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<TITLE>Creating an Efficient Market on the World-Wide Web</TITLE>
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<H1>CREATING AN EFFICIENT MARKET ON THE WORLD-WIDE WEB </H1>
<P>
<!WA0><!WA0><!WA0><!WA0><A HREF="http://www.cs.cornell.edu/Info/People/rdz.html">Ramin Zabih</A>
<P>
<!WA1><!WA1><!WA1><!WA1><A HREF="http://www.cs.cornell.edu/">Cornell University</A>
<P>
Consumers often purchase mass-produced items that are available
from many different vendors. These different vendors usually charge
different prices. If it were easy to compare prices, consumers
would benefit substantially, and every consumer would be able
to get the best price. This would create what economists call
an efficient market. Until recently it was too expensive to make
pricing information widely available. With the World-Wide Web,
the cost of publishing information has fallen dramatically. Because
of the Web, it may now be possible to create an efficient market
for many mass-produced consumer items.
<P>
As an example, consider the market in computer peripherals (such
as printers, modems, etc). In December 1995, the cheapest nationally
advertised price I could find for the Hewlett-Packard HP660C printer
was $330, while the most expensive price was $490. But it took
many hours of reading advertisements to obtain this information.
There are several hundred vendors who sell mail-order peripherals,
and it isn't easy to compare prices.
<P>
Several efficient markets exist, including the stock exchange
and the commodities market. Items on these markets (such as Hewlett-Packard
stock) are available for a single price at any given time, and
that price is widely known. Consumers rarely benefit from these
markets because they do not trade consumer goods.
<H2>The PriceWeb Experiment </H2>
<P>
Together with some friends at Cornell I have begun an experiment
called <!WA2><!WA2><!WA2><!WA2><A HREF="http://www.priceweb.com">PriceWeb</A> (http://www.priceweb.com).
PriceWeb is an attempt to create an efficient market in computer
peripherals. For a given peripheral, PriceWeb's web site provides
a list of nationally advertised mail-order prices, listed in increasing
order. This makes it simple to find the lowest-priced vendor.
<P>
If PriceWeb becomes widely used, it will have a major impact on
the way that computer peripherals are purchased. Mail-order vendors
would have to charge a single, uniform low price, unless they
can offer customers some additional value. Computer peripherals
are sold with fairly standardized warranties and return policies;
vendors compete primarily on price and availability. This makes
product differentiation difficult.
<P>
In an efficient market, most vendors would have to lower their
prices. Short term, PriceWeb works to the advantage of consumers
and to the disadvantage of most vendors. But in the long term
there are advantages for vendors as well. Consumers will be able
to buy items without worrying that they are over-paying (this
argument is similar to Saturn's no-haggling policy for new car
buyers). And, of course, prices should fall. These effects should
lead to more customers
<P>
An on-line service like PriceWeb could have additional advantages
for vendors. For instance, sometimes vendors wish to clear out
inventory by selling an item very cheaply. (See <!WA3><!WA3><!WA3><!WA3><A HREF="http://www.onsale.com">Onsale</A>
for an example.) On-line pricing information can eliminate the
delays involved in print media advertising, thus allowing vendors
to more rapidly adjust their prices. Also, the Internet users
who monitor pricing information will presumably be quite price-sensitive,
so listing an item at a low price should generate a large response.
These advantages to vendors have to be balanced against PriceWeb's
negative effects on vendor margins. If the negative effects are
larger, there will be consolidation among vendors.
<P>
How much would consumers save in an efficient market? One might
expect mail-order prices on peripherals to be nearly identical,
but they aren't. The average price spread on items that PriceWeb
covers is $130, and some items have large price spreads. For example,
the HP OfficeJet is advertised for as little as $377 and as much
as $769.
<P>
If the vendors wished to avoid an efficient market, they would
have several options. For instance, each vendor could sell slightly
different items. If every HP660C printer were significantly different
from every other HP660C printer, it would be impossible to compare
their prices. But this would increase manufacturing costs and
confuse potential customers, thus reducing HP's market share.
This effect is illustrated by the American automobile industry,
which for years offered an enormous range of options, partly to
prevent consumers from comparing prices. The Japanese offered
very few option packages, which gave them a price advantage in
manufacturing. In the computer industry, almost everything is
mass-manufactured, due to extensive standardization (see <!WA4><!WA4><!WA4><!WA4><A HREF="http://communication.ucsd.edu/pagre/tno/january-1996.html#bibliography">TNO 3(1) </A>for
a discussion of the economic impacts of standardization). So this
option is not viable, because of opposition from the manufacturers.
<P>
An efficient market could also be thwarted by punishing the lowest-price
vendor. For instance, suppose that all the higher-priced vendors
refuse to carry Hewlett-Packard printers unless the lowest priced
vendor is forced to raise its prices. HP could in turn raise the
price that it charges that vendor, or cut that vendor off completely.
But this probably would not be in HP's interests. More importantly,
such actions would violate a number of laws against price fixing,
such as the Robinson-Patman Act (an excellent <!WA5><!WA5><!WA5><!WA5><A HREF="http://www.ftc.gov/opa/speeches/patman.htm">overview </A>is
available from the <!WA6><!WA6><!WA6><!WA6><A HREF="http://www.ftc.gov/">Federal Trade Commission</A>).
These laws make it illegal for a manufacturer to fix the price
that vendors charge.
<P>
An on-line efficient market would also be easier for the Government
to monitor. Price-fixing in efficient markets is more obvious
than in markets where there are multiple prices. For example,
suppose a vendor cut its prices below costs to drive rivals out
of business, and then raised its prices. This pattern would be
fairly easy to spot in an efficient market with pricing information
available on-line. The recent SEC investigation of NASDAQ trading
practices was motivated by an academic study of pricing trends
in this market; if this data were not available electronically,
anti-competitive behavior would be harder to detect.
