Consumer Surplus of Ecommerce
Consumer surplus

By Kati Suominen, Founder and CEO, Nextrade Group and Techical Director, eTrade Alliance

What would you need to get paid to give up Facebook for a month? What about Google Search? What about Whatsapp? Your answers are your consumer surplus – the difference between what you would pay if you had to pay, and what you actually pay. On a Friday morning, you may be willing to pay $20 for a cup of coffee, even if it only cost $2, making you consumer surplus $18.

 

The Internet, apps, and digital technologies have some consumer surplus associated with them that of course varies by user. Economists have sought to calculate the aggregate surplus in order to understand the true value-added of digitization to economies around the world. After all, since many platforms such as Facebook are essentially free to access, they do not show up in GDP calculations (that measure actual money people and businesses pay for goods and services) even if they are valuable for millions of people and businesses. Ecommerce marketplaces may similarly have value to their users beyond the transactions they generate and enable – for example, they help reduce consumers’ search costs by enabling consumers to easily compare prices and features of many products, and improve consumers’ access to a wider variety of products. In addition, understanding the consumer surplus of, say, the Internet, is useful for calculating the total cost of a public service like free WiFi. The provision of WiFi service has a cost, but the total value users derive from it can be significantly greater.

 

Explorations of the “bump” from digitization on economic growth are increasingly relevant for developing economies where large shares of populations are joining the online economy. What, then, do we know by now about the true value of apps, digital platforms, and marketplaces to their users?

 

In a large-scale survey-based study carried out in 2019, Erik Brynjolfsson and Avinash Collis show that the value to an average American user of Google search and other search engines is $17,530 per year, and Facebook $600 and Wikipedia $150 per year. However, the user base is a “barbell”:  some 20 percent of Facebook users would stop using the service for a year for only $1; another 20 percent would have to be paid over $1,000 to stop using it; and the median user would need to be paid $576. Altogether, the authors find that American consumers have derived $231 billion in value from Facebook since its inception in 2004. Facebook is twice as valuable for European consumers – the median consumer would need to be paid €97 to give up Facebook for a month, or about $1,280 per year. The gain from digital maps is estimated at $804 per year to Europeans, and the gain from messaging app WhatsApp $7,332 per year to any of its global users.

 

These data  may still not capture the full value of the Internet and digital services, such as in terms of the expansion in choice, convenience, knowledge, and leisure. Stephanie Lee studies the rise in consumer surplus in Korea in 2010-14, years when the share of Koreans using the Internet skyrocketed from 10 to 70 percent on the back of the proliferation of smartphones. The total value of a smartphone is $492 per year, of which $276 is from expansion (impact from consumers’ use of a smartphone for digital activities that were previously inconvenient, such as searching for information online while on a bus to go to work) and $216 from substitution (how consumers may use a smartphone for activities previously done on other devices, such as dialing a taxi from a phonebooth instead of ordering an Uber from a smartphone app). Min Jung Kim takes a similar approach, comparing the value of “free” apps, something that most apps are since they have a zero price, to apps that need to be paid for and have a cost. She finds that already in 2011, smartphones created up to $271 in annual consumer surplus, with 90 percent of the welfare gain coming from free apps.

 

Of course, the consumer has an opportunity cost to use a digital service: he or she could spend the five hours spent on reading friends’ Facebook posts on some other activity, perhaps working on a well-paying project, in which case the opportunity costs of Facebook could be very high. Worse, perhaps surfing the Internet gets addictive and damages a person’s social life. In a 2005 study, Austan Goolsbee and Peter Klenow ask, how much of your free time do you spend on a digital product and what value (or “utility”) do you derive from it? They take into the account the cost of a residential Internet connection, the time consumers spend online, and the opportunity cost of their time, finding that the value of the Internet is $2,500-$3,800 for the median American. Granted, this number is probably much higher today given that the value of the Internet has risen with users and information. In addition, the average person uses the Internet more and spends more time online today than at the time of the study when the average user spent only 7.7 hours online per week and consumer spending online was only 0.2 percent of all consumer spending – when it is now approaching 20 percent in the United States.

 

The value of digital services is not only relevant for understanding the economic impacts of the Internet and apps; it also matters for gauging the value of a digital public service versus its costs, such as a free public WiFi or a national digital identity. For example, Stephanie Lee backs form data on smartphone use to the overall value of free Wi-Fi in Seoul’s transportation system, finding that the service is worth $117 million per year to the city’s residents, significantly above the total cost the city governments incurs providing the service.

 

What then is the consumer surplus of ecommerce? An important value of ecommerce is that it increases the variety of products and services available to consumers. Expansion of product variety has long been shown to increase consumer welfare. Gains from variety can be very significant: over 15 years ago, when Amazon was starting to sell books online, a group of scholars found that Americans’ welfare increased 7-10 times when they bought books online versus in bookstores, mostly because they could access a wider variety of books online.

 

In a recent study conducted on Visa’s payment network, ecommerce was found to be worth $1,100 annually to an average American household. The estimate is equivalent to a 1.1 percent permanent boost in consumption. Most gains stemmed from substitution from brick-and-mortar offline sellers to online sellers (gain from variety), and some from reduced travel time to offline sellers (gain from convenience). The gains were proportionately greater with higher income segments and in densely populated American counties.

 

Such gains from variety and convenience have also been spotted in the Chinese countryside where consumers have traditionally had access to significantly fewer product varieties than are available to their urban peers. More than 60 percent of goods available in urban areas are not typically available in rural areas. However, ecommerce has enabled rural netizens to access a similar basket of products as available to their urban peers. Ecommerce has also significantly reduced the travel times for rural Chinese, who unlike their big city peers do not have for example great electronics or household appliance stores right around the block. Indeed, the gains from variety are greatest in durable products and electronics. By buying more in general and more online in particular, rural Chinese are in essence increasing their welfare at a more rapid pace than their urban peers, thereby reducing in-country inequalities in China. Ecommerce has also boosted inter-city and inter-regional trade within China.

 

There in sum are various approaches to understand the total gains consumers score from digitization and ecommerce, all of them showing largely positive results. The Internet can of course provide consumers many further benefits – for example, online shoppers are often also online sellers who sell their goods and services online, such as on eBay, Craigslist, or Uber.

 

It might be tempting to argue that the Internet’s consumer surplus would be easy to quantify with online advertisement, say on Google or Facebook. A study from 45 years ago on TV programming however shows that advertising spend is not necessarily a great proxy for consumer surplus – after all, just like websites like Wikipedia and Craigslist, some TV shows have no advertisement but are still frequented and valued by users.

 

Of course, as pointed out by Robert Gordon, a skeptic of new technologies’ impact on productivity, consumer surplus from innovations like radio, TV, or, for that matter, electricity and vehicles, has never been calculated too well or entered into GDP data. While economists are getting much better at understanding the consumer surplus of digital technologies and products, fully understanding the “digitization bump” on economies over time would require accounting for the consumer surplus from past innovative technologies and channels.