«ORBITZ, ONLINE TRAVEL AGENTS AND MARKET STRUCTURE CHANGES IN THE PRESENCE OF TECHNOLOGY-DRIVEN MARKET TRANSPARENCY Nelson Granados (contact author) ...»
ORBITZ, ONLINE TRAVEL AGENTS AND MARKET STRUCTURE CHANGES
IN THE PRESENCE OF TECHNOLOGY-DRIVEN MARKET TRANSPARENCY
Nelson Granados (contact author)
Robert J. Kauffman
Professor and Co-Director, MISRC
Information and Decision Sciences
Carlson School of Management
University of Minnesota Minneapolis, MN 55455 Last revised: July 9, 2003 ____________________________________________________________________________________
KEYWORDS: Airline industry, asymmetric information, consumer demand, industry structure, market microstructure, market transparency, online booking, online travel agencies, Orbitz, travel industry.
INTRODUCTIONThe Internet has become an important information source for end consumers in many industries.
It has brought higher levels of market transparency, permitting consumers to observe information that previously was not available via other distribution channels. As long ago as 1998, referring to Internet sales of airline tickets, Delta Airline’s CEO, Leo Mullin, stated that “there is almost perfect information out there” (Leonhart, 1998).
We define market transparency as the level of availability and accessibility of information about the trading process and the product being traded, including product characteristics and prices. A good example can be observed in the travel industry, where the influence of information provided by online travel agencies (OTAs) has been significant. According to the Travel Industry Association of America (2002), two-thirds of the 96 million people who traveled and used the Internet in 2002 planned and researched travel options online. This led to new revenue dollars for online purchases, and shifted the mix away from offline purchases. Nielsen NetRatings (2001) reported that online travel sales approached US$ 1.2 billion in the United States market in January 2001, representing nearly a third of all e-commerce transactions. In addition, visits to online travel sites stimulated another $681 million in revenue related to purchases by phone, fax, or in person.
Recently, use of the Internet for consumer search and purchase of airline tickets has become common in the United States market. Meanwhile, some OTAs, such as Expedia (www.expedia.com), Travelocity (www. travelocity.com), and Priceline (www.priceline.com), have consolidated their market positions in the online travel industry, following their market entry in the late 1990s.
However, the OTA industry was suddenly shaken up by Orbitz (www.orbitz.com), a new OTA that was launched in mid-2001, with the backing of five large airline firms: American, Continental, Delta, Northwest, and United (Zellner, 2001). Within one year of the start of its operations, Orbitz had captured about 24% of the OTA market in the United States (Mead, 2002). Some industry participants lobbied policymakers to prevent Orbitz from operating, since many observers had suspicions that the firm would operate as an oligopoly, changing the competitive structure of air travel distribution over time (Procomp, 2003).
How has Internet technology transformed the dynamics of air travel distribution in less than a decade? How did Orbitz, a second generation OTA market entrant, influence the industry with the strength of a major competitor in less than a year after its launch? What other impacts were felt within the OTA market following the entry of Orbitz? We explore these questions from the theoretical perspective of market transparency, and comparisons of Orbitz’s OTA offerings with those of other firms. We contend that Orbitz led a new wave of market transparency designs in the OTA marketplace, resulting in a changed basis for com-petition. We argue that market transparency influences the potential size of a market and the price elasticity of demand, which explains the rapid growth of online travel sales. We also discuss the findings of our analysis in specific competitive scenarios, including the discount OTA travel market, where a new player called Hotwire (www.hotwire.com) has also emerged, once again with a new market transparency strategy that has been an attraction for customers (Hotwire, 2002).
THEORETICAL BACKGROUNDMarket transparency is composed of four elements: price transparency, product transparency, supplier transparency, and availability transparency (Morgan Stanley Dean Witter, 2000). Price transparency exists when information about the trading process is made available, such as in dynamic markets that capture the demand and supply forces. For example, auction markets capture a seller’s valuation through the reservation price, while potential buyers’ valuations are captured through the competitive bid process. Product transparency is based on information about the characteristics of the product. Availability transparency refers to the extent to which inventory information is available on the seller’s side. Supplier transparency refers to the identity of the supplier. Each of these provides opportunities in business-to-consumer (B2C) e-commerce settings for the seller to establish different competitive strategies to approach the marketplace.
Financial Market Microstructure Design Theory A common concern among financial market design theorists is how market transparency influences market liquidity. Liquidity is the ability to rapidly trade out of a position at prices that reflect market supply and demand with reasonable trading costs, and the relative certainty that the transaction will clear and settle. In general, the larger the number of buyers and sellers in a market, the higher will be the probability that matching will occur, supporting trade and exchange (Spulber, 1999).
In the B2C e-commerce context in which airline reservations are made by consumers, liquidity is driven by two forces. First is the ability of airlines to sell the “product,” an inventory of empty seats, at a profit. Second is the ability of consumers to find the product that best fits their needs. In air travel, consumers need to find the right combination of itinerary and service at a reasonable price.
