Think about the value proposition of a Walmart superstore. Most everything a customer needs is in the store and easy to find. Yes, Walmart is cheap. But it also eliminates the need for consumers to search for things. In contrast, an employer finding a full-time employee takes work. It takes time, effort and usually money to both find and evaluate candidates. Plus, there is then the negotiation process. Recruiting and job searching have big searching costs. Walmart doesn’t.
Searching costs are everywhere in business. We see them all the time. And there are some really interesting dynamics happening as things go more digital and data driven. The question for this article is: when do searching costs become a competitive advantage?
First, some theory.
Some Basic Theory About Searching Costs
In terms of theory, searching costs are generally considered part of transaction and coordination costs, which I have mentioned previously for platform business models. Platform business models are about lowering transaction and coordination costs and enabling interactions to happen. That includes aggregating supply and demand, providing lots of information and making matching easy. Searching costs are one of the big pain points that platforms target.
For marketplace platforms, both buyers and sellers have a “marginal cost of searching”. That term is important. It means a rational buyer or seller in a marketplace will continue to search until the marginal searching cost exceeds the marginal benefit of additional searching. Basically, they will keep searching until it is not longer worth it. Marginal searching costs can include:
- The costs of acquiring the needed information.
- The opportunity cost of the time used for searching.
- The effort required for searching, sorting the information, and integrating it with what is already known.
In theory, there is an optimal amount of information and effort required for most searches on a marketplace (or other platform business model). However, it turns out searching costs depend heavily on the intelligence, prior knowledge, education, and training of the searcher. Over time, companies get better at what they are searching for.
So what is happening to search in the digital world?
It’s pretty interesting. And more complicated than you might think.
- In theory, the vast information of the internet should lower searching costs. But it turns out the volume and quality of information is a problem. You go from having too little information to too much. And to not knowing what information to trust. The role of search engines and rankings becomes much more important.
- Searching costs also depend on the device being used. Marginal searching costs are lower on a personal computer and people look at more options before deciding. But smartphones have smaller screens and the marginal searching costs are actually higher. People search less before deciding.
Searching costs in a digital world usually become a discussion about marketplaces and other platform business models. And then it immediately becomes a discussion about search engines, filters and rankings. It’s really a discussion about organizing the world’s information, which is a big subject.
Fortunately, I am only looking at searching costs as a form of customer capture. I’m only looking at when it becomes a revenue or demand-side competitive advantage for a business. This is, thankfully, a much simpler subject.
CA3: Searching Costs as a Competitive Advantage
Lots of traditional businesses have long benefited from situations where there was a “searching cost”. Where customers had to spend time, effort and money to to find additional, acceptable suppliers. When the marginal searching costs were significant, customers go with the product they had available. They just stuck with what they knew or was easy to find. And businesses charged them a price premium, which shows up in the gross profits of the company. Searching costs can create a demand-side competitive advantage. It’s a form of customer capture. And it is on my list as CA3.
Here’s an example.
Tourists traveling to unfamiliar locations have traditionally stayed at branded hotels, such as Motel 6 and Holiday Inn. Or they stay at local hotels downtown or in convenient locations. But they generally wouldn’t stay in distant hotels. And they wouldn’t stay in people’s houses. Not because these lodgings were better. But because there was a searching cost to finding and evaluating lodgings, especially in an unfamiliar city or different country. Location and/or brand were the solution to this searching problem. In fact, a lot of what analysts consider to be “brand equity” is just a solution to a lack of information and significant searching costs. Let’s stop walking around with our suitcases looking at hotels. Just go to the Holiday Inn.
Businesses have used brand, location and other mechanisms to benefit from situations with limited information and high marginal searching costs. This is sometimes referred to as asymmetric information. And this situation is common for products and services that are:
- Perceived as critical
- Customized or rare
The standard examples for searching costs are for “complicated products or services”, where quality is important but more difficult to assess. This is when you are trying to find a doctor, lawyer, accountant, or management consultant. Or a full-time job or employee. Basically, think about situations where you usually call someone you trust to get a recommendation. As opposed to hunting online or looking at ads.
The marginal searching costs are even higher when the product or service is “perceived as critical”, such as when choosing the right radiation oncology doctor. Nobody shops around or negotiates price with their heart surgeon. You go with the name recommended or trusted. A less extreme version of this is when consumers buy contraceptives or milk powder. There is heightened level of concern. In this case, critical purchases sound a lot like switching costs. And many consider searching costs a sub-type of switching costs.
A final situation is when the product or service is “customized or rare”. By definition, this is a situation where the marginal searching costs are higher because there just aren’t that many options. Consumers hunting for rare products, such vintage bank notes or collectibles, find the searching costs to be much higher. As well as the prices. If you have customized a product or service, it eliminates most suppliers. Businesses who customize their software quickly realize they have dramatically limited the number of service providers they can go to for problems and upgrades.
How Digital is Disrupting Searching Costs
Searching costs as a type of customer capture are under assault by virtually everyone in digital. There is just more and more data. Marketplaces are getting better and more sophisticated. Filters and matching are getting more accurate. Overall, searching for products and services is getting smarter and easier. Just check out the reviews section of any online marketplace, including for doctors and accountants. They aren’t awesome but they are a lot better than ten years ago.
And this has been devastating for many brands that have long relied on searching costs. My favorite example of this is branded backpacks.
