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Will E-commerce make prices more flexible?

Yuriy Gorodnichenko, associate professor of economics | January 14, 2015

Today, it’s hard to imagine the world without the internet. PewResearch Internet Project reports that the internet is used by 87% of American adults, up from 14% in 1995. Apart from changing the way how people communicate, connect, or acquire information, the internet has also changed our shopping habits: with just a few clicks, one can buy almost anything online and get it delivered promptly! Not surprisingly, the growth of e-commerce has been phenomenal: virtually non-existent 15 years ago, e-commerce sales stood at $263.3 billion and accounted for 5.6% of total retail sales in the U.S. economy in 2013.

Furthermore, the internet offers seemingly limitless opportunities to the retail sector by enabling sellers to collect and process massive amounts of data to tailor prices and product characteristics to specific whims of consumers and ever-changing economic conditions. A popular view holds that prices for goods and services sold online should approach—if not now, then eventually—the flexibility of auction or stock prices. Indeed, the internet makes it trivial to compare prices across sellers, the cost of posting a new price is minimal, the best price is just a few clicks away, the physical location of online sellers is largely irrelevant, and numerous services advise online shoppers on best time and location of the purchase. Should one expect extinction of sticky prices then?

In a recent paper, we provide new evidence on the nature and sources of price dispersion and frictions in price adjustment using data from a leading online shopping platform on daily prices for more than 50,000 goods in 22 broadly-defined consumer categories in the U.S. and U.K. between May 2010 and February 2012. We document properties of online prices (frequency of price adjustment, price synchronization across sellers and goods, size of price changes) and compare our findings to results reported for price data from conventional, brick-and-mortar stores.

Our dataset is unique in a number of ways: First, it covers an exceptionally broad spectrum of consumer goods (precisely defined at the level of unique product codes) and sellers, enhancing comparability with brick-and-mortar stores. Second, it contains daily price listings over the period of nearly two years, allowing us to study high-frequency variation in prices, which is especially important for e-commerce. Third, each price listing comes with data on the associated number of clicks, which serves as a proxy for demand and relevance to consumers.

New evidence on price stickiness and dispersion online

We find that, despite small physical costs of price adjustment, the duration of price spells in online markets is about 7 to 20 weeks, depending on the treatment of sales. While this duration is considerably shorter than the duration typically reported for prices in brick-and-mortar stores, online prices clearly do not adjust every instant. We also find a low synchronization of price changes by a seller across goods and for a good across sellers: by and large, price changes are independent from each other.

The median absolute size of price changes in online markets, another measure of price stickiness, is 11% in the U.S. and 5% in the U.K., which is comparable to the size of price changes in offline stores. Sales in online markets are about as frequent as in conventional stores but considerably smaller: the share of goods on sale is approximately 1.5–2% per week and the average size is 10–12% in the U.S. and below 6% in the U.K.

We observe ubiquitous price dispersion in online markets. For example, the standard deviation of log prices for narrowly defined goods is 23.6 log points in the U.S. and 21.3 log points in the U.K., which is similar to, if not larger than, price dispersion in brick-and-mortar stores. Even after removing seller fixed effects, which proxy for differences in terms of sales across stores, the dispersion remains large, suggesting that lower costs of monitoring competitors’ prices do not necessarily lead to price convergence across sellers.

We also show that price dispersion cannot be rationalized by product life cycle. Specifically, a chunk of price dispersion appears at the time of product introduction, which then grows (rather than falls) as the product becomes older. Price dispersion is best characterized as spatial rather than temporal. In other words, if a store charges a high price for a given good, it does so consistently over time—rather than alternates between low and high prices.

To emphasize price listings that are more relevant to consumers, we also calculate and present all these measures weighted by clicks. Such weighting tends to yield results consistent with a greater flexibility of online markets: price rigidities decline, cross-sectional price dispersion falls, and the synchronization of price changes increases. For example, using weights reduces the median duration of price spells from 7–12 to 5–7 weeks. Yet, even when we use click-based weights, online markets are far from being completely flexible.

Dynamic pricing: Anticipated and unanticipated demand shocks

To shed new light on the use of dynamic pricing—instantaneous price adjustment in response to a change in demand or supply conditions—by online retailers, we consider different ways through which it can affect price flexibility.

