Circumventing Airline Price Discrimination David Suh Introduction Airlines practice price discrimination. Price discrimination involves charging different prices to different customers for the same good.1 This phenomenon occurs everyday. Senior citizens pay less for a movie ticket at the theater, supermarkets give discounts to customer who are willing to purchase in bulk, and nightclubs feature “ladies’ night” which offer waived cover charge and free or discounted drinks to women. Airlines practice price discrimination by differentiating their fares into “booking classes” where each booking class has different rules and restrictions for the passenger. In practice, a cheap ticket likely sorts the customer into a highly restrictive booking class, where he cannot refund the ticket or change the date. If the customer needs those features, he can seek to purchase a fare that places him in a more flexible booking class, but pays a premium for that flexibility.2 Airlines also practice price discrimination based on the markets that they provide service. Markets with little to no competition allow the airlines in that market to name their own price to customers, while markets with heavy competition pit airlines against each other to provide a competitive fare to customers.3 In either case, airlines set the maximum price that they believe the customer is willing to pay in order to maximize profits.4 In order for airlines to maximize profits, they vary fares based on the supply and demand for travel in each market (i.e. a specific origin and destination) for passengers with varying travel objectives.5 Since airlines have many fixed costs, such as multiyear pilot contracts and the cost of the aircraft, airlines seek to maximize their profits from each passenger.6 For example, a business traveler who purchases a fare on short notice and retains the flexibility to change or 1 Hal R. Varian, Intermediate Microeconomics: A Modern Approach 467 (8th ed. 2009). 2 Id. 3 Id. 4 Id. 5 U.S. GOV’T ACCOUNTABILITY OFFICE, REP. No. GAO-01-831, Aviation Competition: Restricting Airline Ticketing Rules Unlikely to Help Consumers 4-5 (2001) [hereinafter GAO]. 6 Id. at 18. 2 cancel his ticket without a penalty will pay more than a leisure traveler who purchases a nonrefundable fare months in advance.7 Leisure travelers with firm travel plans who do not need the flexibility of business travelers can purchase lower fares with restrictions, such as those with a “Saturday night stay” requirement, minimum stay requirement, or flying on red-eye flights.8 When setting prices for travel between two markets, a key factor that airlines consider is whether other airlines offer a similar “product”. If there are multiple airlines flying the same route, airlines must offer a competitive price or they would lose business to an airline that offers a similar service at a lower price. On the other hand, when a flight between two markets has little to no competition, airlines can charge more for travel between these cities since customers would have no viable alternative. By determining the level of competition, an airline can appropriately price its fares so as to quote a competitive price to customers while maximizing profits. As a result, fares tend to be lower on routes where there is heavy competition. Conversely, fares tend to be higher in markets where competition is limited, and such fares may be significantly higher if the origin or the destination is the carriers’ hub.9 Airline hubs are airports where one or two airlines have a strong presence. For example, Dallas Fort-Worth airport is an American Airlines hub. American Airlines accounts for 85% of all traffic out of the Dallas Fort-Worth airport. American Airlines operates more gates, flies to more destinations, and flies to high-demand destinations more frequently than any other airline at this airport. The same is true in Miami. American Airlines operates a hub at the Miami International Airport which account for 72% of all traffic out of that airport. Naturally, American Airlines is in a better position than other airlines to operate direct flights between Dallas and Miami. As of May, 2015, there are 11 daily flights from Dallas to Miami, and they are all 7 Id. at 5. 8 Id. at 13. 9 Id. at 14. 