The past few years have seen the rise in “disruptive” tech startups playing a game of almost pure arbitrage, taking advantage of market inefficiencies to benefit consumers.
- Car services such as Uber and Lyft connect anyone with a smartphone directly to drivers, shortcutting the traditional street-hailing model. Uber is now valued at more than $40 billion.
- Airbnb allows anyone with a spare couch or guest room to connect directly with renters. Airbnb is now valued at around $10 billion.
- Lending Club connects private capital to small borrowers, bypassing banks. Lending Club went public this month and raised almost $1 billion.
Each of these start-ups identified a pricing inefficiency and capitalized on it. The services provided by these start-ups are purely information-based. The value of each company is derived from its “finders’ fee,” representing a portion of the benefits it creates by providing a new service desired by its customers. The rest of the benefits accrue to the consumer in the form of cost savings.
And each of these start-ups has been targeted by regulators in the United States and abroad, as legacy industries seek governmental support for the excess burdens they place on consumers.
The most recent example of industry playing hardball with disruptive technology is the lawsuit United Airlines and Orbitz filed last month against Aktarer Zaman and his company, Skiplagged.com.
Skiplagged operates by selling consumers information they could already find for free, but that airlines count on them not to find— a “hidden city” airline ticket in the middle leg of a multi-city fare.
Because layovers are unattractive, airlines often discount multi-stop itineraries. And in some cases, the cost of the entire itinerary is less than the cost of, for example, the first leg of the trip. In effect, an airline might pay a consumer to fly through multiple airports rather than take a direct flight.
For example, if you are traveling from Los Angeles to New York on United Airlines, you might have a stop-over in Chicago. And the cost of the entire itinerary (Los Angeles to Chicago to New York) might be less than the cost of a direct flight from Los Angeles to Chicago. In such a situation, a savvy consumer might purchase the Los Angeles to New York ticket, but simply leave the airport upon arrival in Chicago.
Using the airlines’ own websites, this can be done, but it is time consuming. And there are websites, such as Orbitz, that already search multiple airlines for consumers and allow seamless booking. Orbitz, however, is not entirely independent of the airlines, and therefore has an incentive to prevent consumers from capturing the “hidden city” value. It was founded by and has been majority-owned by airlines, and even now is largely owned by hedge funds with significant positions in institutional airlines.
Skiplagged allows consumers to search and find these “hidden city” fares, and redirects consumers to Orbitz for booking. It is unclear whether Zaman has profited at all from his website. He claims he has not.
Now, United Airlines and Orbitz have sued Skiplagged and Aktarer Zamen in federal district court, alleging, among other charges, that Zaman has breached a contract it had with Orbitz, and has wrongfully (“tortiously”) interfered in the contractual relationships United and Orbitz have with their customers.
These legal claims are highly questionable.
Apart from technical questions of law, however, the economics of the practice that is being undermined are rather straightforward.
The prohibition on “hidden city” fees is attractive to airlines where the airline determines that there are a number of low-information, price-insensitive consumers seeking to fly to the “hidden cities,” and a number of extremely price-sensitive consumers who are willing to fly through hidden cities to more attractive locations.
In these situations, the airline will price a multi-stop itinerary bundle low, attracting new price-sensitive customers while counting on the low-information consumer to purchase the single-stop ticket at a higher price.
To be sure, some profit on any given high-priced ticket United no longer sells due to Skiplagged’s service might be lost to the airline (and perhaps to Orbitz, if it receives a portion of the higher fares through commission). Yet Skiplagged might actually increase United ticket sales to those marginal consumers who previously were “priced out” (chose not to buy tickets) due to the airlines’ practice of withholding information and charging higher fares on “hidden city” fares.
Whether Skiplagged causes Orbitz or United any harm will have to come out in discovery—ironically, this will also tell consumers the precise magnitude of the harm they were suffering before Skiplagg’s service became available.
The broader point, however, is that Skiplagged—like Uber, Lyft, and Airbnb before it—is being targeted by a legacy industry that sees litigation or lobbying to be cheaper than competition in the marketplace. In fact, Orbitz itself admits its intent and its impotence here:
To counteract Zaman’s conduct, Orbitz is continuing to investigate ways in which it may detect customers originating on Skiplagged.com and prevent the ‘hidden city’ bookings from being made on the Orbitz site. Nevertheless, Zama’s repeated variation in redirection strategies and his use of technical approaches… have frustrated Orbitz’s efforts. Injunctive relief will be necessary to ensure that Zaman does not further alter his software in an effort to circumvent Orbitz’s corrective actions.
It is unclear at this point how Skipplagged has interfered, tortiously or otherwise, with any contractual relationships that Orbitz or United has or what damages (other than greater difficulty charging artificially high prices) they have suffered.
Moreover, it appears that Orbitz has full control over its own destiny. To prevent “hidden city” ticketing, all it needs to do is stop offering hidden city tickets on its website, by, for example, refusing to sell multi-leg fares that are discounted relative to a direct flight. Yet such an option is unattractive, because Orbitz and United are perfectly fine selling the tickets, just at a mark-up.
It seems as if all that Zaman is doing is advertising certain fares that Orbitz offers on its website, but in a way that makes it easier for consumers to save money. This is pro-competitive: the type of activity that markets should encourage, not discourage.
Finally, Google operates free itinerary-searching software as well. So why not sue Google? Perhaps because Google has enough money to push back and defend itself in court.
Disclosure: An executive of Heritage Action for America, a sister organization of The Heritage Foundation, is married to an executive of Uber.
This article has been corrected regarding Orbitz’s ownership and relationship with the airlines.
