Selling Mechanisms & Savvy Consumers
Lessons from the Travel Industry
Associate Professor of Management Rachel Chen studies operations and supply chain management, service operations, and dynamic pricing. In this blog, she teases out key takeaways from her most recent research on travel industry selling mechanisms.
With all the options available when it comes to booking travel arrangements, it’s clear that there’s stiff competition for service providers, especially considering today’s strategic customer. In my most recent research, I compare the two most common selling mechanisms for opaque resellers, who sell last-minute travel products with characteristics (e.g., the provider of the service, or the location in case of hotel reservations) withheld until consumers make the purchase.
The Landscape: Hyper-Competitive Sales and Highly Perishable Products
Travel industry service providers such as airlines, hotels, and car rental companies, face two types of customers: leisure travelers and business travelers. Business travelers are reimbursed by their employer, and their travel needs tend to be last minute. As a result, they are not sensitive to price. On the other hand, leisure travelers pay out of their own pocket and plan well in advance, giving them the opportunity to ferret out the best price.
Knowing that business travelers tend to travel at the last minute, service providers typically sell to leisure travelers in advance and reserve some capacity for the more lucrative business segment in the future. But what happens if the projected business demand is not realized? The airline seats or hotel rooms are ‘highly perishable’; if they don’t sell by the service delivery date, the provider will never recover that revenue. Thus, service providers have an incentive to offer last-minute sales to dispose of the leftover capacity, making it difficult to charge high prices to business travelers at the same time, and even dampens the price for advance sales with forward-looking leisure travelers.
That’s where Priceline and Hotwire come in – these companies sell last-minute products whose characteristics (e.g., the provider of the service, or the location in case of hotel reservations) are withheld until consumers make the purchase. These two companies use very different selling mechanisms. Hotwire uses the ‘posted-price’ mechanism where a retail price is announced to customers, along with limited details about the product such as hotel amenities, the number of stars, and its approximate location. The customer can take it or leave it.
Priceline utilizes the ‘name-your-own-price’ (NYOP) mechanism, where participating providers offer unsold inventory to Priceline at special prices and customers submit bids based on their willingness to pay. Priceline then cross-references the bid against the block rates from providers to accept or reject a bid.
Our research question asked: do service providers needing to sell excess seats or hotel rooms at the last minute prefer the posted-price mechanism used by Hotwire or the NYOP mechanism used by Priceline? In the highly competitive travel industry, which selling mechanism gives service providers the most value?
The Findings: Selling Mechanisms of Choice
We found that travel companies prefer the posted price mechanism (Hotwire) to the name-your-own-price mechanism (Priceline). Consumers, on the other hand, prefer the Priceline model. This result is driven by the combined effect of competition and the inflexible nature of the capacity levels for service providers. Because of this industry preference, airlines and hotels may be reluctant to supply Priceline, who nevertheless can reach out to a larger market of consumers.
The Key Takeaways:
1. The opaque distribution channel that sells brand-shielded last-minute products can be helpful for service providers who face demand uncertainty from the lucrative business segment. The specific selling mechanism used in the opaque channel will have its implications on the profits of competing service providers.
2. Customers are savvier than ever before, and not just in the travel space. The internet has opened up what seems like unlimited options for just about any consumer good, providing an unprecedented wealth of information. Firms who sell products over time via multiple distribution channels need to take the strategic customer behavior into consideration for their pricing decisions.