How Airlines Exploit Laws to Literally Squeeze Customers
Flying on a plane these days is a humbling and sometimes humiliating experience. Basic amenities are being removed and there is no telling where the competitive devaluing of the customer experience will end.
The trends are disturbing. Seat width for the major carriers has shrunk from 18.5 to 17 inches, and seat “pitch”—the distance from one point on a seat to the same point on the seat in front—has shrunk from 35 to 31 inches. Meals and checked bags are no longer included. In 2017, the average fee for merely changing a reservation across the top four legacy carriers was $200; how that figure relates to costs is a mystery. Customer service at the airport is virtually nonexistent. We read in horror that some stranded passenger waited 12 hours in a queue to meet with a real-life representative.
And don’t get me started on the bathrooms, which are now so narrow that all but the smallest of passengers must practically exit in reverse. We get it. It doesn’t take an advanced economics degree to understand that bathrooms fail to generate incremental revenues for the airlines, and in fact are costing the carriers revenues by displacing floor space that could otherwise be used to squeeze in more rows.
In an age when revenue management and cost efficiencies are sacrosanct, can weak competition among airlines be counted on to keep bathrooms from shrinking further or from being removed altogether? If passengers could be induced to wear catheters in exchange for lower fares, would that be a good thing? What’s to stop airlines from stacking passengers vertically, like beef sides hanging in a meat locker?
If certain passengers are willing to endure deep-vein thrombosis for a slightly reduced fare, a libertarian might ask, why not allow the market to satisfy this desire? The answer is that our society does not condone every transaction between a willing buyer and a willing seller; if it did, then prostitution, cocaine, gambling, and the employment of minors would be legal in all 50 states. Our competition policy condones this devaluing of the customer experience on the grounds that consumers are willing to pay for it. Yet increasingly, they have no choice but to do so or to not fly at all.
Competition is typically judged in terms of prices and their relation to incremental costs; the larger the gap, the greater the exercise of market power. But firms compete, at least in theory, in other dimensions as well, including over quality of service. Shrinking seat sizes can be understood as an exercise of market power by airlines—a quality-adjusted price increase in the base fare.
In his new book, The Great Reversal: How America Gave Up on Free Markets, NYU professor Thomas Philippon studies trends in airline consolidation and profitability. (It bears noting that the three large mergers that contributed mightily to airline consolidation occurred between 2010 and 2014, under President Obama’s Department of Justice, implying that lax antitrust enforcement is not exclusively a Republican problem.)
Philippon shows that airline concentration at the national level increased from about eight equal-sized firms in 2008 (an HHI of 0.13) to less than four equal-sized firms by 2015 (an HHI of 0.28). (HHI stands for the Herfindahl-Hirschman Index, a commonly accepted measure of market concentration. The relevant HHI for competition purposes is at the local route level, discussed below, which is significantly larger than the national HHI.) At the same time, he finds that U.S. airline profits have jumped from near zero to positive levels.
According to Statista, airline margins in North America rose from 5.7 percent in 2010 to 14.4 percent in 2015. By 2018, airlines were posting a net profit of nearly $15 billion, and average profit per passenger was roughly $16. The profitability of airlines did not necessarily come from higher base fares; bag fees accounted for over 40 percent of their after-tax profits in 2018. Given the new ancillary fees, the effective price of flying is higher, or put differently, the quality of service is lower for the base fare, and the pricing is more discriminatory.
Is the connection between rising concentration and rising profits a coincidence? There is empirical evidence that concentration could be leading to higher fares. Professors José Azar, Martin C. Schmalz, and Isabel Tecu studied concentration at the route level, and found that passengers on a typical route were served by roughly two equal-sized airlines in 2001 (an HHI of 0.50) and by roughly 1.8 equal-sized airlines by 2013 (an HHI of 0.55).
A modified index that takes common ownership into account indicates even higher levels of concentration—passengers on a typical route were served by roughly 1.3 equal-sized airlines by 2013 (a modified HHI of 0.77). Berkshire Hathaway, by the way, owns stock in American, United, Delta, and Southwest. It is now the first, second, or third largest shareholder in each of the four major U.S. airlines.
Using a regression model, the economists show that common ownership has a large and statistically significant inflationary effect on ticket prices.
The same competitive forces (or lack thereof) that are driving airline margins higher are likely to blame for the deterioration of services and amenities. Indeed, it is much easier for an airline to exercise power in some aftermarket such as checked bags; once the customer has committed to a given carrier, it is harder to turn to outside options. And competition for amenities such as seat dimensions, bathroom size, and customer service will be harder to judge than competition on base fares. Expedia doesn’t sort its search results by quality-adjusted fares.
