April 3, 2009

Variable Pricing on Airlines

Recently, Paul convinced Brett, Nate, Matt, Erik, Kyle, Carrie, and myself to travel to Italy for a beginning of the summer vacation. The trip is shaping out to be a blast and I'll post more about the specifics of the trip in the future.

Our main motivation for this trip was not the sights or sounds of Italy, but the price of the plane ticket. We booked our round-trip flights from Chicago to Italy for $388 dollars a price. We might be flying over on the Wright brothers plane, but this was quite the accomplishment, considering that you cannot get to Phoenix for less than $300 dollars. Or can you?

Everyone has a story where they stuck it to the man, beat the system and booked air travel for a ridiculously low price. There is of course a logical explanation to these low rate flights - variable pricing. This is evident in airline pricing strategy (different classes of tickets). Some people can afford to pay $1000, some $800, $500, down to $100. This is done to meet the demand of the market while still trying to maximize revenue.

Maximizing revenue is a difficult subject, because once the fixed costs of keeping the plane in the air are covered, the marginal cost of adding another passenger to the plane is around $30 (meal, baggage, ticket handling, etc.) If the airlines' marginal cost to add another person to the plane is $30 dollars, why are there empty seats? An airline lowering its rates at the last minute to ensure that the plane is filled would make the most revenue off of that flight.

Airlines cannot conduct a last minute, everything must go fire sale for all of its flights. This practice would increase revenues for individual flights, but would hurt the brand image of the airlines in the long run. People would refuse to book their flights, hoping that they will book at the right time to get the cheap seats. Lack of early bookings would cause a reduction of flights because airlines cannot meet the fixed costs of keeping planes in the air. This would cause customer dissatisfaction, and eventually the airline would go under. Then the economy would collapse and we would revert back to primal tribes of nomads (maybe not that far, but who knows?)

Airlines can decrease rates slightly to get the final 2% of seats filled, but there are still empty seats.

Air travel is an interesting business because it is so broken. There are a multitude of problems with air travel - business and technical - that still have yet to be solved. This slide show was pretty interesting (but its from 2003).

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