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 bestsellers more aggressively than retailers with low cross-selling capabilities. As a result, price dispersion increases when a book makes to the bestseller 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.