Price Adjustments for Multi-component Systems sold Online:
Rational Inattention and Implications for Firm Performance
Sourav Ray*
McMaster University
sray@mcmaster.ca
Charles Wood
University of Notre Dame
cwood1@nd.edu
Paul Messinger
University of Alberta
paulm@ualberta.ca
May 2006
Abstract
In this paper, we investigate the price adjustment patterns of online firms selling
multi-component systems. We explain the variation in price rigidity by adopting a
marketing perspective, where consumers may be inattentive to small price changes.
However, this inattention is neither absolute nor random. Rather, we suggest that there is
a rational basis behind it. Consumer inattention varies with the nature of the product –
some products requiring processing of systems level prices, others requiring processing
more of component level prices. Parenthetically, firms in such markets also adopt either a
systems or a component orientation in their marketing strategies – a decision that is a
matter of degree and often driven by pragmatic considerations of inventory and
procurement costs. The main upshot of the rational inattention perspective then suggests
that because under certain circumstances, rational consumers ignore small changes in
price, – firms will see no demand effect for those same small prices changes. Given a
marketing strategy orientation, optimal price adjustment patterns by firms should
therefore take into account the differing consumer behaviors. While, in the aggregate,
* Contact Author
2nd Annual Statistical Challenges in Electronic Commerce Research Symposium, Carlson School
of Management, University of Minnesota, Minneapolis, MN; May 22-23, 2006
price adjustments are expected to exhibit optimal patterns; at the firm level, those who do
not exhibit such optimal behavior are expected to perform worse than firms that do.
To test the above perspective, we analyze two systems markets – cameras and
computers, in an online selling context. We examine daily prices for 1,212 different highend cameras and computers from 185 different vendors online and combine the results
with available online firm performance data collated from thousands of user feedback.
The empirical analysis finds support for the above perspective.
There are two significant implications of this research. The first is as an
application of the rational inattention perspective in systems markets. The theory of
rational inattention continues to provoke both researchers and practitioners. While both
theoretical models and lay industry accounts of rational inattention are not hard to find,
empirical research on the domain is scarce. Therefore, it is hoped this research will build
on our current understanding of rational inattention and its applications.
The second implication is around our interpretation of price adjustment patterns
of online firms. Price adjustment for online firms are often argued to be simpler because
they do not require the myriad activities associated with changing prices in a bricks and
mortar retail store. This is offered as a reason why online prices can be much less rigid
than offline ones. Yet, the new-Keynesian perspectives would argue that the physical
costs of changing prices are only a small fraction of the total adjustment cost – the
majority being the costs associated with the managerial time and effort required to decide
and implement a price change in a firm’s product lines. The complexity of such decisions
is exacerbated when multi-component systems are involved, requiring consideration of
both components as well as systems prices. In an Internet context, the ability of
competing firms to instantly change prices presumably also adds to the complexity of the
decision. Therefore, the presumed flexibility of online prices cannot be absolute and any
explanation of the differing patterns of price rigidity must take into account the
managerially relevant factors that guide the logic of price change strategies.
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