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Article Excerpt
This paper examines a market where the provision of information service is costly, but information service has the characteristics of a public good. Consumers, on the other hand, can use the information service to make an informed purchase decision and derive higher utility from consuming their ideal product. However, after receiving the information service from an information service provider, consumers can easily free ride by purchasing at low-price sellers who do not provide any information service. The paper examines the competition where sellers compete by providing information service for horizontally differentiated products and where technology reduces consumers' search cost. It is found that in this market a seller needs to establish itself as an information service provider in order to make positive profits, even when there is free riding. A seller, however, cannot make positive profits by free riding all the time. Also, with an increase in competition in the information service market, sellers have reduced incentives to provide information service. It is also found that in this market a decrease in search cost may increase or decrease social welfare.
Key words: free riding; search cost; electronic markets; electronic commerce
History: This paper was received November 7, 2001, and was with the authors 9 months for 3 revisions; processed by Kannan Srinivasan.
1. Introduction
It is argued that electronic markets reduce consumers' search costs and are therefore more efficient than physical markets. However, an important function of the market is to provide information service for consumers to assess their satisfaction from consuming a product, as well as provide information about how to use and maintain the product. For example, garden.com provides information service to determine the flowers and vegetables that could be grown in a garden depending on the features of the garden, and information about how to grow and maintain them. Similarly, amazon.com provides book reviews, tables of contents, and excerpts to enable users to assess their utility for a book. These information services are costly to provide. Therefore, if some firms provide these information services but do not make sales because of free riding by consumers and other sellers, it reduces a seller's incentive to provide these information services.
The free-riding problem was first examined by Telser (1960). He argued that competition might dissuade retailers from offering presale information service. A consumer may be convinced to purchase a product by the information service provided by the retailer. However, the consumer may buy the product from another retailer who charges a lower price. In this way, retailers who do not provide the information service free ride on those who do provide the service. Singley and Williams (1995) found that free-riding increases the price disparity between free-riding and nonfree-riding retailers, and drives consumers not currently free riding to free ride in the future. Free-riding also leads to a reduction in information service provided to consumers, and therefore to less demand for the product (Mittelstaedt 1986). Despite the free-riding problem, in physical markets information service providers still exist, as high search costs deter consumers from free riding. However, electronic markets reduce consumers' search costs. If the reduced search costs enable consumers to easily find lower prices, it is not clear if any seller would provide free information service.
In the search-cost literature (Varian 1980, Rob 1985, Stahl 1989, Zwick et al. 2003), consumers search for lower prices for homogeneous products; consumers do not need any information service. This literature therefore sidesteps the free-riding problem. Similarly, in markets where sellers sell differentiated products, sellers need not worry about free riding (Alba et al. 1997, Lal and Sarvary 1999, Lynch and Ariely 2000, Zettelmeyer 2000, Mehta et al. 2003, Wu and Rangaswamy 2003). The literature also suggests that lower search costs should make electronic markets more efficient than comparable physical markets, and that the market price should go down to the competitive price (Brynjolfsson and Smith 2000, Clay et al. 2001). However, in markets where sellers sell the same set of horizontally differentiated products and consumers need information service to identify their ideal product, it is expected that a competitive price may eliminate sellers' incentive to provide free information service.
In the model presented in this paper, we examine a market where information service is valuable to consumers, and retailers compete to sell a set of horizontally differentiated products. In particular, we examine the incentives of sellers to provide free information service when consumers' search costs are reduced. It is found that as long as a certain proportion of consumers have a positive search cost, some sellers do provide free information service. Even in the presence of free riding, sellers are better off incurring the costs of providing free information service and having the reputation as sellers who provide information service, as against sellers who always free ride. It is also found that as the competition in the market increases, fewer sellers provide free information service.
In this market a decrease in search cost has a direct and an indirect impact on the social welfare. The direct impact is that a decrease in search cost increases social welfare by decreasing the cost of each search. The indirect impact is that it reduces social welfare by reducing sellers' incentives to provide information service, which in turn increases the amount of search required by consumers. The net impact of reduced search cost on social welfare depends on which effect is stronger. This suggests that if free riding is also considered, a decrease in search cost may increase or decrease social welfare. The rest of the paper is organized as follows. The model and its assumptions are described in [section] 2, the equilibrium is presented in [section[beta], and [section] 4 examines the managerial and welfare implications of the equilibrium. We conclude in [section]5 with future extensions.
2. The Model
There is a continuum (1)...
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