Market transparency can have an influence on both these drivers of liquidity. For example, an unbiased OTA may attract airlines to the extent that they believe their prices are displayed correctly and with equal priority as those of other airlines. Also, an unbiased OTA attracts consumers if it brings to market the best prices and products in the selection process, regardless of the service provider. In our analysis, we focus on the ways market transparency can attract consumers, but recognize that such transparency also generates more broad-based liquidity in the market to the extent that it attracts suppliers.
Market transparency can play a major role in industrial organization. Due to existing information asymmetries, some market participants may be able to appropriate value from a transaction due to an informational advantage that they hold. To the extent that market transparency transforms the nature and extent of these asymmetries, both the market dynamics (e.g., price competition levels and discounting strategies) and industry structure (e.g., new entrants that disintermediate established players) may change. For example, Clemons and Weber (1990) studied the "Big Bang" at the London Stock Exchange, where floor trading was replaced by screen-based trading. This transformation changed the level of market transparency, and increased market liquidity and turnover, but reduced margins for the equity market-maker intermediaries. This led to large-scale transfers of wealth between the financial sector and the public.
Demand, Strategic Pricing and Market Transparency We propose a new theoretical perspective on the potential impact of market transparency on consumer demand. Our conceptualization suggests that market transparency may increase liquidity by attracting consumers and hence increasing the potential market size. We believe that market transparency may result in lower consumer search costs for product information, which, in turn, may result in a more accurate evaluation of the alternatives or an increase in the number of alternatives to be considered. This also will tend to increase consumer surplus and result in a lower elasticity of consumer demand. This theoretical perspective is consistent with other research on consumer behavior, which suggests that if consumers do not receive expected information about the product, they may view it with suspicion (e.g., Johnson and Levin, 1985). We hypothesize that if the change in market transparency is large enough, it may attract new consumers, thereby increasing the base demand, and it may influence the sensitivity of existing consumers to price changes. Finally, we also conjecture that when price dispersion exists, an increase in price transparency will tend to make consumers aware of lower prices in the market, increasing the pressures for a decrease in price. For additional details on the development of the related theory, the interested reader should see the theory paper by Granados, Gupta and Kauffman (2003).
If one of the effects of a move to market transparency is a change in market demand, then managers may need to adopt different pricing strategies to maximize the value of their business operations in the new competitive environment. For example, if we focus only on product transparency, it seems that a market mechanism that supports the revelation of more information about the product to the consumer will result in a higher level of willingness-to-pay by consumers.
Consider a perspective that is consistent with what Akerlof (1970) theorized in his classic “Market for Lemons” article: that a diminution in information asymmetry between buyers and sellers in product markets will help to “shore up” the fundamentals for a sound market. To the extent that different forms of market transparency—price, product, availability and supplier—are considered as design variables for the firm in its selling activities, there is a potential for beneficial impacts relative to competitors, who may handle the design opportunity differently. On the other hand, higher price transparency also may have countervailing effects: a positive one due to lower demand elasticity and a negative one due to lower search costs that makes cheaper options available.
Other aspects of the environment that are present in Internet-based selling also deserve some comment. For example, the more digital are the product characteristics and the more dynamic the market mechanism, the greater will be the potential for transparency. For example, an informationbased product sold in an electronic auction market is more likely to be presented to the market in a transparent way compared to a durable good that is sold under a traditional posted-price mechanism.
Also, in the airline industry, the emergence of the OTAs has enabled consumer access to information about prices and products that was never available through traditional travel agencies. As a result, given the nearly exclusively information-based characteristics of airline tickets, we expect the effects of increased market transparency due to the Internet to be significant in this industry.
AIRLINE INDUSTRY AND OTA SERVICESIn this section we follow the developments that led to the current competitive scenario in the U.S.
online air travel industry. First, we review the airline industry prior to the advent of OTAs. Second, we present the history of OTAs, with special focus on Orbitz. Orbitz is an airline-owned OTA that has brought new competitive dynamics and fast penetration based on state-of-the-art technology and a novel business concept.
Deregulation, CRSs and Re-Regulation Prior to 1978, the government exerted control over fares and airline routes. In 1978, the airline industry was deregulated and airline firms have since been able to set fares and schedules based on competitive and demand forces (Global Aviation Associates, 2001). According to Copeland and McKenney (1988), to deal with this new competition, the airlines introduced three strategies. First was the implementation of pricing strategies to increase revenues, which commonly lead to fare wars.
The second strategy was the development of computer reservation systems (CRSs) to automate the distribution of airline tickets. CRSs were installed at travel agency locations, accompanied by longterm contractual sales agreements (Duliba, Kauffman and Lucas, 2001). This provided incentives for airlines to be the first-movers in installing CRS terminals at the agencies, which would lock them in and create a “halo effect” for market share that favored the airline firm owners of the CRSs (Copeland and McKenney, 1988).