Designing Price Ladders in Competitive Environments: Theory and Field Experiments

点击翻译按钮获取中文摘要

Airlines, e-retailers, and hotels change their fares dynamically. How are these fares determined? Typically, companies begin by creating a fare ladder-i.e., a ladder with multiple price points. Once this ladder is designed, the selling season begins and, as time goes by, the fare progressively changes as a function of sales and inventory. Now consider price ladders in a competitive environment, where different companies offer products of varying "quality" or desirability. Think, for example, of two airlines offering a flight between Montreal and Ottawa-with one offering a direct flight and the other a flight with multiple layovers. In such an environment, how should competitors incorporate quality differences when designing the price ladder? In practice, firms do not typically differentiate their price ladders. For example, airlines and hotels use a "ladder matching strategy," whereby competitors design the same price ladder for a given market. We can verify, via the Airline Tariff Publishing Company database, that ladder matching occurs in 96.5% of the airline markets. In fact, ladder matching happens even when there are outlandish differences in  quality-e.g., a direct vs a connecting itinerary, or a short vs a long layover. Why would competitors design the same price ladder when one product is more attractive than the other? Their idea behind this strategy is that the market forces dynamically drive price differentiation. Thus, if a company offers a better product, consumers will buy it aggressively and the fare will quickly escalate up the ladder (while a low-quality product will stay locked to the bottom). Thus, companies do not proactively infuse quality difference into the ladder but, instead, let differentiation be "demand-driven." This strategy may have been efficient in the past, when consumers lacked systems to compare products-e.g., fare aggregators like Expedia-and when quality differentiation was minor. But, as firms themselves admit, times have changed, and it is time to revise how price ladders are designed. In this 5-year research program, my goal is to study price price ladder differentiation in competitive environments. To achieve this goal, my  program will be broken into three modules, each with its own short-term objective: In Module I, I seek to find optimal ladder differentiation strategies (and the competitive implications of these strategies) via game-theoretical models. In Module II, I seek to understand, via optimization models, how dynamic pricing should be optimized when competitors use quality-differentiated ladders (as opposed to matched ladders). And, in Module III, my objective is validate the theoretical findings in the real world, via a large-scale field experiment, by leveraging an ongoing research partnership with an airline. This program will help managers increase market efficiency, develop  equitable and efficient pricing, and, thus, positively impact on firms and consumers.