See discussions, stats, and author profiles for this publication at: https://www.researchgate.

net/publication/353210705

PRICING ON THE INTERNET LITERATURE REVIEW

Preprint · July 2021

CITATIONS READS

0 1,595

1 author:

Andras Kalacsi
Dania Erhvervsakademi
1 PUBLICATION 0 CITATIONS

SEE PROFILE

All content following this page was uploaded by Andras Kalacsi on 15 April 2022.

The user has requested enhancement of the downloaded file.

 PRICING ON THE INTERNET
LITERATURE REVIEW
by Andras Kalacsi
Working paper1
Dania Academy, Prinsens Alle 2, 8800, Viborg
2021

ABSTRACT

The aim of this literature review is to investigate the literature that is currently available on online
pricing. After a short introduction to the topic, the methodological considerations are presented. The
literature review identifies the original expectations regarding pricing online and how reality turned
out to be compared to the initial expectations. The review continues with a more detailed discussion
regarding the law of one price and how it is violated in many cases in the cyberspace. Then the
research conducted on investigating the causes for market frictions online is summarized followed by
the identification of various online pricing strategies. This paves the way to the next section where the
literature on pricing algorithms and the issues with them are presented. In the last section a short
summary of the macroeconomic implications of online pricing are shown, but as the research
regarding macroeconomic effect is limited, this section does not provide a detailed insight into the
topic.

Keywords: Microeconomics, Online pricing, Digital pricing, Internet, Frictionless markets, Search
cost, Menu cost, pricing algorithms

1. INTRODUCTION theory is applied in practise in many cases,

As a lecturer in economics at Dania Academy I
often experience that the Academy’s overall
teaching strategy focusing on practices and
application of knowledge rather than on
theoretical knowledge and theory building
poses challenges when teaching economics.
Even though there is an ample selection of
undergraduate course books in economics
available on the market I face two limitations.
First and foremost, while books present the
theory, they fall short of discussing how the
especially in a digital world. While students are
introduced, for instance, to Supply and
Demand there is no evidence of how the
industry works with these concepts digitally. A
typical book in economics discusses good, but
outdated, or at least, non-digital examples.
Secondly, as Coppola (2021) points out in his
article approximately 1.92 billion people
purchased online with sales amounting to 3.5
trillion USD in 2019. He also argues that online
retail sales have been on the rise and is

