Saturday, September 29, 2012

Why did Airlines Start Charging for Bags and Meals?

Twenty years ago, it was taken for granted that the price of your airline ticket covered checked luggage—and a meal if the flight was long enough to justify one. Today most airlines—the major exception is South-western—charge for each checked bag. All airlines within the U.S., in my experience, charge for meals. Soft drinks and peanuts are still usually free.

Looking at it as an economist, charging for extras that cost the airline something to produce seems like a sensible enough policy. If it costs the airline five dollars to provide dinner in the air, passengers who want the meal should be indifferent between the current fare and a free meal and a fare five dollars lower, accompanied by a five dollar charge for eating. Passengers to whom the meal is worth less than five dollars should prefer the latter arrangement. So charging for a meal, or any other costly add-on, while adjusting fares accordingly, benefits some customers, hurts none, and costs the airline nothing.

Bag charges may be an exception. As my wife likes to point out, the result of charging for checked bags is that people carry more as carry on, making it harder for everyone to board. At least one small airline I know of solved that problem by charging for carry on luggage as well, but, so far as I know, none of the majors have imitated it.

Charging for things makes sense now. Not charging for them made sense forty years ago. Under airline regulation, the industry functioned as a cartel; an airline could not lower its price without CAB approval. That held fares well above their competitive level, making it in the interest of airlines to compete on non-price terms—including free meals.

If the airlines had switched to charging for meals and luggage in the late seventies or early eighties, shortly after deregulation, there would be no puzzle—but they didn't. As best I can determine by a quick google, the first airline to do so was American, which only started charging for checked luggage in 2008. Airlines started dropping free meals earlier, about 2001, and started offering meals for sale a few years later. Why then?

One possible explanation for when free meals started to disappear might be 9/11, which caused considerable financial problems for the airlines—perhaps they decided they could no longer afford them. But that does not make sense from an economic standpoint. After deregulation, the airlines were free to raise or lower their fares. If meals cost the airline more than they were worth to their customers, why not abolish them earlier and lower prices accordingly? If not, then dropping the free meals was a less attractive alternative to raising fares, so why do it?

The closest I can come to an explanation of this puzzle requires me to replace the economic assumption of rational behavior with a form of predictable irrationality—the widespread belief in just prices, a subject I discuss in an old article linking economics to evolutionary psychology. 

Many people act as if they believe that they have a moral right to continued transactions on whatever terms they are used to having them in the past—that a seller who raises his prices is somehow trying to cheat them. It is not an unqualified belief—evidence that the seller's cost has increased may sometimes rebut it—but it is at least a presumption. And one way of acting on it is to avoid doing business with sellers who act that way, who offer you the same transaction at the same price for a period of years, then suddenly raise the price or reduce what they are giving you in exchange. 

For instance, airlines that stop providing you with free meals.

Of course, airline prices change all the time. But then, they also vary according to where you are flying, when you are flying, and how long in advance you bought your ticket, a pattern complicated enough so that the average passenger cannot easily keep track of whether the airline is offering the same fares this year as last. He can notice if the airline stops offering free meals or starts charging for checked luggage. And resent it.

If this analysis is correct, an airline that stopped offering meals with no obvious reason would suffer a reputational loss. Customers would decide that that airline was not their friend, was trying to exploit them, and would avoid it when possible. 9/11 offered an excuse. I do not know what set off the later switch to bag charges, but it may be significant that, within a fairly short period of time, most airlines were doing it, perhaps because the later ones had the practice of the earlier movers to justify their charges. And it may be significant that South-western, a very successful firm, continues to carry bags for free and makes a large point of that fact in their advertising.

This is a possible, partial, explanation of what happened, but not a very convincing one. Readers with better answers to my puzzle are invited to offer them.


Anonymous said...

I would offer an opinion, but the EMH indicates that you should pay for it, so I'm holding out for a better offer.

McKibbinUSA said...

The primary reason airlines began charging for bags and meals was to remind people that providing service is a hassle for the airlines -- it's that simple -- anyone who can't afford to fly private small aircraft is considered a third class citizen and passenger to be put up with -- just look at the slovenly appearance and performance of airline gate employees -- trust me, the passenger airline business could care less what passengers think -- by the way, most tickets used by passengers in major airlines are reimbursed by third parties -- there's no reason at all for the airlines to treat passengers as guests or as important people -- the reality is that passengers really are a hassle for airlines...

Anonymous said...

