On-line International Price Discrimination with and without Arbitrage conditions Enrico Bachis...

On-line International Price Discrimination with and without

Arbitrage conditions Enrico Bachis Claudio A PigaNottingham University Loughborough University

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.

Example 1: no PD

~118GBP

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,

Example 2: PD and Arbitrage

Yes

It can be

Done!!

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.

Example 3: PD and Arbitrage

~41GBP

Example 4: Perfect Segmentation

~83GBP

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.

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)

Data Collection1. 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.

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 departure’s currency.

UKirtcbP

EUirtcbP

The matching of queries

UKirtcbP EU

irtcbP

Conditions for the LOP 0/ / UK

irtcbb

UKEUEU

irtcb PeP

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

Company Statistic Bmibaby RyanAir EasyJet Buzz GoFly MyTravel Total International Flights p1 0.60 0.06 0.05 0.03 0.05 0.50 0.06 p5 1.23 0.39 0.24 0.23 0.29 0.91 0.32 p10 1.67 0.88 0.46 0.45 0.62 1.37 0.63 p25 2.56 2.32 1.07 1.03 1.91 2.53 1.50 p50 4.25 5.32 2.35 2.05 3.62 4.20 3.41 p75 7.15 9.93 4.15 3.45 9.56 6.32 6.53 p90 10.67 17.20 5.92 8.17 16.95 10.13 12.13 p95 14.58 23.51 8.53 14.01 23.23 14.35 17.50 p99 22.79 36.81 17.58 29.50 42.21 32.96 34.08 mean 5.56 7.68 3.17 3.65 7.05 5.53 5.38 min 0.00 0.00 0.00 0.00 0.00 0.01 0.00 max 79.99 79.84 79.97 79.91 79.98 79.36 79.99 sd 4.85 8.08 3.81 5.62 8.65 5.94 6.53 N 168750 803782 849313 42333 30957 23289 1918424

Domestic Flights p1 0 0 0 - 0 0 0.00 p5 0 0 0 - 0 0 0.00 p10 0 0 0 - 0 0 0.00 p25 0 0 0 - 0 0 0.00 p50 0 0 0 - 0 0 0.00 p75 0 0 0 - 0 0 0.00 p90 0 0 0 - 0 0 0.00 p95 0 2.52 0 - 0 0 0.00 p99 0 10 5.00 - 10 0 5.00 mean 0.05 0.40 0.12 - 0.26 0.00 0.18 min 0 0 0 - 0 0 0.00 max 55.50 63.00 75.00 - 39.15 3.99 75.00 sd 0.88 2.05 1.39 - 2.20 0.13 1.54 N 54601 71408 137083 - 7534 1772 272398 Total N 223351 875190 986396 42333 38491 25061 2190822

Violating the LOP - 2b

UKEUUK

irtcbEU

irtcb ePP //

05

1015

2025

Ke

rnel

de

nsity

1.2 1.4 1.6 1.8

Ratio EUPrice/GBPrice Exchange Rate

Euro-area routesKernel Density of Ryan Air

05

1015

20K

ern

el d

ens

ity

1.3 1.4 1.5 1.6 1.7


Euro-area routesKernel Density of EasyJet

010

2030

Ke

rnel

de

nsity

1.4 1.45 1.5 1.55 1.6 1.65


Euro-area routesKernel Density of BmiBaby

010

2030

40K

ern

el d

ens

ity

1.4 1.5 1.6 1.7 1.8


Euro-area routesKernel Density of MyTravelLite

020

4060

8010

0K

ern

el d

ens

ity

1.4 1.5 1.6 1.7


Euro-area routesKernel Density of GoFly

05

1015

20K

ern

el d

ens

ity

1.3 1.4 1.5 1.6 1.7


Euro-area routesKernel Density of Buzz

A Taxonomy of cases UK

irtcbb

UKEUEU

irtcb PeP //

Discrimination Type values

Condition Logic

Oper.

Condition

0 – Non Discriminatory.

|Δ|<5

1- Discrimin. no arbit.

(UK AND Δ?-5) OR (Cont.EU AND Δ?5)

2 – Discrimin. No prof arbit.

(UK AND Δ?5 AND Δ?AC) OR (Cont.EU AND Δ?-5 AND Δ?-AC)

3– Discrimin. with prof arbit.

