Search Cost/ Vendor Management

1. Search Cost/ Vendor Management By Johnny Lee Department of Accounting and Information Systems University of Utah

2. Why is Search Cost important? • Customer Attraction cost • Revenue generated by attracted customers • Profit= Revenue-cost

3. Agenda • Reducing Buyer Search Costs: Implications for Electronic Marketplaces (Bakos 1997) • Comment on Bakos 1997 (Harrington 2001) • An information Search cost Perspective for Designing Interface for Electronic Commerce (Hoque & Lohse 1999) • Measuring Switching Costs and the Determinants of Customer Retention in Internet-enabled Business: A study of the Online Brokerage Industry (Chen & Hitt 2002)

4. Reducing Buyer Search Costs: Implications for Electronic Marketplaces • Bakos 1997 • Gap: • How might the “lowered” search cost in Electronic Market impact buyer and seller’s behaviors? • Non transaction cost perspective.

5. Research Question: • How do buyers trade between search cost and fit cost ? • How do search cost impact buyer’s decision in a market place? • How do different search cost structure impact the incentive of market provider?

6. Market Function • Commodity market: • Existence of seller • Price • Differentiated market: • Product Characteristics • Price

7. Commodity Market • Lower search cost • Electronic market place  move market toward Walresian auctioneer (Fully Informed) • Sway the market to Buyer’s market • Wipe out abnormal return for sellers Seller might try to delay the introduction of E-market

8. Differentiated Markets • Different products for Different buyers’ demand • Standardized rating system  Compare different products • Buyers face an optimization problem.

9. Buyer Choice Model • Spatial differentiation models: (Chamberlin 1993) • Fit cost: the distance from buyers preference to product attributes. • Ex.: Red car vs. Orange car • Fit cost= U(Red)-U(Orange)

10. Model: Search Cost • Differentiated market • Unit circle (pp.1679): • Products are offered along this circle • Buyers pay search cost to find location and price of product by seller • Buyers make decision on Buying or keep searching

11. Model: Search Cost • Unit circle (cont..): • Fit cost: Distance between buyers preference and actual product bought • Electronic market provide low-cost search (search time)  Reduce fit cost Higher utility

12. Model 1 • Buyer: • Risk neutral • Identical demand subject to r (reservation utility ) • Enter the market when expected Total Cost (TC) <= r

13. Model 1 • Seller move first: decide where to locate product • Number of sellers=m • c= buyer search cost (constant) • f= buyers’ prior distribution for sellers prices • Assumption: search with replacement • Expect to have Perfect Bayesian Equilibria: satisfy the rational expectations constraint that f is the actual distribution of seller prices

14. Model 1 • If search cost (c)=0 p*=t/2m t= the degree of differentiation • If c<>0 and m>>0 P* depends on t and c Equilibrium: seller charge p*

15. Model 1 • Buyer’s reservation price • Expected fit cost • Utility at price

16. Electronic Market Prevent Market Breakdown

17. Electronic Market Benefit Buyer • Promote price competition • Reduce the market power of sellers

18. Investment Incentives • To maximize total social surplus • Invest X* that Solve for x

19. Investment Incentives • Seller: can expect to capture a certain proportion of buyers’ efficiency gain Convex: seller invests in socially optimal level Convex: seller will under-invest Convex: seller will resist

20. Investment Incentives • When convex, buyers will over-invest due to rent redistribution at the expense of sellers

21. Investment Incentives • Intermediary: can capture a certain proportion of buyers’ efficiency gain Over invest Same a social optimal Under invest

22. Separating Search Cost for Price and Product • c1 =cost to visit seller s • c2 =cost to acquire price information from seller s • c3 =cost to acquire product information from seller s

23. Markets • Market with low cost of Price information • Market with low cost of Product information

24. Contribution • Formally establish search cost model for different type of markets • Introduce the concept of investment incentive

25. Future Research • Differences in buyers’ ability to obtain information on the web • Distribution of the payoffs generated by e-market among Buyers, Sellers, intermediaries. • Expansion of the separating model • Multiperiod model

26. Comment on Bakos 1997 • Harrington 2001 • Research Question: • How valid the results found on Bakos 1997 when separating search cost for price and product are?