3 operated by American Airlines. American Airlines’ overwhelming presence at these airports stifles competition on the Dallas-Miami route, allowing American Airlines to charge a heavy premium to passengers who wish to fly on a direct flight. What is hidden-city ticketing? Hidden-city ticketing is the practice of purchasing a ticket to a city beyond the actual destination and getting off the aircraft at the layover city. This can make economic sense for customers because airlines charge different fares based on supply and demand for travel between the departure and destination markets, not the total distance flown between them. This price discrimination leads to scenarios where purchasing airfare beyond the actual destination can be cheaper than purchasing airfare only to the intended destination. Hidden-city ticketing opportunities are possible because of airlines’ hub-and-spoke model.10 Airlines operate “hub” airports as a transfer point for passengers who are traveling between two “spoke” airports that do not operate a direct flight. As explained above, hub airports are often dominated by one or two airlines that operate heavily out of that market (e.g., United Airlines at San Francisco International Airport, American Airlines at Dallas/Fort Worth International Airport).11 Since airlines set fares based on the market and the type of passenger, hidden-city ticketing opportunities arise when greater competition exists for travel between spoke airports than on routes to and from hub airports, and where airfares in those markets reflect such competition.12 As a result, passengers whose real destination is the hub airport may be able to 10 Airlines to Public: Please Ignore this Blog Post, THE ECONOMIST BLOG (Jan. 12, 2015, 5:37 PM), http://www.economist.com/blogs/gulliver/2015/01/hidden-city-ticketing. 11 See generally, United announces new routes from SFO and LAX hubs, UNITED HUB (Oct. 9, 2013, 9:00 AM), https://hub.united.com/en-us/news/company-operations/pages/new-sfo-and-lax-routes-on-united.aspx; Travel the world from Dallas/Fort Worth, WWW.AA.COM, http://www.aa.com/i18n/urls/dfw.jsp?anchorLocation=DirectURL&title=dfw (last visited April 25, 2015). 12 GAO, supra at 6. 4 save money by purchasing a ticket with a lower fare to a spoke airport but deplaning at the hub airport. For example, because of the differences in airfares for nonstop travel between Chicago and Houston and for travel from Chicago to Houston via a layover in Cincinnati, a possible hidden-city opportunity existed for travel to Cincinnati. The fares for nonstop travel between Chicago and Houston were approximately $162.50.13 Three other airlines offered flights to Houston connecting in cities such as Cincinnati, Dallas, Boston, Phoenix, and St. Louis.14 To compete with direct flight prices, the fare from Chicago to Houston on an airline that connected in Cincinnati was $91.60.15 In comparison, direct travel from Chicago to Cincinnati was $353.10.16 Because of the fares and services other competing airlines offered between Chicago and Houston, a hidden-city ticketing opportunity existed for travelers between Chicago and Cincinnati that allowed passengers to save $261.50 by purchasing tickets to Houston but deplaning in Cincinnati. Enter Skiplagged.com In the past, passengers who wished to take advantage of hidden-city ticketing had to research airlines’ fares between certain markets to uncover opportunities. Skiplagged.com (“Skiplagged”) makes this unnecessary. Skiplagged provides an online flight search engine that lays out possible hidden-city ticketing opportunities in a digestible user interface. Considering the example above, most Online Travel Agencies (“OTA’s”) such as Orbitz or Priceline will only show the cost of flights from Chicago to Cincinnati, with possible layovers in between. In this case, all leading OTA’s showed that the cheapest fare from Chicago to Cincinnati was 13 See Matrix Airfare Search, https://matrix.itasoftware.com (fare search conducted on March 12, 2015 for travel on April 16, 2015). 14 Id. 15 Id. 16 Id. 5 $353.10.17 Skiplagged not only showed these “legitimate” fares but also showed hidden-city fares (e.g., flights from Chicago to another destination city with a layover in Cincinnati).18 When a customer attempts to taken advantage of a hidden-city fare on Skiplagged.com, the website redirects the user to a separate website where he can purchase the flight. Since Skiplagged is not a true OTA, customers cannot book tickets on the site. Skiplagged only shows the cheapest fares between two city pairs, whether they are hidden-city fares or legitimate fares. When an itinerary involves hidden-ticketing, Skiplagged warns its readers to use carry-on bags only, since passengers cannot reclaim baggage at the layover city. Further, Skiplagged warns hidden-city ticketers to expect changes to their itinerary during irregular operations. Considering the previous hidden-city example, airlines facing inclement weather in Cincinnati may cancel the segment to Cincinnati and rebook their passengers through another layover city, or even book them on a direct flight. What other types of strategies exist for circumventing airfare price discrimination? Skiplagged is just one example of circumventing airfare price discrimination. Even prior to Skiplagged’s inception, hidden-city ticketing was already a well-known “trick” in small online communities such as FlyerTalk and MilePoint.19 Commercial aviation enthusiasts gathered on these message boards to share cheap fares, discuss strategies for minimizing the cost of travel, and discuss issues related to frequent flyer programs.