What is Search Cost?
Search cost is the time, energy, and money that buyers and sellers in a market expend in trying to find one another in order to engage in transactions. Search costs include the opportunity cost of the time and effort spent on searching plus any explicit costs of money or scarce resources expended in searching. Search cost is a type of transaction cost that is incurred even before the transaction takes place.
- Search cost includes any costs incurred in the process of buyers and sellers in markets finding one another in order to do business.
- Search cost is a type of transaction cost, which can apply to both the buyer and the seller in any transaction.
- Common examples of search cost are researching prices and availability of goods and market research to identify potential customers or vendors.
- Familiar examples of search are car buyers shopping around for the right car at the right price and job seekers searching through job postings.
Understanding Search Cost
Search cost arises because the information we have about potential trading partners is always scarce and imperfect. Carrying out a purchase, exchange, or other transaction requires a willing counterparty on the other side of the deal. Finding someone else who has what you want or wants what you have takes some time and may mean that you have to spend some money to obtain information about other market participants and what they have to offer (or to share information about yourself and what you are bringing to the table). Time, money, effort, and real resources expended to obtain this kind of information make up search cost.
Search cost also involves risk; when searching for the right item to purchase or job to apply for, the searcher always runs the risk that they will ultimately fail to find what they are after. The economic theory of search argues that it is economically rational to incur search costs up to the point where the marginal cost of continued search equals the expected marginal benefit of a successful search, considering the estimated probability that the search will ultimately be successful. This means that oftentimes, people will settle for the best match they can find, even if it is not ideally what they want, once the search cost rises high enough. People will also end their search and either settle or exit the market once they believe that their chances of successfully finding what they want make further search not worth the time and effort.
Search cost is a type of transaction cost: a cost incurred not as payment for the desired good or service, but in the process of engaging in the transaction itself. Search cost is incurred before the transaction itself occurs, so a high enough search cost can prevent a transaction from ever occurring, and some search costs will be incurred even if no transaction takes place in the end. It may take time, effort, and money just to find out that no buyers are interested in your product or that no sellers offer what you want at a price you are willing to pay.
Thanks to the internet, shoppers generally face lower search costs for almost anything they want to buy today compared to the past. This is simply because users can now get fast, accurate information on products and services without having to leave home. However, there is still a trend for consumers to comparison shop online and then make the purchase offline when the price is significant. To ensure that business still comes in, retailers also tend to offer customizations on large purchases that are only available through retail locations.
Prices for the same or similar items differ across stores and locations for a variety of reasons. Given that a product can be bought for an equal or lower price usually provides enough incentive to conduct a search. However, if a product is purchased infrequently, the effort to check the price on every shopping trip might outweigh the benefit of saving a few dollars. Sometimes, promotions and advertising for a particular product increase the consumer’s incentive to search. This change in incentives leads to an increase in traffic, which, from a store owner's perspective, is desirable.
Search time and related search costs tend to be higher for transactions involving big-ticket items, like motor vehicles, or transactions that require a larger or long-term commitment. It makes more sense to spend time, energy, and possibly money researching a potential transaction when the expected costs and benefits of the item or service changing hands are high. Finding a reliable and affordable car, for example, likely matters more than how to get a tasty and affordable sandwich. The consequences of making a bad purchase decision on an expensive item are much greater than those for an inexpensive one.
Factors in Search Costs
Search costs are divided into external and internal costs. External costs include the monetary costs of acquiring the information and the opportunity cost of the time taken up in searching. External costs are not under the searcher's control. However, the decision to incur the costs are at the searcher's discretion. Internal costs include the mental effort given over to undertaking the search, sorting the incoming information, and applying it in context with existing knowledge. Internal costs are determined by the searcher's ability to undertake the search. This, in turn, depends on intelligence, prior knowledge, education, and training. In economics, search costs are often studied in conjunction with switching costs to identify barriers that consumers face in changing suppliers.
External costs are not under a searcher's control, but the decision to incur the costs are at the searcher's discretion.
Examples of Search Cost
Two readily familiar examples of search cost are the costs incurred by shoppers looking for the best deal and job seekers searching for a new job.
Consumers research a product or service for purchase and incur search costs in the form of the money spent to travel between stores examining different options, purchasing research data, or consulting experts for purchasing advice. This is time and energy that could have been devoted to other activities. Retailers depend on high search costs to prevent too much price-based shopping from eroding margins.
Job seekers engage in search for the best job for their skills and preferences at the highest compensation they can find. Scanning through job listings, updating and posting resumes to job sites, researching employer websites, and following up with questions to potential employers are all costly activities job seekers normally engage in to sell their labor at the best price and conditions they can find. Employers, on the other hand, also incur substantial search cost to attract, identify, screen, and interview potential applicants, which shows how search cost (like most transaction costs) typically occur on both sides of any transaction.