The Limits of Reverse Auction Pricing Strategy and Priceline.com
Cotter, James F., Marcum, Bill, Journal of Business and Entrepreneurship
Priceline.com was thought to be the ideal e-Commerce company in that a simple reverse auction pricing mechanism was wedded to the unique opportunities of the Internet. At its inception, Priceline.com was considered a sure thing, because it provided participating firms the opportunity to better implement yield management while giving consumers access to irresistible discounts. And, in fact, the company's initial public offering at $16 ($3.2 billion market capitalization) and subsequent stock price run up to over $160 attests to the market's confidence in the Internet and Priceline.com's niche in it. Unfortunately, the market reassessed its confidence, resulting in a stock price decline from peak to trough of 99% of value in just four months. We argue that at least part of the reason is the fact that participating goods and service providers (GSPs) reduce their pricing aggression toward Priceline.com customers as the proportion of participating firms in a relevant market approaches 100%. While the ultimate demise of Priceline.com is not predicted, the paper casts considerable doubt on the ability of the reverse auction concept to revolutionize corporate pricing strategy.
Because of the Internet, for the first time in history it is conceivable that every business in a developed economy has global access to customers and markets. A number of established companies, however, have had difficulty in applying this new medium to their business models. On the other hand, the new breed of entrepreneurs, that is, Internet entrepreneurs, has not been encumbered by the need to adapt an existing business model. Rather, the Internet business model is created in virtual space and engineered on the premise that those who can create and deliver products and services unimaginable just 10 years ago will pave the path to riches.
This paper examines the Priceline.com (PCLN) business model and the likely reaction to industry-wide adoption of its reverse auction pricing mechanism.1 Initially, goods and services providers (GSPs) view Priceline.com as a potentially powerful component of a yield management system since it provides access to relatively price sensitive consumers. To liquidate their perishable excess inventory, the GSPs follow an aggressive pricing strategy that expands PCLN's trading volume by luring discount hunting bidders. Inevitably, however, the price aggression that fueled PCLN's volume is destined to plateau or abate as the proportion of participating GSPs approaches 100 percent. As the industry begins to uniformly participate in the reverse auctions, price aggression becomes better characterized as price predation. Rather than liquidating idle industry inventory, GSPs discover that the price transparency provided by PCLN allows customers the opportunity to save money by essentially swapping out their reservations. Essentially, GSPs find that they are more likely to be swapping customers rather than expanding their industry's sales or profits. Unfortunately for PCLN and its shareholders, limited GSP price aggression means the ultimate consumer is less likely to employ the reverse auction mechanism. In the end, PCLN will be relegated to opening new markets that rapidly disappear as GSPs make direct connections to customers.
THE REVERSE AUCTION BUSINESS MODEL
Priceline.com was founded as the patent of Digital Walker, which is an intellectual property laboratory, conceived by Jay S. Walker to devise patentable business models using the Internet as a platform.2 PCLN's business model is based on a reverse auction or conditional offer framework. The firm maintains inventory that consists of connections with companies that provide airline travel, new cars, hotel rooms, mortgages and rental cars provided by its confidential list of participating GSPs.3 To initiate the reverse auction process, potential customers specify product parameters (e.g., dates and destination for airline tickets) and a price (bid) at which they are willing to transact. …