Spirit’s carry on charge–smart move or not?

You’ve probably heard about Spirit Airlines’ decision to charge customers for carry on baggage–$30 per bag if purchased in advance, or $45 “at the door.” You’ll still get your one free “personal item.”  This latest example of an airline unbundling one more feature of its service offering resulted in a promise to Sen. Charles Schumer (D, NY) from five other major airlines that they will not follow Spirit’s lead, at least for now.

Spirit claims on its website that this charge will lower overall costs to passengers and improve service.  Here’s how this is supposed to work:  fares will be lowered somewhat, as will fees for checked baggage.  Since carry on bags have a big impact on how long it takes to board and to deplane (according to Spirit, but many passengers will probably agree), reducing the number of carry on bags on a flight will reduce turnaround time and get passengers off the plane more quickly once it has arrived at its destination.  Security lines will also move more quickly (ignoring the effect of passengers traveling on other carriers who will still have their carry on bags).

One wonders whether Spirit gathered any consumer intelligence or conducted any experiments to arrive at this decision.  Airlines have had varying success at generating revenues by implementing fees for service features that were once bundled into the fare.  US Airways, for example, seems to have retreated from charging for non-alcoholic beverages (including bottled water).  JetBlue has started charging for headphones but recent experience suggests that on some flights they still may give them out for free once the plane has left the gate.  Fees for checked bags may stick–as long as you get that free carry-on–but any additional fee gives a competitor a potential point of differentiation.  Have you seen the Southwest commercial, “Battle Cry,” where the ramp crew, in the manner of sports fans, flash the passengers on a rival airline with “BAGS FLY FREE” spelled out across their chests?

People’s Express was one of the first post de-regulation airlines built around a low cost no-frills business model, and perhaps the first to charge for checked baggage ($3 per bag).  Many elements of PE resembled Southwest’s model–one type of aircraft, open seating, and really large overhead compartments for those carry-on bags.  Food and drink were available for purchase, and all the seats on a given flight were the same price.  In many ways, the experience was more like being on a train or bus than an airplane, and with one-way fares between Newark and cities like Boston as low as $19, a lot of passengers were likely switching from those modes.   There’s no question that PE helped democratize flying, overcoming the affordability barrier for many passengers.  Following it’s initial success, People’s Express went on a buying spree (taking on a lot of debt) and the legacy carriers discovered yield management, enabling them to match or come close to PE’s fares for at least some passengers.  With all that debt, PE abandoned its original customer value proposition and profit formula and began to look more like other airlines.  Ultimately, PE was acquired by Texas Air and ceased to exist as a brand.

Whenever an airline makes a move like charging for carry-on bags or for using the lavatory (Ryanair), I can’t help but wonder if they even have a customer value proposition.  One problem may be that flying on an airplane is only a means to an end (the job that the consumer wants to do at the other end of the flight) rather than an end in itself.  This makes it hard to find a price that both matches the value to the passenger (which is a function of the value of completing the job at the destination) and the cost of providing the service, plus some profit.  The carriers have long inferred that business travelers place more value on the job to be done at the destination, and they have implemented a variety of pricing strategies to segment their customers based on the assumption that leisure travelers are far more price sensitive.  However, most of the assumptions about pricing do not reflect any understanding of the ways customers evaluate pricing relative to the value of the jobs to be done.  In the absence of such understanding, carriers have resorted to “mechanical” solutions to pricing and revenue generation.

Actions like Spirit’s carry-on fee often provide new instances of the law of unintended consequences.  It will be interesting to see what happens in the next few months.  Will Spirit retreat, or will other carriers follow suit?

Copyright 2010 by David G. Bakken.  All rights reserved.

 

Book review: Why Popcorn Costs So Much at the Movies and Other Pricing Puzzles

Why Popcorn Costs So Much at the Movies and Other Pricing Puzzles, Richard B. McKenzie, Copernicus Books/Springer, 2008.

One of the rituals of high school is the senior picture.  Nowadays, that often means a trip to a professional studio for a shoot involving multiple outfits, poses and backgrounds.  The student is not obligated to buy any photos–the yearbook photo is provided for free–but the studios hope to sell a package of prints to the student and his or her family.  When one of my children went through this a few years ago, we were presented with a confusing array of packages that varied in the number of poses, the sizes of the prints, and the number of prints of each size that were included.  Say you want to have a more formal pose for the yearbook (that counts as one pose, even though that picture is “free”) and an informal pose for wallet-size prints–you’ll have to buy a package that includes two poses.  That’s not all–in order to get those two poses and a certain number of wallet-size prints, you may be forced to take so many 5x7s and a couple of 10x12s or some other mix of sizes.  And don’t think you’ll be able to figure out the individual prices for wallet-size, 5×7, and 10×12 prints.  There likely is no a la carte offering.

