Annals of commerce: Do airline companies know what they’re doing?

What’s wrong with this picture, retailed in The Economist [sic] from an air traveler web site where the discussion has some sensible observations about seat pricing?  Right: the seat with no legroom, and the original seat with some legroom, are treated as though they are the same good that will sell for the same price, even as the seat with extra legroom is credited with a higher price.  If markets work, the squooshed seat has to sell for less than the standard seat.  In Patrons Despite Themselves, we examined resale royalties laws that obliged art collectors to pay artists a fraction of any appreciation a painting experienced after they (collectors) bought it.  Artists lobbied hard for this nonsensical piece of policy, because they couldn’t see that when the dust cleared, collectors must pay less for “Sunset less 15% of its appreciation after purchase” than for Sunset in fee simple, and that the real effect of the law, even leaving aside the nuisance of keeping track of your work after you sell it, is to transfer risk from (rich) collectors to (poor) artists and money the other way, something no-one would knowingly advocate as abstract goals.  It’s the same mistake, subconsciously treating both deals as though they involved the same thing.

Do markets work? Of course, but not always and not the way the examples in chapter 1 work.  Economics begins with mythical creatures modeled as Economic Man (and his sister Sue) and Profit-maximizing Firm.  There’s a lot of insight to be drawn from this cast, but no economist I know thinks real people are like that; the interesting stuff happens when we think about all the standard market failures and the real psychology of human decisionmaking.  What’s really going on with the airline seats?  To understand this, we have to look at how airline ‘seats’ are actually sold, and at the history of the industry. Most people start their search for air travel at a web site that presents options whose descriptors are an origin and destination, a schedule, and a price. (First class and business class seats are elements of an almost completely separate market.)  There’s nothing about food, seat pitch (legroom), seat width, warmth of FA smile, or movie on offer. This information is available with some effort, but as few passengers bother to look, the cheap seat gets the traveler and airlines have pretty much stopped competing on any of the other product qualities except to reward repeat buyers, and to unbundle separable services like checking a bag.

The tradition of “just selling a seat” originated when fares were regulated by governments, mostly to protect weak firms in the business, and load factors (percentage of seats sold) were much lower than today; adding seats to an airplane didn’t add much revenue.  It used to be a good bet on a transatlantic flight in the winter that you could appropriate all four or five center seats in coach, flip up the armrests, and lie down. At that time, airlines competed by lobbying the CAA and congress for fares, routes (what TWA had and Pan Am couldn’t ever get was domestic routes to connect with and feed its international flights) and in-flight comforts. At one time transatlantic carriers decided to limit their offerings of better and better meals, which was becoming a positional arms race no-one could win, by allowing only “sandwiches” in coach.  This produced the late lamented “sandwich wars” in which commissary chefs competed to see how much of a three-course meal they could load onto a piece of bread.

With deregulation, the industry entered a new world, but with an executive corps habituated to the rules and coddling of the old one.  I believe the persistent organizational culture of airlines is one reason they are so bad at what they do now, and why an industry with such wonderful technology has not made a penny of net profit since the Wright Brothers (admittedly, government management of national airlines over decades for purposes other than carrying people about  had a lot to do with this).  Look again at that seat diagram: the extra legroom seat is now regularly sold for a premium price on many airlines…but why isn’t it listed as a separate class right on the booking web page with the other options?

More puzzling is their failure to recognize or at least experiment with a business market that isn’t traveling to party.  On most wide-body aircraft, seven international business class seats take up about the same cabin floor space as 18 coach seats. So the airline should be indifferent between selling coach seats for $C and business seats for 18/7 x C, a little more than twice as much.  Instead, they charge five to six times as much for business. For the $1150 SFO-FRA RT itinerary I just looked at on United, this should be about $3000, but the business fare is $5600 or $6200.  What’s the extra two-and-a-half large for?

Let’s break down the pieces of these goods.  In coach, you get a couple of paper plates of swill, free soft drinks, a pillow and a sort of a blanket, a couple of movies, and ten miserable hours during which you can neither sleep nor work, with a small chance of a fatal blood clot forming in your legs.  Checking a second bag costs extra, and should (though I’m not sure the prices make sense).  In business, you get access to the airport lounge on departure, an imitation of a restaurant meal served on real dishes and a cloth napkin, all you can eat of nuts and snacks, free drinks, slippers and an eyeshade, a better chance of getting your carryon into the overhead storage, a choice of movies, and a lot of fussing over from the FAs.  You also get a power outlet and a seat you can actually sleep in (going) and work in (coming home), and at least two free checked bags (note that this last item is better described as, you get to pay the average cost of checked bags whether or not you have one).

The space is covered in our notional $3000 price that would make the revenue from one business row equal two coach rows’; what is the rest of the business package worth?  I can’t make it more than $100, drinks and all, though at that price I would instead buy a nice sandwich in the airport for $10, travel with a bag of trail mix, and just pound on-board orange juice.  I have no interest in drinking alcohol when I’m already fighting dehydration and facing a nine-hour time change. What I care about is the space and the outlet, period, and I bet I’m not alone.

What’s in it for the airline to trade 18 coach seats for seven no-frills business? A lot: eleven fewer  ticket sales and processing, eleven fewer bags to wrangle, and about a ton less of passengers to keep aloft (aviation cost is all about weight, especially with high fuel prices). United charges $100 for the second bag on that route, so if that’s close to right, the business seats save the airline $1100 for eleven fewer bags alone.  All in all, if the airline could sell seven business seats with coach-grade frills at $3000 each instead of 18 coach seats at $1150, it would be coining money and should be converting two rows of coach to one row of business right down the aisle.

Most businesses are very stingy about buying business class seats, understandably at the prices on offer, so the cabin is only a quarter business.  What might justify an $1800 basic-business premium, instead of $4400, on that route?  It’s 22 hours of flying, or more than half a working week, during which you can sleep or work; in a coach seat that time is lost (if you can’t sleep at night, your next day is a total loss and the one after that is no picnic if you’re also dealing with jetlag).  It’s also more productivity at the destination, because you’re not an exhausted wreck stepping into your hotel room in the morning.  A lot of people are worth $80/hour, not so many $200; there is a market for business-class travel shorn of silly frills, and sold at a price that’s much more profitable than the same square footage of cabin in coach. But the airlines can’t see it, because they won’t make it available.

Why is this so hard for airline managers – who have finally figured it out comparing profit from equivalent areas of steerage and economy plus – to understand?