Searching for Search Costs

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Search costs — the time and money spent locating the best product at the best price — are a familiar and often unwelcome aspect of everyday life. Think of the nail-biting hours you logged on the phone last December when trying to get your hands on a PlayStation 2 or the teeth-gritting experience of driving from dealership to dealership in search of the perfect car.

But search costs look considerably more attractive from a seller's point of view. They buffer profit margins by making it difficult and time-consuming for buyers to find the best deal. Eliminate search costs, and fierce price competition is likely to ensue, making brand largely irrelevant and driving prices close to marginal cost.

E-commerce threatened to do just that: make vast amounts of information readily available, leading to slashed prices and razor-thin margins. But recent studies suggest that the Internet's impact on pricing has been less dramatic — especially online — than some may have feared.

The Internet has helped drive significant price declines in life insurance and cars, both markets in which buyers use the Internet to gather pricing information but typically make purchases offline. In a working paper for the National Bureau of Economic Research (NBER), economists Jeffrey R. Brown and Austan Goolsbee find that the rising use of specialized comparison shopping sites caused prices for term life insurance policies to fall 8% to 15% between 1995 and 1997. Many other factors, such as improvements in risk management, also contributed to lower prices in this period, says Brown, but the Internet explained up to half of the total decline.

In another NBER study, Fiona Scott Morton, Florian Zettelmeyer, and Jorge Silva-Risso calculate that car buyers who used, an online referral service, saved 2% on average (roughly $450), compared with off-the-street customers, in 1999. While the possibility that tends to attract good bargainers may explain part of this finding, econometric tests indicated that using the service independently lowered prices, Scott Morton explains.

By contrast, over the same period, Internet retail prices began to climb. A team of researchers at Carnegie Mellon University reports that after falling between the spring and fall of 1999, online book prices were flat or rising for several months. This trend picked up in 2000, when raised prices across the board by 10% to 20%, bringing them level with offline prices, according to an article by David D.

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