Tag: Airlines

Why Free is a Bad Price, American Airlines Edition

Companies often run into trouble when they offer a service at a zero price.

Not always, of course. Many all-you-can-eat buffets continue to thrive even though the marginal cost of the next chicken nugget is zero. And many content providers manage to stay in business by selling radio, TV, or display ads against the free content users enjoy.

But all too often, a zero price attracts bad customers and encourages excessive consumption. Marco Arment of Instapaper, for example, discovered that a zero price attracted “undesirable customers” for his app. And AT&T famously discovered that offering unlimited iPhone data could overwhelm its capacity.

Thanks to Ken Besinger of the Los Angeles Times, we now have another juicy example: the lifetime passes that American Airlines sold to a small group of customers:

There are frequent fliers, and then there are people like Steven Rothstein and Jacques Vroom.

Both men bought tickets that gave them unlimited first-class travel for life on American Airlines. It was almost like owning a fleet of private jets.

Passes in hand, Rothstein and Vroom flew for business. They flew for pleasure. They flew just because they liked being on planes. They bypassed long lines, booked backup itineraries in case the weather turned, and never worried about cancellation fees. Flight crews memorized their names and favorite meals.

Each had paid American more than $350,000 for an unlimited AAirpass and a companion ticket that allowed them to take someone along on their adventures. Both agree it was the  best purchase they ever made, one that completely redefined their lives. …

But all the miles they and 64 other unlimited AAirpass holders racked up went far beyond what American had expected. As its finances began deteriorating a few years ago, the carrier took a hard look at the AAirpass program.

Heavy users, including Vroom and Rothstein, were costing it millions of dollars in revenue, the airline concluded.

How did things go wrong? American Airlines miscalculated how pass holders would behave:

“We thought originally it would be something that firms would buy for top employees,” said Bob Crandall, American’s chairman and chief executive from 1985 to 1998. “It soon became apparent that the public was smarter than we were.”

In economic jargon, American fell victim to both adverse selection and moral hazard. What customer wants to buy an unlimited, lifetime pass? One who’s happy to spend a great deal of time flying about in first class with friends, family members, or a random person they just met at the gate. And how will they behave? As though first class seats are costless, easy to book, free to cancel, a great gift for friends and strangers, and even, in some cases, as a revenue source.

What happened next shouldn’t be surprising. First, the passes went through a death spiral with American raising the price in a vain effort to make them profitable. When last offered, a single pass cost $3 million and was purchased by a grand total of nobody. Second, American sicced its “revenue management executives” on the most flagrant of the frequent flyers. As a result, several had their passes revoked for misuse. And American faces some lawsuits that make one wonder whether it crossed the line in trying to rid itself of these outrageously expensive customers.

Cuddle in Coach, But Don’t Get Too Comfortable

Yesterday’s Wall Street Journal had a fun article about Air New Zealand’s latest innovation: Cuddle Class. As “the Middle Seat” columnist Scott McCartney describes it:

Steve Metz of Houston cuddled up with his wife Jackie and slept as they flew to New Zealand on a small futon. This flying couch wasn’t in a private jet or even a high-priced business-class cabin. They snuggled in coach.

“I don’t sleep well on planes, but I actually slept a good five hours,” said Mr. Metz, aboard a 13-hour Air New Zealand flight from Los Angeles to Auckland recently. “It’s no king-sized bed, but we made do.”

“Cuddle class” is an innovative seat design that has given coach passengers the first real opportunity to lie flat for sleep on long flights. To create the extra space, three seats in a row have fold-away armrests and a padded foot-rest panel that flips up and locks into place. Two passengers take up three seats and pay an average of half the cost of the third seat, typically an extra $500 to $800 for an overnight flight.

This sounds a fun innovation, but don’t get too excited:

The sky couch has limitations. To make it fit, Air New Zealand narrowed the aisles in the coach cabin. And since the couch is only about 4½-feet long, most people have to scrunch up to keep their feet from hanging into the aisle. In the middle of the night on a recent flight, it was impossible to walk through the coach cabin without bumping feet and legs hanging out of sky couches. And since it’s still the cheap-ticket cabin, two people have to cuddle closely in only 32 to 33 inches of width for each row, including the seat.

