Price Dispersion and Loss‐Leader Pricing: Evidence from the Online Book Industry

In this paper, we develop a theoretical model to analyze the pricing strategies of competing retailers with asymmetric cross‐selling capabilities when product demand changes. Our results suggest that retailers with better opportunities for cross‐selling have higher incentives to adopt loss‐leader pricing on high‐demand products than retailers with low cross‐selling capabilities. As a result, price dispersion of a product across retailers rises when its demand increases. The predictions of our model are consistent with the empirical evidence from the online book retailing industry. Using product breadth as a proxy for cross‐selling capability, we find that retailers with high cross‐selling capabilities reduce prices on best sellers more aggressively than retailers with low cross‐selling capabilities. As a result, price dispersion increases when a book makes it to the best‐seller list, and the increase is mainly driven by the difference in pricing behavior between retailers with different cross‐selling capabilities. Our empirical results are robust against a number of alternative explanations.This paper was accepted by Sandra Slaughter, information systems.