Market Segmentation: The Role of Opaque Travel Agencies

34 Pages Posted: 10 Nov 2007 Last revised: 6 Feb 2008

See all articles by Dmitry A. Shapiro

Dmitry A. Shapiro

UNC Charlotte

Xianwen Shi

University of Toronto - Department of Economics

Date Written: February 2008

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 Classification: D43, D82, L11, M31

Suggested Citation

Shapiro, Dmitry A. and Shi, Xianwen, Market Segmentation: The Role of Opaque Travel Agencies (February 2008). Available at SSRN: https://ssrn.com/abstract=1028865 or http://dx.doi.org/10.2139/ssrn.1028865

Dmitry A. Shapiro

UNC Charlotte ( email )

Charlotte, NC 28223
United States

Xianwen Shi (Contact Author)

University of Toronto - Department of Economics ( email )

150 St. George Street
Toronto, Ontario M5S3G7
Canada

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