effect of pricing efficiency of multi channel retailing outlet, data collected on standardized DVD’s showed that prices and as well as price dispersions for multi-channel retailing is sharply greater than the purely internet based retailers. As the authors suggest, this can have a crucial effect on the future of pure internet retailing. If multi-channel retailing overtakes pure internet retailing then the price efficiency which is somewhat felt in lower search costs would be lost. Price dispersion research, as mentioned before, has obvious implications for retail outlets. The most important consequence of such price variances is that it affects the level of competition between retailers themselves. They can assess the market and choose to widen and narrow down these dispersions in order to attract the maximum market share. They can build price strategies and undercut their competitors by observing these price dispersions. References Ancarani, F., & Shankar, V., 2004. Price Levels and Price Dispersion Within and Across Multiple Retailer Types: Further Evidence and Extension. Journal of Academy of Marketing Science, 32(2), pp.176–187. Bailey, J., 1998. Intermediation and Electronic Markets: Aggregation and Pricing in Internet Commerce. Ph. D. Technology, Management and Policy, Massachusetts Institute of Technology, Cambridge, MA. Bakos, Y., 1997. Reducing Buyer Search Costs: Implications for Electronic Marketplaces. Management Science, 43(12), pp.1676–1692. Baylis, K., & Perloff, J.M., 2002. Price Dispersion on the Internet: Good Firms and Bad Firms. Review of Industry Organization, 21, pp.305–324. Brown, J.R., & Goolsbee, A., 2002. Does the Internet Make Markets More Competitive? Evidence from the Life Insurance Industry. Journal of Political Economy, 110(3), pp.481–507. Brynjolfsson, E., & Smith, M., 2000. Frictionless Commerce? A Comparison of Internet and Conventional Retailers. Management Science, 46(4), pp.563–585. Chen, P.Y., & Hitt, L.M., 2003. Understanding Price Dispersion in Internet-Enabled Markets. Working Paper. Philadelphia: The Wharton School of Business, University of Pennsylvania. Clemons, E., Hann, I., & Hitt, L.M., 2002. Price Dispersion and Differentiation in Online Travel: An Empirical Investigation. Management Science, 48(4), pp.534–549. Erevelles, S., Rolland, E., & Srinivasan, S., 2001. Are Prices Really Lower on the Internet? : An Analysis of the Vitamin Industry. Working Paper. Riverside: University of California. Lee, Z., & Gosain, S., 2002.A Longitudinal Price Comparison for Music CDs in Electronics and Brick-and-Mortar Markets: Pricing Strategies in Emergent Electronic Commerce. Journal of Business Strategies, 19(1), pp.55–71. Morton, F.S., Zettelmeyer, F., & Silva-Risso, J., 2001.Internet Car Retailing. Journal of Industrial Economics, 49(4), pp.501–519 Pan, X., Ratchford, B.T., & Shankar, V., 2002. Can Price Dispersion in Online Markets Be Explained by Differences in e-Tailer Service Quality? Journal of the Academy of Marketing Science, 30(4), pp.443–456. Pan, X., Ratchford, B.T., & Shankar, V., 2004. Price Dispersion on the Internet: A Review and Direction for Future Research. Journal Of Interactive Marketing, 18(4), pp.443–456. Scholten, P.S., & Smith, S.A., 2002.Price Dispersion Then and Now: Evidence from Retail and E-Tail Markets. Advances in Microeconomics: Economics of the Internet and e-Commerce, 11, pp. 63-88. Tang, F., & Xing, X., 2001.Will the Growth of Multi-Channel Retailing Diminish the Pricing Efficiency of the Web? Journal of Retailing, 77, pp.319-333. Read More