Geography Lesson: Why Internet Retailers Should Pay Attention to Where Potential Customers Live

While the Internet holds immense promise for reaching retail customers far beyond traditional trading areas, new Wharton research indicates that old world dynamics, such as neighbors sharing word-of-mouth recommendations, can still have powerful effects on Internet sales.

In two recent papers, researchers found that geography continues to have an impact on efforts to market through the Internet in ways that could help online merchants target new customers. Specifically, the papers examine the effect of economic geography on Internet retailers trying to reach potential buyers of specialty products who live in an area where their purchasing decisions make them a minority.

According to Wharton marketing professor David R. Bell, a co-author of both papers, the research set out to explore “how consumption and purchasing behavior varies over space. Depending on where you live, for example in a big city or in a small town, there are different opportunities to buy offline. What’s interesting is the way your physical environment shapes what you do online.”

Bell said the papers’ findings relate to the essential strengths and weaknesses of traditional, bricks and mortar retailing compared to online shopping. Physical stores have the obvious advantage of a presence in a region with a concentrated population. Traditional store-based retailers can find and reach out to potential customers relatively easily with well-established methods of advertising and promotion. The downside is that customers will only travel so far to shop, limiting the number of consumers a physical retailer can ever hope to attract. Internet retailers have the opposite problem — and advantage. The number of online customers is practically unlimited, but it is difficult to find them because they are dispersed across wide geographies and are harder to target.

“Surprisingly, we found there is a strong offline component to the Internet,” said Bell. Even if consumers find that their “needs can be fulfilled on the Internet, they still live in the physical world. Having people talk about a product in their offline, daily life seems to be very important.”

The first paper, “Traditional and IS-enabled Customer Acquisition for an Internet Retailer: Why New Buyer Acquisition Varies by Geography and by Method,by Bell, Wharton marketing professor Leonard Lodish and Jeonghye Choi, a professor at Yonsei University in Seoul, compares traditional methods of reaching customers with Internet-enabled techniques. The traditional methods include word-of-mouth among friends and neighbors, and magazine advertising. The web-based tools studied include online word of mouth, such as message boards, blogs and virtual communities; keyword searches, either paid or naturally occurring, generated through search engines; and connections from sponsored price comparison sites.

The researchers used zip code-level sales data from a large Internet retailer of children’s products to study how the proximity of customers to one another, price and convenience affect the performance of each customer acquisition method.

The study results show that personal, offline word-of-mouth had an especially significant impact on Internet customers, while online word-of-mouth is, on average, less effective. As an example, Bell said Internet retail customers in Miami and Philadelphia would likely be living in different physical retail environments that would make online acquisition strategies, such as word-of-mouth or buzz, less meaningful. The shopper in Philadelphia and the shopper in Miami are comparing the Internet to a different physical world.

“If my friend and immediate neighbor tells me something, there is trust. But whatever benefit he reaps, I will get the same benefit because we are physically co-located,” noted Bell. “If he lives in Miami, and emails me, there is still that same level of trust. However, his word-of-mouth is less effective because different local conditions might mean there is a different cost-benefit to shopping online.”

According to the paper, “It is clear that while information systems-enabled methods are vital for increasing the ‘reach’ of the customer base, traditional methods of acquisition remain significant, even in the new economy. Since Internet retailers have different ways of attracting customers, this suggests local customization of acquisition strategies could be worthwhile.”

The paper continues: “We conclude that traditional marketing efforts are still important to firms in the new economy and provide some evidence that geo-targeting will be vital to the success of Internet retailers, especially those with limited resources.”

The authors outline additional research in this area that they expect to pursue, such as showing how firms would benefit economically by buying search keywords in locations that their model — based on zip code data — indicates have high potential. A second area of study would examine the role of online forums in propagating information, how a firm could generate word-of-mouth and which elements of a product or service would be the most important to emphasize.

The Product Hunt

A second paper written by Choi and Bell titled, Preference Minorities and the Internet: Why Online Demand Is Greater in Areas where Target Consumers Are in the Minority,”also studies Internet retailing in the context of the physical world.

