On-line International Price Discrimination with and without Arbitrage conditions

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On-line International Price Discrimination with
and without Arbitrage conditions

• Enrico Bachis Claudio A Piga
• Nottingham University Loughborough University

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Introduction

• A new form of Price Discrimination on-line
• Surprisingly, this comes with Arbitrage
  opportunities
• PD and Arbitrage opportunities persist over time
• Evidence consistent with high (not low) search
  costs on-line.
• Discrimination seems to constitute a highly
  flexible pricing strategy, suitable to very
  different market conditions.
• Finally, discrimination is more likely within two
  weeks prior to departure, suggesting it is used
  to manage stochastic demand.

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Example 1 no PD
118GBP
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No PD a theoretical rationale
Consistent with a situation where the airlines
are confident that aggregate demand is
sufficiently high to fill the flight to capacity.
Thus, the single price corresponds to the
maximum fare a passenger in either country is
willing to pay. Search costs are not relevant
here,
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Example 2 PD and Arbitrage
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Yes It can be Done!!
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PD and Arbitrage a theoretical rationale
The airline believes aggregate demand is not
enough to fill the flight to capacity, and
therefore resorts to standard third-degree price
discrimination to maximize a flights load
factor. the high demand group is made up of
passengers that are returning to their country of
residence (the Britons), thereby raising the
possibility of arbitrage. Absent search costs,
it is likely any price divergence would be
arbitraged away. It is reasonable to assume that
the presence of consumers with positive search
costs makes on-line price discrimination and
arbitrage a feasible strategy for the LCCs.
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Example 3 PD and Arbitrage
41GBP
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Example 4 Perfect Segmentation
83GBP
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Perfect segmentation a theoretical rationale
The airline believes aggregate demand is not
enough to fill the flight to capacity, and
therefore resorts to standard third-degree price
discrimination to maximize a flights load
factor. the high demand group is made up of
passengers that are leaving their country of
residence (the Italians), so no possibility of
arbitrage.
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Discussion

• An innovative form of on-line pricing, different
  from any discussed in literature.
• For the same flight, at the same time, the
  airline posts two different fares denoted in
  different currency, that violate the Law of One
  Price.
• Price Dispersion is only due to Discrimination,
  as no cost difference exist between the two
  prices.
• Arbitrage opportunities seem to accompany some
  cases of Discrimination
• Surprising because arbitrage is assumed to be
  incompatible with discrimination (Lars Stole,
  2005 Jean Tirole, 1988)

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Data Collection

1. Primary data on fares and secondary data on
   routes traffic
2. May 2002 fares collected using an electronic
   spider from only the main LCCs (i.e., Ryanair,
   Buzz, Easyjet, GoFly)
3. In Jan03, the spider was updated to retrieve
   fares from the Bmibaby and MyTravelLite sites.
   Flybe hard to crack!!!
4. Prices were gathered for both UK domestic and to
   European destination flights.
5. We collected the fares for departures due,
   respectively, 1, 4, 7, 10, 14, 21, 28, 35, 42,
   49, 56, 63 and 70 days from the date of the
   query. No kind of study where these fares are
   studied for such a long period and for so many
   routes.

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Data Collection 2

• Other flights info, such as date and time of
  departure and flight code, were also saved.
• Each query for a round-trip was carried out
  separately (but simultaneously).
• In one type of query, the outgoing flight
  originated in UK and fares were denoted in GBP
• In the other, the direction of the round-trip was
  reversed, the outgoing flight originated in
  continental Europe and the fares were denoted in
  the country of departures currency.

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The matching of queries
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Conditions for the LOP
Violations to LOP occur only for international
flights, where search costs are higher. Plus,
data within Europe (not in the paper) confirms
that fares in the same currency (Euro) do not
differ
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Violating the LOP - 2
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A Taxonomy of cases
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Is arbitrage rare?
Non profitable Arbitrage for EU travellers
EU travellers adversely discriminated
For Britons
For EU travellers
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Is Arbitrage worthwhile?
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E-commerce

• A typical assumption in e-commerce literature
• Low search costs lead to high price transparency.
• Solution to this Brand allegiance and/or
  obfuscation strategies.
• The existing literature assumes away the
  possibility of different prices for the same
  e-retailer, on the same site at the same time.
• Price Dispersion is across e-retailers, both in
  theoretical and empirical work.
• Theoretical reference for Dispersion within the
  same firm Salop (1977, RevEcStud)

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Making arbitrage consistent with on-line PD

• Two non-mutually exclusive explanations for our
  findings
• In a particular sense, Search costs may not be as
  low as one might think
• bounded rationality due to psychological inertia
  prevents the search in the first place.
• The airlines may not be too worried if some
  arbitrage is exercised, when demand is low.

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The econometric model

• We use a Bivariate Probit model with Sample
  Selection to study two discrete variables
• Discriminatory, and
• Arbitrage. This is relevant only for the
  sub-sample where Discriminatory1

A
D
NA
ND
Note NA includes non-profitable arbitrage cases
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Descriptives
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Marginal Effects
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Estimates
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Econometric Results

• Persistence over time characterizes
  discriminatory cases
• arbitrage opportunities may remain posted for
  long periods
• evidence generally suggests a relation between
  discriminatory observations and route
  concentration
• Market Size and the presence of charter
  operators are both positively correlated with
  discriminatory cases

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Conclusions

• We conclude that PD seems to be of a competitive
  type.
• arbitrage opportunities tend to be more likely
  when the airlines enjoy a dominant position.

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