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The prevailing theory about Internet pricing was neatly summarized by strategy guru Gary Hamel in a 1998 interview with the Financial Times. Hamel, the widely quoted co-author of bestseller Competing for the Future, said the main threat facing companies is that consumers’ ability to shop around using the Web could cause price wars, causing profit margins to shrink perilously. Yet, it hasn’t happened that way. And it won’t. What most analysts forgot was that the Internet makes it easy for everyone to compare prices—not just the buyers, but sellers, too. Businesses check prices with search engines that are just as good as any consumer’s, and they probably use the tools more often. Once businesses see competitors’ pricing, they may react instantly—but not necessarily in ways that will lead to price cuts. Instead, businesses with great knowledge of each other often engage in what economists call "tacit collusion." The concept states that companies come to recognize how intertwined they are with one another, especially when they interact over and over. The belief is that businesses will maintain noncompetitive prices, even if they don’t explicitly collude. Historically, this tacit collusion has shown up in air fares, gasoline prices, long-distance telephone rates, and many other types of prices. Airlines, for instance, know that a price increase will stick only if all competitors go along, so any carrier that posts an increase will sit and watch to see what happens. If, after a day, even a single airline that flies the route hasn’t gone along, any airlines that did increase prices will roll prices back. Long-distance companies, which face increasing competition, might be expected to slash prices almost to zero. After all, the marginal cost of carrying a call is virtually nothing. They don’t, because they know that competitors could go just as low or lower, and everyone would lose in a price war. Despite the idea that the Internet has ushered in a New Economy that gives customers so much information that they have gained an advantage over manufacturers, it appears that moving the economy online also speeds up the tacit collusion and works against the shift in leverage. Knowing that competitors will instantly learn about any price reductions, manufacturers and retailers have become increasingly cautious about cutting prices and instead have started adopting similar price structures. Sure, some small, new competitor can come in and undercut the bigger producers or retailers for a while. But the leading players, those with a strong customer base and brand name, behave as though they believe in the Cold War doctrine of "mutually assured destruction" (which assumed that a nuclear first-strike attack would be met with an all-out nuclear response, ensuring that both forces or countries would be destroyed). Although there are lots of competitors in e-commerce, just as there are in industries such as airlines and long-distance telecommunications, nobody will launch the first missile, because it would lead to a nuclear winter that would kill everyone. It is true that companies were undercutting each other on prices a year or two ago, as they jockeyed for position. Some companies convinced themselves that they could make a profit while selling products at prices below cost, so they didn’t fear a price war. Now that some of the most aggressive e-commerce business models have been discredited, though, everyone is playing pretty much by the same old rules and is winding up with the same, less-than-bargain-basement prices. With the pressure off, online retailer Amazon.com Inc. (www.amazon.com), for instance, has cut its discounts on bestsellers to 40% from 50%. Many books no longer carry any discount off the list price. Prices, at least in many cases, are now so uniform across the Web that repeated searches for an electronic Pokemon figure on mySimon.com Inc. (www.mysimon.com), the well-known comparison site, showed the exact same price—down to the last penny. It made no difference who the producer was, nor who the retailer was: Hasbro or Nintendo, Amazon or Nuttyputty. Time had no impact, either. During a two-month period, the Pokemon price didn’t move at all. Although, by definition, the workings of tacit collusion are almost impossible to track, studies and price comparisons offer plenty of evidence this phenomenon has mitigated the expected plunge in online prices. One study, coming out of Massachusetts Institute of Technology (www.mit.edu) shows just how closely online companies track each other. The study found that prices for books, software, and compact discs changed at least twice as often as they did offline—sometimes many more times than that. Some companies not only make constant price comparisons, but also make them available to visitors to their Web sites. American Airlines Inc.’s Web site (www.aa.com) displays schedules and fares for other airlines, including those of its main competitor, United Airlines Inc. (www.united.com). The Web site for Progressive Casualty Insurance (www.progressive.com) offers quotes from its main competitors. It isn’t that tacit collusion is the only reason that prices online haven’t been as low as expected. E-commerce companies also have borrowed tried-and-true techniques from the physical world to obfuscate price comparisons, making it easier for everyone to limit competition based on price. For instance, each online electronic store on MySimon offers varying options for shipping, financing, and warranties. Levels of customer service, online security, and convenience are all across the board. By bundling in different levels of service and unique options, companies can make it hard to compare one similar product with another. Similarly, online retailers often will differentiate themselves from each other by carrying different models than their competitors. When looking for an MP3 player on Shopping.com, you will find that the top 10 retailers carry different models from different manufacturers. Price comparison is meaningless. Still, it is becoming clear that online companies are tacitly colluding and that, as a result, they are behaving more rationally than was initially projected. They have stopped well short of beating each other’s brains out and will restrain themselves in the future, too. That may be bad news for consumers, who had been led to believe that they would have the upper hand in their dealings with manufacturers for the foreseeable future. But for e-commerce companies—at least, those that can survive the current drought of capital—the return to historical patterns of tacit collusion is a welcome sign.
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