Differences in average prices on the internet: evidence from the online market for air travel.

I. INTRODUCTION Airlines adopt sophisticated flight-specific pricing strategies, charging dozens of different fares for tickets within the same class (see Borenstein 1989; Borenstein and Rose 1994). While advances in Internet technology have streamlined the information gathering process--making it easier for consumers to identify sites offering the best fares--average ticket prices varied widely in online markets during the late 1990s. For instance, Clemons et al. (2002) examine data from 1997 and observe that the fares for given flights systematically depended on where travelers purchased tickets. They document average price differences as large as 18% for tickets purchased through different online travel agents (OTAs), even after controlling for numerous factors that could affect the fares posted at different OTAs. Have competition and the evolution of the market for online travel information eliminated average price differentials across competing online sites, or are there any systematic differences in the fares obtained through different online travel sites? This question and my analysis are motivated by three important changes in the online market for air travel that have occurred since the late 1990s. First, between 1997 and 2002, there was an 11-fold increase in the use of OTAs; (1) today, 6 in 10 Americans book air travel on the Internet. (2) Second, since 1997, major airlines entered the online market and now directly compete with OTAs; today, travelers can bypass online travel agents altogether and purchase tickets directly from the carriers. Third, in summer 2001, five major airlines (American, Continental, Delta, Northwest, and United Airlines) established a joint venture, Orbitz, joining the crowd in the online market for air travel. One might expect the combined effects of more savvy shoppers and heightened online competition among competing sites to result in significantly lower fare differentials today than in 1997. To address these and related issues, I have assembled two data sets consisting of daily ticket price quotes collected from seven travel Web sites in 2002. The Web sites sampled include relatively new sites developed by individual carriers (both major and small airlines), as well as two of the largest OTAs. One data set tracks daily prices for flights with a fixed (future) departure date, and the other tracks daily prices for tickets satisfying a 60-day advance-purchase requirement. Each data set contains fares quoted at OTAs and carrier Web sites for 28 different pairs of flights between Los Angeles (LA) and New York City (NYC). (3) This permits me to examine whether the average price of a specific flight varies, depending on whether it was quoted directly from the carrier's own site or at one of the competing OTAs. In general, I find that after controlling for ticket availability and other factors that affect ticket prices, there was little systematic difference in the average fares when quotes were available at multiple online sites in 2002. This suggests that the market has evolved considerably since 1997. The parity in average fares observed in the 2002 data may stem in part from the fact that airlines directly compete for online travel dollars today but did not in 1997. Nonetheless, there is evidence that OTAs and carriers charge significantly higher average prices at their sites--ranging from 14.1% to 40.2%--in the absence of competition from other sites for those tickets. These findings are consistent with a growing literature comparing prices across traditional and online markets. Bailey (1998), Lee (1998), Brynjolfsson and Smith (2000), Scholten and Smith (2002), Clay et al. (2001), and Morton et al. (2001) document that the Internet need not eliminate price differences in online and traditional markets. Pan et al. (2003) as well as Baye et al. (2004) make similar points, but they also note that declining differentials are consistent with an evolutionary story regarding the increased competitiveness of the online marketplace over time. …