In previous blog posts, we touched upon all the possibilities online retailers have when it comes to pricing, most notably their ability to price dynamically and apply sophisticated algorithms that recognize patterns in customer data. But the fact that all prices online are available for everyone to see with a single click also means that price monitoring is much more accessible and affordable.
Initially, one will probably think that this increases the price competition further in the market as every price decrease will be undercut instantly be a price monitoring competitor. However, research suggests this is not the case -- quite the contrary, in fact.
To see why, let's think about price monitoring in terms of game theory. In the airline example below, the profit maximizing outcome is where both airlines charge a high price (yielding a total profit of £240m), however, both airlines have an incentive to charge a low price to maximize their own profit, (i.e. getting £140m rather than £120m), and so it follows that the outcome will be the suboptimal low/low that yields a total profit of £200m.
This hurts both players, which is why there is an incentive to enter collusion agreements and agree on a fixed, high price. Of course, fixing prices is prohibited by antitrust laws, but research found that online retailers enjoy similar benefits from price monitoring: that is, price monitoring increases the likelihood of obtaining a high-high outcome.
Typically, when ecommerce firms monitor each other's prices, they will indirectly peg their prices to competitors'. And so, when one decides to raise the price, the others will follow, increasing everyone's pricing power since this is in everyone's interest. A win/win outcome for all parties is obtained, not a lose/lose one as some would intuitively think.