How the Internet Lowers Prices: Evidence from Matched Survey and Auto Transaction Data

There is convincing evidence that the Internet has lowered the prices paid by some consumers in
established industries, for example, term life insurance and car retailing. However, current research
does not reveal much about how using the Internet lowers prices. This paper answers this question
for the auto retailing industry. We use direct measures of search behavior and consumer
characteristics to investigate how the Internet affects negotiated prices. We show that the Internet
lowers prices for two distinct reasons. First, the Internet helps consumers learn the invoice price of
dealers. Second, the referral process of online buying services, a novel institution made possible by
the Internet, also helps consumers obtain lower prices. The combined information and referral price
effects are -1.5%, corresponding to 22% of dealers' average gross profit margin per vehicle. We also
find that buyers with a high disutility of bargaining benefit from information on the specific car they
eventually purchased while buyers who like the bargaining process do not. The results suggest that
the decisions consumers make to use the Internet to gather information and to use the negotiating
clout of an online buying service have a real effect on the prices paid by these consumers.