Buying online: intense competition is driving down pricing

5 May 2016

Is the internet to blame for the lower inflation that we have seen in the past few years? Internet usage has grown vastly (in 2015 78% of adults in the UK used the internet every day, or almost every day, up from 35% in 2006), and online shopping has continued to gain popularity. In the UK, the proportion of shopping that takes place online has risen sharply: in 2007 it accounted for around 3% of retail sales, in early 2016 that was over 13%. In the US the proportion is lower, around 7.5% currently, but the trend is the same. This is reinforced by the fact that online shopping is pressuring town centre shops to close, encouraging more customers to turn online. Online shopping is helping to keep prices lower in four main ways.
First, prior to the advent of internet shopping consumers had to go to the nearest town, where there might be only one or two places that would sell what they wanted. The customer then had to pay the asking price without question. The internet has effectively removed search costs, lowering the cost of goods as firms can no longer sell at a local mark-up. What’s more, customers might buy the goods over the internet, or research where to find the best deal and buy from the cheapest physical store. The subsequent competition that this incites as firms compete on a global playing field rather than a local one is likely to cut profit margins and reduce prices.
Second, the fact that internet retailers are based in vast hangers on the outskirts of town, rather than having a store front in prime retail premises means that they have lower overheads, which reduces their costs further. They are also able to hold a wider range of stock and more manageable levels of stock, because they can service the whole country from one centralised warehouse. If they don’t have the stock, they can adjust the information on the website. These lower costs can be passed onto the consumer as lower prices.
Further developments such as click and collect (where you order the goods online and collect them at a time and location that suits you) are further removing the effort of having goods delivered- the potential inconvenience of a product that might not fit through the post box for example. Click and collect and other developments like Amazon Lockers (a version of click and collect) can also lower the delivery cost and times by reducing the logistics of getting the product to you.
The third way that the internet is helping to lower costs is by digitalisation. This is true across a number of industries; books, newspapers, music, film, TV, video games. This helps lower the costs as well- there is no physical product to manufacture, no stores to sell in, and thus they are sold at a lower price point.
The fourth way that internet sales are keeping prices lower is by mobilising new supply via apps like Uber and Airbnb. Effectively these apps are increasing supply and thus likely to decrease the price in various industries.
Sweden is one of the most digitally advanced nations, with higher regular internet usage than almost all other countries. The thesis that internet shopping has helped cause their country’s low inflation has even been put forward by their central bank, the Riksbank. A summary of their points can be seen in figure 1 below.
In the UK, the monthly retail sales data only provides limited direct information on online shopping, but they do provide a deflator for non-store sales. This includes catalogue and TV sales, but is predominantly (over 70%) online sales. If we consider this as a proxy for the online sales deflator, then we can see that the online sales have a far lower rate of inflation for the entire period of the time series. While it’s hard to find conclusive proof that internet sales are pulling down prices, it’s not hard to find plenty of anecdotal, circumstantial or suggestive evidence. It seems that there is little that is safe from the clutches of online shopping.
When considering the price implications of internet sales, it is important to differentiate between deflation (falling prices and falling volumes) and a deflationary boom (falling prices and rising volumes). Internet sales are a structural change that initially lowers prices, but they are also likely to increase demand: it is easier for more people to buy a wider range of products at lower prices. When prices are falling in these circumstances it is a far cry from the mire of deflation.
Figure 1: The effects of digitalisation on inflation
Data source: Riksbank
Figure 2
Data source: ONS

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