On-line International Price Discrimination with and without Arbitrage conditions

1. On-line International Price Discrimination with and without Arbitrage conditions Enrico Bachis Claudio A Piga Nottingham University Loughborough University

2. 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.

3. Example 1: no PD ~118GBP

4. 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,

5. Example 2: PD and Arbitrage

6. Yes It can be Done!!

7. 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 flight’s 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.

8. Example 3: PD and Arbitrage ~41GBP

9. Example 4: Perfect Segmentation ~83GBP

10. 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 flight’s 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.

11. 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)

12. Data Collection • Primary data on fares and secondary data on routes traffic • May 2002: fares collected using an “electronic spider” from only the main LCCs (i.e., Ryanair, Buzz, Easyjet, GoFly) • In Jan03, the “spider” was updated to retrieve fares from the Bmibaby and MyTravelLite sites. Flybe hard to crack!!! • Prices were gathered for both UK domestic and to European destination flights. • 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.

13. 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 theother, the direction of the round-trip was reversed, the outgoing flight originated in continental Europe and the fares were denoted in the country of departure’s currency.

14. The matching of queries

15. 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

16. Violating the LOP - 2

17. A Taxonomy of cases

18. Non profitable Arbitrage for EU travellers Is arbitrage rare? EU travellers adversely discriminated For Britons For EU travellers

19. Is Arbitrage worthwhile?

20. 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)

21. 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.

22. 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 “Discriminatory”=1 A D NA ND Note: NA includes non-profitable arbitrage cases

23. Descriptives

24. Marginal Effects

25. Estimates

26. 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

27. 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.