Holding All the Cards

More reasons why online mass merchandisers are category killers

One of the great pleasures for book lovers of all ages is the opportunity to settle into a comfortable armchair amid the stacks of an expertly curated bookstore and peruse the pages of possible purchases. It’s an old story already that those opportunities are disappearing as online mass merchandisers crowd out independent bookstores. The meticulously analyzed data in a recent research study adds more chapters to that history.
In the study, “Pricing Best Sellers and Traffic Generators: The Role of Asymmetric Cross-selling,” Professors Cenk Kocas of Istanbul’s Sabanci University, Koen Pauwels of Northeastern University, and Jonathan D. Bohlmann of North Carolina State University set out to understand how profit-maximizing online retailers should price items that are potential traffic generators in a competitive market. Their analysis of how Amazon prices books, using both game theory and empirical data, illustrates with exquisite precision the rather subtle dynamics that enable multi-product online retailers like Amazon and Walmart to undercut smaller merchants and how their pricing strategies across the board are even more effective due to the depth and breadth of their other offerings. 
Kocas notes, “Although our work uses data on books, the model in general is not book-specific, and applies to all categories where products can be identified uniquely and hence be price-compared.” Movies, toys, games, and music are other examples.
The key distinction the researchers draw between the Amazons and Walmarts of the world and smaller online and brick-and-mortar retailers is the number and variety of items with which the digital mega-merchants can entice buyers – their cross-selling potential. The researchers created a model that focused on situations where there was significant asymmetry in size between retailers – which is typically the case. Mass merchandisers usually achieve larger shopping basket sizes than smaller niche sellers, whether online or offline.  Using game theory and a series of regressions, the researchers showed how this larger and more profitable basket size enables these large retailers to offer deeper and more frequent discounts on the most anticipated best sellers – and still achieve better overall profit. 
This asymmetry as compared with smaller, less diverse sellers is a powerful driver of Amazon’s success: it enables the behemoth to price best-selling books – even those far down the best-seller list – with an eye toward generating cross-category sales, whether or not the consumer was initially searching for that book. “Shoppers who are mainly interested in a ‘best seller’ may impulse buy one or more items…also, a buyer not necessarily interested in a best seller may, in addition to purchasing the planned shopping basket, also buy a best seller,” they explain. Clearly, the retailer most likely to profit from cross-selling is the multi-category player, an advantage that enables it to offer the deeper discount.
Empirical data supported what the model had predicted. The researchers collected and analyzed data on new book releases offered on Amazon over a three-month period in 2011, as well as price, sales rank, number of sellers, average customer reviews, and physical formats of a sample of more than 819,000 books. The analyses confirmed that multicategory retailers offered the deepest discounts on the top best sellers – of 19 retailers, the top four discounters are multicategory retailers, offering price cuts of 45 percent to 48 percent, while the remaining retailers, all of them bookstores, averaged discounts of 7 percent to 44 percent. 
The multi-category giant is left with a strategic decision that a smaller retailer can only envy. If one buyer comes to the retailer to purchase a best-seller, a deep discount will clinch the sale and perhaps spur her to put other items in her shopping cart. But the next customer may log in to purchase a completely different item, notice the best-seller and decide to buy it regardless of the discount because he hasn’t been comparison-shopping for it. How should the retailer price this best-seller? “The simple answer,” says Kocas, “is to discount some products sometimes for some customers (like the first), but sell other products at full price for the second customer (and cross-sell to the first).”
The Amazon data revealed that discounts were deeper for products with a better sales rank, even far down the best-seller list. Lower-list-priced books also had deep discounts, but not for those below a sales rank of 10,000 – indicating that the better sellers offered more potential to generate traffic and cross-category selling.  “Uncovering the tensions of this linkage between the motivation to lower prices of traffic generators and the motivation to increase their prices in anticipation of higher-margin basket incidences is a unique contribution of our model,” the researchers write.
Practical implications for online mass-market merchandisers are enormous, the authors suggest. Says Kocas, “The better is the sales ranks of a product, the more likely that it will be discounted, and the deeper will be the discount.”  However, because their model and empirical findings show that books going far down the sales rankings – even down to the millionth place – can cumulatively contribute to cross-category sales, online retailers should pursue a strategy of frequent discounts at all levels. For independent sellers like the local bookshop, the denouement of this competition story is not uplifting.  “We would expect the continued decline of independent booksellers that cannot adapt to being niche players,” Kocas says.
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