A-La-Carte Pricing in the Airline Industry - Graduate Student ...

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Between 1993 and 2007 alone, average domestic one-way fares fell from around $300 to $220 inreal terms (Goetz and Vowles 2009, 257). With lower prices, airlines now face a broad customerbase composed of individuals with a variety of tastes and preferences.Even prior to the ancillary revenue movement, airline pricing techniques were developedto differentiate among different types of consumers. For example, before the 2000s (though it hasmade a comeback in recent months), airlines offered discount fares to travelers that stayed attheir destination during a Saturday night. This practice ultimately served as price discriminationtechnique to ensure that customers with high valuation of time and high willingness to pay—usually non-leisure business travelers—would not receive the deepest discounts (Gale & Holmes1993, 144). Furthermore, fewer discount seats are offered during peak times when the most timesensitivecustomers would want to arrive and depart.While such pricing techniques are aimed at pricing differently based on consumerreservation prices and extracting additional consumer surplus for the base fare, a basic evaluationof the travel experience indicates that there may be additional opportunities for pricedifferentiation. Historically, airlines have not solely been in the business of providing passengerswith a seat from point A to point B: once passengers are onboard, airlines have provided mealsand snacks, drinks, and entertainment. The existence of various cabin classes of service—first,business, premium economy, or economy—represents an effort to extract additional surplus fromconsumers with high willingness to pay for additional features.Furthermore, airlines may be able to benefit from market power once the passenger isonboard the aircraft to engage in price differentiation. Economic theory dictates that a firm‘sability to differentiate among its customers depends on its ability to exercise market power(Carlton & Perloff 2005, 294). As discussed earlier in relation to Oi‘s (1971) paper about an24
amusement park‘s monopoly position, an airline has some ability to serve as a monopolist oncethe aircraft doors have been closed. Additionally, the only place an airline customer can obtainchecked luggage service is from the airline from which the ticket is bought; to date, competingairlines or other shipping firms do not offer to take any customer‘s bag before flight and return itright after.Despite a limited monopoly position and certain aspects of price differentiation via cabinclass, prior to unbundling and a-la-carte pricing there may have been numerous opportunities tocapture additional customer revenues, and some of these opportunities may still exist. Teichert etal. analyze the stated preference data of 5,800 airline customers and find that customersegmentation by cabin class alone does not fully capture customers‘ preference heterogeneity.Instead, they suggest airlines should use additional product attributes to more effectively targetvarying customer willingness to pay (Teichert et al. 2008, 239–240).As shown by Teichert et al., customer heterogeneity gives airlines a variety of options todifferentiate through different onboard products. From a strategic standpoint, airlines facecustomers who are spatially distributed along a sort of preference map for the air travelexperience. A key consideration an airline must make, therefore, is what sort of pricingarrangement and what sort of products it should offer to target customers that are located indifferent positions along a distribution of tastes for onboard product attributes.In such a way, an airline facing a distribution of customer taste experiences a situationsimilar to the one outlined by Hotelling (1929) in his paper about duopolistic competition forspatially distributed customers. Hotelling considered the decision that a firm would make indifferentiating itself to capture the greatest amount of revenue from consumers uniformlydistributed along a linear space (he spoke of a main street in a town). He found that a firm in25
Page 3 and 4: A-La-Carte Pricing in the Airline I
Page 6: IntroductionAnyone who has flown re
Page 10 and 11: Additionally, the chapter will prov
Page 12 and 13: compete with their rivals to attrac
Page 14 and 15: The Start of the Ancillary Revenue
Page 16 and 17: In these examples, this fee exists
Page 18 and 19: this strategy. Nonetheless, Button
Page 20 and 21: and/or services. This is because co
Page 22 and 23: new production process will have a
Page 24 and 25: entrepreneurial awareness that a mu
Page 26 and 27: Chapter 1 ReferencesAdams, William
Page 28 and 29: Sharkey, Joe. 2001. ―Business Tra
Page 32 and 33: such a scenario faces strong incent
Page 34 and 35: uncorrelated with their spatial loc
Page 36 and 37: additional price differentiation di
Page 38 and 39: gallon to 298 cents per gallon: dur
Page 40 and 41: Despite these indications that the
Page 42 and 43: Despite this open question, it is c
Page 44 and 45: transactions at the airport. Histor
Page 46 and 47: The Role of Entrepreneurial Attenti
Page 48 and 49: additional legroom throughout its f
Page 50 and 51: ConclusionThis discussion in this c
Page 52 and 53: Chapter 2 ReferencesAir Transport A
Page 54 and 55: Morrell, Peter. 2005. ―Airlines W
Page 56 and 57: most recent quarter for publicly re
Page 58 and 59: variation is present, with peaks du
Page 60 and 61: compete for customers in a manner s
Page 62 and 63: always perfect, however. For exampl
Page 64 and 65: chance for bags to get delayed or g
Page 66 and 67: customers may pay to upgrade to a h
Page 68 and 69: than it would if it offered that pr
Page 70 and 71: airline‘s decision to offer a cer
Page 72 and 73: New Mexico Business Weekly. 2010.
Page 74 and 75: A number of interviewees pointed ou
Page 76 and 77: airline, and even the industry as a
Page 78 and 79: they have not significantly impacte
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potential to lower fares, but that
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Figure 4.3 - U.S. Airlines Average
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Figure 4.4: Ratio of JetBlue Airway
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emembered that this characterizatio
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One additional consideration that m
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there‘s . . . a quality issue the
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kit are able to keep the pillow and
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(such as meals, books, and blankets
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[certain customers] because there
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Chapter 4 ReferencesArmstrong, Mark
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Chapter 5: The Policy Implications
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Niskanen (1968) points to the budge
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Necessity is ultimately a term that
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who do not check luggage would end
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they are lowering their effective t
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Unsurprisingly, no airlines have cl
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each scenario, meaning that they se
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Figure 5.1: Ancillary Fee Disclosur
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unaware of certain airline pricing
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One important consideration involve
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Chapter 5 ReferencesArrow, Kenneth
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Niskanen, William A. 1968. ―The P
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Far from being a mechanical solutio
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