1
Working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or
been subject to a review by the Academy.
2 Kalacsi: Pricing on the Internet – Literature review
expected to reach 22% of global retail sales by
2023. Consequently, it is important to
investigate how economic theory works in
online marketplaces. Thus, the overall goal of
this paper is to identify how economics works
online and to identify real-life examples that
could be used during lectures.
2. FOCUS AND SUBJECT
According to Machi and McEvoy (2016) one
can differentiate between two types of
literature review, a simple literature review
and a complex literature review. While a
simple literature review is defined as an inquiry
in the currently available knowledge on a
particular topic, a complex literature review
has a wider scope, not only scrutinizing the
current knowledge, but identifying issues for
further studies as well. This literature review
will have its scope limited to a simple literature
review.
Cooper (1985) identifies 4 different research
focuses, which are research outcomes,
research methods, theories and practices and
applications. Even though the article
presented by Cooper was originally written for
education and psychology, arguably the
framework presented by him is applicable to
social sciences in more general. In this
literature review the focus will be on
identifying practices and application. After
defining the scope of this literature review as a
simple literature review with practice and
application focus the next step is to clearly
define the subject of interests.
As described in the introduction to this paper
there appears to be a gap between the course
books available in economics and the
application of economic principles in a more
and more digitalised world. Economics is a
social science that aims at understanding how
we make choices, and it can be split into two
Dania Academy
main branches. Microeconomics focuses on
individual markets, such as the pharmaceutical
market, while macroeconomics aims at
understanding how the economy works as a
whole. As such, the discipline is very broad and
this narrowing the subject of interest down is
necessary. This paper will solely focus on
microeconomics, and more precisely pricing on
the Internet. The reason for this choice is that
pricing and price optimisation is the main focus
area in the curriculum for Marketing
Management students. This paper, therefore,
aspires to identify relevant literature that can
support the currently used course books by
identifying two main elements:
1. How can microeconomic models be
used in online pricing?
2. What real-life examples of online
pricing could be identified in the
existing literature?
3. METHODOLOGY
In order to develop a transparent approach to
assessing the current level of knowledge on
online pricing a three-step search will be
conducted as proposed by Machi and McEvoy
(2016). The very first step in their model is
referred to as scanning, which is defined as an
organised search in both online and library
catalogues to identify sources that may be
relevant for the subject of interest. The initial
scanning is followed by the skimming phase,
during which the sources identified in the first
step are skimmed so as to identify the core
ideas in them and to decide whether the given
sources are relevant or not for the focal
literature review. Finally, the procedure ends
with the mapping, in which the sources are
organised for writing. (Machi & McEvoy, 2016)
Scanning:
Related to the subject of this literature review
the following keywords are considered as
relevant: microeconomics, pricing, Internet,
3 Kalacsi: Pricing on the Internet – Literature review
examples. The potential synonyms for these
keywords based on a thesaurus search are
organised in search blocks that are then
connected with Boolean operators (Bibliotek,
2021). As the topic of digitalisation and digital
solutions is a current one the search will not be
narrowed down by date, since it is considered
unlikely that obsolete materials will be found
on the topic.
• Search block 1: pricing, price, mark-up
• Search block 2: Internet, online, digital
• Search block 2: example, case
These keywords are used to search library and
online catalogues applying Boolean operators
between them in the following manner:
• (price OR pricing OR mark-up) AND
(internet OR digital OR online)
• (price OR pricing OR mark-up) AND
(internet OR digital OR online) AND
(example OR case)
The following sources will be used to identify
potentially relevant literature (McCombes,
2021):
• Google Scholar
• JSTOR
• Project Muse
• EconLit
• Academia.edu
• ResearchGate.net
Skimming:
During the skimming process the sources
identified in the scanning phase will be
evaluated for relevance. This phase has two
main goals. Firstly, to identify if the source is
relevant or not, i.e. if it will be included in the
simple literature review or not. And secondly,
to identify the main ideas in the given source.
(Machi & McEvoy, 2016) In order to do so the
table of contents and/or the abstract and/or
the conclusion of the article will be read first,
Dania Academy
followed by a review of the relevant sections of
the source. The third aim of the skimming
phase is to identify additional sources in the
bibliography/reference list of these sources
that could be relevant. If such sources are
identified those will be skimmed as well. All the
findings will be recorded in a Word document.
Mapping:
The last step is the mapping, during which the
core ideas presented in the selected sources
will be organised to prepare for the writing of
the literature review. Machi and McEvoy
(2016) suggest that the literature review can
be mapped either by core idea or by author
contribution. In this paper the sources will be
organised by core ideas.
4. THE ORIGINAL OUTLOOK
On November 20th, 1999 The Economist
published an article entitled Frictions in
cyberspace, which started with the following
sentences: „The explosive growth of the
Internet promises a new age of perfectly
competitive markets. With perfect information
about prices and products at their fingertips,
consumers can quickly and easily find the best
deals. In this brave new world, retailers' profit
margins will be competed away, as they are all
forced to price at cost.” reflecting the
expectation of many economists at the time.
Brynjolfsson and Smith (2000) published an
article shortly afterwards, in which they also
