operators and travel agencies also filter information, which further increases the efficiency of the search process.
However, no matter how much information consumers receive from sellers prior to
purchase, they still have to trust what the sellers say about their products. Often sellers
(hotels, airplane companies) may not provide enough information for consumers to fully evaluate their products or services, or the information may be inadequate to judge whether sellers are reputable companies or fly-by-night operators. In light of this, a TO’s role in a search market extends beyond being an information depositary and distribution centre. This is the issue that we analyse in the following subsection.
2.3 The tour operator and quality uncertainty
Economic theory distinguishes between ‘experience goods’ and ‘search goods’. Search goods are those goods whose quality may be learned prior to consumption and, thus, prior to purchase. For experience goods instead, their quality is learned only from experience, during or after actual consumption of the good. It is immediate to notice that the tourist product, like most (if not all) services, is an experience good. The quality of the service in a hotel can only be ascertained during stay; quality of a flight (punctuality in the time of departure, etc.) is only known during the flight itself; the quality of meals is Buyers Sellers.
Figure 3: Intermediation or des-intermediation in the search for information
Another example of experience good; and the same for all other goods and services that compose the tourist product. Thus, a crucial issue is the uncertainty that the tourist faces about the true quality of the tourist product prior to consumption, that is, prior to the vacation itself. In a rather more technical language, there exists asymmetry of information between the seller (hotel, airplane company) and the buyer of the tourist service, since the seller has better information than the buyer (the tourist) concerning the precise characteristics and quality of whatever tourist good or service in exchange.
Box 1. The ‘market for lemons’(Akerlof, 1970), applied to the tourist sector.
Suppose Alice, from Germany, is willing to go on vacation to the Balearic Islands. There are a priori two different types of hotel accommodation available. Type H with a high quality service, which she values in (for which she is willing to pay) 1000 €, and a type L with a low quality service which she values in (for which she is willing to pay) 500 €. There are a priori in the market a 50% of hotels offering the high quality service, and a 50% offering the low quality one. The cost of offering the high quality service is 800 €, whereas the cost of the low quality service is 400 €.
Alice does not know which hotel offers high quality or low quality service, this is private information of each hotel. There is thus a problem of asymmetric information: when booking some accommodation, she does not know whether the hotel offers high quality or low quality service. What she knows though is that there is a 50% chance that it is a type H hotel, and a 50% chance that it is a type L hotel.
As a consequence, her expected valuation of the stay is ½·1000 € + ½·500 € = 750 €. This means that at most she is willing to pay a price of up to 750 € for the accommodation. Otherwise, she would be paying more than what she values it in expected terms. The problem is that at a price lower than 750 € no type H hotel is willing to supply accommodation, since the cost of accommodation with high quality service is 800 €.
As a consequence, knowing this, Alice infers that the only hotels offering accommodation are type L with low quality service, which implies that she is only willing to pay a price up to 500 €.
Thus, it is immediate to see that the only Nash equilibrium is a price higher than 400 € and lower then 500 €, at which only type L hotels offer their service (type H hotels would abandon the market), and at which Alice goes on vacation. This is exactly what it means that ‘bad products drive-out good products’, and is the case of the ‘market for lemons’ that Akerlof first presented in his paper in the Quarterly Journal of Economics. It is well known in the economics literature that a consequence of such informational asymmetries may be a market failure: a transaction that would be a priori beneficial, value enhancing for all parts, might not take place. 7 This is what might happen in a situation of adverse selection (defined as that in which the seller has superior information than the buyer
prior to signing of the contract), and was first described by Akerlof . Akerlof
showed that in markets with asymmetric information between sellers and buyers (e.g. in used car markets), adverse selection might lead bad products to drive-out good products from the market. Because the buyer is uncertain about the quality of the good, it fears that it is one of low quality and thus it is only willing to pay a low price. Again, incomplete contracts are crucial. In a framework where a complete contract was available, no problem would arise. However, it is not difficult to see that quality cannot be perfectly and unambiguously described and, as a consequence, contracts are not capable of perfectly solving the problems related to the existence of asymmetric information.
Box 1 provides a numerical example of adverse selection in the
accommodation sector. Given the existence of informational asymmetry between the seller (or sellers) and the buyer, and the resulting potential market failure, the issue is what can be done about it. The obvious remedy is that sellers of the tourist product inform – and convince – potential buyers about the true quality of the product, thereby eliminating informational asymmetry.
