Over the past two decades, a flourishing industry of price comparison websites (PCWs) has emerged. The sites command billions of dollars in revenue annually and are prevalent across a wide range of goods and services including utilities, financial services, hotels, flights, and durable goods. The sites provide consumers with multiple offers in one place, allowing them to easily navigate to the best deal.
At first glance this is a boon for consumers: instead of being limited to only the sellers they have heard of or can easily find, they are potentially able to access the whole marketplace of offers in one location. The sites also tend to be free for consumers to access. In addition, the presentation of many firms’ offers in the same place heats inter-firm competition, lowering prices. Consumers can then sleep well at night, safe in the knowledge they got the best deal out there. Or so the story goes.
In his recent paper, BCCP Fellow David Ronayne argues that such a story is incomplete. This is because it fails to recognize that the revenue of these profit-maximizing entities must be generated: it comes from sellers in the form of commissions for sales. In turn, sellers embed that cost in the prices they offer consumers. The question this research addresses is when this indirect cost to consumers inflates prices to levels above those we may expect without PCWs.
The author compares the prices generated by a model he constructs, with and without PCWs. To account for the different types of consumers we see in reality, the author models a market with two types of buyers. Some are relatively active and compare the prices of all the firms they are aware of. Others are inactive and buy mechanically from their “default” seller regardless of the presence of a PCW (akin to automatically renewing with a current insurance carrier or buying habitually from the same airline). Without PCWs, active consumers choose to compare the offers from the (potentially very few) firms they are aware of. With a PCW everything is the same except that the PCW sets its commission rate, sellers choose whether to list their price on it, and active consumers choose where to look for prices: firms’ own websites or the PCW. The model predicts that all sellers choose to list a price on the PCW and active consumers find the best deal on the market there. As such, the PCW transports consumers from a world in which they are exposed to a handful of firms to one in which they effortlessly search the whole market. The cheapest seller sells and pays the PCW its commissions. Two countervailing forces are exerted on prices. On the one hand, firms respond to the increased competition by fighting hard to be the cheapest. On the other, the commission pushes the whole distribution of prices up.
The author shows that, under a wide range of circumstances, the inflationary pressure of commissions outweighs the benefit of greater price competition. In fact, both types of consumers face higher prices on average in the setting with PCWs – those who use the sites and those who do not. The cost of comparison is reflected in the prices all consumers face, even those who do not engage in comparison.
Further, the result is unaffected by the number of PCWs in the market. This is because in the model it does not make sense for consumers to visit more than one of these sites: firms list on as many of them as possible to cast the widest net (in the language of the literature, firms “multi-home”), which gives consumers no reason to check more than one (consumers “single-home”). These contrasting homing behaviors are consistent with those reported in various studies, including the UK’s Competition and Markets Authority’s. Accordingly, even a marketplace with very many PCWs only gives the illusion of competition: each PCW has the power of a monopolist because consumers do not check rival comparison websites. This allows each PCW to demand high commissions from sellers, who pass them on to consumers in high prices, reducing their welfare.
What could help secure better outcomes for consumers? In principle, requiring PCWs to clearly publish or advertise their commissions could help if consumers respond by patronizing the site with the lowest rate. But this is unrealistic because consumers do not care about commissions, paid as they are by firms to PCWs. In contrast, the author extends his analysis to show how inter-PCW competition is more naturally ignited when PCWs compete for consumers directly (e.g., through discounts) instead of indirectly (e.g., through commissions). And as such, he argues that policy should focus on facilitating competition in those dimensions to create an effective competitive environment.
The full paper “Price Comparison Websites” is published in the International Economic Review.
This text is jointly published by BCCP News and BSE Insights.