What Priceline.com Learned from Economists

Inventor Jay Walker may not be an economist, but the successes of the company he founded is rooted behind the economics of price.

Innovation is one of the latest buzz words you hear everywhere – in conversations about what firms need to do to stay on top of their game (and to keep their stock prices up), and on what the U.S. economy needs to keep doing in to enhance living standards for itscitizens.

It is only natural to think of inventors, entrepreneurs and established businesses as being key to innovation. But one normally doesn’t hear the words “economist” and “innovation” in the same sentence, unless it is about the views of the economist about innovation.

I have recently written a book, Trillion Dollar Economists, centered around a very different notion, one which many economists may not appreciate about their profession – namely, that economists themselves have come up with ideas that either directly or indirectly have had hugely positive impacts on U.S. business. My central audience, however, is business executives and entrepreneurs themselves (and also students and would-be students of the subject, hopefully demonstrating its practical usefulness which may not be readily apparent in the math and chart driven way in which the subject continues to be taught).

One excellent example of a direct impact is the invention of “name your price” travel by Priceline.com. The inventor, Jay Walker, was not a professional economist, though he obviously paid close attention to the economics courses he took as an undergraduate at Cornell University in coming up with an innovative economic idea that has since revolutionized the travel industry.

That idea was more complicated than simply asking consumers to name their own price. For if that is all it was, then travelers would bid a dollar or two, or even pennies – prices that the airlines and hotels listed on Priceline obviously could never accept and stay in business. There was further complication. Airline seats and hotel rooms, or at least the right to use them on a particular day at a particular time, are no different than fruit: they are perishable. Any unsold seats on a given flight or for unbooked hotel rooms for any given day disappear after the flight takes off or the day is over.

Walker and his colleagues brainstormed how to solve three interrelated problems confronting all sellers of perishable merchandise, of which airline travel and the hotel business are prime examples:

• How can sellers discount the seats or the rooms (or any perishable item, for that matter) and attract new buyers without encouraging or allowing other buyers who are willing to pay full price from also taking advantage of the discount?
• How can regular, full-price customers be discouraged from delaying their purchases in order to receive last-minute discounted fares or prices?
• Because sellers cannot see the demand curve for their products (how many buyers there are at each price), they cannot discover it without lowering their prices in a way that cuts into their profits.

Walker’s team came up with the “conditional price offer” that solved all of these problems and is responsible for the travel revolution that made Priceline into a $60 billion-plus market cap company, while transforming the travel industry. The conditional price offer is one which says to travelers that must pay what they bid if the seller, the airline or the hotel, accepts the bid. Priceline ensures this will happen by requiring travelers to provide their credit card information up front.

The conditional price offer also signals to travelers who want a Priceline reservation that they must make serious bids – below the going market rate to be sure, but still high enough to induce the airline or hotel to accept the bid – if consumers really want the ticket or the room.

The genius of the conditional price offer is that has no effect on full price or regular customers, nor did these customers have any incentive to submit last minute low-price offers for what, in essence, were somewhat impaired versions of the normal service: flights whose times or departure airports (within a given radius of the customer’s departure location) only Priceline could control.

Name your own price travel appeals primarily, or course, to leisure travelers (and perhaps a few business travelers really trying to save money) who cared only about price and were flexible on other terms. In more technical terms, Priceline thus targeted the most price-sensitive customers on the demand curve for travel, and ignored other travelers.

The rest, as they say, is history. Using a series of clever television ads, starring William Shatner from Star Trek, Priceline quickly became a phenomenon in the late 1990s, had some growing pains after the Internet bust, but has gone on to become one of the leading travel booking sites on the web. Walker left the company long before all of this success was achieved, moving on to patent inventions relating to vending machines and inventing and manufacturing casino games. At last reckoning, Priceline’s market cap exceeds $60 billion – all from the implementation of a new economic idea that was a twist on what all undergrads learn about economics and consumer behavior in their introduction to the subject.

Walker’s story proves that one of the ways of transferring economic ideas from the Ivory Tower to business is through the entrepreneurial efforts of single individuals trained in economics. Other ways include hiring economists full-time, as a number of Internet companies are doing, and as I predict many more will do in the future. After all, there is much more for economists to do than think up or apply economic ideas and suggest putting them into practice.

The big data revolution has induced many firms to look for ways in which they can harness data about their consumers, suppliers, or anything else out there to refine their products, their marketing strategies or cost control efforts. Much of the analytical work required to make sense of Big Data is carried out by statisticians—ideally, those also having good skills in computer science. I am one among many who believe that practitioners of data science will be one of the hottest and best paid careers in at least the first half of the 21^st century (any students out there, are you paying attention?).

But there remains a role for economists, who not only have statistical training as part of their toolkit, but also a framework for analyzing business problems and challenges. Statisticians can help from having a guiding hand when trying to discover hard-to-find correlations that will stand the test of time and be relevant to predicting future behavior, rather than representing some statistical quirk. Economists can provide that guiding hand.

The great British economist John Maynard Keynes famously wrote “Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.” That statement remains as true today as it was when it was written roughly eight decades ago – with one amendment: many of the economists who have had and are still having important impacts on U.S. business are still very much alive.