Internet Car Retailing

As with financial services, the Internet is changing the way consumers buy cars. A new study published by the National Bureau of Economic Research (NBER) finds that "Buyers who use an Internet referral service save about 2 percent on their average new car purchase." Here's how a referral service works. Buyers who use an Internet referral service submit a purchase request that specifies the kind of car they want (with features) and the time frame in which they expect to make their purchase. The referral service typically has contracts with one or two care dealerships in each geographic area. They send the consumers' requests to their affiliated dealerships in the consumers' geographic area. The dealerships pay the referral service some combination of a fixed annual fee and/or fee per referral. Dealerships who have poor conversion rates (e.g., low sales per referral) or who generate numerous consumer complaints may get dropped from the referral network.

Economists Fiona Scott Morton, Florian Zettlemeyer, and Jorge Silva Risso based their analysis on a comparison of over 2 million purchase requests processed by Autobytel.com (a major online auto referral service) in 1999 with a J.D. Power and Associates sample of all new car purchases from 1,101 California car dealerships from January 1, 1999 through February 28, 2000. The authors found that customers using the referral service were less likely to finance their cars through the dealer or purchase insurance or extended warranty through the dealer. In addition, they tended to have higher average incomes. On average they paid 2% less for the car. About one quarter of this price difference was due to Autobytel franchise dealerships having lower prices, on average.

What about the other three-quarters of the savings? There are two possibilities, with very different implications for dealers. It could be that the Internet makes it easier for naïve or unsophisticated buyers to shop for the best deal. Alternatively, it may be that buyers who were always inclined to shop around have migrated to the convenience of the Internet referral services. If the first explanation is correct, the referral services could reduce dealer profits by educating the population of potential buyers. In the second case, participating dealers are no worse off than if the price-conscious customers had found them through traditional channels.

Further analysis of the data revealed that even the less sophisticated buyers were benefiting from the discounts if they purchased via the Internet. The authors conclude that the observed savings through Internet referrals derives from increased buyer information and bargaining clout. But, they note that although Internet buyers pay less for their cars, participating in the referral service can still be profitable for dealers. Based on detailed dealership data, they estimate that the cost of a traditional sale could be as much as $600 higher than the cost of selling to an Internet referral. The observed discount on the price averages $300-500. Consequently, dealers may well be better off to participate in the Internet referral network, despite receiving a lower price per sale.

The complete study is available at http://papers.nber.org/papers/W7961.