<H2>Challenges </H2>
<P>
There are a number of challenges that will need to be overcome
in order to create an efficient market. One potential difficulty
concerns updating price information. PriceWeb's information comes
from printed national advertisements. In a market where prices
change rapidly, advertised prices may be out of date before they
appear in print. The obvious solution would be to use on-line
prices from vendor's Web sites, but there are some obstacles.
While a few vendors (such as <!WA7><!WA7><!WA7><!WA7><A HREF="http://www.computability.com">Computability</A>)
provide on-line pricing information, most do not -- in fact, surprisingly
few vendors have Web sites. Also, a price that appears in a printed
ad comes with legal protections against false advertising. These
guarantees may not apply to Web-based advertising.
<P>
Even if most vendors put their pricing information on-line, it
may be hard to compare prices. For instance, consider Andersen
Consulting's <!WA8><!WA8><!WA8><!WA8><A HREF="http://bf.cstar.ac.com">BargainFinder</A>,
which helps consumers buy audio Compact Discs cheaply. BargainFinder
queries 9 on-line vendors that sell CD's via mail-order. Unfortunately,
3 of these vendors currently block BargainFinder from accessing
their sites. Because BargainFinder actively queries on-line Web
sites, it exists at the pleasure of the vendors. In the short
term, they may not wish to cooperate.
<P>
PriceWeb will need to become economically self-supporting, which
is a challenge. On-line pricing information is what economists
call a public good (like, for example, a lighthouse). It is notoriously
difficult to get the beneficiaries of a public good to pay for
it. In addition, the Internet's culture makes it hard to charge
users for information. I believe that consumers will not use PriceWeb
if they have to pay for it. There are companies that think consumers
will pay for such a service -- <!WA9><!WA9><!WA9><!WA9><A HREF="http://cybersave.com/shop.htm">CyberSave Shopper</A>,
for example. If these companies are correct, they will create
a market in pricing information. Mark Casson's chapter in Information
Acumen (Routledge, 1994) discusses the effects on markets of information.
An efficient market requires perfect information; as the costs
associated with information fall, the market can become more efficient.
There are costs associated with obtaining pricing information
for computer peripherals. PriceWeb does not reduce the costs of
obtaining the information, but instead collects the information
centrally and makes it freely available.
<P>
PriceWeb might be viable simply because the cost of running the
experiment is so low. Placing information on a Web page costs
almost nothing, and the costs associated with gathering and entering
data are also small. Even a small amount of revenue (from advertising,
for instance) could make PriceWeb self-supporting. In addition,
there are a number of services that PriceWeb could provide for
vendors that would provide revenue. For instance, vendors could
be automatically notified if a competitor beats their advertised
price.
<H2>Will the Web Eliminate Retailers? </H2>
<P>
A web-based efficient market could also affect the relationship
between vendors and manufacturers. Most manufacturers do not sell
directly to customers, but via retailers. Retail stores carry
products from multiple manufacturers, so a customer can compare
products side by side. Manufacturers attempted to protect their
retailers by various means; for example, the Manufacturer's Suggested
Retail Price is usually quite high, so that every retailer can
charge less than MSRP. Manufacturers protect retailers to ensure
that retailers carry their goods. But with the growth of mail-order,
the value provided by retailers could diminish. It may become
profitable for the manufacturers to enter the mail-order business
themselves. An efficient market could eliminate many middlemen.
<P>
An efficient market in consumer goods would have a substantial
impact on society. For example, it could eliminate many retail
stores in favor of mail-order vendors, who can locate in areas
with low fixed costs. This could have massive consequences for
many communities, which have downtowns built around retail shopping.
Of course, consumers shop for other reasons than obtaining the
lowest price. For some items (such as Tylenol), the savings may
be so small that it isn't worthwhile to find the best price. However,
large supermarkets spend a great deal of effort trumpeting small
price advantages. It is possible that many shoppers are price-sensitive,
and would prefer an efficient market. If the Web creates such
a market, its impact could be far greater than any effects we
have witnessed thus far.
<P>
While many retailers might disappear, some new businesses will
also come into existence. For instance, it will become much cheaper
to establish the kind of specialty businesses that traditionally
only flourish in large cities. A business that only appeals to
a small percentage of the population can flourish on the Web,
because it can be easily reached by potential customers.
<H2>Conclusions </H2>
<P>
There have been several experiments in Web-based consumer empowerment,
which are similar in spirit to PriceWeb. One example is the <!WA10><!WA10><!WA10><!WA10><A HREF="http://web1.osf.org/faq/bbn-auto-mech.html">BBN Auto Mechanics List</A>,
profiled by Rich Lethin in <!WA11><!WA11><!WA11><!WA11><A HREF="http://communication.ucsd.edu/pagre/tno/august-1995.html#lethin">TNO 2(8)</A>.
This site lists local auto mechanics in the Boston Area. Besides
providing names and addresses, it also includes customers' comments
on their experiences with each shop. The comments are summarized
by the moderator to provide an overall grade for the repair shop.
A potential customer can view the comments of other customers,
and can also add their own comments. Another example is <!WA12><!WA12><!WA12><!WA12><A HREF="http://thelist.com">The List</A>,
which performs a similar service for Internet Service Providers.
Like Consumer Reports, these sites focus on giving consumers useful
subjective information.
<P>
The Web has made an efficient market in consumer goods possible,
because it has dramatically lowered the cost of publishing information.
Until recently, only large corporations or a few unusual individuals
could reach a large audience. The Web has changed this, and we
are just beginning to understand its implications.
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