A decade of change for the U.S. auto industry: the internet, promotions, and rising gasoline prices.

• Author: Zettelmeyer, Florian

During the last decade the U.S. automotive industry has been affected by a series of major changes. First, automotive retailing, which had been firmly controlled by franchised automotive dealers, started to feel the effect of the Internet in the late 1990s. Although state franchise laws require all new cars to be sold by dealers, the Internet has become a major source of information about car characteristics and pricing.

Second, the 9/11 terrorist attacks changed the way that automotive firms compete in the United States. Eight days after 9/11, GM started an incentive promotion with the name "Keep America Rolling" which offered zero percent financing on all GM vehicles for up to five years. While manufacturers had used financing or price incentives before, "Keep America Rolling" is thought to have started a substantial escalation of average incentive amounts. (1)

Third, the dramatic increase in gasoline prices from below $1 in early 1999 to $4 at their peak in 2008 made it much more expensive for consumers to operate an automobile. This has affected manufacturers differentially, depending on the fuel efficiency of the cars they sell. In a series of research papers, my co-authors and I have investigated the consequences for the industry of these changes.

The Effect of the Internet on the Auto Retailing Industry

Even though consumers remain interested in physically inspecting a car, the Internet has become a very important complement to the car-buying process. As early as the year 2000, 54 percent of all new vehicle buyers used the Internet in conjunction with buying a car. My work with co-authors Fiona Scott Morton and Jorge Silva Risso looks at whether and how the widespread use of the Internet by consumers has affected auto retailing.

We first investigate the effect of Internet car referral services (Autobytel. com, Autoweb.com, Carpoint.com, and the like) on dealer pricing of automobiles in the United States in 1999. (2) Combining transaction data with data from a leading online auto referral service, we compare online transaction prices to regular "street" prices. We find that Internet prices, controlling for the car purchased, on average were 1-2 percent lower than those paid by conventional consumers. In addition, we find that dealer average gross margin on an online vehicle sale was lower than an equivalent offline sale. However, these findings do not imply that the Internet is shifting rents from car retailers to consumers. If online car buyers would also have negotiated low prices in the offline world, then the Internet merely provides an alternative channel for a consumer-dealer interaction.

To determine whether the Internet has a causal effect on car prices, we use instrumental variables to control for selection. We find that traditional buyers pay 2.2 percent more than Internet buyers) This is consistent with consumers choosing to use the Internet because they know that they would pay more in the traditional channel, perhaps because they strongly dislike collecting information and bargaining in the traditional way.

This finding raises the question of the Internet's effect on groups of consumers who have traditionally been considered disadvantaged in the car buying process. In a follow-on paper, we analyze whether the Internet's dual role of reducing a dealer's ability to accurately assess a consumer's willingness to pay and increasing consumers' ease in...