ORBITZ, ONLINE TRAVEL AGENTS AND MARKET STRUCTURE CHANGES IN THE PRESENCE OF TECHNOLOGY-DRIVEN MARKET TRANSPARENCY

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1 ORBITZ, ONLINE TRAVEL AGENTS AND MARKET STRUCTURE CHANGES IN THE PRESENCE OF TECHNOLOGY-DRIVEN MARKET TRANSPARENCY Nelson Granados (contact author) Doctoral Program Alok Gupta Associate Professor Robert J. Kauffman Professor and Co-Director, MISRC Information and Decision Sciences Carlson School of Management University of Minnesota Minneapolis, MN Last revised: July 9, 2003 ABSTRACT Air travel distribution has been transformed by Internet technology because of an increase in market transparency, the level of availability and accessibility of product and price information. This article attempts to explain and interpret changes in the market for online travel with the market entry of air carrier consortium-owned Orbitz, a second generation online travel agency (OTA) that significantly changed the competitive dynamics around market transparency. Our interpretation of the developments is based on market microstructure theory, and more recent work that relates market transparency to firm pricing strategies and consumer demand. Our interpretation is developed in three stages. First, we explore market transparency-related developments in first generation online travel since the mid-1990s in the United States. Second, we analyze Orbitz s market transparency strategy and its impacts on the industry, leading to the emergence of new consumer expectations in the Internet channel. Third, we assess other related changes in the industry that have emerged that further suggest the broad impacts of Orbitz s strategy, including recent changes in the highly pricesensitive leisure travel segment of the OTA market. Overall, our findings suggest that market transparency changes will continue to drive additional changes in the OTA sector. KEYWORDS: Airline industry, asymmetric information, consumer demand, industry structure, market microstructure, market transparency, online booking, online travel agencies, Orbitz, travel industry.

2 INTRODUCTION The 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 ( Travelocity (www. travelocity.com), and Priceline ( 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 ( 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 2

3 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 ( has also emerged, once again with a new market transparency strategy that has been an attraction for customers (Hotwire, 2002). THEORETICAL BACKGROUND Market 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 3

4 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. 4

5 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 5

6 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, 6

7 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 SERVICES In 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). The third strategy was screen biases, the act of purposely positioning information on-screen to influence specific purchase behaviors that are beneficial to the vendor, but unfair to other airline 7

8 suppliers. A number of observers have claimed over the years that the halo effect was due to screen biases, displays that favored sales of the owner airline, for example: This is not just a theory. The federal government accepted this as fact over 20 years ago with the first widely used computer network in this country the computer reservation systems developed and promoted by the major airlines in the 1970s. When the airlines developed this technology, they found that even the subtlest forms of bias in the display of information on the computer screen could have a dramatic effect on the purchasing patterns of consumers. According to one industry study, more than 50% of all consumers selected the flight shown on the first line of the computer screen, and more than 90% chose a flight from the first screen. By ensuring that their own flights appeared on the first line or screen disproportionately often, the network owners were able to shift a tremendous amount of revenue to their own services. As the CRS screens became the major distribution channel for airline tickets, air carriers that owned CRSs were able to charge "tolls" and disadvantage competitors. Some competitors were charged a fee for screen placement of their flights. Others, whose flights were in direct competition, found their screen placement to be less favorable. (ProComp, 2003) Similarly, CRS owners developed co-hosting agreements with other airlines to provide preferential treatment of schedules in the screen displays for a fee (Global Aviation Associates, 2001). By 1983, 80% of tickets were sold by travel agencies through a CRS terminal (Global Aviation Associates, 2001). As a result, CRSs became a critical asset for airlines and agencies to survive in a recently deregulated environment. Soon, however, allegations emerged suggesting that retail automation of airline tickets had not occurred in the public interest. In June 1983, the Civil Aeronautics Board concurred with these allegations and concluded that the airlines were demonstrating anti-competitive behavior through built-in screen bias and preferential treatment (Copeland and McKenney, 1988). Subsequently, CRS business practices were regulated, prohibiting the vendors to employ screen display biases and to charge discriminatory fees to rival carriers. In addition, CRSs were instructed to provide data on their flights and ticket prices to competitors, albeit for a fee. While these measures curbed the alleged discriminatory behavior, industry participants still argued that the measures were not enough to eliminate the anti-trust concerns. Subsequent lawsuits 8

