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Market Segmentation: The Role of Opaque Travel Agencies

  • Dmitry Shapiro
  • Xianwen Shi

This paper investigates the role of discount travel agencies such as Priceline and Hotwire in the market segmentation of the hotel and airline industries. These agencies conceal important characteristics of the offered services, such as hotel locations or flight schedules. We explicitly model this opaque feature and show that it 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.

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File URL: http://www.economics.utoronto.ca/public/workingPapers/tecipa-310.pdf
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Paper provided by University of Toronto, Department of Economics in its series Working Papers with number tecipa-310.

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Length: 35 pages
Date of creation: 05 Feb 2008
Date of revision:
Handle: RePEc:tor:tecipa:tecipa-310
Contact details of provider: Postal: 150 St. George Street, Toronto, Ontario
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  1. Glenn Ellison, 2003. "A Model of Add-on Pricing," NBER Working Papers 9721, National Bureau of Economic Research, Inc.
  2. Deneckere, R. & McAfee, R.P., 1995. "Damaged Goods," Working papers 9508, Wisconsin Madison - Social Systems.
  3. Scott Fay, 2004. "Partial-Repeat-Bidding in the Name-Your-Own-Price Channel," Marketing Science, INFORMS, vol. 23(3), pages 407-418, February.
  4. Il-Horn Hann & Christian Terwiesch, 2003. "Measuring the Frictional Costs of Online Transactions: The Case of a Name-Your-Own-Price Channel," Management Science, INFORMS, vol. 49(11), pages 1563-1579, November.
  5. Thomas E. Cooper, 1986. "Most-Favored-Customer Pricing and Tacit Collusion," RAND Journal of Economics, The RAND Corporation, vol. 17(3), pages 377-388, Autumn.
  6. Charles A. Holt & David T. Scheffman, 1987. "Facilitating Practices: The Effects of Advance Notice and Best-Price Policies," RAND Journal of Economics, The RAND Corporation, vol. 18(2), pages 187-197, Summer.
  7. Steven C. Salop, 1979. "Monopolistic Competition with Outside Goods," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 141-156, Spring.
  8. Stole, Lars A., 2007. "Price Discrimination and Competition," Handbook of Industrial Organization, Elsevier.
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