Price Discrimination by the FAA

February 2008 Pricing

Bring up the topic of price discrimination, and you are sure to find at least someone state that it isn’t fair, perhaps even illegal.  Yet, the world around abounds with examples, state sanctioned as well.  Recently, the Transportation Secretary proposed a plan that would allow price discrimination by the FAA.

New rules proposed by Treasury Secretary Mary Peters would allow airports to vary take-off and landing fees throughout the day.  The approach would allow for higher fees during periods of peak demand, also known as congestion pricing or peak demand pricing.

The reasoning behind peak demand pricing is to use the price signal to influence behavior.  Change the price, and the demand changes.  Economic theory, from the time of Alfred Marshall (1842 – 1924), has posited that price influences demand.

Peak demand pricing allows the pricing mechanism to encourage demand shifting between peak consumption periods towards lower consumption periods.  It is used by theatres (matinee discounts), drinking establishments (happy hour), and hotels (weekend getaways).  It is under experimentation with roads (the Chunnel), electricity (City of Anaheim, CA), and water (Phoenix, AZ).  And, it is definitely practiced by airlines themselves.

If you notice, each of the above examples shares common traits.  The goods delivered in the above industries are created through infrastructure and processes with limited capacity and high sunk costs, and marginal increases in capacity require large, upfront investments.

Once full, a hotel cannot add a room to meet the demands of the next customer.  Likewise, once maximized, an electric utility cannot produce another megawatt without new generation and transmission equipment.  Similarly, once loaded, an airport cannot take another landing without building a new runway.

The alternative to peak demand pricing is usually less palatable.  Forced rationing, where demand is limited by fiat, typically leads to aftermarket trading in either black, grey, or white markets.  Queuing, as observed in anticipation of sold-out sporting or entertainment events, results in the loss of time that could be more productively or enjoyable spent elsewise.  And, we cannot leave out the potential for allocation of limited resources through personal relationships, also known as politics.

Yet peak demand pricing is also a form of price discrimination.  People, or in this case airlines which presumably attempt to re-coop costs from consumers, have a choice between flying at peak times or off peak times.  For those flying at peak times, they accept that their convenience comes at a cost.  For those with a lower willingness to pay, they accept that their frugality requires patience.   It is a tradeoff society can work with.

Despite the rationality of the approach, expect airlines to raise hoopla against peak demand pricing, claiming that it is unfair.  True, peak demand pricing on runways would affect airlines reliant upon the hub and spoke approach to air transportation disproportionately over those running a point-to-point service.  And true, most large airlines operate via the hub and spoke system.  Yet I never read in our legal structure that laws should be made to support the most powerful players, nor have I seen an instance where progress was made because nothing changed.

About the author

Tim J. Smith, PhD is the Managing Principal of Wiglaf Pricing, and an Adjunct Professor at DePaul University of Marketing and Economics. His most recent book is Pricing Strategy: Setting Price Levels, Managing Price Discounts, & Establishing Price Structures.

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