IKEA Index, Internet Price Discrimination
The Times‘s World Business section is a marvel of design: filled with some of the cruft that makes the regular Business section just a bit bulkier, it can be tossed in the trash without more than a glance through the headlines. Every six months or so, there might be a sufficiently interesting article in it worth reading. (I’m not being willfully ignorant of international business; I read the Economist for that. It’s that the NYT World Business section is particularly uninteresting.)
Today was the day of the semi-annual interesting article: it’s about an IKEA index, similar to the Economist’s Big Mac index. Instead of comparing the prices of McDonald’s burgers across the world, the IKEA index compares a basket of identical IKEA furniture across European and North American markets. It shows that the EU single market isn’t quite as of yet, as there are not insignificant price differences across countries, even those countries on the Euro. There is progress towards market integration in terms of prices and volume, but less than expected.
Over the long term, prices should converge for tradeable goods across countries. The Big Mac index indicates current price differences between relatively identical goods, which indicates whether a country’s currency is overvalued or undervalued. It may be a fanciful notion, judging exchange rates in terms of burgers, but it’s not the worst idea in the world, and it captures fundamental economic ideas about purchasing power parity in a handy index. The IKEA index perhaps does the Big Mac index one better, at least in the countries in which IKEA has a presence. IKEA furniture is centrally produced from the same factories, is of identical design, and presumably can be put into a box and shipped elsewhere. The Big Mac is generally produced from local agriculture and must generally be eaten locally, though it tends to be centerally designed with minor tweaks for local tastes. In terms of approaching the ideal of a trade good, IKEA furniture is therefore a better example.
The results of the IKEA index is that the same basket of furniture costs 17% more in Finland than in the Netherlands, both Euro countries. Shipment costs from IKEA factories clearly don’t account for the difference; presuming the factories are in Sweden, Finland would seem closer, and in any case international freight costs are relatively minor. Also, Belgians pay 33% more for Billy bookcases than Germans, even though there’s a German IKEA store just across the border. The US had the least costly basket of IKEA goods.
The explanation for these differences is that local market conditions — tax regimes, local competition and labor markets — are still relatively strong, and that IKEA is able to price discriminate between these local markets. An example given in the article is that IKEA competes against small, high-end furniture stores in Italy and is able to charge more than in the US, where IKEA has to compete against Wal-Mart. It’s unclear to me, though, why the German IKEA store would have such a large difference compared to the Belgian one for some items. With open borders, people should be able to travel to the cheaper store, much as New Yorker’s schlepp over to Elizabeth, NJ. Presumably, the Belgian store is sufficiently far away from the German store.
An interesting note is that the economist who compiled the IKEA index was able to do so once IKEA put it’s catalog — with prices — online. Before this, it was too difficult to gather up all the current IKEA catalogs for a trivial research subject. The Internet is having the effect of making economics research less costly.
There is an interesting paper on price discrimination increasing because of the Internet. One summary is over at TechDirt. Internet price discrimination is suprising because services like Froogle or PriceWatch should flatten prices between retailers; consumers have so much more information about what the other guy is charging. It turns out that price discrimination is possible because of eroded privacy. With personal information more readily available (both from purchasing information from third parties or collecting it directly), Internet retailers can tailor offers very precisely, giving discounts on goods to attract the marginal consumers.
Price discrimination is not a bad thing in itself. It increases overall consumer utility by providing marginal consumers with a price point they can live with. Producers like it, too, since they, of course, capture more profits, both by selling more to the marginal consumer and by selling at a higher price to other consumers. Increased production may also lower overall prices, assuming lower bulk production costs. It’s the other consumers who hate price discrimination, since they feel gypped that other people are buying for less. A few years ago, Amazon experimented with price discrimination based on personal buying habits, but had to back down because of the backlash.
Amazon’s mistake, as implied by the paper, is that the prices of its goods are easily compared by different consumers, who then got into an uproar. This sort of effect would be predicted by the readily available price information on the Internet. Price discrimination therefore requires stealth, mainly by bundling goods together so that price differences are harder to spot. Price discrimination can also proceed on non-tradeable goods, since there’s no arbitrage opportunity. For example, airline tickets have a great deal of price discrimination between when you buy the tickets, when you intend to fly, frequent flyer clubs, and so on. This is because your name is on the ticket, and it can’t be traded to someone else.
IKEA’s online catalog does some of this by having country-specific versions of their web site and by refusing the ship goods to countries not specific to that site. The trivial personal information of which country you live in is sufficient for this bit of price discrimination, since a secondary market for IKEA furniture is limited: shipping costs for consumers are relatively high.
Note that price discrimination because of personal information happens off-line, too. Really, when you use that club card at Duane Reade, you’re trading information on your buying habits for discounts on goods. For many people, this is a worthwhile trade, or at least a necessary trade for belonging to a modern society.