9 further supported this notion. By 1992, new regulations were introduced to prohibit the anticompetitive practices that eluded the original rules (Global Aviation Associates, 2001). To further enjoy the benefits of economies of scale, in the early 1990s the CRSs expanded to become global. These extended systems today are called global distribution systems (GDSs) and their development shows the resilience of airlines to maintain control of their distribution channels. They are widely recognized as a source of sustainable competitive advantage for their owners, which were consistently able to exploit business opportunities that emerged as these systems and the markets they served continued to evolve (Duliba, Kauffman, and Lucas, 2000). However, the regulatory developments in the 1980s and 1990s created disincentives for airlines to own the GDSs. As a result, the airlines have been divesting ownership of the GDSs. For example, the Sabre GDS, spun off from American Airlines in the 1990s, is now publicly owned by Sabre Holdings ( which also owns Travelocity, and GetThere, www. getthere.com), and the Galileo GDS ( is owned by the travel distribution, rental car and real estate giant, Cendant Corporation ( which owns CheapTickets, and WizCom, Budget and Avis rental cars, and Coldwell Banker real estate). The Online Travel Agency Industry Industry Gestation. The development of the Internet enabled new B2C distribution channels in many industries, and the airline industry was no exception. In 1995, Internet Travel Network (ITN) launched the very first online travel reservation Web site. In 1996, Sabre Holdings, operator of the GDS formerly owned by American Airlines, capitalized on the technological opportunities offered by the Internet and introduced Travelocity, which used Sabre as its fare search and booking engine. Soonafter, new market players emerged to perform fare searches and sell tickets based upon a 9

10 customer s booking request. Some non-travel firms set up capabilities to position themselves as e- commerce-only intermediaries and entered the OTA market (Chircu and Kauffman, 2000). For example, Microsoft introduced Expedia ( powered by the Worldspan GDS, which is jointly owned by Delta, Northwest and American Airlines. By using GDSs as the fare search engines, these Web sites were able to offer fares from most airlines. Travelocity and Expedia soon became market leaders, while other key players emerged. In 1997, Travelbids was created to offer leisure price quotes. In 1998, Priceline.com emerged as the first low transparency OTA, by shielding product and price until the consumer commits to a contract-binding bid. In 1999, ITN created GetThere.com, one of the first business-to-business (B2B) OTAs, creating new market transparency for the segment (Web Travel News, 1999). Look-to-Book and Market Transparency. With the proliferation of OTAs, there was an explosion of look-to-book visits to their Web sites, and increased demand by consumers to book online. In 2001, for every dollar of online travel sales, the OTAs generated about 60 cents for tickets purchased via phone, fax, or in person (Nielsen NetRatings, 2001). With these developments came more comparison shopping, as only 10% of online shoppers buy after visiting just one site (Reagan, 2001). To retain consumers, OTAs began offering add-on services, such as Travelocity s Best Fare Finder and Online Trip Review. The latter enables travelers to view up-to-date information on flight schedules, weather, and maps of travel destinations. Although the GDSs entered the OTA market early as owners of OTAs (e.g., Sabre and Travelocity) or by forming alliances (e.g., Worldspan and Expedia), the airlines later took individual stakes. They also introduced airline portals, extensions of the airlines reservation offices that offered online ticket purchasing services. And they participated through their involvement and ownership in the GDSs, which provided real options to scale up their commitments to the OTA marketplace. Today, participation in this manner 10

