Search Costs, Demand Structure and Long Tail in Electronic Markets: Theory and Evidence

Abstract

It is well known that the Internet has significantly reduced consumers' search costs online. But relatively little is known about how search costs affect consumer demand structure in online markets. In this paper, we identify the impact of search costs on firm competition and market structure by exploring a unique theoretical insight that search costs create a kink in aggregate demand when firms change prices. The significance of the kink reflects the magnitude of online search costs and the kinked demand function provides information on how search costs affect competition in the online market. Using a dataset collected from Amazon and Barnes & Noble, we find that search costs vary significantly across online retailers. Consumers face low search costs for price information from Amazon.com. It leads to a higher price elasticity when the firm reduces prices than when it increases prices, increasing Amazon's incentive to engage in price competition. On the other hand, consumers face relatively higher search costs for price information from Barnes & Noble. This leads to a lower price elasticity when Barnes & Noble reduces prices than when it increases prices, reducing Barnes & Noble's incentive to engage in price competition. We also find that search costs decrease with the passage of time as the information about price changes dissipates among consumers, leading to increased price elasticity over time. Finally, we highlight that search costs are lower for popular books compared to rare and unpopular books. These findings have implications for the impact of the Internet on the Long Tail phenomenon.

Virtual borders

“…However, sales ranks are available for all of our retailers except Chapters.ca. This information has been used in a number of studies to approximate sales volume (see Chevalier and Goolsbee, 2003;Ghose and Gu, 2006;Brynjolfsson et al, 2003). Based on a number of experiments, Chevalier and Golsbee show that a power 21 We use respectively Amazon.com and Amazon.ca to compute the international relative prices of Canadian and US retailers.…”

Is Tom Cruise Threatened? An Empirical Study of the Impact of Product Variety on Demand Concentration

“…Ghose and Gu (2006) argue that search costs are even lower for popular products than for niches, which may limit the Long Tail effect. Hervas-Drane (2009) provides an analytical model to show that different search processes have mixed impacts on demand concentration.…”

The Impact of Search and Recommendation Systems on Sales in Electronic Commerce

“…For this reason, decreasing search costs can also be a strategic competitive advantage for the company to differentiate itself from its competitors. As the study by Ghose and Gu (2007) shows, Amazon uses this option consistently as Amazon's systems ensure that a customer can find products comparatively faster than with the competitor Barnes & Noble. The introduction of several search technologies is highly recommended.…”