A Strategic Analysis of Electronic Marketplaces

Information systems can serve as intermediaries between the buyers and the sellers in a vertical market, thus creating an “electronic marketplace.” A major impact of these electronic market systems is that they typically reduce the search costs buyers must pay to obtain information about the prices and product offerings available in the market. Economic theory suggests that this reduction in search costs plays a major role in determining the implications of these systems for market efficiency and competitive behavior. This article draws on economic models of search and examines how prices, seller profits, and buyer welfare are affected by reducing search costs in commodity and differentiated markets. This reduction results in direct efficiency gains from reduced intermediation costs and in indirect but possibly larger gains in allocational efficiency from better-informed buyers. The economic characteristics of electronic markets, in addition to their ability to reduce search costs, create numerous possibilities for the strategic use of these systems. Simple microeconomic models typically assume that buyers can costlessly acquire full information about the prices and product offerings of sellers in a market. For example, this assumption underlies the central result of convergence to a unique competitive price-taking equilibrium in competitive markets. In certain oligopolistic settings, it leads to the result that sellers will not be able to keep prices above marginal costs and thus will realize zero profits, known as Bertrand’s paradox. There is little disagreement that costless, perfect information about market prices is an unrealistic simplification. Yet the actual implications of deviations from this assumption for market prices and for the conduct and welfare of firms and consumers have been the subject of much debate. In real-world markets, the evident variability of prices and the emphasis on dissemination of information through advertising and other media suggest that the cost and the availability of price and product information are important determinants of economic behavior.