[LINK] Internet commerce will foster price competition

[David Boxall]

Ross Gittins gives an economist's perspective.

From:<http://www.smh.com.au/business/internet-commerce-will-foster-price-competition-20111120-1np8p.html>.

November 21, 2011

The critics of economists often accuse them of trying to change the 
world to make it more like their textbooks. But now the mountain is 
coming to Muhammad. The internet, and the electronic commerce it 
promotes, is making real-life markets work more the way economists 
assume they do.

As the retailers - particularly the department stores - have sought to 
explain the weak growth in their sales, their gaze has fallen on the 
internet. The high dollar has made it more attractive for people to buy 
stuff on the net from overseas sites. And people who buy from foreign 
sites don't have to pay goods and services tax on purchases of less than 
$1000.

As an explanation for their weak sales, it's not persuasive. The share 
of consumer spending accounted for by internet purchases is still quite 
small. The more likely explanation is simply a shift in consumer 
preferences from goods to services.

But internet purchases will become a significant competitive challenge 
to retailers as people get more experienced at and relaxed about 
internet shopping. (And as Australia Post gets better at delivering 
parcels to households without a stay-at-home spouse.)

It's a mistake, however, to imagine it's primarily the high dollar that 
will drive this trend (or that the presence or absence of a 10 per cent 
GST makes much difference). No, the primary source of internet bargains 
is the existence of what economists call ''price discrimination'': the 
longstanding practice of international suppliers charging higher prices 
in some markets than others.

Global firms selling books, music, DVDs, software, sneakers and much 
else know the punters' ''willingness to pay'' varies greatly between 
countries. Why? Because, for instance, Aussies are simply used to paying 
higher prices than Americans are.

Such price discrimination is a great way to maximise profits - provided 
you can keep the various markets separate and stop people in high-price 
markets switching their purchases to low-price markets.

Various global industries have long used legislated restrictions on 
''parallel imports'' to protect their price discrimination arrangements 
- against which economic rationalists have long fought mainly losing 
battles. But all that legal protection is being swept away as the 
internet provides us with direct and easy access to cheaper American 
goods. This will put a lot of pressure on Australian retailers (and 
their foreign suppliers and landlords) to lower their prices.

Cyberspace breaks down the natural protection provided by oceans and 
geographic distance (although, of course, this becomes less true as the 
bulkiness of the goods in question increases, making transportation over 
long distances uneconomic).

So it breaks down barriers between certain geographic markets and also 
breaks down barriers to firms entering a particular market. If you're a 
big, established player in a physical market, it's very hard for me to 
start up in competition with you and get myself noticed. In cyberspace, 
however, a web browser that finds your huge site will list my bedroom 
operation beside it. It takes the punter only a few clicks to check me 
out after he's checked you out. Since I don't have the brand recognition 
you have, my price may well be 5 or 10 per cent lower. I can't charge a 
premium for my established reputation for quality and reliability.

In its basic form, the economists' model assumes there's no cost in 
money or time to gather all the information you need to be a fully 
informed buyer or seller in a market. In reality, there's often a lot of 
cost involved.

So much so that the possession of information is often ''asymmetric'' - 
the seller knows a lot more about what's what than the buyer does. This 
asymmetry tends to favour (professional) business over (amateur) punters 
(except in the labour market, where a worker knows far more about their 
personal strengths and weaknesses than a potential employer does).

Clearly, the internet greatly reduces the cost of gathering information 
so as to make better-informed decisions. This should reduce the 
asymmetry of information, thus shifting reality closer to the model.

The economists' model focuses on price - the price of the item in 
question relative to other prices - as the key to how markets work. It 
assumes relative prices (''incentives'') are the only motivator and that 
all competition is price competition.

In reality, oligopolies much prefer non-price competition via 
advertising, marketing (such as the nature of the packaging) and 
merchandising (where and how you display items in your store).

On the internet, many of these non-price devices are a lot less 
''salient'' (prominent), thus making prices more salient. And the 
internet is a lot better at gathering and comparing price information 
than information about qualitative considerations.

According to a psychology experiment, when people face a choice between 
an interesting job paying $80,000 a year and a boring job paying 
$90,000, most choose the boring one. That's not because they're 
money-hungry, but because of the limits to our neural processing power: 
we focus on the numerical comparison because it's a lot easier than the 
qualitative comparison.

Information technology makes it a lot easier and less costly for firms 
to adjust their prices (while allowing them to collect better 
information about the right direction and size of those adjustments).

So it's likely the more commerce we do on the net, the more importance 
will be attached to price - just as the economists have always assumed.

-- 
David Boxall                    |  Drink no longer water,
                                |  but use a little wine
http://david.boxall.id.au       |  for thy stomach's sake ...
                                |            King James Bible
                                |              1 Timothy 5:23