Tuesday, January 11, 2011

Alfred Kahn and the Airline Business

Recently the news of Alfred Kahn's death.  Fred Kahn was a Cornell University economist, the head of the Civil Aeronautics Board and the father of airline deregulation.  My good friend (whom I saw over the weekend in Denver at the AEA meetings) worked with him at NERA and said he was busy right up until his death.  He had a large personality and was famous for his belief that bureaucrats needed to do better using plain spoken language in their official communications (here is a nice essay on this in the New York Times from Bob Frank). My favorite anecdote is from when he retired as the Dean of the College of Arts and Sciences at Cornell, he said: 'dean is to faculty as fire hydrant is to dog.'

His death, given his role in airline deregulation, as well as my recent travel have prompted me to think about the airline industry and the very swift adoption of a la carte pricing.  Which, of course is all part and parcel of deregulation. It seems strange, given the amount of grumbling, how widely adopted such pricing schemes are. When I book a ticket I am immediately assaulted with offers of more leg room, faster check in, faster security lines, when I check in there are fees for bags, on the plane you can buy a snack or a meal, and so on.

To an economist this is both a rational strategy and an efficient one.  Rational because the more price discrimination there is generally the better the revenue for the firm.  The goal of price discrimination is to get people to play different prices for essentially the same service based on willingness to pay.  It is efficient because it allows very price sensitive travelers to buy a seat on the plane for as little as possible and those less price sensitive can get more leg room, get to take more luggage, get faster check in and so on.

[As an aside, how is it that TSA participating in this? I think they must have a fee structure that charges higher fees for the express lane but I wonder how they keep track of the airlines they have to charge or if they rely on airlines themselves to self-report.]

Despite how much I and other economists understand, we still grumble when we have to pay $25 to check a bag (no one said rational individuals cannot be emotional).  As far as I can tell, however it is a successful strategy because there is only one airline that bucks the trend and makes it a point of pride: Southwest.  To me this is a product differentiation strategy - they are looking to pick off precisely those customers for whom the price discrimination strategy particularly irritates.  By distinguishing themselves thusly, they can actually charge a higher base price and subsidize the baggage handling operation.

I guess the point of all this is that remember when you complain about such prices that they are making the base ticket price as low as can be and so for someone like me who has to do another quick overnight trip on Thursday and Friday to San Francisco.  Since it is a quick flight, I barely need any luggage and I don't need extra leg room.  So I can go without any extra charge and I appreciate that I do not have to subsidize those with three big suitcases.  I complain at other times when I do have a suitcase to check in, but I remind myself of the economics and try to be more rational than emotional.  Overall, I both understand and appreciate the airlines' pricing strategies as irritating as they are.

1 comment:

Brian said...

With regard to TSA, my understanding is that they are simply there to provide screening. They screen anybody that approaches the screening area, and it is the airport that controls the access to the screening process. So if you walk down the express lane and approach the screening area, TSA really does not care whether or not you complied with the airport's queueing system, as it is not part of their security screening.