Perspective: It's a Revolution, Who Is Winning?

Regional ReviewQuarter 3, 1999
by Jane Katz

The Internet is revolutionizing shopping; so say the gurus and the high-tech Jacobins. And indeed it is, giving us the chance to bid for Pez dispensers online and trade stock 24 hours a day.

Those leading the ideological charge onto the Web get much of their zeal from their powerful conviction that the new technology will rein in the power of sellers and put the customer in charge. But Internet retailers will continue to have an incentive to fight back. And a revolution can cut both ways.

Take priceline.com, the Stamford, Connecticut, company launched in April 1998 that is worth a cool $12 billion on paper (as of late July) after its IPO last March. Priceline offers airline tickets, hotel rooms, mortgages, and new cars for sale online. “A revolution for buyers and for sellers,” trumpets the website. “Priceline is a buying service that lets you name your price.” Just specify the amount you want to pay for an airline ticket and, with the click of a mouse, the vast power of the Internet is at your disposal. Priceline’s proprietary software whirs away; and within an hour, you’ll know whether you have a deal.

The benefits are obvious. You can shop at any time of the day or night, with all the comforts of home. There are no phone calls to airlines with endless waits on hold, and no travel agents.

But by setting up the process this way, priceline actually shifts power away from the buyer. And rather than turning up the lowest possible price, the company is able to extract the highest price the customer is willing to pay.

Consider a prospective traveler who cares about (wants to maximize) the chances of getting a ticket. The lower the offered price, the more likely it is to be rejected. But once rejected, an offer can’t be resubmitted without changing either the travel date or the destination. So without a second chance, a committed buyer has an incentive to name the most he or she would be willing to pay. Of course, you want the ticket to Hawaii for only $100 (in fact, you want it for free). But the rules encourage you to think hard about the price at which you will actually walk away. Priceline is, in effect, a consolidator for airlines and hotels that have extra capacity to unload. Except that rather than sizing up demand and setting a single price that will clear the shelves (that is, setting price at the margin), priceline encourages each customer to part with their maximum dollars.

Now, as a price-setting strategy, this is hardly revolutionary. It is simply a time-honored way to sell to the price-sensitive at a low price, while still commanding a premium from those who are willing and able to pay more — like offering student discounts or pricing the afternoon movie lower than the evening show. The problem for firms has always been figuring out prospective customers’ willingness to pay, since buyers obviously have an incentive to conceal this information. In the past, they might have used an observable characteristic — such as student status or whether the customer is a household or a business — to infer price sensitivity. Priceline has figured out how — with its software, the Internet, and the promise of a revolution — to get customers to simply declare it themselves.

That is not to say that priceline does not expand the consumer’s options for finding a good deal. Some travelers will save modestly over published fares. Those who can be flexible about when or where they travel can toss out a lowball offer and see if anyone bites.

In the long run, getting a good price will depend on the number of sellers competing for customers. Ultimately, the airlines control when and under what circumstances they sell off seats to discounters. But to the extent that priceline must vie with other ticket outlets, consumers will be able to drive a harder bargain. One might argue that it is competition that offers the real revolution.

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