Now what does this have to do with economics, you might ask? Well, Air New Zealand faces a classic problem for any supplier who offers different levels of service. On the one hand, it wants to offer better service to attract more customers. On the other, it wants to make sure that some travelers still opt for higher-priced service. As McCartney puts its:

Air New Zealand doesn’t want to make the couch longer or wider—if it were better, it might start cannibalizing passengers from business-class or premium-economy seats.

So there you have it. Coach air travel isn’t unpleasant just because the airlines want to reduce costs. It’s unpleasant so that some flyers will pony up for better service.

P.S. For more economics of the air, see this post on the Tragedy of the Overhead Bin.

Ultra Trouble for the Ultra Low Cost Airline?

Last week Spirit Airlines announced that it would start charging fees for carry-on bags this summer. Spirit described the benefits of this move as follows:

“In addition to lowering fares even further, this will reduce the number of carry-on bags, which will improve inflight safety and efficiency by speeding up the boarding and deplaning process, all of which ultimately improve the overall customer experience,” says Spirit’s Chief Operating Officer Ken McKenzie.  “Bring less; pay less.  It’s simple.”

As I’ve noted in previous posts, carry-on bags have become a problem on many flights. With advances in roll-aboard technology and in the face of new fees for checked luggage, more passengers are bringing baggage on board, sometimes overwhelming the capacity of the overheads. Airlines need to find a solution to that problem. Spirit’s fees are one possible answer.

I’m sure Spirit expected that some passengers and passenger advocates would object to these fees. I wonder, however, whether the airline ever suspected that it would incur the wrath of Washington?

Over the weekend, New York Senator Chuck Schumer denounced the proposed fees and sent a letter to Treasury Secretary Tim Geithner asking that he stop them. He’s also threatening legislation to prohibit them.

If you are like me, your first reaction should be to wonder why the Treasury Secretary–rather than, say, the Transportation Secretary–is the lucky recipient of Schumer’s letter. This being the middle of April, however, the answer shouldn’t surprise you: taxes,  specifically the taxes that are levied on airline tickets (but not on some other fees associated with flying). The narrow issue is whether the carry-on fees should be subject to the tax. The broader issue is whether carry-on fees should be allowed separate from the ticket price.

Meanwhile, the Transportation Secretary, Ray LaHood, wasted no time in denouncing the proposed fees as well, saying:

I think it’s a bit outrageous that an airline is going to charge someone to carry on a bag and put it in the overhead. And I’ve told our people to try and figure out a way to mitigate that. I think it’s ridiculous.

So watch out Spirit Airlines; your experiment in pricing scarce overhead capacity may not be welcome in Washington, even if it does lead to lower fares and faster boarding.

P.S. The tempest over the baggage fees is temporarily overshadowing a much more interesting and important issue: the transparency and intelligibility of airline fees. Secretary LaHood touches on this in the interview linked to above, as does this article over at Philly.com’s Philadelphia Business Today. Given the panoply of fees and taxes on air travel–thanks both to the government and to the airlines–there’s a real question about whether consumers understand the full costs of flying when they make their purchasing decisions. And some airlines–most notably Spirit with its “penny” and “$9” fares–seem to be playing on that.

Spirit Airlines Combats the Tragedy of the Overhead Bin

As any frequent flyer knows, the competition for overhead space is tight. As I noted a few months ago (“The Warped Economics of Carry-On Luggage“), the situation has only become worse since airlines started charging fees for checked luggage. Budget-conscious travelers caught on quick and started carrying on more of their luggage.

In economic terms, the basic problem is a lack of property rights to overhead space. Without those rights, there is a tragedy of the commons as travelers try to grab space before their fellow travelers (just as some guacamole eaters compete for appetizers). Particularly egregious? The passenger in row 35 who brings on two over-sized roller bags and stows them in the overheads around row 15. No, I’m not bitter.

