The Hidden Truth About Airline Prices: A blog about how airline prices are set and why that is.
A recent piece from the Wall Street Journal got me thinking about the role of price discrimination in airfare pricing. In the article, WSJ describes how an airline passenger was able to buy tickets for his group at different times for different prices and end up paying less as a result.
This isn’t exactly news, but it is something that isn’t widely understood or acknowledged by people who travel by air. Many people assume that airlines use algorithms to adjust their fares up or down to the lowest possible fare to keep demand steady. Most people don’t realize that airlines could care less if they get one extra passenger on a given flight — they are looking to maximize profits across all flights, not just any single flight. Airlines do this in two ways: they can either lower prices (which attracts more passengers) or raise them (which deters demand).
The problem with this strategy is that you must know what each passenger is willing to pay, so you can maximize your profits.”
This week’s post is an article that I wrote for the New York Times. It is a bit longer than usual so I will not post it here in full, but you can read it at the link above.
The article was a lot of fun to write and has been getting a great response. You can read some of the reader comments at the bottom of the New York Times page. I also got a lot of interesting emails from readers who are smarter than me and have more experience in airline pricing than me, which was great. If you would like to get in touch with me about this topic, or anything else for that matter, please email me at:
The main point I hope comes through in the article is that airline pricing is complicated, but maybe not as complicated as people think. I have heard from a number of readers who work in airline pricing and they thought my description was pretty good. So did academics who study this issue (because there has been a lot of academic research on airline pricing). One reader even said that my description was “scarily accurate.”
As air travel has become more accessible to people, the interest in airline prices has grown. Air tickets can be so expensive sometimes that they become unaffordable for many people.
There are some reasons why we see such big differences in the price of a ticket. One of them is that airlines have a complicated algorithm to set their prices. This algorithm takes into account different variables like the day of the week, the time of booking and even how you buy it. Airlines use all this information to price their tickets according to how much they think you are willing to pay.
They also know how many people will buy tickets at each price and they try not to leave any seats empty when the flight is about to take off. So if a flight is half empty, airlines usually lower their prices in order to attract more customers.
Since air ticket prices are so complex, it’s hard for us as customers to understand why and if we’re paying too much for our ticket or not. There are some tools that can help you find out if you’ve paid too much or not but I think we’ll never get used to being charged so differently from other customers just because we booked our ticket later than them or bought it through a different website.
In the past two years, a number of airline pricing experiments have shown that the situation is more complicated than this.
We think of an airline ticket as a price, but in fact an airline ticket is really a bundle of many different prices. It’s something like a magazine subscription. If you subscribe to Newsweek you pay $25 for 52 issues and get a bill once a year. But if you walk into a newsstand and buy Newsweek each week, it will cost you $5 an issue, or $260 a year.
Airlines know that most people don’t want to spend time figuring out what they are paying. They just want to buy the ticket with the lowest price and move on with their lives. So the airlines have taken advantage of this laziness by tacking on extra fees for things people used to take for granted, like checked bags or assigned seats.
I have been a frequent traveler since I was 20 years old. I like to travel and I love to fly, but I hate the process of buying a ticket.
If you’ve ever bought an airline ticket — and who hasn’t? — you know that it’s frustrating. It’s not just that finding low fares can take a lot of time and effort. It’s also that when you think you’ve found the lowest fare, you worry that you haven’t. Did you really compare all the airlines? Did you leave money on the table by buying too soon or too late? Did you make the best choice between nonstop and connecting flights?
In fact, the process is so mind-numbing that we usually end up paying whatever fare is first quoted to us. We might spend another five minutes looking for a better deal if we have the time, but few of us will go much beyond that. (I suspect that most people don’t even try.) And for us frequent business travelers, the whole thing is so unpleasant that we often pay to avoid it: We buy more expensive tickets by using our corporate travel agents or by buying fully refundable tickets from an airline directly, with no advance purchase
The airline business is a very simple industry. There are two things that an airline sells. One is seats and the other is bag space. In modern aircraft the margin between these two things is measured in fractions of an inch. The difference between an overweight bag and a passenger who purchases a seat but needs to stand in the aisle is zero.
The second thing you need to understand is that airlines do not care what people pay for their tickets. They care only about how many seats they can sell at whatever price will result in every flight leaving with every seat filled.
Prices are the result of a dynamic bidding process. The price of an airline seat is not simply set by the airline and then posted for travelers to see and purchase. There is no explicit price for a ticket from San Francisco to New York. Instead, airlines combine fares from different flights (or even different airlines) into a bundle of tickets known as an itinerary. Travelers pick one of these bundles and pay the associated price. Airlines then adjust their bids based on how much travelers are willing to pay for their itineraries.
This is not just a game theory abstraction; this is how real airline tickets are priced.
By learning about how prices are set, we can understand some surprising facts about the economics of air travel. For example, why do airline tickets sometimes cost more when your flight has a stopover? Why do prices sometimes rise as your travel date approaches? How come airfares are so high in some cities and so low in others?