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

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additional price differentiation dimension relative to other firms using two-part tariffs, such asamusement parks and movie theaters.Why Now? Drivers and Timing of the Ancillary Revenue MovementAs proposed in the section above, a-la-carte pricing in the airline industry is a stableequilibrium arising from customer heterogeneity and distribution in a spatial framework. So longas duopolistic firms in such a situation employ non-linear pricing, Armstrong and Vickers predictthat a two-part tariff will emerge as a stable equilibrium in the industry. If two-part tariffs and a-la-carte pricing are profitable strategies for airlines, given varying customer preferences anddifferent valuations of ancillary services, there remains an additional nagging question: why haveairlines waited until the 2000s to implement a business model focused on ancillary revenueswhen they have had pricing freedom since deregulation?Though interviewees broadly discussed conditions endemic to the airline industry as awhole, interview data can only be assumed to apply to that air carrier alone. Nonetheless, thesedata can be combined with industry facts and economic theory to build a model of why airlinesmight not have adopted an a-la-carte model earlier. Ultimately, it appears as if there are fourprimary rationales for this observed delay: revenue pressure from excess capacity and low-costcarrier (LCC) competition, technological and exogenous changes, the role of entrepreneurialattention, and solving the first-mover problem.Revenue Pressure from Excess Capacity and LCC CompetitionThe clearest conclusion from interviewees was that a struggle to raise revenues was theprincipal reason why airlines began unbundling certain products and services—most prominently30
aggage fees—and looking for other avenues for instituting new products and services in the2000s. This pressure in the 2000s came from two principal sources. Following a time of modestindustry profits in the late 1990s (Doganis 2002, 18–19), the September 11th terrorist attacksresulted in weak demand for commercial air travel. Ito and Lee estimate that the terrorist attacksresulted in a negative demand shock of 37.8 percent in the month after the attacks (87), as well asan ongoing drop in demand of 7.4 percent through 200 (89). Within the four days following theattacks, the Air Transport Association estimated that airlines lost $1.4 billion due to theshutdown of the national air transportation system, and industry losses in 2001 totaled more than$7 billion due to the drop in passenger demand (Makinen 2002, 30).While September 11th can be viewed largely as an exogenous shock, there are alsoendogenous factors that exacerbated the pressures to generate more revenues. Riding a wave ofincreased profitability in the late 1990s, a number of legacy carriers entered the 2000s withextremely high costs relative to other airlines, largely due to high employee wages and restrictivelabor contracts, higher capital costs, a commitment to providing a number of onboard services(such as onboard meal service), and other factors (Morrell 2005, 306–309). This cost differentialis evidenced by the fact that while legacy airlines collectively sustained multi-billion dollarlosses in the years following 2001, the LCCs collectively remained profitable (Hecker 2005, 7).It is also one of the reasons that legacy airlines undertook post-September 11th initiatives to cutfixed costs through efforts such as outsourcing a variety of functions and eliminating aircraftweight (and, in many cases, associated services) to use less fuel.Following an improvement in the industry after the attacks, airlines again faced stiffrevenue pressures as fuel expenses increased due to a rise in the price of petroleum. Between2007 and 2008, the average U.S. jet fuel price increased by 37.6 percent, from 216.5 cents per31
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 34 and 35: uncorrelated with their spatial loc
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
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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
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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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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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