NCPA - National Center for Policy Analysis

Free Riding Over The Internet

July 3, 2001

Retailers have always had a free rider problem. The Internet has worsened the problem, say economists, by allowing customers to try a product in a traditional bricks-and-mortar store and then purchase it online at a sizable discount.

In a recent paper, researchers who analyzed the free riding problem looked at three products: 1,100 perfumes, 34 brands of DVD players and five kinds of refrigerators. All three of these goods are highly reliant on sales support and have great potential for free riding. Additionally, they are projected to account for 5 percent of category retail sales by 2003, according to the Forrester Research Group.

The researchers found certain factors affect the severity of free riding:

  • Manufacturers who rely on exclusive distribution can target customers so as not to antagonize distributors by selling only to those areas outside of a retailers' area or by charging higher prices than off line.
  • Newer goods are more prone to free riding since there is less second hand knowledge available about the product from other users compared to older goods.
  • Free riding is less of a problem, the greater the concentration and dominance of a store in the industry; for example, BestBuy does not mind if someone tries out a product in their store and then purchases it online at BestBuy.com. Check Out : Best Buy Flyer

Researchers also analyzed the theory that bricks-and-mortar businesses could free ride from online Web sites. They found that while retail companies could profit from customers finding information online, the cost of providing that information online is basically nil and thus does not affect the price of the online product. In contrast, the cost of providing face-to-face service is substantial and does affect the price of products. Thus, the free rider effect affects retail stores much more adversely than online stores.

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.

For NBER text

http://papers.nber.org/papers/W8067

 

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