11 is from Northwest, Delta and American Airlines, which own the Worldspan GDS., and Société Air France, Iberia Lineas Aéreas de España, and Lufthansa Commercial Holding, which jointly own the European GDS, Amadeus ( OTA Sector and Transformed Industry Structure OTAs and First-Stage Airline Firm Reinter-mediation. Since the advent of the first OTA in 1995, there has been an unprecedented growth in online sales of airline tickets. Jupiter Research (2003) estimated that the 2002 OTA sales volume was approximately US$ 16.8 billion, representing approximately 23% of total airline passenger ticket sales of nearly US$ 74 billion (Bureau of Transportation Statistics, 2003). To provide an idea of how significant this percentage is, in 2002 the cross-industry average of e-commerce sales relative to total retail sales was 1.4% (U.S. Census Bureau, 2003). But who will control the e-channel: the airlines or the e-commerce intermediaries (Salkever, 1999)? Chircu and Kauffman (2000) presented a framework that predicted the transformation of industrial organization, as sector competitors struggle for survival in e-commerce. They proposed an intermediation-disintermediation-reintermediation cycle to characterize their expectations about how the attention of the traditional firms in a sector would shift over time, as new intermediaries captured market share of traditional business, and changed the composition of the overall competition. Reintermediation occurs when a traditional competitor that has been disintermediated by e- commerce-only intermediaries develops new capabilities to be effective as an e-commerce-enabled intermediary. In a first stage response to the entrance of OTAs, the airlines began to pursue reintermediation by attracting consumers to their direct channel airline portals (e.g., Continental.com, Delta.com, UAL.com, AA.com, Southwest.com, etc.). In 1996, airline portals accounted for about 21% of online air travel revenues (Salkever, 1999). Development of more service-oriented airline 11

12 portals Web sites, including the new virtual check-in capabilities and an increased focus on frequentflier programs with discounted online award bookings, brought the share of airline portal sales in the OTA market to 60% in 2001 (Zellner, 2001). Second-Stage Reintermediation: The Entry of Orbitz. In 1999, five major airlines United, American, Delta, Northwest, and Continental announced they would work towards the creation of a new OTA (Salkever, 1999). Dubbed Orbitz, the new Web site was launched in June 2001, and since then has grown into a technology leader in its quest to update the legacy systems of airline reservations (Zellner, 2001). The airlines claimed that Orbitz would dramatically decrease the high costs of making reservations. For that purpose, Orbitz was designed and powered by ITA Software ( a pricing and airfare shopping technology developer launched by researchers from the Artificial Intelligence Laboratory at MIT. ITA is also a software vendor for Continental.com, AmericaWest.com and Air Canada s Fly Tango ( This software is attractive because it obtains fares directly from the Airline Tariff Publishing Company ( which collects and distributes fares from airlines worldwide, and schedules from OAG ( By using ITA s Global Airfare Pricing and Airfare Shopping System, Orbitz is able to avoid reliance on legacy system infrastructures and high CRS and GDS fees. Figure 1 illustrates the technological structure of fare distribution in the airline industry in light of Orbitz. 12

13 Figure 1. Technological Structure of Airline Reservations: Traditional Sellers and OTAs Note: ITA Software also is a booking engine supplier to other OTAs and direct booking airline portals. Other technology suppliers also provide booking engine solutions to other OTAs, the airline portals and reservation offices, as well as some traditional travel agencies. An example is American Express Internet Travel Network ( which obtain its technology solution from GetThere ( In addition, Orbitz provides the reservation and booking engine directly to several airline portals, especially its joint owners American, Continental and Northwest Airlines (Regan, 2002a) and also is making its tools available directly to traditional travel agencies (AQUA Software Products, 2002). In addition to its state-of-the-art IT, Orbitz has claimed it is an unbiased online travel site. According to Salkever (1999), Al Lenza, Northwest Airlines s VP for distribution claimed that Orbitz will give the lowest published fares anywhere. Anything you find on the Web, we will have. The senior management of Orbitz argued prior to its launch that the CRSs and GDSs were continuing the industry s practices of display bias (Global Aviation Assoc., 2001). They further asserted that with Orbitz s matrix-based presentation of information, and its access to the appropriate data sources, that it would be able to offer a truly unbiased search engine and one that would provide a clear presentation of the travel options in a manner that would be clear and simple for the traveler. (See Appendix.) 13

