IntroductionTheory of Search and ObfuscationIncomplete Consumer SearchAdd-Ons and Adverse SelectionThe Pricewatch Universe and Memory ModulesObservations of ObfuscationDataDemand PatternsMethodology for Demand EstimationBasic Results on DemandThe Mechanics of Obfuscation: Incomplete Consumer SearchThe Mechanics of Obfuscation: Add-Ons and Adverse SelectionInstrumental Variables EstimatesMarkupsConclusionReferencesAuthor's AddressesEconometrica, Vol. 77, No. 2 (March, 2009), 427–452SEARCH, OBFUSCATION, AND PRICE ELASTICITIESON THE INTERNETBY GLENN ELLISON AND SARA FISHER ELLISON1We examine the competition between a group of Internet retailers who operate in anenvironment where a price search engine plays a dominant role. We show that for someproducts in this environment, the easy price search makes demand tremendously price-sensitive. Retailers, though, engage in obfuscation—practices that frustrate consumersearch or make it less damaging to firms—resulting in much less price sensitivity onsome other products. We discuss several models of obfuscation and examine its effectson demand and markups empirically.KEYWORDS: Search, obfuscation, Internet, retail, search engines, loss leaders, add-on pricing, demand elasticities, frictionless commerce.1. INTRODUCTIONWHEN INTERNET COMMERCE first emerged, one heard a lot about the promiseof “frictionless commerce.” Search technologies would have a dramatic effectby making it easy for consumers to compare prices at online and offline mer-chants. This paper examines an environment where Internet price search playsa dominant role: small firms selling computer parts through Pricewatch.com.A primary observation is that the effect of the Internet on search frictions is notso clear-cut: advances in search technology are accompanied by investments byfirms in obfuscation.We begin with a brief discussion of some relevant theory. One way to thinkabout obfuscation is in relation to standard search-theoretic models in whichconsumers do not learn all prices in equilibrium. Obfuscation can be thoughtof as an action that raises search costs, which can lead to less consumer learn-ing and higher profits. Another way to think about obfuscation is in relationto Ellison (2005), which describes how sales of “add-ons” at high unadvertisedprices can raise equilibrium profits in a competitive price discrimination model.Designing products to require add-ons can thereby be a profit-enhancing ob-fuscation strategy even when consumers correctly infer all prices.Pricewatch is an Internet price search engine popular with savvy computer-parts shoppers. Dozens of small, low-overhead retailers attract consumers just1We would like to thank Nathan Barczi, Jeffrey Borowitz, Nada Mora, Youngjun Jang, SilkeJanuszewski, Caroline Smith, Andrew Sweeting, and Alex Wolitzky for outstanding research as-sistance. We also thank Patrick Goebel for a valuable tip on Internet data collection, Steve Ellisonfor sharing substantial industry expertise, and Drew Fudenberg, the co-editor, and three anony-mous referees for their comments. This work was supported by NSF Grants SBR-9818524, SES-0219205, and SES-0550897. The first author’s work was supported by fellowships from the Centerfor Advanced Study in the Behavioral Sciences and the Institute for Advanced Study. The sec-ond author’s work was supported by fellowships from the Hoover Institute and the Institute forAdvanced Study.© 2009 The Econometric Society DOI: 10.3982/ECTA5708428 G. ELLISON AND S. F. ELLISONby keeping Pricewatch informed of their low prices. Although atypical as a re-tail segment, Pricewatch retail has many of the features one looks for as asetting for an empirical industrial organization study: it is not too complicated,there is unusually rich data, and the extreme aspects of the environment shouldmake the mechanisms of the theory easier to examine.We present an informal evidence section describing various practices thatcan be thought of as forms of obfuscation. Some of these are as simple as mak-ing product descriptions complicated and creating multiple versions of prod-ucts. We particularly call attention to the practice of offering a low-qualityproduct at a low price to attract consumers and then trying to convince themto pay more for a superior product. We refer to this as a “loss-leader strategy”even though it sometimes differs from the classic loss-leader strategy in tworespects: it involves getting consumers to upgrade to a superior product ratherthan getting them to buy both the loss leader and a second physical good, andthe loss leader may be sold for a slight profit rather than at a loss.The majority of the paper is devoted to formal empirical analyses. Weanalyze demand and substitution patterns within four categories of com-puter memory modules. Data come from two sources. We obtained yearlonghourly price series by repeatedly conducting price searches on Pricewatch. Wematched this to sales data obtained from a single private firm that operatesseveral computer parts websites and derives most of its sales from Pricewatchreferrals.Our first empirical result is a striking confirmation that price search tech-nologies can dramatically reduce search frictions. We estimate that the firmfaces a demand elasticity of −20 or more for its lowest quality memory mod-ules!Our second main empirical result is a contribution to the empirics of lossleaders. We show that charging a low price for a low-quality product increasesour retailer’s sales of medium- and high-quality products. Intuitively, this hap-pens because one cannot ask a search engine to find “decent-quality mem-ory module sold with reasonable shipping, return, warranty, and other terms.”Hence, many consumers use Pricewatch to do what it is good at—finding web-sites that offer the lowest prices for any memory module—and then searchwithin a few of these websites to find products that better fit their preferences.Other empirical results examine how obfuscation affects profitability. We ex-amine predictions of the two obfuscation mechanisms mentioned above. In thesearch-theoretic model, obfuscation raises profits by making consumers less in-formed. In Ellison’s (2005) add-on pricing model, obfuscation raises profits bycreating an adverse-selection effect that deters price-cutting. We find evidenceof the relevance of both mechanisms.Finally, we examine an additional data source—cost data—for direct ev-idence that retailers’