The Offline Impact of Online Prices
How much of a threat does electronic commerce pose to the bricks-and-mortar world today? Not much, suggest recent data collected by the U.S. Department of Commerce. Despite all the hype, online retail sales were estimated to amount to a mere $8.7 billion in the fourth quarter of 2000 or only 1% of retail revenues overall. (These figures exclude sales made by travel services, financial brokers and dealers, and ticket agencies —whether online or offline.)
But measuring aggregate sales is a relatively crude method of assessing the amount of competition that offline merchants face from online sellers. A more sophisticated strategy is to determine how relative price changes affect the choice of where to buy: over the Internet or in a local store.
This is the approach that Austan Goolsbee, associate professor of economics at the University of Chicago Graduate School of Business, applies in a working paper titled “Competition in the Computer Industry: Online Versus Retail.”
On the basis of a December 1998 survey of 90,000 U.S. households commissioned by Forrester Research, Goolsbee constructed a price index measuring the offline cost of a computer in different cities. He then calculated how likely a computer buyer would be to purchase remotely, given the bricks-and-mortar prices.
When online and offline prices are the same, 32% of computer buyers bypass local retailers and buy over the Internet or directly from a manufacturer (often after browsing online). For every 1% increase in the offline price, this ratio rises by 1.5% of its previous level. In other words, if local and online prices were initially equal and local prices were to rise by 10%, bricks-and-mortar stores would see their share of unit sales fall from 68% to 63%, assuming the total volume of purchases remained unchanged.
While the precise size of this effect may vary among sectors — it might be lower, Goolsbee suggests, for products that are hard to compare — the magnitude of the finding suggests that there is less rivalry between online and offline sellers than between retailers operating nearby stores. If the local Best Buy were charging 10% less for the same laptop than Circuit City, you would expect to see a much greater shift in demand, points out Craig Alexander, a senior manager at Accenture.
On the other hand, says Goolsbee, the size of this effect indicates that online and offline purchases are at least as close substitutes “as Honda Civics for Toyota Corollas,” referring to work by other researchers measuring cross-price effects on demand for different types of cars. And as consumers grow more comfortable with remote purchasing, he adds, competition is likely to intensify.