A Brief Observation on Pricing

Michael Cannon writes about the new trend in airline pricing to charge extra fees for different services (ranging from sodas to checked baggage).  I have seen several writers of the progressive ilk all up in arms about these extra fees.  Which in my mind confirms that there is no foundational position among progressives on such matters, only opportunistic attacks on corporations for whatever they happen to be doing.  They want air travel pricing to be bundled into one rate, covering all potential services one may or may not use.  But wait, they want cable TV pricing to be unbundled, with a la carte pricing rather than one rate so viewers can pay for only what they use. 

Anyway, the only irritation I have with the new airline pricing is that it drives people to try to carry on every bag they can, particularly since, at least on US Airways currently, bags that are gate-checked are not charged a fee.  This is fouling up security lines and making it a necessity to board early on a plane to have any hope of finding a carry-on space.  Which may add another revenue opportunity, that of charging extra for the option to board early.  Which, come to think of it, Southwest is already doing.

  • Zach

    Between the liquids ban, long lines at security, the new full-body x-ray thing, reclining seats (I'm 6'2"; if you're in front of me and recline you get my knees), this new bag thing causing even longer lines at security, and the possibility of having your data storage devices detained for weeks upon international reentry, I'm considering not flying ever again.

  • JSmoke

    I think the main reason this pricing scheme bothers people so much when applied to airfares (as opposed to local phone service which also splits out pricing for extras) is it becomes very hard to comparison shop for your airfare when buying a ticket.

    You don't have a lot of choice when it comes to local phone service, but with airfare, you do a search online and get a bunch of options. With these new fees you have to do a lot more homework like, "okay Northwest is $10 cheaper but they charge $35 for fuel, United is next cheapest but you have to pay $15 for the first bag, Southwest is $5 more but they have free food, etc, etc". I'd hate to be the guy programming the airfare consolidating websites to keep up with all these fees so people could really comparison shop.

    I agree that companies shouldn't be coerced into bundling their fees, but it does make it awfully hard to look at a few different fares and weigh the options.

  • Another guy named Dan

    Let's look at what got us into this situation in the first place.

    From the 1930s until the early 1980s, domestic air fares were government regulated. Routes were awarded to ailines based on bureaucratic formulae. The only way airlines could compete against each other was by the level of service they provided in exchange for the fixed fare. Level of service was almost uniformly good, employees were almost uniformly well paid, and air travel was almost uniformly expensive.

    Post-deregulation, the incumbent carriers were thrown into a world where price suddenly became paramount. Waves of airlines went bankrupt (Eastern, Republic, Pan Am, Braniff, etc.) and were replaced by low cost, no-frills airlines, most of which went bankrupt in their own time.

    The computerized ticketing services, first Sabre, then the Internet, made competitors fares visible to all market participants, giving almost perfect knowlege to the market.

    It was the largest airlines that packed the most people into each plane that stayed alive. Now that airlines are running pretty much at maximum capacity, the only way to be the most profitable is to extract the most revenue per passenger after their ticket is paid for.

  • http://www.classicalvalues.com/archives/2008/06/better_than_pri.html SuperMike

    it becomes very hard to comparison shop The guy that writes Dilbert described this in his book as a "confusopoly" It kind of makes sense. If price information is successfully obscured, then all you have to go on is brand loyalty and the established airlines actually get an edge.

    I wish there was an airline that would charge extra for carry-on baggage.

    The reason progressives are so fired-up about cable unbundling is that it makes 'em blind/crazy with rage that they might be supporting fox news, even a little.

  • http://that-xmas.livejournal.com/ Xmas

    SuperMike,

    You forget that for every checked bag, there's at least a dozen workers that have to handle it from the check-out counter at your departure point to the luggage carousel at your destination. Plus, the more luggage handled, the more luggage lost (like that lonely, green, hard-plastic suitcase I saw sitting against a wall this morning while on the bus between Philly's C and F Terminals).

