How to price air travel properly

The current pricing model for air travel is nonsense stacked upon nonsense. Single fares, return fares, fees for changes, discounted and flexi fares, business fares, loyalty bonuses… all nonsense. It developed as an anti-competitive arms race between the airlines of the 70s and escalated from there. Nonsense. Here’s how to price air travel properly.

The cost of a seat has three components:

  • A fare, valid for a segment class, season, and class of service. For example “Between UK and East Coast US, standard service (economy), spring-summer 2014” £345.
  • An option to travel on a particular date, flight, and seat. For example “Option to travel on VS45, LHR-JFK, May 17, 2014, rows 28-37” £73.
  • An efficiency bonus. For example “Returning within a week, returning on the same weekday, checked baggage, full flight” -£65 (discount). Or another example “Short connection, Roll-on luggage, meal” £35 (surcharge).

To travel, you need to purchase a fare and at least one option for the flight you want. When you check in you may get money back as an efficiency bonus, or if you do certain things you may be asked to pay surcharges.

The cost of the fare reflects the cost and value of the service. It should be broadly stable through a season, as airlines amortise their capital and hedge fuel costs. You can buy fares in bulk and in advance, and that makes the price marginally cheaper since the airline can bank the money. If you’re a frequent traveller on a route, you or your company can estimate and bulk-buy your fares a year ahead and save money.

Nothing is refundable. You could resell your fares on a market if one exists, but when a season expires so do the fares. For continuity, fares would be released in overlapping seasons such as spring-summer, summer-fall, etc. The fare is consumed when the flight closes and you’re on it.

The cost of the option reflects the competition amongst travellers to get on specific flights and seats. Daytime flight, busy flight, nice seat, etc. means it’s more expensive. Louy hours, lousy airport, and sitting at the back of the plane are cheaper. The price of the option is shaped by supply and demand.

The price of the option also varies depending on when you buy it. Generally it’s cheaper if you buy long before the flight date, but not always. The option starts at a moderate price when the trip is months away, as the airline has no data on demand. The price may fall when the flight is weeks away and demand is known, which is the optimal time to buy. Then it rises and peaks days before the flight as people who buy late bid up the price. The option price may then drop on the day of the flight, to very low or negative, if there are spare seats. Negative means the airline can call you to get you on that flight.

Options are non-refundable and once you bought them that’s it. They don’t change, but you could in theory transfer them to another person. In practice airlines would prohibit this in most cases to stop people manipulating the market (scalping).

The idea with options is that you buy as many as you need to accommodate flexibility in your plans. Suppose that every year your company holds meetings the second or third week of March and september. Rather than wait to find the actual dates, buy options for both weeks while they are cheap.

Say you’re going to a conference that’s Monday to Thursday, but you’re tempted to stay the weekend if your family will be away from home anyway. You don’t yet know your family’s plans, so you buy an option to return Thursday evening on the company, and another (probably cheaper) option to return Sunday night with your own money.

if you miss your flight you don’t consume the fare, but the option lapses. Buy another option on a later flight, and maybe this time settle for the red-eye. If you think you’re likely to miss the flight, say because a family member is sick or the weather is turning bad, maybe buy the second option defensively.

As for the efficiency bonus, it’s a way to share the efficiencies or inefficiencies of travel as it actually turns out. It’s more efficient for airlines if aircraft are full as they travel back and forth between two airports than if one leg flies empty. That can be partly addressed through the option price, but another way is to reward specific passengers for taking balanced trips. It’s more helpful for the airline if you return a few days or a week after you go out, and kind of irrelevant if you return two months later. The efficiency bonus reflects that.

Although supply and demand says that full flights should cost more (high option price) they’re actually quite efficient for the airline. Airlines want full flights. The passenger’s experience, on the other hand is much beter on a flight where every other seat is empty. The option price for this price is low, so the passenger is getting a great deal, but he airline is losing money. The efficiency bonus can mitigate that. Fares should be priced for average loading. If you arrive and the flight is packed, you get money back. If it’s half empty, enjoy the space.

Other efficiency bonuses can be whatever makes the airline’s job easier, such as checking in your luggage. Yes, its more efficient if everyon does that, so the airlne should reward you. Conversely if you’re causing delays and inconvenience with your roll on, or booking short connections that you’re likely to miss (and cause a late passenger inconvenience) you should pay a premium.

There should not be free meals on flights. They’re awful, they’re incredibly bad for you, and they represent an enormous waste as passengers eat and airlines carry the food that passengers don’t want and almost nobody would buy if it were fairly priced. Long-haul flights should offer restaurant-quality meals to passengers who want them for a surcharge, which is entirely doable and enjoyable.

The efficiency bonus is just that, a bonus (or surcharge) that gets worked out when you actually travel, typically at check-in since things like baggage and meals have to be settled then. Efficiencies about return flights and full flights similarly get worked out when you check in, taking into account your previous trips. The airline can’t charge you extra for things that are the airline’s problem, like an empty flight, but when you arrive for a full flight you’ll get a pleasant surprise.

That’s it. No return fares, no change fees, no mileage, no Saturday night stays, no complicated fare classes and rules. Just fares, options, and bonuses on the day. Airlines, do that, make money.

Questions and answers:

Q: Won’t people just buy one fare and one option always? What’s the point.
A: That’s good for many people, and that’s the pricing model of budget airlines (rolled into one number). But many business travellers and other regular travellers, who still don’t buy flexi fares today, would buy more than one option.

Q: What’s wrong with flexible fares?
A: Fully flexible fares are extremely expensive because they really contain an option to travel on any day at all. Nobody needs that much flexibility. Options for specific dates would be much more cost-effective.

Q: Can’t you just rebook your flights for a fee?
A: Sometimes you can, but then you’re effectively buying a new option when your current one lapses or is about to lapse. That tends to be close to the date of the flight so it’s expensive, and you’re badly in need of a flight so you tolerate high prices. Prudent travellers should be able to buy the options they need well in advance.

Q: How will airlines plan capacity? Giving the passengers options will result in flights less than 100% full.
A: If customers buy the options it means they value them, and if they’re priced correctly they will be profitable to airlines. Although flights need to be near capacity, they don’t necessarily need to be 100% full. If you fly a plane 95% full but have sold 115% in options, you make money.

Q: How do I explain these fare and options charges in my expense reports?
A: Probably easier than you think, as it’s standard finance terms. They’re also perfectly sound expenses. It’ll be easier to explain a fare and two options than a missed fare and a rebooking.

Q: Would you really charge passengers for roll-on luggage?
A: If you delay X-ray and boarding with your bulky luggage then you should pay, yes. Also I always check my luggage, so there 🙂

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