claimed that the Internet should, theoretically,
lead to a frictionless market, where both menu
costs and operational costs are lower and
there are no entry barriers. A high number of
new entrants should lead to increased
competition in these markets that invariably
leads to lower prices.
Another early prediction during the rise of e-
commerce was that because of low search
costs for customers and the high level of
4 Kalacsi: Pricing on the Internet – Literature review
competition, prices will be driven down to cost,
and just as in economic theory this will lead to
perfect competition, where companies cannot
deviate from the market price, i.e. the
standard deviation will reach zero. (Clay, et al.,
2000). One of the early works to prove the
prediction wrong was presented by Clay et al.
already in 2000. While scrutinizing the online
book market they found that the price
convergence for best-selling books in online
markets is higher than offline, but the standard
deviation is still above zero, implying higher,
but not perfect competition. The authors
concluded that there is no clear correlation
between the level of competition, market price
and standard deviation. They also observed
that many companies in the online book
market tried adopting a cost leadership
strategy, by undercutting the price charged by
Amazon by 10 cents. But many of these
companies quickly went bankrupt, while
others changed their pricing strategy. (Clay, et
al., 2000)
Contrary to all initial expectations, reality
turned out to be different and the law of one
price does not work in the cyberspace, even
though customers do have access to all the
information to make a rational decision. (Baye,
et al., 2007) It is important to note that
customers’ access to information also
improved over the years, which, again, should
lead to less market friction. Clay et al. (2000)
argued that customers may not have been
familiar with price comparison sites and their
claim was supported by Baker et al. (2001),
who found evidence that 84% of book buyers
choose to make a purchase at the first online
store they visit. Johnson et al. (2004) also
concluded that many buyers do not search at
all. However, by 2009 there was significant
improvement, as Brynjolfsson et al. argued
that shopbots do reduce search costs. A report
Dania Academy
by the European Commission (2013) confirms
the positive trend, showing that 74% of
customers did use a comparison site over the
past 12 months. (Consortium, 2013). This
tendency clearly shows that customers have
better access to information and that they
have become more conscious about using
them.
Brynjolfsson et al. (2009) also concluded that
markets are far from frictionless while
investigating the online book market. They
argue that even though books are
homogeneous products, and the same title has
the same marginal cost, they observed a price
dispersion on the online book market. In a
more recent article Gorodnichenko et al.
(2018) also came to the same conclusion.
Although the Internet led to lower search costs
and lower menu costs as well, they argue that
online markets are still far away from
becoming frictionless. While menu costs are
lower there is still some rigidity in the
cyberspace, potentially because of the cost of
information gathering and the cost of
coordinating price changes with suppliers and
other sellers. (Gorodnichenko & Talavera,
2014)
5. THE LAW OF ONE PRICE
The law of one price quite simply states that
the same good should have the same price
everywhere and consequently price dispersion
should not exist on the market, however, from
the evidence presented above it is clear that
price dispersion still exists on online markets.
But let us first take a look back in history. Up
until the mid-19th century price differences
were natural and existed everywhere as back
then pricing was based on individual price
negotiations (Reisman, et al., 2019). While
certain sources claim that the first department
store Le Bon Marché was opened in 1852
(Song, 2020) others claim that the first one was
5 Kalacsi: Pricing on the Internet – Literature review
opened as early as 1796 (Glancey, 2015).
Although the date and the location are
disputed, one thing is certain; the birth of the
department store necessitated scaling existing
business models up and this resulting in using
a price tag instead of price negotiations
(Reisman, et al., 2019). While using a price tag
for every customer quickly became a practice
for most businesses the arrival of the Internet
quickly changed the one-price-fits-them-all
strategy. While in the pre-Internet era
companies adopted a “take it or leave it” price
strategy (Rezabakhsh, et al., 2006), already in
1996 firms with high fixed costs used price
differentials extensively. Such companies
include airlines and publishers. (Klein &
Loebbecke, 1999)
While price disparities became more and more
common online, many argued that this will
lead to better resource allocation as firms are
becoming better at reacting to changes in
demand. The ability to collect demographic
data retrieved from the registration on e-
commerce sites and tracking online behaviour
using cookies enabled companies to identify
their product’s utility as perceived by the
customer, i.e., to identify the customer’s
willingness to pay. Before online solutions
made data collection possible at a relatively
low cost, only a fraction of companies
researched their customers’ price sensitivity.
Such a research can take 6-10 weeks and cost
up to 300,000 USD (Baker, et al., 2001). But
online technology drove the cost of research
down significantly. Just consider the delivery
address and the amount of information that
the company has access to by knowing the
customer’s address. The cost of housing in a
neighbourhood, the average income in the
area are all available data that can be used to
measure the customer’s willingness to pay
(Kapur & Daripa, 2001). By being able to do so,
Dania Academy
companies can engage in a flexible pricing
mechanism (Klein & Loebbecke, 1999). This
claim is also supported by Karup and Daripa
(2001) who claim that price discrimination
exists not only offline, but in online markets as
well. They argue that information asymmetry
is lower, meaning both the buyer and the seller
has better access to information. By collecting
data about the customer, sellers can
discriminate their prices and that can
