Online and Offline Demand and Price Elasticities: Evidence from the Air Travel Industry

Abstract

T he Internet has brought consumers increased access to information to make purchase decisions. One of the expected consequences is an increase in the price elasticity of demand, or the percent change in demand caused by a percent change in price, because consumers are better able to compare offerings from multiple suppliers. In this paper, we analyze the impact of the Internet on demand, by comparing the demand functions in the Internet and traditional air travel channels. We use a data set that contains information for millions of records of airline ticket sales in both online and offline channels. The results suggest that consumer demand in the Internet channel is more price elastic for both transparent and opaque online travel agencies (OTAs), in part, because of more leisure travelers self-selecting the online channel, relative to business travelers. Yet, after controlling for this channel self-selection effect, we still find differences in price elasticity across channels. We find that the opaque OTAs are more price elastic than the transparent OTAs, which suggests that product information can mitigate the price pressures that arise from Internet-enabled price comparisons. We discuss the broader implications for multichannel pricing strategy and for the transparency-based design of online selling mechanisms.

Using Transaction Prices to Re-Examine Price Dispersion in Electronic Markets

“…This finding thus contributes to the literature on the welfare benefits of the Internet (Brynjolfsson et al 2003, Ghose et al 2006, Bapna et al 2008, Forman et al 2009). Consistent with an emerging stream of work (Granados et al 2009), we find that online markets exhibit higher own price elasticity, compared to that of offline markets. Thus, our paper also contributes to the literature that compares demand estimation in electronic markets with that in traditional markets (Chellappa et al 2007).…”

“…These estimates are consistent with the conclusions of earlier studies, which find that prices in electronic markets are generally more elastic than in traditional markets because of increased efficiency and market transparency (Ellison andEllison 2005, Granados et al 2009). In particular, Granados et al (2009) find that own price elasticity for online travel agencies is −1 29, whereas for offline travel agencies it is −0 82. 15 Having estimated the own price elasticity, we follow the approach used by Ghose et al (2006) to estimate the gain in consumer surplus attributable to the use of the electronic market.…”

“…Other studies, such as those of Ellison and Ellison (2005) and Granados et al (2009), also find that prices in electronic markets are more elastic than in traditional markets because of increased market transparency and competition. Hence, we expect that the inverse relationship between own price elasticity (i.e., a buyer's sensitivity to the change in the price of a seller) and price dispersion to be even stronger in electronic markets than in traditional markets.…”

“…Smith and Brynjolfsson (2001) and Smith (2001) estimate that search costs in electronic markets may be reduced by "at least 30-fold," compared to those in telephonebased shopping, and even more compared to the price of physically visiting the retailers. Second, electronic markets increase information transparency in both B2C and B2B scenarios (Granados et al 2009) and reduce information asymmetry (Clemons et al 1993). For example, electronic markets can increase information availability and processing capability, thus …”

“…When product availability information is private, all sellers tend to charge similar prices (for example, an inferior seller with low product availability can also pretend to be a superior one and charge a high price). Because of increased supplier transparency in electronic markets (Granados et al 2009), sellers are likely to set their price based on their actual service level, thereby resulting in greater price dispersion. This is particularly true for products with longer order cycle times, because these products tend to have a greater variation in offerings among sellers than do products with shorter order cycle times.…”