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.