My earlier joke aside, I think prescriptions for sedatives are the main replacement for the airline meal. The equilibrium is no crappy salad, eat something at the gate, drop a Valium just before boarding a transcontinental flight, and go to sleep for the duration.

The marginal cost of a lousy meal goes to the drug store.

AndyHat said...

I'd look at the disintermediation of travel agents in the purchase process. Any decent travel agent would know to skip the fares that are $10 cheaper but have a $25 bag check fee. But on a fare search site, your average naive traveler is just going to go for the apparently cheapest fare that shows up at the top of the list. Thus, it's unbundling to get the cheapest fare up to the top of the search results...

(And you'll note that for the frequent travelers who know better than to shop on fare alone, the airlines offer elites free bag check).

SheetWise said...

If you ask everyone on an airliner what they paid for their ticket, you'll probably find that everyone paid a different fare -- independent of baggage, food, or other services contracted.

The question reminds me of Steven Ladsburg ruminating on the price of popcorn at the theater. Everybody came with the intention of purchasing a different type of experience, and the provider made it possible for them to do so.

I wish the airlines would carry this concept further, having the passengers step on a scale with their luggage upon entering the airport to determine (or verify) the fare (base + weight), and then make decisions about what was carry-on. Beyond a minimum weight requirement (i.e., minimum fare) a passenger should be able to purchase an adjacent empty seat at a base cost and distribute their total weight.

These wishes will probably never come true, because everyone is purchasing a different product and experience. And I don't really care, because I quit flying commercial aircraft when the TSA was formed. I'm so flexible in my travel arrangements now that I expect to be compensated for it. After all, I've often got the choice of auto, taxi, private air, charter air, train, ship, tramper ...

David Friedman said...

"The question reminds me of Steven Ladsburg ruminating on the price of popcorn at the theater."

Possibly based on my discussion of the issue in my old Price Theory?

SheetWise said...

"Possibly based on my discussion of the issue in my old Price Theory?"

I'm obviously an amateur in the field of economics, but I love the abstractness and blend of disciplines. Fortunately, there are so many authors whose theories are now a part of the lexicon that simply reading a blog entry may expand my reading list by several volumes. Unfortunately, Price Theory has not previously made that list. It is now added to my Amazon cart, and I will give it great consideration when I next perform triage.

BTW, at $20 for a used copy -- and $236+ for new -- maybe a "new" version by the author is in order.

David Friedman said...

"BTW, at $20 for a used copy -- and $236+ for new -- maybe a "new" version by the author is in order."

It's available online for free, linked to my web page.

Phil Birnbaum said...

I agree with AndyHat. It's not just the fare search sites, it's also newspaper advertising. They want to grab the reader with a lower price.

It's like automakers having a cheap barebones model that hardly anyone buys ... it allows a low "starting from" price that grabs the reader's attention.

In Canada, airlines (Air Canada, WestJet, and Porter) just started advertising the "real" price instead of the price before taxes/addons ... that followed the government musing about forcing them to do so. It used to be that there'd be a $49 price from Ottawa to Toronto, but it was $150 after fees. Now, it appears in the paper as $150 from the get-go. They all changed at once.

BTW, I don't think any of the three Canadian airlines charges for the first bag. This supports the "advertised price" theory, but not the "fare search site" theory (since Canadian and American carriers appear together, and American fares don't include a bag). However, I still think that AndyHat's theory is right.

I actually wonder why the Canadian travel sites don't post fares with bags included. Hotwire now posts which hotels have free internet ... they didn't do that before. (I wish they'd do it for parking, too.)

Glen said...

It's only in the last decade or so that most people started to use fare search sites such as Kayak that make it easy to sort by price with the cheapest fares first. Given that dynamic, the first airline to unbundle extra charges had an edge until everyone else followed suit.

Southwest, on the other hand, generally has *not* taken part in the common reservation systems used by everyone else. To do an exhaustive search for lowest fares you had to do a search on Kayak/Hipmunk/Expedia *and* then do a separate search at . This protects them a bit from that competitive pressure.

Tim Worstall said...

I'd run from the European experience. Plus the fact that it takes time for a new equilibrium to develop (which speaks a little to David's point about consumer attitudes).

The low cost carriers in Europe really boomed in the last couple of decades. Ryanair being the poster child for the whole thing. They charge for absolutely everything over and above the simple ticket. They most certainly check (and carefully!) the size of your one permitted carry on and will charge you fiercely if it has to go into the hold. They even, get this, charge you an insurance fee to cover the mandatory hotel room etc they must provide if the flight is cancelled etc.

