Alacarte Aviation

First-degree price discrimination is where the seller gets each consumer to pay the highest price he or she is willing to pay. In doing so, the seller maximises revenue from each customer. In the diagram below, rather than simply getting revenue equal to the light green square, through first degree price discrimination, the seller gets a revenue equal to the light and dark green areas. Airlines tried to do this initially through the different ‘classes’ of seats (eg. Economy, Business, and First class). In this way, for the same journey from city A to city B, travellers could pay three different amounts.

Nowadays, airlines are looking to take first-degree price discrimination to the next level. On top of relatively low base rates, airlines charge a host of additional fees for minor luxuries like checked-in baggage and alcoholic drinks. Some airlines are even considering a toilet charge for short-haul flights. The result is that airlines have improved their ability to derive the maximum possible revenue from each passenger.

While it may sound rosy for airlines, it’s not. By even considering levying tiny fees for things like going to the loo, airlines are on a slippery path. The reason being that the additional administrative cost of levying such fees (eg. Staff for money collection, staff for accounting of extra fees) will eat away at the revenue itself. The more tiny sums they charge, the higher the administrative cost.. a classic case of diseconomies of scale.

While I agree that levying a few extra fees that bring in substantial enough revenues per passenger would be a wise thing to do for airlines, it is important that they don’t go too far. I fear that the recent frenzy to charge additional fees is a sign that airlines are falling into the trap of targeting revenue-maximisation rather than profit-maximisation.

Note: Price discrimination is when different prices are charged for the same product. Hence, the above is only a valid example of price discrimination if you define ‘the product’ as air-transportation from city A to city B.