14 Market Transparency Issues and the OTAs. Industry participants have lobbied the U.S. government to control or restrict the participation of Orbitz in the online travel market, based on its relationship with the airline suppliers and the heightened ability of the airlines to signal price changes (Zellner, 2001). Meanwhile, Orbitz committed to neutrally display all fares, regardless of whether it has a favorable contract with an airline or whether the airline has ownership interest in Orbitz (Mead, 2002). Since the prospects of an airline-owned booking mega-portal appeared, the U.S. Department of Transportation has been closely scrutinizing the business practices of Orbitz. But it has found no reason to regulate or restrict it, and even made the case in the recent of three assessments that Orbitz has kept its promise of neutrality (Mead, 2000 and 2002; U.S. Dept. of Transportation, 2001). Based on this characterization of Orbitz, we classify it and the other OTAs based on their market transparency in Table 1. Table 1. Levels of OTA Market Transparency TRANSPARENCY OTA TYPE TYPE PRICE PRODUCT DESCRIPTION Orbitz Very High Very High Unbiased, numerous alternatives per request Interairline High High Alternatives limited by GDS technology Airline portals High Medium Alternatives limited to airline specific offers Leisure price quotes Medium Low Mechanism reflects low buyer price sensitivity Name-your- price Low Low Price and product information concealed until after purchase While the market shares of Travelocity and Expedia eroded due to Orbitz s success, they continued as the top OTAs with market shares slightly above 30% in Travelocity continues to be a model of customer service, recently introducing 24-hour customer phone service. Expedia has continued to grow its niche in the sale of travel packages. Orbitz is a close follower, with a share of 14

15 approximately 25%, an indication of the inroads it has made in the market since 2001 (Mead, 2002). In addition, Orbitz is consolidating its position as a direct competitor to the GDSs, potentially making itself "the first Internet company to replace all intermediary functionality in order to book tickets directly with airline reservation systems" (Regan, 2002b). ANALYSIS We next explore the impact of Internet-driven market transparency on the sale of airline tickets and competitors strategies to confront the new challenges. We also discuss the basis for the recent success of Orbitz in the OTA market, from the perspective of changes in market transparency on consumer demand. Market Transparency in the Airline Industry We recognize that there is significant potential for market transparency in B2C electronic markets and Internet-based selling. The higher are the digital characteristics of a product, the greater is the potential product transparency in B2C electronic markets. Also, the more dynamic the market mechanism, the higher is the potential price transparency. This conceptualization suggests that the potential for market transparency can be expressed in terms of these dimensions: digital vs. nondigital characteristics and market microstructure type. We note that airline tickets are digital products that are typically sold in static market microstructures involving lower price transparency (since sales are based on prices posted by airlines or intermediaries) but potentially high product transparency (since air carriers, departure/arrival dates and times, number of stopovers, and seat assignments can all be communicated online). Prior to the creation of OTAs, CRS and GDS technology was complex and only addressed the end consumer s needs with assistance by a traditional travel agent. Today, a typical fare availability 15

