Reducing Market Search Costs: Implications for Electronic Marketplaces

Yannis Bakos
Graduate School of Management
University of California, Irvine

This version: July 1996
First draft: April 1991

ABSTRACT

Information systems can serve as intermediaries between the buyers and the sellers in a market, creating an "electronic marketplace" that lowers the cost of buyers in acquiring information about seller prices and product offerings. As a result, electronic marketplaces reduce the inefficiencies caused by buyer search costs, in the process reducing the ability of sellers to extract monopolistic profits while increasing the ability of markets to optimally allocate productive resources. This article models the role of buyer search costs in markets with differentiated product offerings. The impact of reducing these search costs is analyzed in the context of an electronic marketplace, and the allocational efficiencies such a reduction can bring to a differentiated market are formalized. The resulting implications for the incentives of buyers, sellers and independent intermediaries to invest in electronic marketplaces are explored. Finally, the possibility to separate price information from product attribute information is introduced, and the implications of designing markets promoting competition along each of these dimensions are discussed..