Market Segmentation: The Role of Opaque Travel Agencies

Abstract:     
This paper investigates the role of discount travel agencies such as Priceline and Hotwire in the market segmentation of the hotel and airline industries. The distinct feature of these agencies is that they conceal important characteristics of the offered services, such as hotel locations or flight schedules. We show that this opaque feature enables service providers to price discriminate between those customers who are sensitive to service characteristics and those who are not. Service providers can profit from such discrimination despite the fact that the opaque feature virtually erases product differentiation and thus intensifies competition. The reason is that the intensified competition for less sensitive customers enables service providers to commit to a higher price for more sensitive customers, which leads to higher profits overall. This explains why airlines or hotels are willing to lose the advantage of product differentiation and offer services through discount travel agencies. It also gives a new story of how the Internet can reduce competition.

Keywords: market segmentation, opaque travel agency, separation equilibrium, price discrimination

JEL Classifications: D43, D82, L11, M31

Working Paper Series