potentially lead to higher prices on the given
market. This claim is supported by Clay, et al.
(2000), who measure a standard deviation of
prices between 17-28%.
6. SOURCES OF FRICTION ONLINE
As online markets are not frictionless and the
law of one price is violated it is important to
investigate the sources of friction. Under
conditions of Bertrand competition products
are perfect substitutes, retailers have no
advantage attracting customers vis-à-vis each
other and customers do have access to perfect
information. Under this condition the only
base for competition is price, which equals
marginal cost. Consequently, customers buy
from the retailer that offers the lowest price.
This was the expectation presented by Baker,
et al. in 2001. They expected that by tracking
customers, companies will be able to set their
prices accordingly and ultimately price will be
the only differentiating factor in e-commerce
overshadowing quality, service, or reputation.
However, this is clearly not the case as
Brynjolfsson et al. (2009) observe in case of
online book markets that approximately half of
the customers do not choose the lowest price.
It is important to note that in an earlier article
Brynjolfsson and Smith (2000) argue that while
they observe substantial price dispersion on
the Internet (33% in case of books and 25% in
case of CDs), the reason behind the difference
is not a result of information asymmetry. This
6 Kalacsi: Pricing on the Internet – Literature review
customer behaviour violates one of the most
elementary principle in economics, i.e. the
assumption in the basic competitive model
that the buyer is rational. If one can observe
that contrary to all early expectations
customers do not choose the lowest price even
when they have access to information and the
product itself is homogeneous it is logical to
investigate the reason behind.
The price differences that one can observe on
online markets is due to branding, awareness,
and trust (Brynjolfsson & Smith, 2000). They
mention the example of travelling, where
customers’ price sensitivity is different online
and offline. After purchasing in a brick-and-
mortar store, customers who make another
purchase online appear to be less price
sensitive online. Other similar examples are
lower price sensitivity of online grocery sales
(Degeratu, et al., 2000) and car auctions,
where online auctions result in higher prices
than their offline versions (Lee, 1998). Kapur
and Daripa (2001) support some of the claims
presented by Brynjolfsson and Smith (2000).
They also observe that the lack of trust distorts
the market and customers in some cases
perceive online offers as “too good to be true”
and steer clear of them. In addition to trust,
they also mention switching costs being bigger
than initially expected, leading to friction.
Choosing to switch retailers incur switching
costs to customers in the form of registering
themselves as new customers in new systems
every time they want to purchase from a new
retailer. Alternatively, customers may
experience endogenous costs in the form of
loyalty schemes. (Kapur & Daripa, 2001).
They also argue that while price comparison
sites exist and while more and more customers
use them, they are not perfect. In case of
search comparison sites two practices distort
the picture. Retailers often state a low price
Dania Academy
but add extra charges on top of that (Kapur &
Daripa, 2001). In the early versions of price
comparison sites Ellison and Ellison (2009)
report an extreme case, where the retailer
charged 1 USD for the product and 40 USD for
shipping and other charges. On the other hand,
some retailers engage in so called “bait and
switch” strategies, where they offer a low-
priced product on the price comparison site
but entice the customer into buying a higher
priced version once they are on the retailer’s
site (Kapur & Daripa, 2001). Another reason for
friction according to them is the high cost of
online presence. While a new entrant can start
a website at a relatively low cost, advertising
online is expensive. Price comparison sites can
operate with a click-through fee between 40
cents and 1.50 USD. Considering that the
average conversion rate is 3% this is a
significant cost for a retailer. Imagine a retailer
operating with a 4% conversion rate and
paying half a dollar for click-through fee. This
particular retailer incurs 12.50 USD in click-
through fee alone! (Baye, et al., 2007) Large
companies can take better advantage of
economies of scale when doing online
advertising and that inevitably leads to a high
level of industry concentration.
Kung, et al. (2002) also list a number of reasons
explaining why customers may choose to order
from a retailer that does not charge the lowest
price. They list the following reasons:
• customer support
• delivery time
• shipping
• privacy policy
• ease of ordering
• product information
• Web site navigation
• product selection
7 Kalacsi: Pricing on the Internet – Literature review
Besides the above-mentioned practices Ellison
and Ellison (2009) also observe a few cases,
where retailers develop obfuscation practices
in order to make customers buy PC parts at a
higher price. One misleading practice is to
include no warranty in the price and offering it
as an add-on later on during the buying
process. Other examples of add-ons are
upgrades for shorter shipping time and
pretesting the hardware before shipping.
Another commonly observed practice in the PC
component market is to offer a low quality,
cheap product and then convince the customer
to upgrade (Ellison & Ellison, 2009). One can,
for instance, see this practice on Dell’s website,
where the customer first encounters the
cheapest version and then is offered several
updates.
7. PRICING STRATEGIES
As early as 2001 Baker et al. offer two very
simple pricing strategies. They argue that
companies can continue selling their product
online at the same price level as in their brick-
and-mortar stores or alternatively lower the
prices. They expect to see start-ups adopting
the second practice, hoping to acquire first
movers on the market.
Another summary of pricing strategies online is
offered by Rezabakhsh et al. (2006), who
differentiate among three strategies, auctions,
name-your-own-price models and group-
buying models. The largest and most well-
known auction site on the internet is eBay.
However, there is evidence that online
auctions have been used in the B2B segment as
