price discrimination in the airline industry - Fagbokforlaget

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employee buys an air ticket, receives the frequent flyer bonus, and the employer pays forthe ticket. Obviously, there are some potential incentive problems in such a system. Theemployee has no strong incentives to make a cost efficient decisions concerningtraveling. On the contrary, each employee can receive large bonuses from the frequentflyer program if s/he travels more and travels more expensive than what s/he otherwisewould have chosen to do. This is an argument saying that such a system may lead toexcess consumption of this particular good, and thereby an excess cost burden for firmsand for the society.Second, we have so far assumed monopoly. If there is more than one active firm,or one active and one potential firm, it is important to discuss how a frequent flyerprogram affects competition. In the literature, it is pointed out that frequent flyerprograms are loyalty programs. 8 The consumers are becoming loyal to one firm, toaccumulate frequent flyer bonus on this particular firm. On the other hand, firms competeto attract new consumers that can become loyal. Although the net effect is ambiguous intheory, in his survey Klemperer (1995) concludes that loyalty programs typically aredetrimental to welfare:‘While there are exceptions to these conclusions, they suggest a presumption that publicpolicy should discourage activities that increase consumer switching costs (such asairlines’ frequent flyer programs), and encourage activities that reduce them’ (p. 536)According to his conclusion, frequent flyer programs are expected to haveanticompetitive effects. In particular, it is reason to be aware of the possible effect in asetting with one (or a few) established firm(s) and a potential entrant. If established firmshave many members in their frequent flyer programs, an entrant can find it difficult tocapture those consumers that are more or less loyal to the established firms.8 See, for example, Klemperer (1984, 1995) and Carns (1990).© Steen and Sørgard 18
3. THE AIRLINE INDUSTRYIn the previous Section we have briefly mentioned the airline industry, primarily as amotivation for the theoretical analysis we have undertaken, but also more directlyconcerning the frequent flyer programs. In this section we relate our results more directlyto the airline industry. We first report some empirical findings concerning the airlineindustry (Section 3.1), and then discuss the implications for public policy (Section 3.2).3.1 Some empirical findingsIn the previous Section we discussed three different forms of price discrimination:versioning, discounts for large consumers and frequent flyer programs. Let us herediscuss the role of each of them in the airline industry.VersioningAs we have already argued, it is quite obvious that the airline industry practicesversioning. The high quality version is the flexible ticket, where you can reschedule yourflight at any time and even cancel the flight without any costs attached to it. The damagedversion is a so called restrictive ticket. There can be several restrictions on it. Forexample, Saturday night stay-over, advance purchase and no flexibility concerningrescheduling of the flight. Note that the main reason for damaging the product was tomake it less attractive for the consumer with the high willingness to pay. This isobviously the driving force in the airline industry when they introduce a particularrestrictive ticket. All three restrictions mentioned above are important for the businesstravelers and damages the product from their point of view, but not so important for theleisure traveler. For example, a Saturday night stay-over restriction implies that thebusiness traveler – who typically travels during the week – finds such a versionunattractive. A leisure traveler, on the other hand, might prefer to travel in the weekendand then such a restriction is not a problem at all. The observed behaviour is consistentwith the findings in Gale and Holmes (1993). In their theoretical study they find that amonopoly airline will offer tickets with restrictions to ‘weed out’ consumers with highvaluation of time.© Steen and Sørgard 19
Page 1 and 2: PRICE DISCRIMINATIONINTHE AIRLINE I
Page 3 and 4: various kinds of price discriminati
Page 5 and 6: If the quality of the good equals Q
Page 7 and 8: As shown in Figure 3, the quality o
Page 9 and 10: consumers’ consumer surplus. Rear
Page 11 and 12: products. This would lead to an inc
Page 13 and 14: A price increase for the group with
Page 15 and 16: Even if third degree price discrimi
Page 17: The solid line is the demand if the
Page 21 and 22: flexible air ticket, labeled C-clas
Page 23 and 24: city pair market and the importance
Page 25 and 26: very intense rivalry on prices. The
Page 27 and 28: When airlines compete, there might
Page 29 and 30: Holmes, T. J. (1989): ‘The Effect

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