  • John Dewey

    Another guy named Dan: "It was the largest airlines that packed the most people into each plane that stayed alive. Now that airlines are running pretty much at maximum capacity, the only way to be the most profitable is to extract the most revenue per passenger after their ticket is paid for."

    I agreed with your assessment of the airline industry up to these last two statements.

    Southwest Airlines has been the most profitable airline over the past 20 years. Southwest's load factors have been consistently lower than those of other large carriers. Unlike its competitors,Southwest Airlines is freedom from fees:

    - No fees for 1st or 2nd checked bags;
    - No change fees;
    - No fuel surcharges;
    - No snack fees;
    - No aisle or window seat fees;
    - No curbside checkin fees;
    - No phone reservation fees.

  • http://thelibertypapers.org/ Brad Warbiany

    "I agree that companies shouldn't be coerced into bundling their fees, but it does make it awfully hard to look at a few different fares and weigh the options."

    That's the point... Because the base airfare is the typical driver of purchasing decisions for many consumers, they know that having a pissed off customer at the gate paying $15 per bag may be better than charging $5 more per ticket -- then not having a customer at the gate at all.

  • Dr. T

    If, as Xmas and others have said, carry-on luggage is cheaper for the airlines than checked luggage, then why have the airlines failed to order passenger planes with a more suitable design? Just lower the passenger compartment floor 10-15 inches (sacrificing checked luggage space) and increase the capacity of the overhead luggage bins. With this change, passengers could stow a medium-size bag under the seat and a large-size bag (or two small-size bags) in an overhead bin. To make this even better, they could build into the overhead bins some type of device to assist with lifting heavy bags. (Even a few bungie cords would help.)

  • http://www.tinyvital.com/blog John Moore

    Airlines are in a business that is less than zero sum historically. They try one trick after another to win fares, and few seem to care about customer loyalty (largely, I suspect, because customers book by price and availability, not airline, with notable exceptions).

    One of the most successful tricks over the years has been the rewards programs, which take advantage of an externality - the winner of the award is usually paying for the trip with his employer's dollars (note that if the employer is paying, you can check that bag at their cost, but you probably didn't pack much anyway). But as rewards programs became competitive, they also became huge financial liabilities.

    As a long time user of Southwest's rewards, I was horrified to discover that they have recently changed their program to have two levels of awards - one revenue managed (seating limited) and another not. I had to convert two rewards into one just to get seating for a mundane trip. And Southwest has always been the best (as noted above) in behaving well towards customers. Well, there go my personal and Southwest Visa cards.

    When one of the first discount airlines started, it showed price was very important. But the big airlines struck back with what is called "revenue" or "yield" management. American (or was it Delta) drove their competitor out of business, while charging higher fares, by using this technique. The way RM affects pricing has been driving people crazy ever since. Have you ever wondered why you paid $400 for a ticket and the person next to you paid $50? Pricing transparency is there, but only by the second. The fares change continuously and have been for a couple of decades.

    The purpose of revenue management is to optimize the passenger revenue for a flight (or a hotel room, or a rental car). The key is that it is better to sell a seat (bed, car) at anything over non-recurring cost than it is to leave it empty. I have worked in automation of the hospitality industry, and there it pays to sell a room for anything over about $35 rather than leave it empty. In other words, the cost of selling the room is laundry and maid service. The cost of not selling it is foregone revenue but fixed costs (capital, staff, energy).

    Revenue management systems use elaborate computer models to estimate the demand for a perishable commodity (seat on a flight, car on a date, room on a date). The reservation systems then compare the demand to the estimate, and if the demand is lower than expected, reduce the price; if the demand is higher, increase the price. The time lags in this process range from a day to a millisecond - most systems have both.

    So, the airlines are used to driving customers bananas. Furthermore, all the ancillary hassles of traveling by air are only marginally increased by what they do to you at the gate (or apparently so they figure). Hence they are cherry picking revenue (and cost reductions) like mad.

