Frictionless Commerce? A Comparison of Internet and Conventional Retailers

There have been many claims that the Internet represents a new "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 4,500 price observations collected over a period of 9 months. We compare pricing behavior at 37 Internet and conventional retail outlets. We find support for the hypothesis of increased efficiency in Internet channels on several dimensions, but we also find evidence of considerable price dispersion. We find that prices on the Internet are 8-15% lower than prices in conventional outlets, depending on whether taxes, shipping and shopping costs are included. 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. However, we also find substantial price dispersion across retailers on the Internet. Prices for books and CDs differ by as much as 47% across Internet retailers at any one time and the dispersion of posted prices on the Internet is equal to or greater than comparable measures of dispersion across conventional retailers. Moreover, the Internet retailers with the lowest prices do not receive the most sales for either books or CDs. The observed dispersion is not easily explained as a response to existing models of search costs. However, price dispersion on the Internet may be explained by retailer heterogeneity with respect to factors such as branding and consumer "trust." We note that branding and trust may play an enhanced role on the Internet because of the spatial and temporal separation between buyer, seller, and product in Internet channels for books and CDs.