A TO (an intermediary, in general) improves market efficiency by providing third party credible information about product quality. This way, it eliminates the possibility of a market failure due to quality uncertainty, and it does so at a lower transaction cost than the alternative organisational arrangements whereby the tourist deals directly with all sellers. The role of an intermediary might be of two types. An intermediary might be an expert, whereby it has acquired the appropriate knowledge and skills to evaluate the quality of the good or service in question. This type of intermediation is specially important in settings where usage and consumption is not fully sufficient to assess the quality of a good; for instance, some retailers that evaluate the quality of a DVD player.
Some of this role as experts is played by TOs in the tourist industry; for instance, some TOs evaluate and keep track of the environmental friendliness of hotel establishments. However, probably the main role of TOs arises because of the TO’s ability to build a brand name and reputation signalling the package of high quality tours. In this case, intermediation can enhance market efficiency even when intermediaries do not have superior knowledge and skills to evaluate quality (are not ‘experts’). TOs are a source of quality information simply by credibly building a reputation for providing high quality products. We see how this works in the following subsection.
2.3.1Reputation and repeat purchases
A conventional method to counter the quality uncertainty is to build brand name and a
seller-specific reputation. The key issue to building a reputation for providing high quality.
With the underlying assumption that consumers care about the environmental behaviour of hotel establishments, some examples of tour operators that have programs on environmental quality are Orizzonti (an Italian TO), Japan Travel Bureau, Scandinavian Leisure Group and TUI.
Products is that the firm be a long run player or that the product is purchased repeatedly. While in a one shot interaction the firm has large incentives to misreport quality to the potential buyer, in a framework with repeated interaction the firm may have an interest in maintaining a sound reputation so as to ensure future business.
The same incentive to build a sound reputation may appear in case the firm interacts
repeatedly with different buyers – in that case the reputation is passed along consumers. For products or services which are used only once, the reputation is built over a firm rather than a product so that firm specific reputation becomes the brand name by which the firm may transfer consumers’ trust from product to product. Furthermore, a basic requirement for any system of reputation is that each side (both the seller and the buyer) should be able to evaluate quality correctly after purchase, that is, evaluate the past behaviour of the other side. In box 2 we provide a numerical example in which a hotel establishment is able to build a reputation for providing high quality goods or services.
Box 2. Reputation for quality.
Consider one hotel that can provide two types of accommodation services: high quality and low quality service. A high quality service has a cost of 80 € per night of accommodation, whereas low quality service costs 40 €.
Anne is planning to spend a night in the hotel, and she values it by (her willingness to pay is) 100 € in case the service is high quality, and by 50 € in case the service is low quality.
The price per night of accommodation is 90 €. This implies that in case the service is high quality, Anne will have a utility of u=100 € - 90 € = 10 €; whereas if the service is low quality she will have a utility of u = 40 € - 90 € = -50 €. This implies that if Anne expects a low quality service she’d better not stay in the hotel. In case Anne stays in for the night, the hotel has two options: either offer a high quality service or a low quality service. The hotel’s profits per night with a high quality service is 90 € - 80 € = 10 €; whereas with a low quality service, the profit per night is 90 € - 40 € = 50 €. If the ‘game’ is played only once, that is, if Anne in any case will only stay one night at the hotel, the only Nash equilibrium is that Anne chooses not to stay in the hotel and, in case Anne stayed in, the hotel would offer low quality service. This is a clear cut result: the hotel is better off offering low quality service since its profit is then 50 €, rather than 10 € offering high quality service. In that case, foreseeing such behaviour, Anne will choose not to visit.
However, when the ‘game’ is played indefinitely (repeated infinite times), then the hotel may have an incentive to offer high quality service. Consider that Anne gives a bow of confidence to the hotel and chooses to visit, and then repeat if and only if the quality of the service was high. Then, the hotel must choose between two options. On one side, offering low quality service and gaining 50 € one night, and then never again accommodating Anne and thus having zero profit in the future. And on the other side, offering high quality service and thus keep hosting Anne repeatedly. This implies that the hotel’s profits are (since they must be discounted, which we do at the daily interest rate.
As a consequence, the hotel will choose to offer a high quality service whenever
Then, in such a case, supplying high quality service and Anne staying in the hotel as long as quality is high is a Nash equilibrium. We see then that the hotel has an incentive to build a reputation of providing high quality service since this ensures future business. Thus, when interaction between the seller and the buyer is not frequent or, when it is difficult for an outsider to the transaction to ascertain the quality of the good that has been exchanged, building a reputation is difficult or impossible. And this is quite exactly the case for the tourist industry in a direct exchange between final sellers (e.g. hotels) and tourists.