(UK AND Δ?5 AND Δ?AC) OR (Cont.EU AND ?-5 AND Δ?-AC)

)/,min(05.00.6 bEUirtcb

UKirtcb ePPAC

Is arbitrage rare? Variable “Discrimination Type” – Frequency (row %)

Departure From

0- Non discriminatory

1 Discriminatory - no arbitrage

2 Discriminatory -no prof. arbitrage

3 Discriminatory - with arbitrage

Cont. Europe 49534 (58.9%) 34357 (40.8%) 18 (0.0%) 211 (0.3%) UK 51281 (60.6%) 112 (0.1%) 24912 (29.4%) 8325 (9.8%)

Bm

i Bab

y

Total 100815 (59.7%) 34469 (20.4%) 24930 (14.8%) 8536 (5.1%) Cont. Europe 193133 (48.1%) 62909 (15.7%) 36163 (9.0%)

109552 (27.3%)

UK 191923 (47.7%) 143864 (35.8%) 20756 (5.2%) 45482 (11.3%)

Rya

n

Air

Total 385056 (47.9%) 206773 (25.7%) 56919 (7.1%) 155034 (19.3%)

Cont. Europe 329673 (78.7%) 77628 (18.5%) 7665 (1.8%) 4143 (1.0%) UK 381208 (88.6%) 16873 (3.9%) 27315 (6.3%) 4808 (1.1%) E

asy

Jet

Total 710881 (83.7%) 94501 (11.1%) 34980 (4.1%) 8951 (1.1%) Cont. Europe 17673 (84.2%) 2463 (11.7%) 169 (0.8%) 679 (3.2%) UK 18437 (86.4%) 1221 (5.7%) 767 (3.6%) 924 (4.3%) B

uzz

Total 36110 (85.3%) 3684 (8.7%) 936 (2.2%) 1603 (3.8%) Cont. Europe 9317 (60.6%) 2170 (14.1%) 1636 (10.6%) 2240 (14.6%) UK 9595 (61.5%) 3624 (23.2%) 504 (3.2%) 1871 (12.0%) G

o

Fly

Total 18912 (61.1%) 5794 (18.7%) 2140 (6.9%) 4111 (13.3%) Cont. Europe 6657 (61.0%) 4021 (36.9%) 62 (0.6%) 167 (1.5%) UK 7762 (62.7%) 188 (1.5%) 3244 (26.2%) 1188 (9.6%) M

TL

Total 14419 (61.9%) 4209 (18.1%) 3306 (14.2%) 1355 (5.8%) N 1266193 349430 123211 179590 %N 66.0% 18.2% 6.4% 9.4%

For Britons

For EU travellers

EU travellers adversely

discriminated

Non profitable Arbitrage for EU travellers

Is Arbitrage worthwhile? Variable “Discrimination Type”

Departure From

0- Non discriminatory

1 Discriminatory - no arbitrage

2 Discriminatory -no prof. arbitrage

3 Discriminatory - with arbitrage

Mean 2.9 9.7 7.1 15.9

Arbitrage Cost 7.7 10.1 9.3 11.3

Bm

i Bab

y

Mean UK

irtcbP 33.5 82.1 66.6 107.5

Mean 2.3 12.8 6.4 14.8


Rya

n A

ir

Mean UK

irtcbP 24.6 41.0 40.7 40.5

Mean 2.1 8.4 7.0 19.2


Eas

y Je

t

Mean UK

irtcbP 41.0 83.0 93.7 65.3

Mean 1.9 13.6 6.4 19.2


Buz

z

Mean UK

irtcbP 42.9 58.8 80.6 32.5

Mean 2.3 14.7 7.3 18.2

Arbitrage Cost 9.0 9.2 10.6 9.0 Go

Fl

y

Mean UK

irtcbP 61.3 73.6 98.1 70.6

Mean 2.9 9.7 6.9 17.4


MT

L

Mean UK

irtcbP 22.5 66.5 60.5 89.3

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)

Making arbitrage consistent with on-line PD

• Two non-mutually exclusive explanations for our findings:

1. 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.

2. The airlines may not be too worried if some arbitrage is exercised, when demand is low.

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

D

ND

A

NA

Note: NA includes non-profitable arbitrage cases

Descriptives

Marginal Effects

Estimates

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

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.

On-line International Price Discrimination with and without Arbitrage conditions Enrico Bachis...

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