Tuesday, August 21, 2007

Internet in Hotels—a Puzzle

In my experience, low and medium priced hotels/motels usually provide a free internet connection, high priced ones usually charge for it. This seems to be true not only in the U.S. but in Europe as well, although that conclusion is based on less data—one fancy hotel in Helsinki, one each less fancy in London and Paris.

Does the pattern hold in general? If so, why? The obvious guess is that it has something to do with price discrimination, but I'm not sure just why it makes more sense to price discriminate against internet users in expensive hotels than in inexpensive ones.

25 Comments:

At 7:39 AM, August 21, 2007, Blogger Seebach said...

I think that generally holds true. I suppose people staying in cheaper hotels are usually younger people that are much more likely to have free wifi as a definitive requirement, while the ones in the more expensive hotels are more likely to consider internet a luxury that obviously will have a cost.

Another factor I think may influence this, is that some hotels probably outsourced thier connectivity back in the late 90s on 10 or 15 year exclusive contracts, and simply can't roll that back, even if they wanted to.

 
At 7:51 AM, August 21, 2007, Anonymous Perry E. Metzger said...

Less expensive hotels are more likely to offer amenities like free breakfast as well.

I'm not entirely sure what the reason that cheaper hotels offer more free services might be, but it appears to be consistent across different services of this type -- that is, services that cost nearly nothing to offer but which people make use of quite frequently.

 
At 7:55 AM, August 21, 2007, Anonymous jahn said...

Perhaps the fancy hotels want to discourage people from staying in their rooms (free internet) in the hopes the guests will go to their fancy (and expensive) restaurant?

Cheap hotels usually don't have a restaurant, so they don't really care if people stay in their room or not.

 
At 8:03 AM, August 21, 2007, Anonymous Anonymous said...

Expensive hotels are primarily occupied by people on expense accounts- when someone else is paying, who cares about silly upcharges for a host of amenities.

Moderate hotels are paid for by individuals with hard earned, often after tax dollars- they are maximizing their value.

 
At 8:10 AM, August 21, 2007, Blogger Steve said...

It's the "Other People's Money" syndrome at work: I found this a lot when negotiating with con hotels and then doing "day-job" event organising in the 1990s.

Basically, if people are paying their own way, they'll look for bargains. If the company's picking up the tab, though, they'll go with convenience. The larger hotels know that most of their customers are corporate, and so charge what they can get away with.

I'm surprised, to be honest, that there isn't a separate section of economics that looks at what happens when the direct customer isn't the one who pays....

 
At 8:21 AM, August 21, 2007, Blogger smilerz said...

Low price hotels are typically competing on price - one way to provide more "value" for the price is to include free stuff.

Higher class hotels aren't competing on price - they are competing on location, ambiance, luxury and similar things. Given the different type of competition they do not need to provide free services.

 
At 8:58 AM, August 21, 2007, Anonymous Michael Martin said...

I agree with anonymous 8:03. It's price discrimination, and it's designed to select out the business travelers from the vacationers, who can forego internet access.

What's more interesting to me is how the marketing has changed so much. It seems that more franchises used to be targeting recreational travelers 10 years ago. Almost every big franchise is geared towards the business traveler now. I guess the business travel market just grew faster.

 
At 10:39 AM, August 21, 2007, Blogger Matt Brubeck said...

The Quarterly Journal of Economics published a paper by Laibson and Gabaix with an interesting explanation for extra fees in the hotel industry:

"The smartest strategy, they say, is for the sophisticated consumer to choose the service with the most hidden charges and highest add-on prices, but then avoid paying those added costs. 'The sophisticated consumer takes advantage of that,' Mr. Gabaix said. 'The naïve pay all the fees.'"

 
At 11:11 AM, August 21, 2007, Blogger David Friedman said...

"I'm surprised, to be honest, that there isn't a separate section of economics that looks at what happens when the direct customer isn't the one who pays...."

The technical term is "agency problems"--what happens when A is acting as an agent for B.

But the fact that people at fancy hotels are on expense accounts, even if true, doesn't explain the puzzle. Why don't the hotels take advantage of that fact by charging higher room rates instead of by charging for extras?

 
At 12:30 PM, August 21, 2007, Blogger Arthur B. said...

Not all people in fancy hotels are on expense accounts. Those who are, the business travelers, are more likely to need internet access than those who are not, the vacationists. If the hotel were merely charging higher rates they would lose some of the vacationists. Subtle price discrimination.