One solution to this problem would be to create property rights to overhead space. But that would be hard to operationalize.

Another possibility–which Spirit Airlines announced today–would be to charge for carry-ons. Spirit announced:

In order to continue reducing fares even further and offering customers the option of paying only for the services they want and use rather than subsidizing the choices of others, the low fare industry innovator is also progressing to the next phase of unbundling with the introduction of a charge to carry on a bag and be boarded first onto the airplane.

The carry on fee ranges from $20 to $45, the same or more than the fees for a single checked bag (fees for multiple bags may be higher). Personal items (i.e., the things you put under your seat) remain free.

Note how Spirit frames this as helping the airline reduce fares. In the future, I hope some enterprising economist studies the different bag pricing approaches that the airlines use to see to what extent higher bag fees–checked or carry on–translate into lower fares and either more or less crowded overhead compartments.

The Warped Economics of Carry-On Luggage

I just got home from a quick trip to Denver, where I spoke at a Concord Coalition event on our nation’s dire fiscal outlook. That’s a big, complex problem, but today I’d like to share some thoughts on an even more vexing problem: the warped economics of carry-on luggage.

As you probably know, most major airlines now charge fees if passengers want to check luggage. Many travelers object to these fees in principle (as you can easily confirm by surfing around the blogosphere), but what’s most interesting to me is how people respond to them.

Based on my travels, I see three related issues.

1. If you charge fees to check bags, passengers will bring more and larger carry ons. Like everyone else, airline passengers respond to incentives. So if you make it more expensive to check bags, they will bring more carry-ons. The overheads thus fill up more quickly and are often at capacity before everyone has boarded. More travelers thus get to experience the ignominy of losing the carry-on equivalent of musical chairs (and flight attendants have to waste time removing bags and checking them).  (This observation is hardly new; my student Kerry mentioned it to me last week, for example, and others have written about it.)

2. This effect may get magnified when airlines offer to check bags for free at the gate. As I was waiting to board my flight to Denver, the gate agent announced repeatedly that customers could check bags for free if the overheads ended up being full. I presume that the airlines do this in order to avoid adding insult to injury for the passengers who lose at musical bags. (Imagine the flight attendant telling you: “Sorry, the overheads are full; please give me your bag and $35.” ). This does have the side effect, however, of encouraging even more customers to bring their bags onto the plane to see if they will fit. The worst case (financially) is that they end up avoiding the fees for checked luggage.

The increased competition for overhead space is worsened by the lack of property rights. Just as competing boats can over-exploit a fishery, so do airline passengers overexploit overhead space. In econ-speak:

3. There is a tragedy of the commons as passengers compete for overhead space. Without enforceable property rights, travelers engage in all sorts of inefficient behavior to gain overhead space (e.g., fighting to be among the first in their seating group to get aboard). Perhaps the most galling is when passengers seated in row 35 bring on two over-sized roller bags and stow them in the overheads around row 15. They then saunter, unencumbered and without shame, to their seats in the back of the plane, while the unsuspecting souls in row 15 (who usually board later) face a major nuisance: what to do with their bags. Let me tell you, it’s not a pretty sight when the folks in row 15 have to stow their luggage in the overhead space back in row 35 — if there’s any left at all.

The fees worsen this tragedy of the commons, of course, since even more bags are competing for the limited resource of overhead space.

So what’s the solution?  Well, one option would be to create property rights in the form of assigned overhead space. One roller-bag sized space could come bundled with each seat, for example, or perhaps the airline could sell spaces separately. Maybe there could even be a secondary market in which passengers buy and sell spaces among themselves. Row 35 person: If you really want this space over my seat in row 15, how much are you willing to pay?

OK, that vision is a bit fanciful, and there are a host of challenges (e.g., different size bags and the transaction costs of running a real-time overhead bag space market) that may make it impractical. But it is fun to dream.