Do Market Characteristics Impact the Relationship between Retailer Characteristics and Online Prices?

Abstract

Theoretical expectations suggest that with increasing competition online retailers would lower prices and within a given market, online retailers with higher levels of service quality would charge higher prices. Empirical investigations of online price differentiation have found reduction in price dispersion with increase in number of competitors. However, the effect of service quality on online retailers' prices has not been found to be consistent. Empirical evidence from offline markets indicates that retailers customize prices at the brand store level and that market characteristics that reflect competition are a major determinant of their pricing strategies. Together, these findings lead us to believe that a better understanding of the sources of online price dispersion can be obtained by examining interactions between retailer and market characteristics. In this paper we examine if retailer characteristics such as service quality and transaction channels impact online prices. Departing from earlier studies, we specifically seek to answer when and how, in the context of different market characteristics, do they enable the retailers to price differentiate? The market characteristics examined include number of competitors, nature of competition, and scope for differentiation in terms of both service quality and transaction channels, Given that the retailer and market level determinants are at different levels of abstractions, simple linear models are not suitable for capturing the interactions between them. We adopt a hierarchical linear modeling approach that closely reflects the levels of abstraction in the market structure and allows us to test for interactions between retailer and market characteristics. Using 13,393 price quotes for 1,880 best selling products across eight product categories, from 194 Internet retailers, we find that retailer and market characteristics interact significantly in influencing retailer price levels. The better fit between the model and the online market structure is reflected by an 25% increase in the explanation of price dispersion as compared to similar studies. Extending prior research, and consistent with theoretical expectations, we find empirical evidence for a significant positive influence of service quality on posted prices across all product categories. We observe that an increase in number of competitors induces a downward pressure in prices for all retailers, albeit at a decreasing rate. Interestingly, highly competitive markets, marked by the presence of a large number of competitors, a wider variance in the service quality of the retailers selling the product accentuates the price-premiums demanded by high service quality retailers. On the other hand, retailers with low service quality charge higher prices either when there are a large number of competitors and low variation in service quality or when there is a large variance in service quality and few competitors. Our results indicate that the posted prices of national brick-and-click retailers are sensitive to competition from other national brick-and-click retailers selling the product. Our study demonstrates that while retailer characteristics do significantly influence online prices, their impact is enhanced or diminished by the market characteristics.