- Huge online retailers are changing how inflation behaves, by making retail prices less resistant to external economic shocks.
- A study from Harvard Business School shows that retailers such as Amazon and Walmart change prices more frequently and across larger areas.
- Algorithm-driven technology allows them to immediately adjust prices in response to external shocks, such as a rise in oil prices.
The rise of online retail has changed how inflation behaves, according to a study from Harvard Business School.
HBS associate professor Alberto Cavallo says retail prices are now less resistant to changes in other markets.
Instead, they are more closely tied to external one-off shocks such as a change in oil prices and currency fluctuations.
Cavallo noted that much of the discussion around retail inflation has focused the competitive threat from online retailers, which acts to keep price inflation low.
In a speech last week, RBA deputy governor Guy Debelle noted retail prices in Australia have actually declined since 2015.
He added that the level of competition in the sector adds an element of uncertainty to the central bank’s inflation outlook.
For his part, Cavallo noted that price competition could be a factor contributing to low price inflation. However, “the lack of firm-level costs and price information makes it empirically hard to distinguish from other forces,” he said.
Instead, his research focused on how online retailers such as Amazon use technology and scale to change their pricing behaviour. To do that, Cavallo highlighted the following two trends:
1. High price flexibility; and
2. The implementation of uniform prices across large geographical areas.
“Changes in the way these pricing decisions are made can have a much more persistent effect on inflation dynamics than a one-time reduction in markups,” he said.
What Cavallo found is that huge retailers such as Amazon and Walmart use algorithm-driven technology to automatically shift prices based on various external factors.
The number of price changes has steadily increased over the last 10 years, particularly for products that have heavy online demand such as electronics and household goods.
“These results are consistent with intense online competition, characterised by the use of algorithmic or “dynamic” pricing strategies and the constant monitoring of competitor’s prices,” Cavallo said.
He then looked at price-points for identical goods across different locations, and found that online strategies had very little price discrepancy across different geographical areas.
What it reveals is that the rise of online retail has added an element of transparency, which “imposes a constraint on brick-and-mortar retailers’ ability to price discriminate across locations”.
The net effect is that the big online players — in response to changes elsewhere in the economy — are able to a) use their database to tweak prices more frequently, and b) apply those changes across bigger shares of the market.
So if the cost of oil rises by X which increases shipment costs by Y, an online giant such as Amazon can immediately shift its pricing accordingly.
“For monetary policy and those interested in inflation dynamics, the implication is that retail prices are becoming less ‘insulated’ from these common nationwide shocks,” Cavallo said.
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