The tour operator and quality uncertainty

Economic theory distinguishes between ‘experience goods’ and ‘search goods’. Search goods are those goods whose quality may be learned prior to consumption and, thus, prior to purchase. For experience goods instead, their quality is learned only from experience, during or after actual consumption of the good. It is immediate to notice that the tourist product, like most (if not all) services, is an experience good. The quality of the service in a hotel can only be ascertained during stay; quality of a flight (punctuality in the time of departure, etc.) is only known during the flight itself; the quality of meals is Buyers Sellers.

Figure 3: Intermediation or des-intermediation in the search for information

Another example of experience good; and the same for all other goods and services that compose the tourist product. Thus, a crucial issue is the uncertainty that the tourist faces about the true quality of the tourist product prior to consumption, that is, prior to the vacation itself. In a rather more technical language, there exists asymmetry of information between the seller (hotel, airplane company) and the buyer of the tourist service, since the seller has better information than the buyer (the tourist) concerning the precise characteristics and quality of whatever tourist good or service in exchange.

Box 1. The ‘market for lemons’(Akerlof, 1970), applied to the tourist sector.

Suppose Alice, from Germany, is willing to go on vacation to the Balearic Islands. There are a priori two different types of hotel accommodation available. Type H with a high quality service, which she values in (for which she is willing to pay) 1000 ?, and a type L with a low quality service which she values in (for which she is willing to pay) 500 ?. There are a priori in the market a 50% of hotels offering the high quality service, and a 50% offering the low quality one. The cost of offering the high quality service is 800 ?, whereas the cost of the low quality service is 400 ?.

Alice does not know which hotel offers high quality or low quality service, this is private information of each hotel. There is thus a problem of asymmetric information: when booking some accommodation, she does not know whether the hotel offers high quality or low quality service. What she knows though is that there is a 50% chance that it is a type H hotel, and a 50% chance that it is a type L hotel.

As a consequence, her expected valuation of the stay is ½·1000 ? + ½·500 ? = 750 ?. This means that at most she is willing to pay a price of up to 750 ? for the accommodation. Otherwise, she would be paying more than what she values it in expected terms. The problem is that at a price lower than 750 ? no type H hotel is willing to supply accommodation, since the cost of accommodation with high quality service is 800 ?.

As a consequence, knowing this, Alice infers that the only hotels offering accommodation are type L with low quality service, which implies that she is only willing to pay a price up to 500 ?.

Thus, it is immediate to see that the only Nash equilibrium is a price higher than 400 ? and lower then 500 ?, at which only type L hotels offer their service (type H hotels would abandon the market), and at which Alice goes on vacation. This is exactly what it means that ‘bad products drive-out good products’, and is the case of the ‘market for lemons’ that Akerlof first presented in his paper in the Quarterly Journal of Economics. It is well known in the economics literature that a consequence of such informational asymmetries may be a market failure: a transaction that would be a priori beneficial, value enhancing for all parts, might not take place. 7 This is what might happen in a situation of adverse selection (defined as that in which the seller has superior information than the buyer

prior to signing of the contract), and was first described by Akerlof . Akerlof

showed that in markets with asymmetric information between sellers and buyers (e.g. in used car markets), adverse selection might lead bad products to drive-out good products from the market. Because the buyer is uncertain about the quality of the good, it fears that it is one of low quality and thus it is only willing to pay a low price. Again, incomplete contracts are crucial. In a framework where a complete contract was available, no problem would arise. However, it is not difficult to see that quality cannot be perfectly and unambiguously described and, as a consequence, contracts are not capable of perfectly solving the problems related to the existence of asymmetric information.

Box 1 provides a numerical example of adverse selection in the

accommodation sector. Given the existence of informational asymmetry between the seller (or sellers) and the buyer, and the resulting potential market failure, the issue is what can be done about it. The obvious remedy is that sellers of the tourist product inform – and convince – potential buyers about the true quality of the product, thereby eliminating informational asymmetry.

A TO (an intermediary, in general) improves market efficiency by providing third party credible information about product quality. This way, it eliminates the possibility of a market failure due to quality uncertainty, and it does so at a lower transaction cost than the alternative organisational arrangements whereby the tourist deals directly with all sellers. The role of an intermediary might be of two types. An intermediary might be an expert, whereby it has acquired the appropriate knowledge and skills to evaluate the quality of the good or service in question. This type of intermediation is specially important in settings where usage and consumption is not fully sufficient to assess the quality of a good; for instance, some retailers that evaluate the quality of a DVD player.

Some of this role as experts is played by TOs in the tourist industry; for instance, some TOs evaluate and keep track of the environmental friendliness of hotel establishments. However, probably the main role of TOs arises because of the TO’s ability to build a brand name and reputation signalling the package of high quality tours. In this case, intermediation can enhance market efficiency even when intermediaries do not have superior knowledge and skills to evaluate quality (are not ‘experts’). TOs are a source of quality information simply by credibly building a reputation for providing high quality products. We see how this works in the following subsection.