16 screen in a CRS is filled with codes for city pairs, inventory availability, and fare types, making it a tool that is mostly for expert users. Hence, without access to an OTA, consumers have very little control over the information they are given about possible trips and fares. Instead, they have to rely upon airline reservation offices and travel agents to interpret the results of GDS-based search requests. Complicating matters, there are so many choices that the traveler normally faces in deciding the trip details that human expertise is needed to weed out undesirable options and to select the best alternative. With their new ability to reach consumers via the Internet, OTAs such as Travelocity and Expedia seized the opportunity to display GDS output in a user-friendly manner. The displays represent the translation of information in GDS availability and fare screens, expressed so a non-expert can readily understand. Impact of Market Transparency on Demand. We believe that the link between increased market transparency and the surge in OTAs market size and sales is clear. Initially, Internet technology alone increased the potential market transparency of air travel products to the consumer. However, the fare search and information display technologies (which are based on the legacy systems of the GDSs) create biases and limit a traveler s view of the relevant trip options. Orbitz has brought the online travel industry to a new level of product and price transparency by introducing more powerful fare search and display technology. Overall, the combined use of the Internet and state-of-the-art Web-based reservation technology has expanded the potential for fuller market transparency to an even higher level than what the Internet has brought. We expect the demand growth of OTA online sales to continue. While the growth so far has been extraordinary, the potential for even greater market transparency has not yet been fully exploited by the OTAs. We expect that the state-of-the-art technology that is being offered to the OTAs and 16

17 airlines is only the beginning. It should fuel additional competitive moves on the part of other firms (including the non-airline-owned OTAs) to match the technological leadership that Orbitz has demonstrated. This will result in improved market transparency, which will only fuel the further growth of the market for OTA services. Impact of Market Transparency on Prices. The consequences for airfares are less predictable than the observed and expected growth in consumer demand. The structural increase in market transparency due to the existence of OTAs may decrease demand elasticity. So as consumers obtain the information provided by OTAs in the process of purchasing a ticket online, their sensitivity to price changes may diminish. This may result in price increases. Also, a higher level of price transparency and the availability of product alternatives may result in lower prices due to the higher probability that a consumer finds a lower fare than she would otherwise have found without consulting an OTA. This perspective is supported by Stigler (1961), who analyzed a scenario where lower search costs increased the probability of discovering lower market prices. Thus, leaving aside the exogenous factors that affect airline prices, the long-term impact of increased price transparency on prices is uncertain (at least theoretically), due to the opposite forces that are exerted on prices. And, indeed, these opposite forces appear to be present in the OTA market. Given the historical lack of transparency to consumers prior to the OTAs market entry, we expect consumer willingness-to-pay to increase as firms realize that different market transparency strategies may be an important design variable in their Internet-based selling activities. On the other hand, given the price dispersion that exists in the industry (Clemons, Hann, and Hitt, 2002) and the opaqueness in distribution via the GDSs (e.g., through OTAs Travelocity and Expedia), the increased price transparency offered by OTAs should drive prices down, as consumers are able to discover and purchase the lowest available fares. This trend may be supported by the emergence of independent 17

18 online agents that search for the lowest prices on multiple OTAs. Examples are Farechase ( and Sidestep ( both launched in Impact of Market Transparency on Pricing Strategies. The likely impact of market transparency on demand suggests that firms should price based on the relative level of market transparency of their market mechanisms. The logic involves recognizing that the higher the level of product and price transparency, the higher will be the willingness-to-pay of consumers, with the result that firms will be able to afford to price higher than less market transparent firms to maximize revenue. Low prices are commonly matched by airline competitors that fear losing market share, which sustains there operational load factors, in spite of the fact that this ultimately will have problematic impacts on long-term profitability (Morrison and Whinston, 1996). However, we expect that industry players will continue to realize that different levels of market transparency can be used to segment consumer markets and enable price differentiation. The emergence of last-minute inventory air travel Web sites, such as Priceline, Hotwire and LastMinuteTravel.com, are cases in point. In order to compete effectively, OTAs now have the capability to combine pricing strategies with market transparency strategies. For example, major U.S. airlines have adopted a dual market transparency strategy. Five major airlines own Orbitz, which provides high levels of transparency to support consumer search in the larger competitive market for airfares. On the other hand, six major airlines own Hotwire, which was launched in 2000 to compete directly with Priceline for pricesensitive and last-minute leisure travelers, using heavily discounted prices. Although Hotwire offers lower fares, it also offers a lower level of transparency than Orbitz, thus allowing the airline firm owners to effectively achieve high transparency-low transparency market segmentation and effective 18

