Just as web-based stores seemed to have fully disrupted the retail industry, and pure-play online retailers (PPO) would slowly, but steadily, take over retail, Amazon, the world’s leading PPO, goes out and buys Whole Foods and its fleet of more than 400 physical stores.
As industry-leading brick-and-mortar giants watched PPOs take away their market share, they launched their own online shops to counter this movement. Soon enough, traditional brick-and-mortar retailers became omnichannel retailers, and gained some of the competitive advantages that PPOs had profited from, so far.
Of course, the newly born omnichannel retailers would soon find out that customers expected exactly that: an omnichannel experience. Rather than treating the online and offline channels as two separate entities, the omnichannel retailer was expected to treat it as one, integrated retail channel.
In this article we will look at one of the most vexing challenges that both pure-play online retailers and omnichannel retailers face: setting prices that are aligned with willingness to pay. In particular, we look at how willingness to pay differs between PPO and Omnichannel’s online stores.
Willingness to Pay for Pure-Play Online Retailers
PPOs have one main advantage: their overhead costs are very low. This allows them to set very low prices, and still maintain an acceptable profit margin. However, PPOs have a very hard time differentiating themselves from each other as the shopping experience is very homogenous, and research suggests that the PPO market is characterized by perfect competition, where prices for similar products are very low and approach the law of one price, where profits are negligible. Moreover, as customers cannot view, assess and compare the product optimally online, the perceived risk of making a purchase is generally much higher for this retail channel.
Consequently, willingness to pay for products at PPOs is very low in general.
Willingness to Pay for Omnichannel Retailers
Omnichannel retailers have some of the same advantages for their online stores, in terms of low overhead costs, but at the same time, they can accompany this with their in-shop experience. For one thing, this means that omnichannel retailers can create a much more differentiated shopping experience prior to the purchase, with personalized service, and with in-store product showings, the perceived risk of making a purchase is much lower.
Many customers will check out a product in-store before purchasing it online to reduce their risk, and reduce their costs at the same time. Therefore, omnichannel retailers must also maintain parity between offline and online prices, however, the willingness to pay for omnichannel retailers’ online store products is also higher than PPOs, primarily due to the much lower perceived risk of making a purchase as products can be viewed and compared prior to the purchase.
Determinants of the Magnitude of the Differences
We know from studies and experience that there is, indeed, a higher willingness to pay for online store products when this store belongs to an omnichannel retailer rather than a pure-play online retailer. However, the magnitude of this difference is based on a variety of factors, hereunder product type and product life.
Product type matters since it affects how difficult it is to accurately compare the goods. Some goods are incredibly easy to compare, and thus the perceived risk of purchase is not significantly lower at an omnichannel retailer. In particular, the distinction is made between functional and expressive goods.
Functional goods are essential, utilitarian goods that enable the owner to achieve a goal or complete a practical task. These goods are, in general, distinguished by product characteristics which can be evaluated prior to purchase. Such goods can quite easily be compared online, and customers don’t require the viewing facilities that offline stores provide. Thus, the difference in willingness to pay for functional goods is typically much smaller.
Examples of functional goods include kitchen items and home appliances.
On the other hand, we have expressive goods. Expressive goods are much more likely to be evaluated in terms of sensory attributes and symbolic features, which are much more difficult to compare: and hence, there tends to be a wide gap between willingness to pay for such goods, PPO v Omnichannel. For such goods, price signalling becomes very important: while PPOs may be tempted to set low prices due to the market conditions, it may be beneficial for them to resist such temptation, as the only quality indicator customers have to go on with such goods is the price.
Examples of expressive goods include furniture and colognes.
Product life matters, since for goods which are expected to last long, i.e. electronics, white goods, and furniture, the quality and ‘performance’ of such goods is more crucial. In terms of product life, we distinguish between durable and non-durable goods, durable goods being characterized as lasting longer than 3 years, while non-durables last less than 3 years.
Since quality and performance is important for durables, the difference between willingness to pay for PPO and omnichannel is greater for durable goods, while for non-durable goods the willingness to pay is more insignificant. The perceived risk of purchasing a non-durable good is generally not as great. Examples of durable goods include carpets and drapery.
Both PPOs and omnichannel retailers should consider both product life and product type when setting prices for goods. The willingness to pay for expressive, durable goods is much higher for omnichannel retailers, while the difference is not as significant for functional, non-durable goods.
That being said, willingness to pay research is still advised as it can be hard to compute and characterize whether goods are functional or expressive, durable or non-durable.