NCPA - National Center for Policy Analysis

Manufacturers, Retailers Face Online Free Riding Problem

July 9, 2001

Online retailers pose a threat to traditional retail stores that who provide customer service. Online retailers free ride off of the customer service because customers try out products in a bricks-and-mortar store and then purchase them online. A recent study analyzes manufacturer's attempts to control free riding.

Manufacturers appear to limit free riding by controlling two aspects of sales, namely product pricing and availability. For example, the study found that manufacturers strictly controlled perfumes:

  • Perfumes are offered to select stores and only the manufacturer sells them online -- as much as 21 percent of perfumes are available exclusively on manufacturers' Web sites, in addition to exclusive retailers with physical stores.
  • Nearly 19 percent of perfumes not sold online by the manufacturer are sold by select department stores.

In contrast:

  • Nearly all online Web sites have DVD players, but manufacturers will honor warranties only from authorized sites.
  • The limitation on warranties allows the manufacturers and authorized retailers to charge more -- as much as 22 and 11 percent, respectively -- as unauthorized dealers.

Refrigerators are unavailable online because of two primary reasons: the inability to ship across far distances and because of the free rider problem. Refrigerators are simply too cumbersome to allow for easy shipping and online availability. Additionally, appliances are extremely susceptible to the free riding problem:

  • Most people inspect such appliances first hand and then purchase them.
  • This puts bricks and mortar businesses at a large disadvantage so manufacturers tightly control their availability online.

The authors conclude that free riding problems will continue to affect online sales strategies.

Source: "Dealing With Free Riding on the Internet," Economic Intuition, Winter 2001; based on Dennis W. Carlton and Judith A. Chevalier, "Free Riding and Sales Strategies for the Internet," National Bureau of Economic Research, Working Paper No. w8067, January 2001.

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