Search Costs

Reverend Clayton: You wanna quit, Ethan?
Ethan Edwards: That'll be the day.
--The Searchers

Search costs are costs incurred by buyers ahead of a purchasing decision. They largely involve identifying and assessing various alternatives related to a prospective purchase. What sellers and products do I have to choose from? What are the product features that are important to me and how do the various choices stack up? How much do the various alternatives cost? Where can I buy this product? What are the risks associated with each alternative?

Although they may be paid in monetary terms, search costs are often paid in the form of time and attention required to scope out the purchasing choices. Search costs are 'up front' costs, meaning that they are paid in advance and largely independent of the actual purchase.

The search process itself can be viewed as a risk reduction strategy. The more buyers engage in search, the lower the risk that the subsequent purchase will be a dissatisfying one.

Parenthetically, producers and sellers also face up front costs. Often referred to as 'set-up' or 'order' costs, these are the costs of getting ready for production or for selling. Equipment changeovers, finding appropriate suppliers, filling out purchase requisitions, blueprinting, fixturing, and employee training are some of the up front costs that producers might encounter.

Because people are economizers, seeking the most personal benefit from the least personal cost, buyers are naturally interested in ways to reduce search cost. Because sellers know this, advertising and other media that push product information toward consumers have been developed to lower the search burden. Advertisers are not engaging in benevolent activity for doing so, of course. They hope that they will gain an edge by providing information about their products to consumers.

The internet has also been a major search cost reducer for buyers. And arguably quite an empowering one, as consumers have much more information from various sources at their fingertips.

Buyers doing their 'due diligence ahead of purchases is an important feature of unhampered markets. When buyers carefully engage in search, subsequent purchases provide high fidelity signals to sellers about what buyers perceive as value--i.e., benefits vs cost, reward vs risk. Sellers respond to positive signals (purchases) by doing more of the same. Sellers respond to negative signals (no purchases) by doing less of the same and more of something different (improvement and innovation).

Scarce resources are therefore well economized and goods are rationed according to the needs signaled by consumer purchases.

Hampered markets often prompt consumers to engage in less search than they otherwise would. Buyers search less ahead of purchases because they view interventionary forces as substitutes for search, thereby reducing the risk that purchases will be dissatisfactory. Doing so appeals to buyers' economizing nature.

The examples are legion. If buyers are concerned about the safety of food and there is a government agency that purports to oversee food safety among producers, then buyers will be apt to engage in less search to make sure that food is appropriately safe. If government subsidizes health care purchases, then consumers will be less apt to look for low cost alternatives. If government promises to reimburse all account holders in the event of bank failure, then prospective depositors will engage in less due diligence to study the balance sheets of banks as long as a 'government insured' sign hangs in the window.

Purchase behavior in hampered markets sends a distorted signal to producers about what buyers truly value--because they have not completely 'done their homework' ahead of purchases. Moreover, hampered markets create conditions of moral hazard where buyers take on more risk (by searching less) because they perceive their purchases as insured by the government.

If the interventions are severe enough, then subsequent purchasing signals sent to producers are likely to drive a significant misallocation of resources in the production and distribution systems.

Moreover, buyers, by cutting their search processes short, are likely to take on more risk than government has the capacity to mitigate.