Online Price Dispersion: A Game Theoretic Perspective and Empirical Evidence

Abstract

The Internet has changed the nature of doing business as well as the nature of competition in many industries. Consumers are more empowered than ever with valuable information such as prices, products, and store ratings. Because of this, some researchers even predicted, during the early stage of e-commerce, a frictionless economy in which online prices would be driven down to marginal costs. However, many studies have subsequently observed the wide price dispersion online, and its existence and persistence has now been well documented. Possible explanations of this price dispersion, derived mainly using hedonic price models, have seen only modest success. In this paper, we propose an alternative competitive model, based on online retailers' differentiation, to explain price dispersion. We empirically test the predictions of this model and find that the model is a viable alternative to the hedonic price model. In addition, our competitive model is able to predict and explain observations that are seemingly inconsistent with a hedonic model. Practically, our model yields important recommendations for the online etailing industry and can help an e-tailer to choose a desirable position in the competitive market.