In this case, the researchers investigate people whose shopping needs might be different than most of the people in their geographic area. For example, young parents living in a zip code populated mostly by elderly people would find fewer offerings in local stores because the retailers need to devote the bulk of their shelf space and inventory to meeting the demands of the majority of their customers.

To verify that local merchants tend to cater to the majority preference in any region, Bell and Choi examined the product selection in a specific category for retailers in the zip codes with high and low percentages of target customers in the Philadelphia area. They measured the size of the product displays and found more emphasis on the product in areas with relativelymore target customers. The zip codes had roughly the same total number of target customers, but the relative proportions were different.

In their study, the authors used data from a leading Internet retailer to analyze the behavior of preference minorities. The products studied were good for research because per-capita consumption is relatively constant, and consumption in a location can be tied to the number of target customers living there. The researchers were also able to study online purchase patterns of a niche brand versus popular brands across different geographies by observing sales of a specialty brand.

First, for each zip code, the authors developed an index to separate preference minorities from preference majorities (specifically, one minus the proportion of households requiring the focal products). If this “preference minority index” is close to one, then customers requiring the focal products are preference minorities. Using census data the authors found that for markets with the same number of potential customers, online sales in high preference minority zip codes, (90th percentile, according to the index) were roughly 50% higher than in low preference minority (bottom 10th percentile) zip codes. This is important because the online retail sales potential of a zip code is determined by the relative proportion of target customers living there, not the absolute number.

The research also shows that online demand in preference minority markets is less sensitive to relatively favorable online prices. When the price advantage at the site increases, demand in low preference minority markets increases substantially — up 24% — but in high preference minority markets it rose only 8%, meaning that customers in preference minority markets are less price sensitive. The authors also found that online sales of “niche” brands respond more strongly to the presence of preference minorities than local online sales of “popular” brands do. This is because in zip codes where it’s already relatively difficult to find a good offline assortment of popular brands, it will be even more difficult to find a good assortment of niche brands.

The Long Tail theory says the Internet allows an increasing number of small, custom buyers to account for a larger number of sales than has been possible in traditional retail distribution. The online sales sensitivity of preference minorities to popular and niche brands also has an important implication for distribution patterns. While popular brands and niche brands both had more substitution from offline to online in markets with a high preference minority index, niche brands with a lower overall sales rank drew a greater proportion of their total online demand from high preference minority areas.

The authors suggest that Internet retailers should focus on reaching customers who diverge from the profile of their offline neighbors. This population benefits most from a specialty product or service that would not be readily available from traditional local retailers who are setting aside shelf space and investing resources in inventory that is most in demand by local customers.

“Our findings imply a further reason that selling niche brands in high preference minority markets is an especially attractive proposition for an Internet retailer,” the paper states. “Relative demand is not only strong in these locations, but also relatively insensitive to the difference between online and offline prices.”

In the offline world, the researchers suggest, retailers attempt to improve the economics of stocking slower-moving items by using distributors willing to stock smaller quantities. However, bulky, low value or niche brand products are difficult to manage this way. “Online retailers can exploit this assortment gap, particularly in high preference minority markets,” the authors write. “We demonstrate this for one category, but other categories with similar properties should also benefit in the same way.”

The authors point to new areas of research in this area that they hope to pursue. First is the idea of connecting Central Place Theory — a long-standing retail premise linking distances between cities to the emergence of retail stores — to online retailing. Central Place Theory argues that larger towns have more stores and more variety of stores. The authors say it might be possible to develop a similar theory for Internet retailers, in contrast to the distribution of physical stores. Internet retail sales might cluster by relative attractiveness of offline options, and not according to city size per se. In addition, the researchers hope to explore how customers develop preferences for variety. “Preference minorities might go online for the reasons we suggest, but having got there, expand their brand preferences within a category,” the authors state.

“Internet retailers are ubiquitous but the net benefit to individual consumers still depends largely on where they live and who lives next to them,” they conclude. “‘Old economy’ data can be used to find and target local markets with high potential. In other words, understanding local geography still matters a good deal for ‘borderless’ retailing.”

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