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  • Circumventing Airline

    Price Discrimination David Suh

  • 2

    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. GOVT 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.

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    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.

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    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.

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    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 (OTAs) 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 OTAs 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.

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    $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 rea

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