well, mainly for procuring raw materials at
significant savings. As online auctions of raw
materials are facilitated by an intermediary
and follow a disciplined procedure the overall
cost is lower. In addition to this shorter price
negotiations (typically hours instead of
months) and the presence of potential new
Dania Academy
suppliers that companies may choose also
leads to lower procurement costs, thus
lowering the company’s cost of goods sold and
consequently its price (Emiliani, 2000). As an
example of a name-your-own-price
Rezabakhsh, et al. (2006) mention
priceline.com, where customers can book
hotels. This model will be discussed in more
detail later on in this paper. Finally, group-
buying sites are based on the collective
bargaining power of buyers dispersed on
various parts of the globe. An example of the
adaptation of this model is letsbuyit.com,
which quickly went bankrupt.
A pricing strategy used in the hotel industry is
following real-time supply and demand on the
accommodation market. Hotels rely on
eWOM, i.e. electronic Word-of-Mouth to
estimate demand. Linear regression models
show that positive reviews lead to increased
volume and increased willingness to pay,
consequently hotels can set their prices based
on eWOM (Pulina & Santoni, 2018).
Seasonality is also a major consideration in the
hotel industry as it leads to peaks in demand,
such as the Oktoberfest in Munich (Herrmann
& Herrmann, 2014). Providers of
accommodation can take such peaks in
consideration when setting their prices. On the
other hand, supply can be estimated real-time,
by the number of real-time competitors online.
While there is evidence that the hotel industry
uses demand data to set the price this
tendency does not apply to all industries.
While sellers are typically responding to
seasonality effects, such as Christmas and
Thanksgiving, they fail to respond to weekly
changes. A study of 50,000 products, in 22
product categories conducted in the US and
the UK by Gorodnichenko et al. (2018)
concluded that demand for these products is
33% higher on Monday than on Saturday, yet
8 Kalacsi: Pricing on the Internet – Literature review
companies fail to react to this change in
demand.
Baye, et al. (2007) argue that a one size fits all
pricing strategy does not work online. In order
for companies to remain profitable they should
set an optimal price. They argue that a
company can do so by using the following
steps:
1. Determine the wholesale price of the
item
2. Determine the incremental cost, i.e.
the click-through fee multiplied by the
number of click-through it takes to
conversion
3. Determine the price elasticity.
Although price elasticity can be
determined by using sophisticated
statistical measures, online
marketplaces enable sellers to easily
experiment with price changes and
their effect. By doing so, they can
measure price elasticity using the
following formula: ε=
Q1−Q0 P1−P0
� �� �, where Q is the sales,
Q1+Q0 P1+P0
while P is the price of the product. A
example for such a practice is
Pixmania. While selling a PDA in 2004
Pixmania change the price of the PDA
11 times over a period of 14 weeks. By
varying the price between 286 GBP
and 283 GBP they could estimate the
elasticity of the product.
4. Determine the optimal markup using
price elasticity. The more elastic the
product is the lower the mark-up the
company should charge. The formula
for setting the right mark-up is:
𝜀𝜀
1+ 𝜀𝜀
As demonstrated above, the optimal mark-up
ultimately depends on the price elasticity of
the underlying product. Baye, et al. (2007)
identify two factors influencing price elasticity;
the Product Life Cycle (PLC) and the number of
competitors. Regarding the Product Life Cycle,
they argue that PLCs have significantly
Dania Academy
shortened and in many cases can be as short as
a few weeks. As early implementers are usually
the least price sensitive, while those who tend
to delay a purchase are more price sensitive, it
is essential for companies to understand the
evolution of their products and adjust the price
accordingly. An example for following the PLC
and pricing accordingly is illustrated by the
case of Comet and C&A Electronics. These two
online retailers sold the same PDA, but while
Comet kept its price constant over a period of
approximately 8 months, C&A Electronics set a
higher price initially, but quickly dropped the
price several times as the product was
maturing on the market. As a result, C&A
Electronics could dominate sales for the
product. (Baye, et al., 2007). Another example
of temporal price discrimination are movie
ticket prices for the premier date and later on,
or real time stock quotes that are expensive,
but with a 15-minute lag they are already
available online for free. (Kapur & Daripa,
2001)
The other factor influencing the elasticity of
demand is the number of competitors on the
market, affecting the optimal mark-up. While
the number of competitors is relatively stable
in case of physical locations, the number of
real-time sellers vary quickly in an online
marketplace, consequently, companies must
monitor the number of competitors and adjust
their mark-ups accordingly. Following the
above strategy Expansys adjusted its price for
the Palm Tungsten T3 PDA several times over a
year, where the number of sellers varied
between 8 and 18. By monitoring the level of
competition Expansys could constantly set the
optimal price for the PDA. (Baye, et al., 2007)
Perhaps the most detailed overview of online
pricing strategies is offered by Reisman et al
(2019), who also introduce a new term
“FairPay” in their article, introducing pay-
9 Kalacsi: Pricing on the Internet – Literature review
what-you-want (PWYW) and the
aforementioned name-your-own-price (NYOP)
schemes. The interesting point in these
schemes is that they involve participative
pricing, i.e. the customer also pays a role in
setting the right price. According to classical
economic theory such a scheme should not
work, yet the authors report cases of increased
profit when participative pricing is used. They
claim that participative customers have both
intrinsic and extrinsic motivation to set a fair
price. Among intrinsic motivation they suggest
that customers may be concerned about the
well-being of the supplier as well as they would
appreciate a fair offer and in return set a fair
price. Extrinsically, customers may seek a
reference price than can be fair. This reference