19 price discrimination. Priceline recently announced the availability of a fixed-price option and an auction mechanism through a deal with auction site ebay ( (Grant and Losi, 2002). Based on our framework, we can view this competitive effort as a strategic move for Priceline to modify its price transparency strategy. Like Priceline, Hotwire conceals product characteristics until after purchase. However, Hotwire is more transparent because it reveals up front a limited set of discounted fares. Even though Priceline s name-your-own-price mechanism has a lower level of price transparency than Hotwire, it is likely receiving similar net fares from airlines than is Hotwire. Therefore, Priceline s mechanism may be effectively pricing itself out of the market due to a disadvantageous price transparency strategy choice with respect to Hotwire. To wit, in February 2002, when Hotwire announced it had doubled the number of unique visitors with respect to Priceline, CEO Karl Peterson stated: We are gaining on our competition fast, because we don t require customers to bid, our consumer experience is far superior to Priceline, and it shows in the number of new users coming to our site. (Hotwire, 2002) Thanks to the Internet, airlines and intermediaries now face new choices about whether to disclose product and price information, and how to configure their market mechanisms for Internet-based selling. For example, recently Continental Airlines and ebay created a co-branded site that allows customers to bid on items using their frequent flier miles (Kane, 2002). Frequent fliers can bid for different types of travel and entertainment items, including travel packages. We expect the airlines and OTAs to continue to develop and test novel market mechanisms that will achieve further market segmentation and effective price discrimination. 19

20 CONCLUSION This research offers three contributions to our understanding of recent developments in the market structure of the online travel agency segment of electronic commerce. First, we found that GDS technology has served the OTA industry well by providing a platform by which complete market information can be made available electronically to air travelers. The existence of well developed electronic markets for trade among airlines and intermediaries was a key stepping stone for the development of OTAs. Second, our framework for assessing market transparency in B2C markets positions airline tickets high in the spectrum of potential product transparency, because airline tickets are information-based products that can be well represented in an electronic medium such as the Internet. The result is in line with the higher than average growth of online air travel relative to other B2C markets. Third, we analyzed the competitive environment of OTAs to find that the state-of-the-art technology developed by Orbitz, as well as its market entry, is increasing the potential for market transparency in the OTA industry, causing a redefinition of the strategies of competitors in the sector. In a major development that changes the competitive pressures related to air travel distribution, Orbitz is now introducing IT solutions that provide the market with assurances of unbiased and complete airfare information. This is an investment effort which is at the heart of several leading airline firms efforts to reintermediate markets that came under pressure due to the earlier entry of Internet-only OTAs (e.g., ITN, Expedia, and Travelocity). In the meantime, the broad spectrum of market transparency possibilities triggered by this new technology and other OTA initiatives is segmenting the market in a way that has not been seen before in the industry. For example, the leisure travel OTAs, Priceline and Hotwire, that target price-sensitive consumers with novel mechanisms consisting of low transparency and low price, offer relevant evidence of these new developments. 20

21 Our analysis of the airline industry also offers new insights into the theory of market transparency in B2C markets. It provides a real world, case-based example that greater market transparency in this case, in product transparency and price transparency terms, increases the potential size of an electronic market. The growth of the OTA market has occurred in parallel with significant improvements in market transparency driven by the Internet in a first stage, and by the state-of-the-art technology developed by Orbitz in a second stage. As a result, market transparency has become a new design choice in organizational strategy in the marketplace for air and other travel and hospitality services. We expect to see the continued emergence of new market transparency strategies combined with pricing, additional IT investments, and niche market strategies. We further argue that the success of major U.S. airlines to reintermediate the market for online distribution of air travel will be driven by a coherent combination of IT, pricing, and market transparency strategies. The airline industry represents a powerful example of the impact of market transparency, analogous to the Big Bang at the London Stock Exchange, but with less obvious consequences to the traveling public. To date, much research has concentrated in the developments related to market transparency in the trade of financial instruments, due to their information-intensive nature and the multiple financial market microstructures that have been transformed over time. Now, with the advent of the Internet, researchers have new opportunities to study the impact of market transparency variations on market demand, liquidity and efficiency in many new B2C market domains. As we have shown in this paper, this is the case with the development of the OTA market in the United States. We have learned a substantial amount already from our consideration of Orbitz s entry and the subsequent observed changes that occurred in the market. But there is still much to be explored in terms of the interaction among market transparency, consumer demand, IT investments, 21