Similarly many hotels sell heavily discounted rooms to sellers targeting price concerned guests.

 
At 12:37 PM, August 21, 2007, Blogger Mark said...

Why don't the hotels take advantage of that fact by charging higher room rates instead of by charging for extras?

Company agent A books the hotel, and is judged by whether she picked a decent hotel with a good rate.

Company agent B induces the service charge for the internet, and is judged as by whether the action was reasonable given the cost.

It's much easier to get agent B to tack on an extra $20 than it is to get agent A to pick a hotel that is has a rate $20 higher than comparable hotels.

 
At 1:39 PM, August 21, 2007, Blogger Justin said...

Why don't the hotels take advantage of that fact by charging higher room rates instead of by charging for extras?

Even when the rental is by individuals, not companies, that's not surprising. It's an incomplete-information problem. Hotel rentals are mainly done based on headline price, not taking the add-ons into account -- by the time a higher-end consumer looks at the add-ons, he's already committed, and will simply swallow the extra cost.

By contrast, someone looking for a bargain is both going to look for a lower headline price *and* look at the add-on costs -- hence, the lower-end hotels can't get away with that particular bait-and-switch as effectively...

 
At 2:52 PM, August 21, 2007, Blogger antoniseb said...

I'm experiencing the same thing. I have two guesses as to why:
1. The expensive hotels put it in first, when they could charge for it, and haven't relaxed the policy yet.
2. The cheaper hotels supply less total bandwidth, and give you spottier service.

 
At 3:17 PM, August 21, 2007, Blogger Brian Dunbar said...

Limited travel over the past five years but that seems to hold true.

Had a new wrinkle at an expensive biz hotel in D.C. two weeks ago;

Internet access was free. If you wanted a bigger pipe and ability to VPN it cost.

VPN is essential to most business folks so this had to be aimed at folks on an expense account.

Luckily we had a dodge - my company has switched over to a web-based VPN which bypassed their system.

 
At 6:06 PM, August 21, 2007, Anonymous Another Dave said...

My travel experiences agree with the theory of price discrimination based on business vs. personal travel.

A data point that supports this theory -- one of the most expensive places I've ever stayed was a mountain side lodge in Vail. The rooms there had free internet access. I think it's a reasonable assumption that almost 100% of this place's clients are personal travelers who intend to not spend much time in their rooms with their computers. Internet access is an interesting differentiating feature but not something typical guests would be willing to pay much extra for.

The reason why business-oriented hotels don't price the fees into the room rate is because corporate travel policies tend to border on irrational. Policies tend to dictate base room rates without regard to the additional fees. I'm required to select a hotel based on room rate even if that means I'll end up paying more for room plus internet plus additional cab fare and so on. I suspect this is to keep the costs of auditing expense reports down.

 
At 10:50 PM, August 21, 2007, Anonymous william h. stoddard said...

I'm surprised, to be honest, that there isn't a separate section of economics that looks at what happens when the direct customer isn't the one who pays.

This seems to be a major issue in the economics of health care, both in countries with tax-funded medical systems and for Americans who have health insurance. I would assume some health care economists have looked at the perverse incentives problems of health care.

 
At 11:57 AM, August 22, 2007, Anonymous Robert S. Porter said...

This precisely what your friend Steven Landsburg talked about in one of his Slate columns.

 
At 6:16 AM, August 27, 2007, Anonymous Anonymous said...

David Friedman asked:

"But the fact that people at fancy hotels are on expense accounts, even if true, doesn't explain the puzzle. Why don't the hotels take advantage of that fact by charging higher room rates instead of by charging for extras?"

Short answer: I think it's lazy supervision by company travel departments.

Long answer: Travelers on expense accounts usually have to answer to accountants at company travel departments. The departments, in turn, will have CFO-initiated cost-cutting policies to enforce. For these accountants, the hotels' base rates are easy to compare. (Even in the most difficult case, they just look them up on the hotels' websites.) The costs of extras, by contrast, are much harder for them to figure out: usually, hotels disclose them only to travelers, and only after they've checked in already. Thus, when accountants evaluate competing hotels, they will typically find it worth their effort to compare base rates, but not the cost of extras.

