Mortgage comparison site

AT FIRST glance, price-comparison websites are an example of capitalism at its best. Savvy consumers can use them to hunt down the best available deal for insurance, electricity or a mortgage. Firms providing such items, terrified of losing customers, feel an obligation to improve their offerings all the time. But recent theory and practice suggest the reality is more complex: comparison sites are simultaneously friends and foes of competition.

In 1971 Peter Diamond, an American economist, showed that even small “search costs”, such as the time it takes to walk down the street to see what is on offer at a rival shop, can seriously undermine competition on price. Industries in which it is much harder to compare offerings and switch providers can expect sky-high prices and profits. In the past, this problem was acute in the insurance market. Many consumers, on discovering their insurance was running out, would lazily renew with their existing provider. The hassle of comparing competing offers, and the need to maintain coverage without interruption, hindered competition. That allowed firms to hike prices for existing customers.

Today, things are very different. Comparison sites have made shopping around and switching insurers a matter of just a few minutes’ effort. In the British car-insurance industry, about a quarter of all sales, and more than half of new business, flows through them. That has caused fierce competition on price and eviscerated profits. In 2011 Towers Watson, a consultancy, in a note entitled “Why aren’t we making money?”, said that “unnecessary” price competition following the rise of comparison sites in Britain had cost insurers £1 billion ($1.5 billion) a year.

Consumers should celebrate that; the firms’ losses are their gains. But there is a catch. Comparison sites, whether for insurance or something else, introduce a new layer of costs, including their own splashy advertising campaigns. In theory, competition in the market for comparison sites ought to keep those costs down. But in a recent paper, David Ronayne of Warwick University argues that consumers often lose out from comparison sites. They earn a commission for each shopper who uses them to buy insurance. That referral cost is incorporated into the price the consumer ends up paying. If the increased costs outweigh the saving the comparison enables, consumers end up worse off.

For instance, suppose some consumers are loyal to a single comparison site, and do not use any others to compare prices. The lucky website can crank up its referral fees, safe in the knowledge that insurers must pay up if they want access to its captive market. Those fee hikes are then passed on to consumers in the form of higher premiums. In effect, consumers are taxed for their loyalty—just as they were before comparison sites were invented. Mr Ronayne argues that this problem can only be avoided entirely if consumers go to the trouble of checking every site.