22 competitive strategy, and firm performance, as well as opportunities for interesting new empirical research. Based on the foregoing analysis, we predict that additional increases in market transparency by the OTAs will continue to create favorable conditions for the attraction of new consumers who are willing to purchase airline tickets online. By the same token, in order to compete effectively, the OTAs will need to develop a sound combination of market transparency and pricing strategies. OTAs that are able to leverage their market transparency design choices for air travel distribution will continue to play major roles in the technological and strategic development of the industry. In contrast, OTAs that do not sufficiently acknowledge the importance of market transparency in its various forms relative to their competitors are doomed to be left behind in future market competition. REFERENCES [1] Adkinson, W. F. Orbitz Should Still Pop Up on Antitrust Agencies Radar Screens, Progress on Point: Periodic Commentaries on the Policy Debate, Release 10.7, March [2] Akerlof, G. A. The Market for Lemons: Quality Uncertainty and the Market Mechanism, Quarterly Journal of Economics, 89, 1970, [3] Anderson, K. The Evolution of GDS, Press release, Tours.com, San Fran., CA, August 7, [4] AQUA Software Products. AQUA Software Products and Orbitz to Offer Web Fares to Travel Agents, AQUA Software Products, Inc., Santa Ana, CA, May 16, [5] Bureau of Transportation Statistics. Air Carrier Financial Reports (Form 41 Financial Data), Bureau of Transportation Statistics, U. S. Department of Transportation, May Accessed May 27, 2003 via TranStats, the Intermodel Transportation Database. [6] Chircu, A. M. and Kauffman, R. J. Reintermediation Strategies in Business-to-Business Electronic Commerce, International Journal of Electronic Commerce, 4, 4, Summer 2000, [7] Clemons, E. K., Hann, I., and Hitt, L. M. "Price Dispersion and Differentiation in Online Travel: An Empirical Investigation, Management Science, 48(4), 2002, [8] Clemons, E. K., and Weber, B. W. The Big Bang at the London Stock Exchange, Journal of Management Information Systems, 6(4), Spring 1990, [9] Duliba, K., Kauffman, R. J., and Lucas, H. C., Jr. Appropriation and Value of Airline Computer Reservation Systems, Organization Science, 12(6), November-December 2001, [10] Copeland, D. G., and McKenney, J. L. Airline Reservation Systems: Lessons from History, MIS Quarterly, 12(3), September 1988,