Now imagine a hotel that has charged, say, $130 a day plus extras. If takes your advice and changes its price to $150 flat. This makes it look expensive to company accountants. Travelers who book it will be asked potentially embarrassing questions, which they can avoid by booking a different hotel. By contrast, imagine the hotel sticking with its old, opaque pricing policy. Now travelers will book, check in, "find out" they need to pay extra for internet, do so, and after the fact send their bill to the travel department. This way, the hotel gets the same amount of money per visit. But company accountants won't ask its customers uncomfortable questions anywhere in the process, making the customer more likely to book in the first place.

***

On a more abstract level, your question seems to indicate excessive confidence in company rationality. As a remedy, may I recommend Herbert Simon's work on the inner workings of corporations? It's almost as sobering as James Buchanan's work on the inner workings of governments, and just as rightly so. It is also fairly similar in its reasoning.

 
At 12:19 PM, August 27, 2007, Anonymous Anonymous said...

With my company it is an agency of an agency problem. The travel services department gets credit for negotiating "corporate rate" cheaper than "rack rate" so they require us to stay in more expensive, less convenient hotels that offer "big discounts" instead of hotels that offer less discount but still have cheaper room rates.

I think this is the same problem house buyers have with realtors "representing" them. Realtor gets paid a percentage of cost so has little incentive to help reduce price.

 
At 1:56 PM, August 27, 2007, Blogger raphfrk said...

I wonder if there would be an effective way of getting around that. Ideally, you want to give your agent a percentage of the saving he makes you.

However, that just encourages sellers to push up list prices and then give reductions to bring the price back to normal.

There was a mortgage agent in Ireland who offered a service where they charged a flat fee for all customers.

They also provided a solicitor who would handle the legal affairs for the house purchase.

What was interesting was that they would still negotiate a broker's discount for you. However, they gave it to the customer (well it was used to offset their fee). This eliminated the conflict of interest for the broker.

For the travel agent. Maybe the travel department should ring a random hotel in the area and obtain a rate. They then offer the agent 25% of the savings that he can make relative to that rate. They would also need to include all the optional extras.

This ofc could lead to company rules that ban internet access.

 
At 8:50 PM, August 28, 2007, Blogger Monty said...

I spent part of the last year doing antitrust work on a merger relating to hotel in-room services.

A couple facts are helpful here. First, marginal cost of internet service for one additional room / night is nearly zero. Second, when most hotels were rolling out internet services, my understanding is that systems to track usage on a per-room basis and to enable / disable service on a per-room-per-day basis were not inexpensive, and would require integration with the hotel's billing system.

Accordingly, for low-end hotels, it was easiest to either provide no internet or to provide it free to all rooms.

Even if some hotels in the low-end range had the sophistication to provide and bill per-room, forces of competition probably made such investments and policy changes unprofitable, even if the investment required to implement per-room tracking and billing has since decreased.

 
At 4:37 PM, August 29, 2007, Blogger scatterbrained said...

Fancy hotels are for business travelers; it's not the individual's money, its their company's. They don't care about the cost.

 
At 5:15 PM, September 03, 2007, Blogger Milhouse said...

Additional datum: cheaper hotels have washing machines and driers. Fancy hotels have no laundry facilities available to guests, and charge per-item rather than per pound for sending out laundry. At last year's Worldcon the hotel concierge desk didn't know where I could find a service laundry; I found one and gave the information to the concierge desk, because I'm sure other guests will have the same question.

Once again, it's a matter of the hotel being geared to the expense-account business travelers staying during the week, not for budget tourists on weekends.

 
At 5:57 PM, September 14, 2007, Anonymous Rex Little said...

One data point which contradicts the tourist-vs.-business explanation: timeshares charge for Internet connection in the room. (At least the one I stayed at in Las Vegas recently did.) Timeshares get few if any business travellers.

 
At 3:02 PM, December 02, 2007, Anonymous econjeff said...

I think people underestimate the amount of business travel at low end chains like Quality Inn. During the week, much of their action is sales reps and the like.

I agree with DDFs general description of the data (and have wondered about the same thing that he does, as well as why expensive hotels charge rip off prices for soft drinks rather than raising room rates - I would not ask to be reimbursed for a Diet Coke but would be happy to have it included in the room price where it is covered the conference or with pre-tax dollars from my research account.

However, one company breaks the pattern, which is Marriott. They have free internet in every one of their hotel lines from top to bottom. When I made a decision last year to start collecting hotel points as well as airline points, this is a big reason I went with Marriott. So perhaps we are not yet at the long run equilibrium and when we get there the puzzle will have disappeared?

Jeff

 

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