price may be implicitly provided by the supplier
itself. The supplier may also, implicitly, provide
the customer with information regarding the
cost of the product, which again can give the
customer a reference point regarding a fair
price level. According to economic theory, in
markets where competition is limited
customers may experience a higher price, but
they are still better-off paying a higher price
than not having access to the given good or
service at all. Consequently, in such a market,
customers may offer a fair price to make sure
that the supplier does not exit the market.
(Reisman, et al., 2019). Reisman, et al (2019)
describe six online pricing strategies:
• Freemium: where the basic product is
free, but add-ons and additional
functions are paid for. This pricing
strategy is widely used in case of video
games, such as League of Legends.
• Name your own price: is a form of
participative pricing, where the
customer can set the price and the
seller accepts it provided that it is
above the reservation price.
Dania Academy
• Pay what you want: is similar to NYOP,
but in this case there is no reservation
price, and the seller has to accept the
price set by the customer, even if it is
zero. Radiohead released an album
online using this pricing strategy and
the overall profit was higher as they
did not have to share it with the record
label.
• Pay within set boundaries: is a version
of PWYW, with a price floor to make
sure that the marginal costs are
covered.
• Mark-off your own price: is a scheme
under which customers are
encouraged to knock the price off
compared to a reference price.
• Pay it forwards, is a scheme used by
Suspended Coffee. Under this scheme
the customer receives a free coffee
that is paid for him by the previous
buyer. He is in turn asked to donate a
coffee for the next customer.
8. PRICING ALGORITHMS
One of the cornerstones of a frictionless
market is zero menu cost. In traditional brick-
and-mortar stores changing prices can easily
be a significant cost. While menu costs are
significantly lower online, they still exist in the
cyberspace. Companies can use pricing
algorithms to make price changes even quicker
at a lower cost. Cavallo (2018) presents
evidence that the number of companies using
pricing algorithms is increasing. However,
Baye, et al. (2007) argue that companies must
avoid a predictable pricing strategy as that may
be exploited by its competitors. They present
the case of Comet and TESCO selling the same
Samsung refrigerator. As TESCO monitors only
the supermarkets it competes with and fails to
monitor specialist stores Comet could easily
predict TESCO’s price and undercut its price to
10
remain the cost leader throughout the period.
A similar problem may arise if companies
engaged in using the same pricing algorithm
for a long period of time.
How quickly algorithms can go wrong is
illustrated by an early example on the book
market. Salcedo (2015) presents the case of
The making of a fly, where two booksellers
selling the same book online used simple
pricing algorithms to set their prices based on
that of the competitor. Seller A took the price
charged by Seller B and multiplied it by 0.9883
to undercut seller B. On the other hand, Seller
B’s algorithm took Seller A’s price and
multiplied it by 1.27059. As a result of an
exponential upward spiral, the price of the
book soon reached 24 million USD on Amazon
and remained there for more than a week
before the price was manually adjusted to 106
USD. (Salcedo, 2015)
Brown and MayKay (2021) studied five
retailers selling over-the-counter allergy
medication and observed significant price
differences in the market. They suggest that
the reason for the price disparity lies in the
different pricing technology that these
companies use. Using the most advanced
software, companies can develop their pricing
algorithm that can change the price as quickly
as every 15 minutes. The slower the re-pricing,
the more significant the price difference on
this market. They found that two of these firms
use a pricing software that can update the
price within an hour, one firm uses a software
that updates prices daily, while the remaining
two firms update their prices once a week. The
firms with the most advanced pricing
technology offer the lowest price, while the
firm updating its price daily offer prices that
are approximately 10% higher. The remaining
two companies offer the highest price, 30%
above the price of the first two firms. Thus, the
Kalacsi: Pricing on the Internet – Literature review
Dania Academy
use of different pricing technology can also
lead to price disparities in the market. The
overall effect of using pricing algorithms in
case of these five firms is the following.
Compared to the Bertrand equilibrium the
average price on the market is 5.2% higher,
resulting in a 9.6% profit increase and a 4.1%
drop in consumer surplus.
A major concern for policymakers regarding
pricing algorithm is the problem of collusion.
Salcedo (2015) argues that using algorithms
that are fixed in the short-run and committed
to a pricing mechanism involving monitoring
the prices of the company’s competitors
inevitably lead to collusion. Brown and MayKay
(2021) suggest that policymakers should
prohibit companies from using algorithms that
monitor competitors’ prices. O’Connor and
Wilson (2019) investigated the effects of using
AI in price setting and unlike Brown and
MayKay (2021) found that AI has ambiguous
effect both on profits and customer surplus.
They conclude that while using algorithms can
lead to collusion and thus negatively affect
consumer surplus it is not always the case.
9. ONLINE PRICING AND ITS
CONSEQUENCES
In a study conducted in the US and Canada
Gorodnichenko and Talavera (2014) concluded
that price changes online are more frequent
than offline and have a smaller volume,
meaning that companies adjust their prices
quicker, but there is still some price rigidity.
They argue that macroeconomic models
cannot account for price rigidity and price
dispersion, both observed in case of online
markets. They also observe that the exchange
rate pass through rate is quicker online than
offline, yet it remains incomplete. An example
for international price setting is IKEA, where
they observe that the law of one price is only
violated in countries that are outside currency
11 Kalacsi: Pricing on the Internet – Literature review
Dania Academy

