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

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uncorrelated with their spatial location, firms must assume a uniform distribution of customersand revert to the Hotelling solution (600).The example presented by Armstrong and Vickers is, of course, a stylized model thatonly compares a situation of duopoly competition. While on certain routes, competition mayonly consist of two air carriers, for the industry overall, there are a number of airlines competingfor customers and market share. Despite its shortcomings, however, the Armstrong and Vickersanalysis gets at the heart of explaining an airline‘s use of a two-part pricing arrangement tofurther differentiate among consumers who have heterogeneous preferences. Some consumersare located ―far away‖ from an airline that provides baggage check, meals, and other ancillaryservices, meaning that they have little use for such services and can go to other airlines closer totheir ideal. These consumers have high costs associated with moving away from their ideal point;these costs are likened to transport costs in Hotelling-type models. Conversely, other consumersare ―close‖ to the airline‘s product offerings. A single price fails to extract the additionalrevenues that can be taken from the close customers who exhibit higher willingness to pay forthe service, as it must be lowered to attract the far away consumer. These consumers are lesswilling to pay for ancillary products and services and are more willing to undertake travel whenthe entry price is dropped.In a later paper, Armstrong and Vickers argue that the equilibrium fixed fee under thetwo-part tariff balances the firm‘s loss of profit on existing consumers against its gain inprofitable consumers from the other firm (Armstrong & Vickers 2010). This commentunderscores the role that that two-part pricing and unbundling in the context of the airlineindustry plays. By being able to charge a base fare separate from fixed baggage fees, the airlinecan appeal to price sensitive customers who may be close to selecting another while still28
ecouping additional revenues from those customers who strongly prefer onboard ancillaryservices.A number of interviews at the airline point to the fact that the decision to engage in a-lacartepricing is in fact an attempt to deal with varying consumer valuation for ancillary productsand services. As one interviewee said, ―I think [a-la-carte pricing] is a constant balancing actaround how . . . you find something that the customer values and is willing to pay for versus itssomething that not only do they not value but . . . also something that costs us a lot of money.‖Another interviewee echoed this rationale: ―I think that I would say that airlines have, you know,for a long period of time before this realized that they were providing services that had very highcosts associated with them that were not necessarily appreciated by the passengers andappreciated by some passengers and not others. It didn‘t seem like a good business model to beinvesting in.‖In discussing price differentiation, another interviewee mentioned an aspect pertaining tocustomers‘ elasticity of demand at different parts of the purchase process. ―We joke about this,but anybody who travels knows that vacation dollars are worth less than regular dollars,‖ theinterviewee said. ―When you‘re on your way to Hawaii, you make a lot of different decisionsthan if you‘re in the home searching the Internet for the lowest fares.‖ From the theoreticalperspective outlined above, a customer‘s preference then may not only be spatially distributedbut also may also exhibit some sort of time dimension. Thus consumers at the time of travel mayhave their ideal preference shift closer to the airline‘s product offerings, further allowing forextracting consumer surplus through a two-part pricing arrangement that levies additional feesfor services offered during the travel experience. This separate pricing time gives airlines an29
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 30 and 31: Between 1993 and 2007 alone, averag
Page 32 and 33: such a scenario faces strong incent
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
Page 80 and 81: potential to lower fares, but that
Page 82 and 83: 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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