Sunday, 23 August 2015

Do we need a price-comparison-website comparison website?

Last month The Economist reported on price-comparison websites (where consumers can compare prices between different providers of insurance, for example, or electricity - like Powerswitch in New Zealand, or other products and services). The article made for interesting reading:
Comparison sites, whether for insurance or something else, introduce a new layer of costs, including their own splashy advertising campaigns. In theory, competition in the market for comparison sites ought to keep those costs down. But in a recent paper, David Ronayne of Warwick University argues that consumers often lose out from comparison sites. They earn a commission for each shopper who uses them to buy insurance. That referral cost is incorporated into the price the consumer ends up paying. If the increased costs outweigh the saving the comparison enables, consumers end up worse off.
For instance, suppose some consumers are loyal to a single comparison site, and do not use any others to compare prices. The lucky website can crank up its referral fees, safe in the knowledge that insurers must pay up if they want access to its captive market. Those fee hikes are then passed on to consumers in the form of higher premiums.
Having a few loyal consumers would not be enough for a price-comparison website to have a high degree of market power. It would need a lot of loyal consumers - enough so that other price-comparison firms would find it difficult to make a profit, and so would choose not to enter the price-comparison website market. In other words, having a high number of loyal consumers constitutes a barrier to entry for other price-comparison website firms. It is hard to say what proportion of loyal consumers you would need to effectively lock out potential competitors, but it may be a lot. Are consumers likely to be loyal to a single price-comparison website? It's hard to say - by definition by using a price-comparison website they aren't loyal to their insurer, so why would we believe they would be loyal to a single price-comparison website?

Anyway, let's assume that there are a lot of loyal consumers, which provide a single dominant price-comparison website with market power. The higher the proportion of consumers who use that site for comparing prices, the more market power the site will have. Firms with market power are able to raise prices above marginal costs - in this case the price of referral fees to the insurance companies (or electricity retailers, or whoever). This leads to higher costs for those firms, who respond by raising prices.

At the extreme, if there is only one price-comparison website, they will (almost) have a monopoly on providing price information to consumers (I say almost because consumers could shop around themselves, albeit incurring higher search costs in the process). The single price-comparison website could increase the referral fee greatly, making consumers much worse off in the process.

How could this problem be tackled? Government could intervene in the market for price-comparison websites through price regulation (regulating the referral fees that price-comparison websites can levy on firms), or the government could run the price-comparison website itself (then it can set a low referral fee, or even none at all if the taxpayer is happy to subsidise the effort). Or the government could try to increase competition between different price-comparison websites, although that will be tricky if consumers are very loyal.

An alternative solution is to turn the price-comparison websites own business against them, and create a price-comparison-website comparison website. Then consumers could investigate to determine which price-comparison website will give them the best deal. That should increase competition between the price-comparison websites, lowering their referral fees and the prices for consumers. But would the price-comparison website comparison website then charge referral fees to the price-comparison websites? Maybe that just shifts the market power problem one step further up the chain.

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