First, we look at the reaction of prices to low-frequency anticipated variation in demand due to holiday sales such as Black Friday and Cyber Monday in the U.S. or Boxing Day in the U.K. In each country and year, the number of clicks goes up and the average price goes down during the holiday sales. This finding is consistent with Warner and Barsky (1995), who find that brick-and-mortar stores choose to time price markdowns to periods of high-intensity demand. Uneven price staggering may affect the timing of optimal monetary policy response to changing economic conditions, similar to the Olivei and Tenreyro’s (2007) argument that uneven wage staggering makes monetary policy more effective in the first half of a year.

Second, we show that there is a large high-frequency variation in demand, proxied by the number of clicks, over days of the week or month. For example, Table 1 reports that the number of clicks on Mondays is substantially larger than on Saturdays. Yet, online prices appear to have little, if any, reaction to these predictable changes in demand, which is inconsistent with the Warner-Barsky hypothesis.

 Table 1. Intraweek Variation in Prices and Clicks, United States

Click Share, percent Log Deviation from Weekly Median, log points
Total Clicks Mean Price Weighted Mean Price
(1) (2) (3) (4)
Monday 16.2 10.0 -0.1 -0.0
Tuesday 15.5 6.4 0.2 0.0
Wednesday 14.8 3.8 0.5 0.0
Thursday 14.3 0.0 1.4 0.1
Friday 13.3 -6.6 2.0 2.8
Saturday 12.1 -16.0 -3.0 -0.8
Sunday 13.8 -4.4 -5.4

-1.9

Finally, we do not find strong responses of online prices or demand to the surprise component in macroeconomic announcements about aggregate statistics such as the GDP, CPI, or unemployment rate. These findings are striking because online stores are uniquely positioned to use dynamic pricing.

Concluding remarks

In summary, our main result is that online prices (especially prices with a large number of clicks) are more flexible than prices in conventional stores. Yet, the difference in properties of online and offline prices is quantitative rather than qualitative. That is, despite the power of the internet, the behavior of online prices is consistent with smaller but still considerable frictions, thus questioning the validity of popular theories of sticky prices and, more generally, price setting. By some metrics, prices of goods sold online could be as imperfect as in regular markets.

These findings have a number of implications:

  • Even if e-commerce grows to dominate the retail sector, price stickiness is unlikely to disappear because it does not seem to be determined exclusively by search costs and/or physical costs of changing a price sticker.
  • Policy-makers should not disregard the effect of e-commerce on properties of the aggregate price level and inflation as pricing in online markets does differ from that in brick-and-mortar stores.
  • Macroeconomists should put more effort into developing theoretical models with alternative mechanisms that generate price stickiness, dispersion, and other imperfections.

Comments to “Will E-commerce make prices more flexible?

  1. Over the past few years, the web has gotten faster, partly because more people may not be flexible enough for an e-commerce site.Affordable and comprehensive e-commerce solutions from best ecommerce development solutions from a range of Pricing Plans that suit your budget and business.

  2. Prices online are also subject to the cost of the goods and services. Although an online shop does not have to pay a rent or a mortgage, it does have to pay for the servers and the IT folks to develop a decent platform (unless you go for some “out of the box” plug-and-play solution, which I honestly do not recommend). So the stickiness of online and offline prices tend to be similar.

    But there is also something that we must consider, which is that online shopping is becoming global shopping as well and many friends and relatives I know of are purchasing goods from the USA or Asia instead of from Europe and in many cases is worth the try including the taxes that are to be paid.

  3. By 2020, the use of internet will reach to every household, schools and colleges. The pupils will carry laptops and reach of internet will be up to 100% of population around the world. Thank you so much Yuriy Gorodnichenko for wonderful information.

  4. Great report, thank you for the data. I work in the ecommerce internet sector, and have spent a great deal of time studying conversion funnels and customer retention which includes price stickiness. Currently we are working on CharityAuctionstoday.com, and while my research is nowhere near as thorough as yours, we find that price stickiness and customer retention are also components of “Brand.”

    Our belief is a new ecommerce site will have to spend a significant amount of time building a brand foot print before consumers will buy – even with significant price reductions. Currently we are testing different models.

    I was curious, do you have any other material on Brands & Pricing that you could verify this?

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