When I went through this with one of my children a few years ago, I wondered how the studio arrived at this particular bundling strategy.  This is precisely the kind of pricing “puzzle” that Richard McKenzie, the Walter B. Gerken Professor of Enterprise and Society in the Paul Merage School of Business at the University of California, Irvine, dissects in this intriguing but (at least for me) occasionally frustrating book.

Pricing makes the economy go ’round.  Pricing is also complex, and economic theory can leave us wanting when it comes to understanding the way that prices work in the “real” world.  Professor McKenzie does a good job of tackling this complexity head on, and anyone whose job is remotely connected to pricing will benefit from reading this book.  Consumers who are curious about the prices they pay (or don’t, for “free” goods) and how they got that way are likely to enjoy this book as well.

McKenzie has given a lot of thought to a wide range of pricing anomalies.  In addition to the title’s question about the high price of popcorn at the movies, here’s a sampling of the puzzles McKenzie ponders:  why there are reduced price sales, why there are so many discount coupons, why some goods are free, why printers are cheap and ink cartridges are expensive, why ticket prices are the same for all movies, why so many prices end with “9,” and why manufacturers offer rebates.

The underlying economic principle in many of these chapters is price discrimination.  In other words, these pricing anomalies arise as a way to distinguish customers who are more price sensitive from those less price sensitive with respect to a given category of goods or services.  A classic example of price discrimination can be found in discount airline fares that require a Saturday night stay in the destination city (thus selecting out the less price sensitive business travelers).  However, this book is nothing if not comprehensive, and McKenzie covers other pricing effects, including distortions introduced by market interventions.

McKenzie’s writing is engaging and readable.  The typical chapter begins with an exploration of the common sense or “obvious” explanation for a pricing anomaly (popcorn costs more at the movies because the consumers are captive, allowing the theater owners to exploit their desire for popcorn) and works his way through competing plausible explanations.  As in, maybe popcorn costs more at the movies in order to keep ticket prices lower.

Maybe it’s just McKenzie’s style, but all too often the explanations for these pricing puzzles come across as speculative hypotheses awaiting empirical verification.  When evidence is offered, as with data on the prices of printers and ink cartridges, it is usually consistent with McKenzie’s explanation, but not necessarily conclusive.  McKenzie gives much more weight to the consumer (demand) side of the pricing problem than he does to the producer (supply) side.  In my experience, manufacturers struggle with a host of cost considerations in setting prices that McKenzie barely touches on.

The chapter titled “Why movie ticket prices are all the same” exemplifies the things I really like about this book, as well as some of the things I found a bit frustrating.  McKenzie provides a fairly rich picture of the relevant economics of the motion picture industry as he explains the apparent anomaly that prices for the most popular movies are the same as those for the least popular. According to McKenzie, this pricing makes sense given that, prior to release there is a lot of uncertainty surrounding the potential popularity of a particular film.  Moreover, there are other pricing “mechanisms” that provide greater returns to the most popular films.  For example, less popular films disappear from first-run theaters fairly quickly, perhaps moving to second and third run screens with lower ticket prices, resulting in higher average ticket prices for the most popular films.

In the case of movie ticket prices, as with some of the other pricing anomalies covered in this book, McKenzie omits or is perhaps unaware of information that might favor alternative explanations.  For example, theater owners do exert some price differentiation for films that are expected to be more popular.  When I went to see “Star Trek” last week, there was a notice at the box office that discount coupons offered by the theater would not be accepted for that movie (at least for the opening weekend). Another nit–there’s no mention of the impact of the multiplex theater configuration on uniform ticket prices.  In the multiplex setting, charging different prices for different films likely would require additional staff to police admittance to the individual movies, thus raising the theater owner’s costs. For a another take on the economics of movie ticket pricing, see The Economic Naturalist:  In Search of Explanations for Everyday Enigmas by Robert H. Frank of Cornell University (Basic Books, 2007).  Frank covers some of the same territory as McKenzie, and I recommend his book as well.

Final verdict–this is a must read book for anyone who deals with pricing.