Wednesday, September 25, 2013

Are Consumers Strategic? Structural Estimation from the Air-Travel Industry

Access the publisher's website Management Science 60, 9 (2014) 2114-2137

Many consumers have learned to delay purchases, anticipating that prices might decrease. Such strategic or forward-looking behavior has attracted increasing attention from various disciplines, including operations management, information systems, marketing, and economics. However, there is currently limited empirical evidence of the extent to which this strategic purchasing actually takes place. Combining two unique data sources from the air-travel industry (posted fare data and booking data), we use a structural model to estimate the fraction of strategic consumers in the population, assuming different levels of sophistication in consumers' perception of future prices: perfect foresight and weak- and strong-form rational expectations. We find that 5.2% to 19.2% of the population is strategic across markets, measured by the first and third quartiles. Our inter-market analysis indicates that shorter trips with alternate modes of transportation have a higher proportion of strategic consumers. Using a non-parametric approach, we further find that most strategic consumers arrive either at the beginning of the booking horizon or close to departure. Finally, our counterfactual analysis shows that, contrary to conventional wisdom, the presence of strategic consumers does not necessarily hurt revenues. Rather, the impact varies by market. Commitment to a non-decreasing pricing strategy is more likely to benefit business markets than leisure markets and it could even hurt leisure markets. Inter-market analysis shows that city-pairs with lower internet penetration, higher average price and shorter distances tend to benefit more from such commitment as well.