April 2016.
Abstract: While the incentives for firms to vertically differentiate have been well documented, less is known about the market outcomes of this sort of competition. This paper explores how quality competition interacts with differences in demand volatility in the hotel industry. Using the variation of demand volatility for hotels experienced at the metropolitan level, I am able to characterize the differential pricing strategies of varying quality segments in the hotel industry from luxury to economy. The empirical results suggest that higher quality (luxury) hotels vary prices much more from the peak to trough of the demand cycle than economy hotels and maintain higher capacity utilization levels. Alternatively, lower quality (economy) hotels have less variation in pricing from peak to trough of the demand cycle, but experience more variation in capacity utilization levels.