Why your bestseller is cheaper at Amazon: Game Theory and Evidence

Remember when the American Booksellers Association accused Amazon.com, Wal-Mart, and Target of predatory pricing? These retailers sold ten hardcover new releases, including best sellers by James Patterson, John Grisham, and Stephen King, for less than $9, half of their own cost and a third of the usual retail price¹. However, The Wall Street Journal Law Blog commented that retailers setting prices below costs was not a sign of predatory pricing but rather an indicator of healthy price competition². Such loss leader strategy draws in customers who might purchase other titles or merchandise.

But is such practice fair competition? It depends on the size of the competing retailers, as we show in our new paper forthcoming in the Journal of Interactive Marketing³. Previous game theory models saw no issue with losing money on a traffic generator that allows the retailer to cross sell other products with high margins. However, this assumes that retailers have similar size and thus ability to cross sell. Instead, we model the more realistic scenario of retailers differing in size, and also allow the best-selling item to be explicitly searched for by some consumers (what we call ‘conversion’) and to be included in the basket by other consumers, who were looking for something else (what we call ‘inclusion’). The common wisdom that loss leader pricing leads to neither a significant increase in store traffic nor an increase in profits does not apply in an asymmetric case.

Because they offer products in many categories and subcategories, mass merchandisers such as Amazon.com and WalMart achieve average basket sizes larger than other sellers. Their larger potential profit margin, due to their larger average basket sizes, motivates and allows them to offer deeper discounts on the most anticipated best sellers. Although smaller retailers can offer similarly deep discounts, they can do so only less frequently or on fewer items because they has less to gain in a cross-selling conversion of a smaller basket. This cross-selling advantage increases the large retailer’s profits.

Beyond our model, we analyze data from Amazon and 18 other online retailers to show support for our theory’s predictions that better selling books are more often and deeper discounted than weaker selling books and that larger retailers do more of this discounting. Did you experience the same? And do you believe this is fair or not?

¹  Tagle, Stephen (2009) http://therumpus.net/2009/11/aba-challenges-big-box-predatory-pricing/

² Jones, Ashby (2009), “Are Amazon, Wal-Mart, and Target Pricing Like Predators? Wall Street Journal Online, (October 23), [available at http://blogs.wsj.com/law/2009/10/23].

³ Kocas, Cenk, Koen Pauwels and Jonathan Bohlmann (2018), “Pricing Best Sellers and Traffic Generators: The Case of Asymmetric Cross Selling”, Journal of Interactive Marketing, February, http://www.sciencedirect.com/science/article/pii/S109499681730052X