To some this is just evidence that they boast the lowest headline price then top it up with as many fees as they can. Which makes sense with online searches for flight prices etc.

Although Ryanair doesn't allow bots to search their site and it doesn't appear in any of the comparison sites.

There is however another way of looking at it. The real big cost to an airline is the capital cost of the planes. The more hours they spend in the air, the lower the turnaround time, the lower that cost per passenger is.

As with SouthWest, what Ryanair has really done is reduce that turnaround time to a minimum. I've been on flights of theirs where the incoming passengers are only just entering the terminal by one door while we outgoing are walking the 50 metres to the plane by another.

In this view they have deliberately made extremely expensive all of the things which make that turnaround time longer. Only one small piece of carry on (the minimum they can get away with under the law). Prices for checked baggage which deliberately dissuade you from doing it. Etc etc.

This has been an extremely profitable set up. And as ever, it takes time for large companies like the US airlines to note this, note the passenger reaction to it and then adopt it.

My actual view is that there's a bit of both going on. Ryanair are indeed deliberately over charging for those things which increase turnaround times (even to the point that there are no pockets in the seat backs for people to leave newspapers in which then take time to extract before the new flight).

And they're also gaining passengers with low up front costs and then charging as much as they can for the extras. They sell lottery tickets onboard for example....

Daublin said...

So, the question is to explain the path sensitivity, not the two equilibria at either end. The two equilibria make sense, but why did it take so long to change from one to the other?

One possible explanation is that people want to use standard deal packages. They don't want every flight they go on to be different, any more than they want every job contract to be different, or every rental contract, or every mortgage to have its own set of fine print. The first airline that split out optional services as separate fees had to explain it to their customers. That adds drag to the transactions, enough that it is not obviously a net win.

As for why a standard deal matters, there is more to it than the transaction cost of using a deal you are already used to. There is also the experience issue. In large part, people make major decisions by thinking back on their experience rather than on reasoning through the implications from first principles. Experience is more helpful when the new deal is just like the last 100 that you have experience with.

Simon said...

I think there is a customer perception of what's 'fair', but it has more to do with broader social norms than with the history of transactions between a customer and an individual airline.

On this theory, two factors slow down the change in airline behavior:
1) Norms change slowly
2) The customer response to changes can be unpredictable, so it is often rational for an airline to wait for some competitor to move first

Simon said...

Here in Europe, two of the top low-fare airlines are RyanAir and EasyJet.

My impression is that EasyJet offers low prices while staying comfortably within the bounds of prevailing social norms; RyanAir is more aggressively lowering prices, testing the limits of the norms. E.g., RyanAir charges for luggage, has even floated the idea of charging for bath rooms (without implementing it), and has sometimes been seen as not treating handicapped passengers as well as they should.

That said, let me add that my own recent experiences with RyanAir have been quite good. It seems that, while they test certain limits, they also know to stay within them.

A good example of the market as discovery process.

Chuck said...

My first thought is that it could be related to the cost of oil. As the cost of oil has increased over the last decade, airlines have sought to compensate for the potential loss by charging for extras.

I recall reading an article that some airlines were proposing charging obese people more because of the additional fuel required to fly them.

jimbino said...

Mysterious to me is the elimination of free wine on international flights. The airlines way overcharge for booze, which they don't even need to pay gummint tax on in international flights.

You can get wine at 10 cents a liter in Italy and at $1.50 per liter retail at Walmart. Why should airlines charge a fortune for a tiny bottle, especially since the service costs on the plane are no more than for the free can of coke?

I don't know about the rest of you, but I always fill my quart ziplock with little bottles of booze on both domestic and international flights.

SheetWise said...

[Price Theory is] available online for free, linked to my web page.

Thank you. I immediately recalled reading the first couple chapters online before. It has been several years, and apparently I lost track of it in a computer reboot or system update -- because I have a fond recall of the content, and now want to finish. HTML is an awkward and difficult book format for me, so I'm going to proceed with a printed copy (unknown hardcover edition available for $3). I'm certain that someday it will be worth its weight in C-notes ;)

Glen Whitman said...

What's the source for meals being dropped around 2001? My perception is that meals were either dropped or made much smaller (or turned into "snacks") much earlier, in the 1980s or 1990s.

As for the mystery of baggage taking so long to be unbundled, I think the flight and the baggage are *nearly* perfect complements. Not truly perfect, because some people travel without baggage and others with multiple bags. But I'll bet the correlation is very high. As a result, it would make sense to bundle them for the same reason it makes sense to bundle right and left shoes.

