How the internet lowers prices

de Florian Zettelmeyer

"There is convincing evidence that the Internet has lowered the prices paid by some consumers inestablished industries, for example, term life insurance and car retailing. However, current researchdoes not reveal much about how using the Internet lowers prices. This paper answers this questionfor the auto retailing industry. We use direct measures of search behavior and consumercharacteristics to investigate how the Internet affects negotiated prices. We show that the Internetlowers prices for two distinct reasons. First, the Internet helps consumers learn the invoice price ofdealers. Second, the referral process of online buying services, a novel institution made possible bythe Internet, also helps consumers obtain lower prices. The combined information and referral priceeffects are -1.5%, corresponding to 22% of dealers' average gross profit margin per vehicle. We alsofind that buyers with a high disutility of bargaining benefit from information on the specific car theyeventually purchased while buyers who like the bargaining process do not. The results suggest thatthe decisions consumers make to use the Internet to gather information and to use the negotiatingclout of an online buying service have a real effect on the prices paid by these consumers"--National Bureau of Economic Research web site.