    Personally, I think they are making a mistake. People don't like to feel nickle-and-dimed. They don't really see it with revenue management, because it is not transparent to them (could be if they wanted to keep watching prices, but they don't). But hassling people over checking bags leads to nightmares at boarding time, and that leads to an even more miserable flight.

    I'll stick with Southwest where I can. They recognize the value of less-frustrated customers - even if they have broken my favorite rewards program (and also added an annoying preferred boarding ticket category).

    BTW, while the other airlines are causing people to pack the overheads with what they would have checked, Southwest recently figured out a way to reduce the hassle of their A,B,C boarding system - by giving out boarding order numbers, and providing markers at the line up points. This means you no longer have to camp in line waiting for departure.

  • http://www.ictradingonline.com Martina

    I have seen several writers of the progressive ilk all up in arms about these extra fees.

  • http://dimer.tamu.edu/simplog?blogid=3 Jim Hu

    I don't think the charge for checked luggage is to reduce labor costs in baggage handlers - it's partly to reduce fuel costs from the higher average weight of the checked stuff (no data on this, just thinking it's likely), and partly what another Dan referred to above - the airlines are competing to be first on the sort by price option in the web travel sites.

    Look for the travel sites to provide user profile options for number of checked bags, average consumption of soft drinks, pillows and blankets etc. Then we can have "sort by real price".

  • Another Guy Named Dan

    John Dewey - southwest is an anomoly in the business, I'll grant. They have acieved their profitablility for two main reasons
    1. They came into the business after the end of the regulated period, so they don't have any legacy union costs.

    2. By their business model, they're a jet fuel trading company that operates some airplanes. They have been remarkable successful using the futures markets and long term contracts to pay between 65%-80% of what other arilines have been paying for fuel. At times I wonder how much more profitable the company could be if they just parked the planes and sold fuel to other airlines.

  • John Dewey

    Another guy named Dan: "They came into the business after the end of the regulated period, so they don't have any legacy union costs. ...By their business model, they're a jet fuel trading company that operates some airplanes."

    Not sure where you got your knowledge about Southwest, dan. I have a very different understanding of Southwest's labor costs and its business model.

    First, Southwest started operations in 1971. Airline deregulation was enacted seven years later.

    Southwest is the most unionized of all the U.S. airlines. it also has the
    http://www.iht.com/articles/2007/11/28/business/hedge.php" rel="nofollow">highest wage rates.

    "Southwest also has the highest labor rates in the industry because it was the only big airline that had not demanded deep wage concessions from its workers."

    It is true fuel hedges sharply increased Southwest's profits the past two years. But the company would have realized operating profits in 2006 and 2007 even without those hedges. Even more significant, hedging was not responsible for the company's industry-leading profits for the twenty years before 2006.

    Southwest Airlines' critical success factor is the high utilization of its aircraft and its flight crew. From the earliest days of the company, the focus has always been on fast turn times at the gate. Southwest recognized that keeping expensive planes and expensive pilots in the air earning revenue would ensure profitability. Many of the airlines other strategies - such as high respect for employees and rejection of the hub and spoke model - arose out of the initial high utilization strategy.

  • John Dewey

    John Moore: "They try one trick after another to win fares, and few seem to care about customer loyalty"

    Overall, I agree with your comment. Your understanding of revenue management is top-notch. But I'm puzzled about why you feel airlines do not care about customer loyalty. Can you explain?

    John Moore: "But as rewards programs became competitive, they also became huge financial liabilities."

    It's true airlines must recognize this liability on their books. American Airlines values the liabilities of its frequent flyer program to be $1.6 billion. But that's only about 6% of the company's overall liabilities. Unlike that airline's huge debt load, the loyalty program liabilities have no debt service cash requirement. Loyalty program liabilities cannot force the company into bankruptcy - at least not any way that I can envision. Do you see that differently?

  • John Dewey

    If spun off, frequent flier programs may be the most valuable asset of some airlines.

    Hard to see how such a valuable asset, which could keep airlines out of bankruptcy courts, can be considered a huge liability.