But in that case, the real mystery is why so many airlines have unbundled them in the last few years. And on that question, I think the other Glen has the right idea; it has to do with the common reservation system, where an airline can (seemingly) benefit from hidden charges. And that would also explain why Southwest is advertising based on this point.

I also recall that baggage charges kicked in around the time of a particularly notable spike in oil (and thus jet fuel) prices. That may have accentuated the incentive to unbundle because it meant more of the price was hidden. Here's an article with quotes from the airlines using fuel prices to justify the baggage fees:

AndyHat said...

I'd suggesting looking at the example of seat pitch, as well. From 2000-2004, American offered "more room throughout coach", offering a couple inches more seat pitch than the industry norm. However, long term they weren't able to get the extra $5 or $10 they needed to cover the lost seats because most travelers book based on schedule and low fare and didn't know the difference.

So now, extra seat pitch has also become an unbundled extra option (Economy Plus/Main Cabin Extra/Economy Comfort) for those who know what "seat pitch" means and are willing to pay an extra $20 for it. And, again, for the elite travelers who make their airline decisions based on factors other than just fare and schedule, this is a free perk.

Rebecca Friedman said...

Meals were still fairly common in at least the late '90s and probably later - given that I remember them quite clearly, for a good number of years, and I was born in '90.

Bob Murphy said...

I can't back it up with anything empirical, but I have been working in the energy sector for several years and I remember thinking that the airlines started charging for bags when their margins were getting crushed by fuel costs.

Frank Lazzara said...

My recall is airlines started to charge extra for baggage to help cover the higher cost of fuel. First airline to charge was spirit, June 20th 2007. I'm still waiting for the fares to be stopped since the price for fuel has dropped to the pre 2007 increase.

Anonymous said...

There are a lot of imaginative and eclectic opinions here. But people need to take a step back.

Airlines are run by the parasitic and exploitative investor class in "holding companies." They are not looking to make a buck they are the ruling class billionaires and multi millionaires.

Their job is to augment their wealth on the backs of working people. Airline fares, fees, cuts in meal service, employee(pilots,fight attendants, ground crew etc.) wage cuts, freezes, benefit cuts and theft of their pensions with the help of the court system etc.. are not imposed on us because the airline is weak and trying to stay afloat. They do it because they are wealthy and strong and have the Capitalist state or "government" and workers tax dollars to make a minority of exploiters obscenely wealthy at the cost of the majority of the working people. They instruct their low paid staff(customer "service") give you all sorts of clever and creative reasons as to why you can't get a refund, why it costs 3,200.00 to fly to Madrid when there re 70 "economy" seats left. As if anyone would pay the "non-discounted fare of 3,200.00 (USD) for an "economy" trans atlantic flight. (Economy is just a term to charge exploitative fares)

Airlines are part of the service sphere i.e. housing, education, healthcare, catering (restaurants and hotels). Significant is the fact that under Capitalist relations of production the service sphere takes on a parasitic nature (dentists, restaurants, hotels, medical industry, physical "therapists", monopoly air transport or "airlines: and many more "services" and "professions"

The ruling class billionaires of the Unites States, France, Germany, Japan, UK and other capitalist imperialist countries cannot find profitable sources of investment in production because the masses have overproduced commodities. The value of the commodities are expropriated by the wealthy financial/industrial billionaires by paying workers low wages. Therefore the private monopoly interests cannot expand profit or surplus value because working people don't get paid enough to buy the things that they produce whether they need or not. Enter the parasitic service sphere like monopoly airlines and "wall street" or as Marxist-Leninists call them, the financial oligarchy.

Surplus value has now become a fetish because only in the production sphere can value be produced by human labor NOT in the service sphere.

So what the "Bill Gates" of the world do is resort to fictitious capital and derivatives etc... Part of this is that the same investors buy out shares of these airline companies, utility providers etc...

It is an indication of the decay and end of Capitalist relations of production where value is created by the majority of working people (socialized) and appropriation is privatized by the Bourgeosie, the financial oligarchy of billionaires.

Humanity has progressed beyond capitalism and now the productive forces (socialized labor) must be in line with the relations of production i.e. transfer of private ownership of a minority of exploiters to social ownership of the means of production by the masses, the overwhelming majority of mankind of exploited and oppressed. This includes all of us that are not part of the 1% of billionaires.

To understand this better it is imperative that people educate themselves in Marxism Leninism. Anti-Communism is alien to the interests of the working people and the advancement of society where production is subordinated to the interests of the masses of humanity not for the enrichment of a tiny minority of a class that history no longer needs.