Imagine you are running a business and a customer approaches you and proclaims the following:

“I am willing to pay $150 for your product, but I swear on my life that I am not willing to pay a dollar more. I know that one of your competitors is willing to sell me a similar product for $150, and if you refuse my offer, I will instead purchase your competitor’s product.”

Would you accept the offer? Even though the offer price of $150 would generate a profit from your product that you otherwise wouldn’t sell, you probably wouldn’t accept, because you have no reason to believe that the customer is telling the truth. If you were open to negotiating at all, you would hope that this is their first offer, and upon refusal, they would continue to raise it. In fact, if you did accept, you would effectively be training your customer to lie to you to get the better deal. Even if you knew the competitor next door was, in fact, selling a similar product at $150, you might hope that the customer places a premium value on your brand. In a normal buyer-seller relationship, as you pointed out, “the buyer has no incentive to tell, as anyone who has haggled with a car salesman well knows.”

Imagine, though, if you could go to two car salesman, discover their minimum price, and somehow convince them that you are not willing to pay a dollar more (and, knowing each salesman’s minimum price, you really wouldn’t pay more to either of the two). This is where the credible commitment factor comes into play. If the supplier has good reason to believe that you are offering your maximum price, it is typically in their best interest to accept (assuming they are covering fixed costs and generating more profit then the next best alternative use of the unit of inventory).

Hotwire is not selling hotel rooms, air tickets or car rentals. At such steep discounts off of full price, the hotels, airlines and rental agencies are perfectly capable of selling their excess inventory directly to the customer without paying Hotwire commission.

Hotwire is instead selling “proof of credible commitment” – commitment on the customer’s part that if you refuse their offer, they will not be offering you a higher price. Hotwire’s business model creates a rate fence around customers that are price sensitive and brand insensitive within a given geographic area and quality tier.

As you mentioned, “sellers create segmented offerings as a way to get at least some customers to pay more”. In between the price insensitive, brand sensitive customer that is willing to pay full price for their preferred brand and the price sensitive, brand insensitive customer, there is a market of customers with a brand preference that are not able or willing to pay full price.

Using the credible commitment model from Hotwire, is there a way to reach this market? What about this: the customer commits to purchasing the product (in the given geographic range and quality tier) from the supplier with the lowest ask price, just like the Hotwire model. After entering their credit card information and agreeing to a non-refundable purchase, they are prompted with the opportunity to bid on the brand of their choice before the winning supplier is divulged, with two possible outcomes: the bid for the desired brand will be accepted and the customer pays a premium over the opaque price but a discount to the full, transparent price, or the bid is denied and the customer is required to purchase the product from the supplier with the lowest ask price in the opaque model.

The fundamental “credible commitment” factor still exists as the customer guarantees that if their offer to their preferred brand is refused, they are guaranteeing to purchase from the competitor. What are the flaws in this concept?

There are many cases in which a seller with excess inventory will say, in effect, “OK, I’ll sell this good or service for less than the price I’d like to, but to avoid driving down the product’s usual price I will actually damage or degrade it in some way first.”

One such tactic is “opaque selling,” you get exactly the same hotel room as you would have gotten at a higher price, but it’s artificially devalued because you don’t know if (for example) it’s convenient to a meeting you’re attending or to public transportation. Another is “crippleware,” in which you get a piece of electronic equipment or software with features artificially turned off. (Often, they can be turned back on by paying the difference between the “crippled” price and the full price, and receiving a code which activates the features.)

The problem with such schemes is that they only work in the absence of competition. If there’s real competition, the price of the undegraded product WILL be driven down as sellers compete for those last few customers. On the other hand, if there are multiple sellers with product available and they ALL engage in selling of degraded products rather than simply lowering their prices, it’s a form of tacit collusion to keep prices high.

I think you could use this approach for many other industry segments where you have excess capacity that is perishable (hotel rooms, flights, food, electronics, ad space, and so on). I don’t know of anyone doing these sort of things, but I didn’t look that hard…

My point on opaque pricing was a bit different — it is that opaque channels may offer sellers the opportunity to have their cake and eat it too. That is, that they can find the market clearing price as they already do and leverage another channel that will have minimal cannibalization of revenue, as has been done effectively in the travel industry.

Over time, price pressure would always set in, for the hotels it is get money now but suffer later. Any five star hotel wants to attract a certain kind of clientele, but with opaque selling the hotel attracts some people it does not want to and that drives down the price people with money are willing to pay for that item.

A lot of brands that tried price discrimination are pulling back and focusing on there core consumers, there is no need to be greedy.