For the same reason that lack of competition causes prices to diverge from costs, carriers that face less competition on their routes can cut back on amenities and services. Take capacity management. If customers are beholden to one or two airlines on a route, and there is little prospect for switching in response to fare increases, it is easier for the carrier to fly at capacity or even overbook flights and use an auction to buy back seats. This capacity management reduces the airline’s costs—which in theory could get passed along to consumers in the form of reduced fares—but extends a passenger’s travel time significantly in the event of a storm or mechanical glitch, as alternative flights are often overbooked. Lower prices über alles.
Consolidation also facilitates coordination among airlines. It is easier to coordinate capacity on a route with one rival than with several. Economists Gaurab Aryal, Federico Ciliberto, and Benjamin T. Leyden found that when legacy carriers communicated about capacity discipline to investors in a given quarter, the average number of seats offered in an origin-destination market decreased by 1.45 percent in the next quarter. Fewer seats lead to higher fares, cramped flights, and longer travel times in the event of a disruption.
The airlines’ pricing strategy is to remove an amenity (size, meals, bags) that previously was included in the base fare, and then impose a surcharge to restore said amenity. This strategy is a close cousin to the more familiar bundled loyalty rebates, in which a firm imposes a penalty on the customer for breaking the bundle, which can be avoided by purchasing the complementary product at an inflated rate. All of the major carriers recently implemented an upcharge for additional legroom or wider seats, the price of which can only be viewed if the customer selects or begins to book a specific flight. That a customer declines to pay for the surcharge does not imply, as some free marketers are prone to believe, that the choice reflects her preferences and she secretly covets child-size seats; it simply means that the customer has achieved the best she could do, given her budget, under the restricted choice set provided.
The “unbundling” of bags from fares is heralded by airline consultants as a good thing for customers. A 2017 GAO review of the economic literature on bag fees reveals, however, that passengers who checked a bag are unequivocally worse off from unbundling. The GAO provides two credible estimates of the base-fare reduction attributable to unbundling for every dollar increase in bag fees: 24 cents (or 76 cents more to fly on net per dollar of checked bags) and 11 cents (or 89 cents more to fly on net per dollar of checked bags). Although it is conceivable that those passengers who never check bags are slightly better off from unbundling, that’s an exceedingly small group of customers. Put differently, a passenger who checked a bag once would have fly between four (for the 24 cent estimate) and nine (for the eleven cent estimate) times consecutively without a bag to be made whole from the unbundling experience.
None of this is to suggest that Congress should ban unbundling. But when it comes to non-price amenities, such as minimum seat size or the maximum time an airline can hold us on the tarmac, we should be skeptical that market forces will lead us to desirable outcomes, especially when we know competition has already been attenuated.
Achieving the lowest possible short-run price for consumers should not be the organizing principle for an economy. Low prices are often in tension with other values, including quality, safety, diversity, innovation, security, conservation, reputation, inequality, and dignity. The market doesn’t always balance these conflicting values very well, especially when benefits or costs cannot be fully internalized. That the market is propelling us towards the low-price equilibrium doesn’t resolve the conflict. Many policy interventions—from minimum wage laws to fuel efficiency standards—can be said to have priced someone out of the market. And that’s okay so long as we get something else in return.
Since the Chicago School revolution, antitrust policy has perversely reinforced this low-price ethic. Colombia Law’s Tim Wu has dubbed this antitrust’s “price fixation”—accommodating horizontal combinations or vertical restraints that lead to lower short-run prices regardless of other impacts. Antitrust is particularly ill-suited to address the airlines’ race to the bottom because it would be difficult to reject the hypothesis that each airline is simply reacting to the seat configurations of its rivals. Fortunately, antitrust is just one remedy in our policy toolkit.
Some competition problems can be resolved via regulation. Indeed, in September 2018, Congress called for minimum standards for seat width and pitch in the most recent Federal Aviation Administration (FAA) reauthorization, and in October 2018, President Trump signed the bill into law. But the FAA is dragging its feet in implementing that mandate; it stands accused of jerry-rigging its safety tests by using volunteers that don’t reflect the demographics of today’s flying public. The FAA has also been criticized for using dolls rather than babies in its prior evacuation testing. Unfortunately, nothing in the reauthorization law prevents the FAA from making Spirit’s industry-trailing 28-inch seat pitch the de facto minimum, effectively undermining the will of Congress.
Congress can end these shenanigans by simply mandating a minimum seat size and pitch. No safety study is required; just the will to exercise their power. Potential elements of a real passengers’ bill of rights—minimum seat size, minimum pitch, limits on overbookings, holding some capacity open for disruptions—could upset the airlines’ best-laid traffic management plans. But this is a small price to pay to reclaim our dignity while flying.
Hal Singer is a managing director at Econ One and an adjunct professor at Georgetown’s McDonough School of Business, where he teaches pricing to MBAs candidates. This article was supported by the Ewing Marion Kauffman Foundation.