27. Bakos 1997 • Result 1: When cost of product information is positive and cost of price is close to zero. The market is close to a perfectly competitive market. The equilibrium price is close to marginal cost

28. Bakos 1997 • Result 2: When cost of price information is positive and cost of product is zero. The equilibrium price is decreasing with the cost of price information.

29. Validation of Results • Result 1 is WRONG • Result 2 is based on an unreasonable implicit assumption  The analysis regarding the separation of search cost for price and product information is flawed

30. Result 1 • The buyer’s utility from the entire searching processes is bounded above by d*= the maxima distance(d) the customer will search until the distance between his/her location and a seller’s product is smaller or equal than d*. There is no Symmetric pure-strategy equilibrium in which buyer’s search Whether an equilibrium with searching exists remains an open question

31. Result 2 • The result from Bakos 1997 is only valid when • Imply that if buyer search but does not buy then the search cost will be refunded

32. Conclusion/Contribution The analysis regarding the separation of search cost for price and product information is invalid

33. An information Search cost Perspective for Designing Interface for Electronic Commerce • Hoque & Lohse 1999 • Gap: • How to implement prior knowledge on user interface design on Web Site design? • Does prior knowledge on user interface design still hold on Internet world?

34. Consumer information search • Research Question: How does subtle changes in the user interface design influence information search costs? • Reducing price information search cost  price sensitive (Alba et al 1997) • Design of on-line stores can alter information search costs(Ariely 1998) • How do web developer build the user interface by applying the knowledge on information search cost?

35. Hypothesis • Serial position • H1: Consumers using electronic directories will be more likely to choose to patronize a business near the beginning of the electronic listing than will consumers using traditional paper directories.

36. Hypothesis • Travel distance • H2: Consumers using electronic directories will be more likely to choose to patronize a business nearby than will consumers using traditional paper directories.

37. Hypothesis • Display advertisements • H3: Consumers using electronic directories will be less likely to choose a business with a display advertisement than will consumers using traditional paper directories.

38. Experimental design • 1*3 design • Three versions of yellow pages • Paper version • GIF version (HTML version of #1) • Hyperlink version present an alphabetical listing of businesses with hyperlink to ads.

39. Experimental Procedures • Read instructions • Given a goal • Using yellow pages to decide which business • Repeat 2-3 for different headings • Questions on yellow page usage and business they typically patronize

40. Subjects • N=177 • Cell size • Paper: 54 (42% male) • Computer 123(70% male) • GIF: 61 • Hyperlink: 62

41. Summary Statistics

42. Result

43. Hypothesis test • H1: Accepted • H2: Accepted • H3: Accepted • Ads on paper + effect on choice • Ads on Computer - effect on choice

44. Discussion and Implementation • Expand the understanding on human-computer interface time parameters • The more you require users to do, the less likely they are buying • Display ads on electronic world has less impact than does in paper yellow pages. • Due to long download time • Is this still true?

45. Measuring Switching Costs and the Determinants of Customer Retention in Internet-enabled Business: A study of the Online Brokerage Industry • Chen and Hitt 2002 • Gap: • Lacking of systems that can measure switching cost • Lack of systems that can measure Customer Retention

46. Research question: • How should the magnitudes of switching cost and brand loyalty for online service providers be measured? • How system usage, service design, and other firms and individual factors affect switching and retention

47. Switching Cost • Heavy investment to attract customers • Lock-in customers • Switching cost: • Transaction cost • Learning cost • Artificial or Contractual costs

48. Switching cost in E-market • Higher/Lower than traditional market? • Friedman 1999: lower switching cost • Brenjolfsson&Smith 2000: Consumers are willing to pay higher price from familiar seller • ?????

49. Hypothesis • H1: There are no significant differences in measuring switching costs across firms. • H2: There are no significant differences in measuring switching costs across firms after controlling for customer characteristics.

50. Hypothesis • H3A: Use of multiple brokers is positively correlated with switching • H3B: Changing in usage patterns is positively correlated with switching • H3C: High volume of Web site usage is negatively correlated with switching