Price Transparency: a Double Edged Sword?

The benefits of increased price transparency are well known. A reduction in consumer search costs places pressure on producers to price their products competitively and, accordingly, enhances consumer welfare. After all, who wouldn’t want to shave a few dollars off their morning coffee?

Technological progress over the past few decades has resulted in the advent of many pro-consumer initiatives: online bargain-spotting forums for the frugal, smartphone apps that find the cheapest petrol prices and even online shopping. It’s no secret that the latter has cut out middlemen across the globe and has forced many brands to develop an online presence.

At first glance, this might seem like a great thing for consumers. And it is – but there are downsides associated with such sweeping change. Although the current level of price transparency means that I can walk into my choice of stores and take advantage of their price-matching policies with nothing more than a quick Google search at my fingertips, these changes have implications for both sides of the register.

And I don’t mean by biting into firms’ profit margins.

(Albæk, Møllgaard, & Overgaard, 1997) describe how in the early 1990s, the Danish Competition Council published a catalogue of firm-level transaction prices for two grades of concrete in select regions of Denmark. While this was driven in part by the fact that select customers received secret discounts, their reasoning was clear: transparency promotes competition. They decided to combat potential oligopolistic collusion by arming consumers with the ability to readily determine the cheapest available price each quarter.

Things did not go to plan. 

While inflation stuck to a low 1-2% per year, concrete prices for the two grades that received this special treatment increased by 15-20% in less than 12 months.

So, what happened?

The authors reject the possibility that this occurred because of an increase in production costs or some other shock.  Instead, they assert that the council’s intervention served to facilitate collusion rather than hamper it.

Although price transparency equips consumers with the ability to make the best choice possible for them, it also grants producers with access to the same information. In certain markets, it is difficult to ascertain the price that competitors are actually selling at. This is one of the biggest obstacles firms face in maintaining a cartel and successfully price-fixing. While each firm can agree to overcharge customers by simultaneously setting the same exorbitant price, there is an incentive for firms to actually undercut the cartel price and steal the entire market (imagine how long the queue would be at a café selling coffee at $5 a cup when all others are selling at $20 a cup).

The cartel, recognising that this incentive exists, can employ a punishment strategy for firms that cheat. Successful cartels operate over long-term horizons, so the firms involved make frequent pricing decisions. If the cartel notices that one firm has dropped its price, it can mandate that all firms price competitively for a certain window. The idea here is to have a policy in place so that each firm knows the profit it can make by cheating on the collusive agreement will be lower than the money it will lose while the cartel dishes out its punishment. For this threat to be credible, however, the cartel needs to be able to recognise when a firm has cheated by undercutting the others.

In the 1990s, this was precisely the monitoring that the Competition Council inadvertently carried out for firms in the Danish concrete market. They enabled firms to monitor each other’s prices and implicitly gave them the ability to react to cheating firms. This, in turn, removed the incentive for firms to secretly drop their price and hence prices stabilised at a significantly higher level than before. By the end of 1996, the Competition Council decided to stop publishing its quarterly price catalogue for the two grades of concrete. And so, in a world where there is no ‘undo’ button for price transparency driven by rampant technological progress and the internet, one must ask whether it is such a good thing after all.

References

Albæk, S., Møllgaard, P., & Overgaard, P. B. (1997). Government‐assisted oligopoly coordination? A concrete case. The Journal of Industrial Economics, 45(4), 429-443.