The Power of Information: How the Internet destroys and creates profit opportunities
March 26, 2004
Florian Zettelmeyer, Associate Professor, Haas Marketing Group, Haas School of Business, UC Berkeley
Summary (and conclusion): Profitability in the information age can no longer rely on customer knowing the market less well than firms do. Instead, profitability results because firms know the customer better than the market does.
Florian addressed the question: What has the Internet changed about what firms know about consumers and what consumers know about the Internet – and what the implications are on profits and ultimately sustainability of industries?
He started by giving a number of examples of how companies make money, showing that many of them make money by customers’ making bad decisions (such as banks making money on fees for customers getting overdrafts on their checking accounts while having money in other accounts) or by customers not having the right information (Profits companies overselling to customers, or the auto industry having dealer cash rebates that the customer does not know about. Firms profit because they know more about their own cost, current demand conditions and product availability. The Internet is reducing this information asymmetry: The form of communication is changing, primarily towards more interactivity; the costs of communicating has been lowered, allowing more product information to be communicated; and the communication costs of consumers has changed so that customers now talk to each other.
Some examples: Froogle has had a big impact on prices, as customers can shop around very fast. However, the Internet affects prices in offline markets – bankrate.com shows mortgage interest rates. It even influences markets where you can’t buy online, such as the car industry, by coming in with information intermediaries showing what the dealer pays for the car, as well as the going market rate.
To document this, Florian researched 5,000 California consumers who purchased a car in April and May 2002, getting a 47% response rate, with matching transaction data from the sellers.
72% used the Internet, 95% of Internet users researched their car purchase one way or the other. When holding this up against the prices paid, controlling for many other variables, it turns out that use of the Internet lowered prices on average $400 (on the average $25000 car,) primarily due to reduced information asymmetries. The Internet did this two ways: Partially by informing consumers (which accounted for $225 of the $400), but also by providing opportunities to submit referrals to an independent internet referral service (such as AutoByTel, which gets the dealer to send offers to prospective customers,) further lowering the price by $175 on average. AutoByTel does only 1 in 5 dealers, so they have a big stick to wave at their dealers – and they create competition. The manufacturers also have referral sites, but are required by law to refer you to the closest dealer – with no price effect.
Interestingly, the effect was stronger for people who disliked bargaining ($550) vs. bargainers ($175). This is consistent across everything. Furthermore, one of the sad facts of the US is that minorities and poor people pay less than rich people (even from the same model, same dealer) by an average of 2.5%. So, the Internet eliminates profits from badly informed customers.