unions, however they note that price practices. There are also a great number of
disparities can reach significant levels in case of examples available that can be used directly
expensive items. during lectures. Some authors also provide a
detailed overview of the different online
E-commerce and the fact that companies can
pricing strategies that can also be used during
adjust prices quicker has some macroeconomic
lectures. However, there are a few limitations
effects as well. However, standard
of the available scientific literature. First and
macroeconomic models do not fit well, and
foremost, there are issues where there is no
further research is required to understand the
consensus yet, such is the case of using
effects of online pricing on the macroeconomy.
algorithms in online pricing and its effects on
(Gorodnichenko, et al., 2018)
markets. While some authors argue that AI
10. CONCLUSION inevitably leads to collusions, others argue that
the results are ambiguous. It is also clear that
Based on the literature review it can be
most of the research identified by this
concluded that there is available literature on
literature review focuses on online price
online pricing and many of these sources can
setting for B2C markets and research on B2B
be relevant when teaching introductory
markets regarding online pricing appears to be
courses in microeconomics. However, it is
sporadic. Another limitation of the currently
important to note that most of the available
available literature is that it fails to address
literature is from the 2000s and there has been
macroeconomic implications of online pricing
only a limited amount of follow-up on them. A
and thus further research in that is necessary.
number of articles provide an overview
contrasting microeconomic theory to real-life
REFERENCES

