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Why Airline Ticket Prices Fluctuate: Understanding Dynamic Pricing Strategies
If you need to take a flight at the last minute, your ticket price is almost certainly going to be very high! However, if you are more flexible in your travel plans, you may notice something interesting: different days of the week have different charges for airfare. Why are tickets priced differently as you get closer to the desired date of departure, and why are they priced differently on different days of the week? The answer is dynamic pricing, which is influenced by demand forecasting. In order to maximize revenue, airlines attempt to charge the maximum amount consumers are willing to pay.
Dynamic Pricing Explained
Dynamic pricing occurs when prices for customers can change on short notice to maximize revenue. It is also known as surge pricing, which has been implemented for ride share apps like Uber and Lyft and some fast food restaurants. During times of peak demand, these businesses know they can charge more and still enjoy roughly the same number of customers - their demand (ability and willingness to pay) is high. For ride share apps, a period of peak demand is likely Friday evening when people want to go out and have fun at bars, clubs, etc. They have likely been anticipating this for much of their week, and thus are not dissuaded from ordering an Uber or Lyft when the price is higher than normal.
Similarly, fast food apps and digital menu boards can be changed instantly during the lunch or dinner rushes. Hungry customers are unlikely to be dissuaded from the purchase by a moderate increase in price. Some other services, such as grocery ordering at supermarkets, also have dynamic pricing features when selecting pickup or delivery on their apps: customers can pay an additional charge to have their groceries ready more quickly. When buying goods online, such as through Amazon, customers can often also opt to pay higher shipping fees to get their items to their doorstep faster.
Airlines and Dynamic Pricing: Inelastic Demand
Like Uber and Lyft, as well as other transportation options, airlines also engage in surge pricing. Transportation companies know that demand for their services is relatively inelastic, meaning quantity demanded changes proportionally less than the change in price. In layman’s terms, this means an increase in price causes little decrease in customers. One factor that makes demand for transportation more inelastic is the fact that it is considered a necessity. While some consumer purchases like clothing, furniture, or a new laptop computer can be delayed, transportation often cannot. You need to get to work, get home, get to the grocery store, etc.
A second factor that kicks in as the travel date draws nearer is lack of suitable substitutes. If you have all summer to get to a vacation destination, you can explore multiple transportation options like driving, taking a bus, taking a train, or flying. Unfortunately, if you have not planned well in advance, your transportation options quickly dwindle for cross-country trips. In many cases, if you have less than a week until you need to be at a destination, your only realistic option is to book a flight.
The Reverse: Flexible Standby Travelers and Low Marginal Cost
If you’re not flexible, your demand is inelastic and you have little choice but to accept rising prices. However, dynamic pricing can advantage those who are very flexible: standby travelers. Airlines and hotels steadily raise rates as peak travel times approach using demand forecasting algorithms. However, this may often be imperfect and result in some unfilled seats or rooms; the rising prices may “price out” some potential customers whose demand was more elastic than anticipated - they choose to forego the trip.
The airlines and hotels have already paid the [mostly] fixed costs, meaning they can afford to accommodate more customers up to capacity for very low marginal costs. For only a little more jet fuel or a few more bathroom toiletries, the airlines and hotels can add to their profits by enticing a final handful of customers to reach capacity. Thus, they can offer very low last-minute prices to potential customers who can drop everything and take the trip. These standby travelers are usually rare, as it requires lots of flexibility during typically non-peak times. Traditionally, these standby travelers were mostly retirees, but the increase in the number of remote workers may be expanding their number.
Airline Competition, Mergers, and Effects on Pricing
Aside from steep discounts offered to standby travelers to fill up capacity at the last minute and shore up revenue, airline ticket prices have remained steady over the past 30 years when adjusting for inflation. However, many consumers have a misperception that airline travel is more expensive than it used to be, typically due to customer service complaints and general anger over inflation. High-profile news reports of unruly passengers over the past few years may contribute to a general feeling that air travel is overpriced, especially given longer security wait times since the September 11, 2001 terror attacks. Economically speaking, however, air travel is actually not increasing in inflation-adjusted price.
The stability of airline prices is also due to two competing results of airline mergers, which began in the late 1980s during an era of air travel deregulation that began in 1978. Mergers allowed the resulting larger airlines to benefit from economies of scale, described as efficiency gains, that lowered costs. The larger airlines could consolidate some services, saving money. However, prices for customers likely did not decrease much due to the increasing market power of the larger airlines. Operational costs may have fallen, but there was also less competition. Thus, the larger airlines were not forced to lower their airfare; customers may be “locked in” to routes that were only serviced by one airline, granting regional monopolies.
Tickets vs. Fees
One complaint regarding airline pricing is that tickets may not be getting more expensive, but that fewer services are being included in the ticket price and are now being charged separately. For example, many airlines allow a certain amount of baggage to be included in the price of a ticket. This “perk” may be ending for many airlines, including some that made it a key brand feature. Increasing rates for baggage likely add to the overall belief that air travel is becoming more expensive, and it may well be for travelers who carry more than a single carry-on.
Likely to encourage fliers to upgrade their status (another example of dynamic pricing), airlines are continuing to offer free checked baggage to those with higher tiered statuses. Regular travelers may find it worthwhile to pay for a membership in an airline’s higher tier of service to enjoy more free baggage. Those who fly only rarely, by contrast, may decide to forgo purchasing any sort of membership and pay out-of-pocket to check baggage or receive any sort of preferential boarding. When it comes to airline travel, there are many options for paid upgrades, which likely adds to a generalized consumer belief that such travel is expensive; they see fees for services even if they choose not to add them.
High Barriers to Entry Limit Competition in Airline Industry
Over the long term, high barriers to entry have limited new firms entering the airline industry and driving down airfare. The airline industry is very expensive and highly regulated, likely requiring billions of dollars to start a new firm that handles full-scale commercial traffic. New airliners can cost between $80 and $200 million, and require constant maintenance and upkeep. Airlines have to lease gate space at airports, as well as hangar space for storage and repair facilities for their airliners. The only new major airline to emerge in recent years is Breeze Airways, founded in 2018 with flights across the United States.
