Frictionless Commerce? A Comparison of Internet and Conventional Retailers

There have been many claims that the Internet represents a new nearly “frictionless market.” Our research empirically analyzes the characteristics of the Internet as a channel for two categories of homogeneous products—books and CDs. Using a data set of over 8,500 price observations collected over a period of 15 months, we compare pricing behavior at 41 Internet and conventional retail outlets. We find that prices on the Internet are 9–16% lower than prices in conventional outlets, depending on whether taxes, shipping, and shopping costs are included in the price. Additionally, we find that Internet retailers’ price adjustments over time are up to 100 times smaller than conventional retailers’ price adjustments—presumably reflecting lower menu costs in Internet channels. We also find that levels of price dispersion depend importantly on the measures employed. When we compare the prices posted by different Internet retailers we find substantial dispersion. Internet retailer prices differ by an average of 33% for books and 25% for CDs. However, when we weight these prices by proxies for market share, we find dispersion is lower in Internet channels than in conventional channels, reflecting the dominance of certain heavily branded retailers. We conclude that while there is lower friction in many dimensions of Internet competition, branding, awareness, and trust remain important sources of heterogeneity among Internet retailers. (Search; Competition; Internet; Price Dispersion; Menu Costs; Pricing; Intermediaries)