Baker, W., Marn, M. & Zawada, C., 2001. Price smarter on the Net. HBR, February, pp. 2-7.

Baye, M. R., Gatti, R. J. J., Kattuman , P. & Morgan, J., 2007. A dashboard for online pricing. The
California Management Review, 50(202-218).

Bibliotek, D. K., 2021. Samf fagsider: Systematisk søgning. [Online]

Available at: https://kub.kb.dk/samffagsider/systematisksogning
[Accessed 25 03 2021].

Brown, Z. Y. & MayKay, A., 2021. Competition in Pricing Algorithms. Game Theory & Bargaining
Theory eJournal.

Brynjolfsson, E. & Smith, M., 2000. Frictionless Commerce? A Comparison of Internet and
Conventional Retailers. Management Science, 46(4), pp. 563-585.

Cavallo, A., 2018. More Amazon Effects: Online Competition and Pricin Behaviours. NBER WORKING
PAPER SERIES.

Clay, K., Krishnan, R. & Wolff, E., 2000. Pricing Strategies on the Web: Evidence from the Online Book
Industry. Pittsburgh, Proceedings of the 2nd ACM conference on Electronic commerce.

Consortium, E., 2013. Study on the coverage, functioning and consumer use of comparison tools and
third-party verification schemes for such tools, s.l.: European Commission.

Cooper, H. M., 1985. A Taxonomy of Literature Reviews, Washington, D.C.: National Inst. of
Education.

Coppola, D., 2021. E-commerce worldwide - Statistics & Facts. s.l.:statista.

Degeratu, A. M., Rangaswamy, A. & Wu, J., 2000. Consumer choice behavior in online and traditional
supermarkets: The effects of brand name, price, and other search attributes. Research in Marketing,
Volume 17, pp. 55-78.

Ellison, G. & Ellison, S. F., 2009. Search, Obfuscation, and Price Elasticities on the Internet.
Econometrica, 77(2), pp. 427-452.

Emiliani, M. L., 2000. Business-to-business online auctions: key issues for purchasing process
improvement. Supply Chain Management: An International Journal, 5(4), pp. 176-186.

Glancey, J., 2015. BBC Culture. [Online]

Available at: https://www.bbc.com/culture/bespoke/story/20150326-a-history-of-the-department-
store/index.html
[Accessed 08 04 2021].

Gorodnichenko, Y., Sheremirov, V. & Talavera, O., 2018. Price setting in online markets: does it
click?. Journal of the European Economic Association, 16(6), p. 1764–1811.

Gorodnichenko, Y. & Talavera, O., 2014. Price setting in online markets: Basic facts, international
comparisons and cross border integration, Cambridge: National Bureau of Economic Research.

Herrmann, R. & Herrmann, O., 2014. Hotel room rates under the influence of a large event: The
Oktoberfest in Munich 2012. International Journal of Hospitality Management, Volume 39, pp. 21-
28.
 13 Kalacsi: Pricing on the Internet – Literature review
Dania Academy

Kapur, S. & Daripa, A., 2001. Pricing on the Internet, London: Birkbeck College.

Klein, S. & Loebbecke, C., 1999. Signaling and Segmentation on Electronic Markets: Innovative
Pricing Strategies for Improved Resource Allocation. Münster, Sixth Research Symposium on
Emerging Electronic Markets.

Lee, G. H., 1998. Do Electronic Marketplaces Lower the Price of Goods?. Communications of the
ACM, 41(1), pp. 73-80.

Machi, L. A. & McEvoy, B. T., 2016. The Literature Review - Six Steps to Success. 3rd ed. Thousand
Oaks: Corwin.

McCombes, S., 2021. How to write a literature review. [Online]

Available at: https://www.scribbr.com/dissertation/literature-review/
[Accessed 21 03 2021].

O’Connor, J. & Wilson, N. E., 2019. Reduced Demand Uncertainty and the Sustainability of Collusion:
How AI Could Affect Competition, WASHINGTON, DC: Bureau of Economics.

Pulina, M. & Santoni, V., 2018. Hotel online pricing policy: A review and a regional. Investigaciones
Regionales – Journal of Regional Research, Volume 42, pp. 93-111.

Reisman, R., Payne, A. & Frow, P., 2019. Pricing in consumer digital markets: A dynamic framework.
Australasian Marketing Journal, 27(3), pp. 139-148.

Rezabakhsh, B., Bornemann, D., Ursula, H. & Ulf, S., 2006. Consumer Power: A Comparison of the
Old Economy and the Internet Economy. Journal of Consumer Policy, Volume 29, pp. 3-36.

Salcedo, B., 2015. Pricing Algorithms and Tacit Collusion, PA: Pennsylvania State University.

Song, V., 2020. CNN Travel. [Online]

Available at: https://edition.cnn.com/travel/article/le-bon-marche-paris-department-
store/index.html
[Accessed 12 03 2021].

View publication stats