Consider the way in which, for instance a hotel company, could build a reputation for
providing high quality service. Many times, interaction between a tourist and a hotel
establishment occurs only once, since tourists switch destination or place of accommodation quite often. Which is then the incentive for a hotel company to maintain, to provide a high quality of the service? Since the tourist will most likely not repeat anyway, and since for outsiders (potential future tourists) it is difficult to know whether quality has been high or low, the incentive to save by providing low quality is high. Thus, each final seller in the tourist industry would not have much incentive to provide high quality. Thus, intermediation by a TO provides a solution to these the lack of incentives of final sellers in the tourist industry to acquire and maintain a reputation and a brand name to signal high quality. A TO has a double incentive to maintain a good reputation. First, with the tourist. Since the TO is going to supply a package tour consisting of many different products, in different places and to many consumers who are potential repeaters, a TO has the right incentives to ensure that quality of the package is as promised; otherwise, the unsatisfied tourist will not repeat purchase to the same TO of the (same or another) package tour. And second, with the final seller (hotel establishment, car rental company). Since the TO is a repeat buyer of the final seller’s product, this final seller has also an incentive to maintain an appropriate quality. Otherwise, in case quality is not good enough, the TO will stop distributing that firm’s product so as to keep its reputation with the consumers.
Three caveats to the previous analysis on the role of tour operators apply to large firms, to firms (of a destination) with a high rate of repeat visitors, and to low quality firms. Large sellers (for instance, large hotel chains such as Hilton) might themselves have powerful incentives to build a reputation and a brand name for quality: since a tourist has the option to accommodate in an establishment of the chain in many different locations, the likelihood that a buyer will repeat is high (or that someone known to the tourist might accommodate in the same chain). As a consequence, a large chain does have an incentive to maintain a reputation for high quality. The same caveat on reputation building can apply to (small) firms of a tourist destination where tourists have a high rate of repetition. When tourist repetition is high, even a small firm may show high levels of quality if it expects that a high proportion of present tourists are likely to come back in a near future. And finally, and intuitively, low quality firms have no need of a tour operator to certify its quality as being low. As we explained above in the market for lemons example, the exchange of low quality goods is not impeded by the existence of asymmetric information.
3 Internet and intermediation in the tourist sector
In the previous section, we have laid down the economics of intermediation in the tourist vertical chain. As Shapiro and Varian write in their 1999 book Information rules: “Technology changes. Economic laws do not”. Thus, with the framework laid down above, we should be capable to discuss the impact of internet and other ICTs on the vertical organisation of the tourist industry. Up to now, we have undertaken our analysis abstracting from the existence of internet and other ICTs; rather, in a sense, we have assumed we were in a scenario previous to the emergence of internet. Even though it has been long since the tourist vertical chain has incorporated several ICTs systems such as CRS (computer)/ However, in spite of the increasing importance of large hotel chains, many hotel establishment through-out the world are stand-alones or belong to a small chain, just like many other final sellers in the tourist industry (such as car rental companies, restaurants, etc.).
As a matter of fact, there is quite some evidence on the importance of such des-intermediation: Garau, for instance, shows that the use of package tour on the trips to Mallorca (one of the largest Mediterranean tourist destinations) has decreased in a
large manner, dropping from an 80% to a barely 50% in just a few years.
Our approach here is to review to what extent the role of a TO (and other intermediaries) in reducing search costs, in increasing the efficiency of coordination among the several components of the package tour, and in providing truthful and credible information on the quality of the several components of the tourist product, is affected by the apparition of internet. Following the transaction cost framework laid down above, we assess to what extent transaction costs of either organisational alternative (direct market exchange or intermediation by a TO) are affected by internet and, thus, in which way the optimal organisational architecture is affected.
3.1 Tour operator and the consumer search for information
Online search offers a tremendous advantage over physical search. To begin with, by using computer technologies such as search engines, consumers may be able to search the whole information space at a very low cost in terms of time and transportation.12 Furthermore, online search allows consumers (potential tourists) to process a wide arrange of information other than price – e.g., location and name of vendors, terms of sales, quality and performance variables, and other product characteristics. Even more, in some cases one may wonder whether search costs are always positive: there are consumers who seem to enjoy searches instead of costing them something, specially so in the planning and design of a vacation.