Reducing Buyer Search Costs: Implications for Electronic Marketplaces

TLDR

Information systems act as intermediaries that lower buyers’ search costs, reduce inefficiencies, curb sellers’ monopolistic profits, and improve resource allocation in markets. The article models how buyer search costs affect markets with differentiated products and examines the resulting incentives for buyers, sellers, and intermediaries to invest in electronic marketplaces. By analyzing the reduction of search costs within an electronic marketplace, the authors formalize the resulting allocational efficiencies and explore how separating price information from product attributes can shape competitive market design. The study finds that lower search costs incentivize investment by buyers, sellers, and intermediaries, and that distinguishing price from product attributes can influence competition along each dimension.

Abstract

Information systems can serve as intermediaries between the buyers and the sellers in a market creating an “electronic marketplace” that lowers the buyers' cost to acquire information about seller prices and product offerings. As a result, electronic marketplaces reduce the inefficiencies caused by buyer search costs, in the process reducing the ability of sellers to extract monopolistic profits while increasing the ability of markets to optimally allocate productive resources. This article models the role of buyer search costs in markets with differentiated product offerings. The impact of reducing these search costs is analyzed in the context of an electronic marketplace, and the allocational efficiencies such a reduction can bring to a differentiated market are formalized. The resulting implications for the incentives of buyers, sellers, and independent intermediaries to invest in electronic marketplaces are explored. Finally, the possibility to separate price information from product attribute information is introduced, and the implications of designing markets promoting competition along each of these dimensions are discussed.