New Evidence Of How E-Commerce Creates Winners And Losers In The Retail Sector

It is by now well-known that the internet has made it much easier for consumers to compare prices and find the best local outlet to buy things they want. But according to research by Professor Chad Syverson and colleagues, e-commerce has also had a big impact on the market structure of retail industries, allowing good firms to increase their market share and driving some bad firms out of business altogether.

Their study, published in the June 2010 issue of the Economic Journal, looks at how e-commerce – the technologies that allow companies to conduct aspects of their business over the internet – has affected retail and ''retail-like'' industries. A lot of previous research has discussed e-commerce''s pricing implications – how, by making it easier for consumers to comparison shop, it drove down margins and prices.

This study points out that more than just prices change. E-commerce creates winners and losers. Good firms expand their market share because e-commerce makes it easier for consumers to find them. This means that even if they can''t charge prices as high as before, they can actually become more profitable.

Bad firms, on the other hand, are doubly hit. Not only does their pricing power fall, their market share falls too, as customers who were once captive – either through ignorance or lack of alternatives – flee to better options elsewhere. Some bad firms are forced out of business altogether.

The authors construct a theoretical analysis that shows how these changes in market structure happen. Casting e-commerce as a technology that reduces consumers'' costs of comparison shopping, the analysis shows how firms'' optimal reaction to this is to cut their prices, as earlier research has emphasised.

But the analysis also shows that consumers respond to these new prices and their newfound abilities to comparison shop by shifting their purchases from lower-quality to higher-quality firms. This causes the latter to grow and the former to shrink or, in some cases, fold up operations completely.

The authors go on to test the theory''s implications in three industries broadly perceived to have been heavily affected by e-commerce: travel agencies, bookstores and new car dealers. They compare growth in consumers'' propensity to shop online over the period 1994-2003 to changes in the composition of each industry''s businesses.

The theory''s predictions hold up in each case: as more consumers used the internet to shop for products and services, the number of an industry''s smaller (and presumably lower-quality) businesses fell while the number of the largest firms rose.

A testimony to the strength of these predicted shifts from small to large businesses is that they occurred even in travel agencies, an industry that was eviscerated by e-commerce. For example, while over one third of travel agency offices closed up shop for good between 1994 and 2003, the number of offices with 50 or more employees actually rose, and the number with 100 employees or more increased by 70%.

In bookstores, the number of stores with fewer than 20 employees fell by one quarter even as the number with 20 or more employees doubled. And while over 1,500 car dealers with between 10 and 50 employees disappeared between 1994 and 2003, there was a net gain of 2,000 dealerships with 50 or more employees.

In addition to documenting these overall results, the study raises some additional points of interest. First, the patterns in the bookstore and car dealer industries hold even looking across markets within a given year. That is, cities where consumers'' internet use grew faster in a particular year saw larger drops (gains) in the number of small (large) bookstores and car dealers from the previous year.

Second, because car dealers in the United States are legally prohibited from selling cars online, the effects of e-commerce in this industry really do seem to depend completely on consumers'' abilities to comparison shop and find the best local outlet at which to buy their car (as the theory assumes), and are not due to some change in technology through which dealers can deliver cars.

''E-commerce and the Market Structure of Retail Industries'' by Maris Goldmanis, Ali Hortacsu, Chad Syverson and Onsel Emre is published in the June 2010 issue of the Economic Journal.