Price comparison websites: the paradox of the lowest price
In my last post, I outlined my interest in e-commerce aggregators and mentioned the central role they play in China’s movie exhibition industry. In this post, we’ll look more deeply into the business model that underlies aggregators in the form of price comparison websites (PCWs) like Google Shopping, PriceGrabber, and Price Spy.
In a world where disintermediation is a growing trend, PCWs stand out as a counterexamples. So what value proposition do PCWs offer? Where does their revenue come from, and how do they affect the prices we pay for goods and services?
A market for information
In their 2001 paper, Baye and Morgan envisage a market for price information, and model PCWs as the gatekeepers to that market. In their model, information within the market flows freely, but the PCW charges an entrance fee for access to the market itself. Baye and Morgan note that while in principle we might expect PCWs to charge fees to both consumers and retailers, in practice consumers access PCWs for free, while retailers pay to be listed. Why should that be? The answer turns out to be that a PCW benefits from having large numbers of consumers participate in its information market, but isn’t as incentivised to aquire a large number of retailers.
A PCW who charges a fee for consumers to access its information leads some consumers to abandon the PCW and just buy directly from the most convenient retailer. The fewer consumers using the PCW, the less reason retailers have to pay the fees, and the PCW goes out of business. The highest consumer participation occurrs, of course, when consumer access fees are zero.
Retailer fees and price dispersion
The same thing isn’t true on the retailer side. If every retailer participated in the PCW’s market, fierce competition would begin to level prices - and if the same product is available from every retailer at the same price, the very raison d’être of a PCW is undermined.
So the PCW is incentivised to prevent full participation by retailers, which it does creating barriers for retailers to join the market in the form of an appriopriate fee (whether a flat fee, click-though fee, or acquisition fee). The entire operation therefore tends to be supported by charges extracted from the participating retailers.
This observation - that in order for a PCW to survive, retailers must offer the same products at different prices ("price dispersion") - has some interesting consequences.
Who pays for price comparisons?
In his 2016 study, Ronayne extended Baye and Morgan’s model to account for the presence of 'inactive' consumers - those loyal customers who tend to stay with their usual suppliers, and also examined the effects of multiple PCWs operating in an information market. He made an interesting discovery.
Ronayne found that in the model the presence of a single PCW - perhaps counterintuitively - raised the prices paid by consumers for goods and services. It’s that fee charged by the PCW to retailers: it gets passed on to customers. Competition between the retailers doesn’t help lower the prices: the PCW will ensure that its fees are set at sufficient levels to prevent competition between retailers from undercutting prices and ensuring price dispersion is maintained.
We might hope that a multitude of PCWs might give retailers better choice, and lower fees through competition, but Ronayne shows how adding more PCWs just makes the situation for consumers worse. A new PCW entering the market doesn’t necessarily create competition. Switching to a new, low-fee PCW means a retailer saves on fees but may lose a proportion of sales (not all consumers will be checking the new PCW), so it’s no sure-thing that a retailer will make that switch. A PCW undercutting its rivals can’t expect to necessarily acquire retailers that way. In fact, the more PCWs in existence the less attractive any specific PCW becomes to retailers, and therefore the larger the fee discount required to entice a retailer to join. At a certain number of PCWs, it simply becomes unprofitable for PCWs to compete on fees, and so fees (and therefore prices) remain high.
Protecting consumer welfare
According to these studies, PCWs aren’t the consumer’s ally that they appear to be. If it turns out that PCWs are simply a mechanism for indirectly extracting consumer surplus via fees charged to (and passed on by) retailers - what might be done?
By regulating the fees charged by PCWs, governments may be able to make PCWs a net benefit to consumers. A number of approaches could be taken:
- Regulators may require that a PCW display prices from all retailers, not just those that pay access fees. The effect would be to increase competition among retailers, driving lower prices. PCWs may instead offer enhanced services to fee-paying retailers, such as highlighted listings or endorsements.
- Less drastically, a ceiling may be imposed to the fees charged, with similar but reduced effect.
- At the most extreme, a government may decide that price comparison services are a public service and maintain its own PCW, which citizens are encouraged to use. By appropriating the information market for itself, a government could set access fees for retailers that encourage competition rather than price differentiation, in a way that a profit-seeking PCW cannot.
But perhaps the most apt regulatory solution would be for a government to force PCWs to disclose to consumers the fees that they charge to retailers. In a shifting of roles, consumers could then ‘shop around’ for and patronise the PCWs that charge the lowest fees to retailers. Retailers would then flock to the low-fee PCWs with confidence that a large proportion of consumers would be seeking price information there. In this way, retailers would enjoy lower fees and consumers would benefit from lower prices.