  • happyjuggler0

    John Dewey,

    The link in your post from 7:38:52 AM doesn't work. I used to follow LUV religiously, but haven't in recent years. As a result I am surprised to learn that their labor costs are higher than the competition. This is a significant change.

    I can verify though that SWA started in the early 70's, and that their competitve advantage lies in large part due to their rapid turnaround times. This is achieved in several ways. First, they fly only to airports that don't require them to keep their planes in a queue forever. Second, the entire staff pitches in to clean the plane between flights ASAP, and to stock up, including the pilots. None of the usual union BS of "only so and so can do that task". Third, they have the quickest boarding times around thanks to no preassigned seating. You find a seat you like, stow your carry-on, and sit down.

    Most of this boils down to astute hiring. Friendly, helpful, intelligent people with good attitudes get hired, the other applicants get the boot instead of getting hired. Sounds easy enough, but the legacy carriers either can't do it or don't care to try, I'm not sure which.

    The other part is they don't treat their staff like shit, although historically they weren't paid very highly compared to the legacy carriers. Of course they also weren't laid off like with the legacy carriers, which helps. Herb Kelleher was/is a genius at labor harmony and common sense, which isn't so common.

    I'd love it if you could provide a link for your assertion that "Southwest also has the highest labor rates in the industry". I'm sure you're right, you are always on the ball on your citations, it just surprises me that's all this time.

  • John Dewey

    Happyjuggler,

    I'm not sure that Southwest Airlines has the highest labor costs. But I'm pretty sure they have labor wage rates which are as high as any other U.S. passenger airline.

    As I understand it, Southwest Airlines crew are used much more efficiently. Southwest pilots incur far fewer non-flying paid hours than do pilots at other airlines.

    Like other airlines, Southwest has many senior pilots at the top of the union wage scales. But they have more less experienced pilots because they continue to grow their fleet and their crew. Most other large airlines have - through poor management decisions - been forced to furlough their less experienced pilots who were at the lower ends of the pay scales.

    The statement I quoted about Southwest's labor wage rates is contained in the International Herald Tribune article Southwest Airlines gains advantage by hedging on long-term oil contracts

    You can find pilot pay rates at the web site Airline Pilot Pay Rates

    American Airlines pilot union last year compared pilot labor costs in AA Domestic vs Southwest. Note the much higher aircraft utilization Southwest manages to achieve: 11.4 block hours per day compared to AA's 9.6. Another revealing statistic is the hours flown per pilot: Southwest pilots fly 21% more hours annually.

  • happyjuggler0

    John Dewey,

    Thanks, that linked worked.

    Speaking of pilot costs and utilization, I just remembered something that I neglected to add (late) last night. Namely that Southwest flys only 737's, and thus only has to keep its pilots (and other staff) trained and certified on one type of aircraft. This reduces the direct costs of training and certification compared to other airlines, increases the availabilty of pilots to actually pilot their planes (instead of sitting in a flight simulator), and no doubt increases the scheduling flexibility of its overall staff of pilots because they don't need a certain number of hours in each type of plane.

  • John Dewey

    happyjuggler,

    All true. Flying only one aircraft also:

    - reduces the inventory carrying costs for aircraft parts;
    - reduces the training costs for mechanics;
    - reduces the size of the maintenance engineering dept;
    - reduces the spare aircraft requirement;
    - reduces the size of the Purchasing department;
    - reduces the number of purchase orders, material receipts, and invoices which must be processed;
    - reduces the training time for flight attendants;
    etc, etc.

    There is a risk, of course. Should the FAA ever ground all 737's due to some risk which must be eliminated, Southwest would lose all its revenue during the grounding period. I don't see that happening wuth this aircraft, but it did happen in 1979 with the DC-10.

  • http://www.ictradingonline.com Martina

    What a danger this animal brief .

  • http://www.ictradingonline.com Martina

    I have seen several writers of the progressive ilk all up in arms about these extra fees.