Business Cases: How Priceline.com Revolutionized the Travel Industry

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In 2001 and 2002, the travel industry was in deep trouble. After the terrorist attacks of September 11, 2001, many people simply stopped flying. As the economy went into a deep slump, airplanes sat empty on the tarmac and the airlines lost billions of dollars. When several major airlines spiraled toward bankruptcy and laid off 100,000 workers, Congress passed a $15 billion aid package that proved to be critical in stabilizing the airline industry.

This was also a particularly difficult time for Priceline.com, the online travel service. Just four years after its founding, Priceline.com was in danger of going under. The change in the company’s fortunes had been dramatic. In 1999, one year after Priceline.com was formed, investors were so impressed by its potential for revolutionizing the travel industry that they valued the company at $9 billion dollars. But by 2002 investors had taken a decidedly dimmer view of the company, reducing its valuation by 95% to only $425 million.

To make matters worse, Priceline.com was losing several million dollars a year. Yet the company managed to survive; as of the time of writing in 2012, it was valued by investors at $31.74 billion. Not only has it survived, it has thrived.

So exactly how did Priceline.com bring such dramatic change to the travel industry? And what has allowed it to survive and prosper as a company in the face of dire economic conditions?

Priceline.com’s success lies in its ability to spot exploitable opportunities for itself and its customers. The company understood that when a plane departs with empty seats or a hotel has empty beds, it bears a cost—the revenue that would have been earned if that seat or bed had been filled. And although some travelers like the security of booking their flights and hotels well in advance and are willing to pay for that, others are quite happy to wait until the last minute, risking not getting the flight or hotel they want but enjoying a lower price.

Customers specify the price they are willing to pay for a given trip or hotel location, and then Priceline.com presents them with a list of options from airlines or hotels that are willing to accept that price, with the price typically declining as the date of the trip nears. By bringing airlines and hotels with unsold capacity together with travelers who are willing to sacrifice some of their preferences for a lower price, Priceline.com made everyone better off—including itself, since it charged a small commission for each trade it facilitated.

Priceline.com was also quick on its feet when it saw its market challenged by newcomers Expedia and Orbitz. In response, it began aggressively moving more of its business toward hotel bookings and into Europe, where the online travel industry was still quite small. Its network was particularly valuable in the European hotel market, which is comprised of many more small hotels in comparison to the U.S. market, which is dominated by nationwide chains. The efforts paid off, and by 2003 Priceline.com had turned its first profit.

Priceline.com now operates within a network of more than 100,000 hotels in over 90 countries. As of September 2012, its revenues had grown at least 24% over each of the previous four years, even growing 34% during the 2008 recession.

Clearly, the travel industry will never be the same again.

1. Explain how each of the twelve principles of economics is illustrated in this story.

Business Cases: Efficiency, Opportunity Cost, and the Logic of Lean Production

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In the summer and fall of 2010, workers were rearranging the furniture in Boeing’s final assembly plant in Everett, Washington, in preparation for the production of the Boeing 767. It was a difficult and time-consuming process, however, because the items of “furniture”—Boeing’s assembly equipment—weighed on the order of 200 tons each. It was a necessary part of setting up a production system based on “lean manufacturing,” also called “just-in-time” production. Lean manufacturing, pioneered by Toyota Motors of Japan, is based on the practice of having parts arrive on the factory floor just as they are needed for production. This reduces the amount of parts Boeing holds in inventory as well as the amount of the factory floor needed for production—in this case, reducing the square footage required for manufacture of the 767 by 40%.

Boeing had adopted lean manufacturing in 1999 in the manufacture of the 737, the most popular commercial airplane. By 2005, after constant refinement, Boeing had achieved a 50% reduction in the time it takes to produce a plane and a nearly 60% reduction in parts inventory. An important feature is a continuously moving assembly line, moving products from one assembly team to the next at a steady pace and eliminating the need for workers to wander across the factory floor from task to task or in search of tools and parts.

Toyota’s lean production techniques have been the most widely adopted of all manufacturing techniques and have revolutionized manufacturing worldwide. In simple terms, lean production is focused on organization and communication. Workers and parts are organized so as to ensure a smooth and consistent workflow that minimizes wasted effort and materials. Lean production is also designed to be highly responsive to changes in the desired mix of output—for example, quickly producing more sedans and fewer minivans according to changes in customers’ demands.

Toyota’s lean production methods were so successful that they transformed the global auto industry and severely threatened once-dominant American automakers. Until the 1980s, the “Big Three”—Chrysler, Ford, and General Motors—dominated the American auto industry, with virtually no foreign-made cars sold in the United States. In the 1980s, however, Toyotas became increasingly popular in the United States due to their high quality and relatively low price—so popular that the Big Three eventually prevailed upon the U.S. government to protect them by restricting the sale of Japanese autos in the United States. Over time, Toyota responded by building assembly plants in the United States, bringing along its lean production techniques, which then spread throughout American manufacturing. Toyota’s growth continued, and by 2008 it had eclipsed General Motors as the largest automaker in the world.

1. What is the opportunity cost associated with having a worker wander across the factory floor from task to task or in search of tools and parts?
2. Explain how lean manufacturing improves the economy’s efficiency in allocation.
3. Before lean manufacturing innovations, Japan mostly sold consumer electronics to the United States. How did lean manufacturing innovations alter Japan’s comparative advantage vis-à-vis the United States?
4. Predict how the shift in the location of Toyota’s production from Japan to the United States is likely to alter the pattern of comparative advantage in automaking between the two countries.