23 [11] Global Aviation Associates, The History and Outlook for Travel Distribution in the PC- Based Internet Environment, Wash., DC, February [12] Granados, N. F., Gupta, A., and Kauffman, R. J. Can You See What I See? Transparency, Consumer Demand, and Strategic Pricing in B2C Electronic Commerce, Working paper #03-20, MIS Research Center, Carlson School of Management, U. Minnesota, [13] Grant, E. X., and Losi, S. Priceline Up, Up and Away with ebay, E-Commerce Times, February 1, [14] Hotwire. Hotwire Q4 New Users Exceed Priceline, Press release, Hotwire, February 4, [15] Johnson, R. D., and Levin, I. P. More Than Meets the Eye: The Effect of Missing Information on Purchase Evaluations, Journal of Consumer Research, 12(3), September 1985, [16] Jupiter Research. Jupiter Research Forecasts Online Air Ticket Sales to Grow 14% Despite War and Threat of SARS, Press release for Jupiter Research reported by Internet.com, May 19, [17] Kane, M. ebay, Continental Team on Web Site, CNet News.com, June 5, [18] Leonhart, D. Fare Deal: Airline Exec Sees More Web Discounts for Flyers, Daily Briefing, BusinessWeek Online, November 19, [19] Mead, K. M. Internet Sales of Airline Tickets, Report #CR , presented to the Committee on Commerce, Science, and Transportation, U.S. Senate in testimony by Mead, K. M., Inspector General, U.S. Dept. of Transportation, Washington, DC, July 20, [20] Mead, K. M. OIG Comments on DOT Study of Air Travel Services, Memorandum CC , Office of the Secretary, from K. M. Mead, Inspector General, U. S. Department of Transportation, Washington, DC, December 13, [21] Morgan Stanley Dean Witter. The B2B Internet Report: Collaborative Commerce, Equity Research, Morgan Stanley Dean Witter, New York, NY, April [22] Morrison, S. A., and Winston, C. "Causes and Consequences of Airline Fare Wars," Brookings Papers on Economic Activity: Microeconomics, Brookings Institution, Wash., DC, 1996, [23] Morrison, S. A., and Winston, C. The Evolution of the Airline Industry, Washington, DC, Brookings Institution Press, [24] Nielsen Net Ratings Online Travel Industry Captures $1.2 Billion in January, Led by Travelocity, According to Nielsen Net Ratings and Harris Interactive, Press release, Nielsen Net Ratings, New York, March 20, [25] Procomp, At the Crossroads of Choice Executive Summary, Research paper, Project to Promote Competition and Innovation in the Digital Age, Procomp, Washington, DC, [26] Regan, K. Orbitz to List Fares Offline, E-Commerce Times, May 17, 2002a. [27] Regan, K. Orbitz Unveils Direct Reservation System, E-Commerce Times, August 19, 2002b. [28] Salkever, A. Dogfight in Cyberspace: The Online Travel Biz Heats Up, Daily Briefing, BusinessWeek Online, November 15,

24 [29] Spulber, D. F. Market Microstructure: Intermediaries and the Theory of the Firm, Cambridge University Press, New York, NY, [30] Stigler, G. J. The Economics of Information, J. Political Economy, 69(3), 1961, [31] Travel Industry Association of America, Online Travel Booking Jumps in 2002, Despite Plateau in Online Travel Planning, Press release, Travel Industry Association of America, Washington, DC, December 9, Accessed May [32] Travel Trade. DOT Report Favorable to Orbitz Is Blasted By Online Group, Article 2492, Travel Trade, New York, NY, December [33] U.S. Census Bureau. United States Department of Commerce News, February 24, [34] U.S. Department of Transportation. DOT Decides Not to Prevent Orbitz s Launch, Press release, Office of Public Affairs, U.S. Dept. of Transportation, April 13, [35] Web Travel News. Internet Travel Network Changes Its Name to GetThere.com, PhoCusWright Inc., Sherman, CT, July 16, [36] Zellner, W. Where the Net Delivers: Travel, BusinessWeek Online, June 11, Appendix. Comparison of Market Transparency Features: Orbitz, Expedia and Travelocity To provide an illustration of the level of transparency associated with the different OTAs Web sites, we show a sample booking request from New York to San Francisco for travel in August Appendix 1 illustrates the resulting matrix display of Orbitz, highlighting the navigation options. We also include the screen displays of Travelocity and Expedia for comparison. Although all of the OTAs offered an initial low price of $301, Orbitz provides greater market transparency. Why? Because its matrix display reduces the potential for bias, including more than 200 priced itineraries for the request, compared to just 28 for Travelocity and 33 for Expedia. In addition, both Orbitz and Travelocity offered an extra search to alternative airports which would result in lower fares, making a final offer of $255. However, Orbitz offered several options lower than $301, while Travelocity locked in the request to just one itinerary from American Airlines. 24

25 Appendix. A Comparison of Market Transparency Features: Orbitz, Expedia and Travelocity (continued) Appendix 1