A couple of years ago, I needed a new backpack, specifically one good enough to carry my laptop and other electronics on business trips. So, I went on Amazon and started searching. Lots of branded backpacks with Swiss names and images of Switzerland popped up. And they all seemed to have stories about how they were founded in the 1800’s and used by famous mountaineers or rangers. Prices were between $80 and $200.
This really got my attention. These businesses were clearly focused on telling a brand story that was associated with quality. Hence, the push to show they had been making backpacks for decades. And in the Swiss alps and used by mountaineers. Because backpack purchases are infrequent. Nobody really knows any backpack brands. And nobody really knows what to look for in terms of quality vs. price. It wasn’t a critical purchase but there was still a big information gap and searching problem. And these companies were using their brand story as a solution to this.
But also in my quick search online, the “Amazon Basics” backpack also popped up. Right next to these branded backpacks for $80-200. And the Amazon basics backpack was $21.
Well, it must be no good. Why would it be that cheap?
But the Amazon Basics backpack had +2,000 reviews. And they were all 4-5 stars. I read through about ten reviews, all of which said the backpack is great. No problem. It’s a well-made backpack, perfect for laptops. So, I bought the Amazon one. And it’s been totally fine. Not a single problem.
Using its marketplace and reviews, Amazon has effectively wiped out the searching costs that these traditional backpack companies had been relying upon. These companies had been using their brand story as a solution to the information gap. And they were charging an extra $100 per backpack for this. Amazon wiped out the information asymmetry and the searching costs. The “brand story” was no longer necessary. Their “brand equity” no longer had value.
So many consumer brands, especially in consumer staples, have been based on a combination of legacy branding, economies of scale in marketing and some degree of power in shelf space. But as the searching costs and information asymmetries fall, their brand power is revealing itself to be exceptionally shallow.
It gets better.
There are actually two important things happening to search costs in digital.
- The first is that increasing data is wiping out information asymmetries. And this is devastating for companies that were based on solving this information gap with their brands. A known, trusted or reasonable brand was how you overcame an information gap for consumers. Now data does this.
- The second is the increasing importance of search and rankings in a world of endless choices in virtually every category. The problem went from too little information to too much. Customers increasingly need search engines, newsfeeds, rankings and curation to sift through their endless choices. For search, this is about which results show up at the top. For feeds, this can be about which post or item shows up next automatically. The most common solution to the endless supply problem right now is to provide “search plus feed”.
It’s a fascinating juxtaposition. We can see the falling power of brands and searching costs – but also the rising power of search engines, newsfeeds, and curation.
But if you think about it, we have always seen these two forces at work. Go back to my initial Walmart example. What is Walmart doing with their superstores? They are jamming tons of products into one gigantic room. But they also place the products very carefully on shelves, optimally placed to get attention with brightly colored packaging as people walk by. Location matters. Then consumers then entire this strange world and wander around both looking aimlessly and trying to fill their shopping lists.
Think about how you buy a consumer staple like ketchup.
- You go to the supermarket or superstore for your weekly purchases. You go down the aisles, while also looking at your shopping list. That is you doing an active search. Just like on Google.
- When you get to the ketchup section, you see, at eye level, the bright red packaging of Heinz ketchup, which you are familiar with. The options on the shelf are the search results being returned. Those at eye level are the top ranked search results. And as you have been seeing and buying Heinz your whole life, you throw it in the cart and move on. It’s just a staple.
- As you go searching for the next item, you pass the candy aisle. That is the newsfeed. Things are being shown to you automatically as you move around the store. Stores are incredibly effective at inducing secondary purchases once they have you inside.
So, you can see both forces in a traditional store. You can see traditional role of brands and searching costs – but also the role of the store as a search engine, newsfeed, and curator. It’s basically a physical version of a search engine plus news feed.
But event this is changing.
- You are now at home looking at your smartphone. Or you are walking in a supermarket looking at both the shelves and at your smartphone at the same time.
- On your phone, you search for ketchup and get multiple results, including the bright red Heinz packaging you are familiar with. But now other brands and their details also pop up. You notice that the top 3 recommended types of ketchup all have 5-star reviews by thousands of people (just like backpacks). And they’re 30% cheaper than Heinz.
- So, you buy it on your phone or just throw it in your cart. It’s just a staple.
The legacy branding that Heinz (and many other CPG staples) has been building for decades is under assault. By superstores. By digital marketplaces. By more information. By more supplies. Because it turns out, it’s just ketchup. You’re never going to get much share of the consumer mind with ketchup. You’re not going to get a lot of consumer engagement. The brand value of ketchup does not translate to customer capture in a data rich world with endless options and falling searching costs.
So we see an interesting picture for searching costs as a competitive advantage. The power of searching costs (and many brands) is falling as the power of search, newsfeed and curation are growing. This situation is now happening in both the physical and online worlds. It’s worth keeping an eye on searching costs as an advantage. Things are changing quickly.
That’s it for today. Cheers, jeff
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From the Concept Library, concepts for this article are:
- Competitive Advantage: Tech and IP Cost and Supply Advantages
From the Company Library, companies for this article are:
I write, speak and consult about how to win (and not lose) in digital strategy and transformation.
I am the founder of TechMoat Consulting, a boutique consulting firm that helps retailers, brands, and technology companies exploit digital change to grow faster, innovate better and build digital moats. Get in touch here.
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