Intermediation and electronic markets: aggregation and pricing in Internet commerce

The Internet continues to grow as a medium to support commerce. Economic analysis of Internet commerce is still in a nascent stage while Internet technology and use has rapidly advanced. The result is an Internet marketplace brimming with entrepreneurs and major corporations experimenting with business strategies and technology advances even though the economics of Internet commerce is not well understood. This thesis responds to this need by exploring how the Internet reduces the market friction common in physical commerce. The intermediaries who help reduce market friction in physical markets may be eliminated, when suppliers and consumers increasingly rely on the Internet as a transaction medium. An intermediary in any market may reduce transaction costs by performing four roles: aggregation, pricing, search, and trust. The intermediary roles of aggregation and pricing may provide little or no value as the Internet becomes the medium for commerce because the technology, not the intermediary, reduces transaction costs. This thesis examines the possible elimination of aggregation and pricing intermediaries in Internet commerce. It does so by extending the theory of the economics of intermediation and electronic markets; developing a methodology for the analysis of Internet price competition; analyzing exploratory empirical data of the book, compact disc, and software markets to test a subset of this theory; and exploring the public policy implications of Internet price discrimination. The approach is interdisciplinary because this thesis integrates the technology, policy, and economics that underpin the role of aggregation and pricing intermediaries in Internet commerce. The thesis shows that Internet commerce may not reduce market friction because prices are higher when consumers buy homogeneous products on the Internet, and price dispersion for homogenous products among Internet retailers is greater than the price dispersion among physical retailers. Internet retailers—even those selling homogenous goods—can develop pricing strategies to differentiate themselves from their competitors and to price discriminate. The ability for the Internet to become a medium for price discrimination is an area that requires the attention of public policy makers. While self-regulation of Internet price discrimination may be the most appropriate policy, monitoring by the United States government through the Federal Trade Commission and international organizations such as the World Trade Organization helps establish a trusted transaction environment for future Internet commerce growth. Thesis Committee: Lee W. McKnight Lecturer, Technology and Policy Program Erik Brynjolfsson Associate Professor, MIT Sloan School of Management David D. Clark Senior Research Scientist, Laboratory for Computer Science