“Economics in the Sky”: Behavioural Insights in Airplane Industry

 

–Exploring How Loss Aversion, Endowment Effect and Other Behavioral Economics Principles Shape Air Travel Strategies

Have you ever swayed between flights because prices seem to be all over the place as your trip gets closer? Airlines have their own sneaky tricks up their sleeves, like tweaking prices by algorithm based on demand and our fear of missing out. Many companies win consumers by introducing flyer miles schemes to keep us hooked. Curious about all this? Let’s dive into the world where behavioural economics collides with the airline industry.

“Loss Aversion” & Pricing Strategies

If your family plan to travel somewhere during holiday, do you start searching for tickets two months in advance to get cheaper ones? Most people know the importance of “timing” when purchasing tickets because it is highly related to demand and supply. It seems common sense that the nearer to departure date, the less available the seats, and therefore the more expensive the airline tickets are. The results studied by CheapAir.com show that best period to buy tickets is 3 weeks to 2.5 months since it is most economic.

However, such “strategies” are apparently not always true. You may have experienced a sudden decline of ticket price several days before departure and feel frustrated about more cost spent. The term “loss aversion” in behavioural economics explains this mindset by stating people prefer to avoid losses instead of acquiring gains, which is also linked to sunk cost. An increase in sunk cost reduces our willingness to give up, so most people aim to be cost-effective. If consumers expect flight costs to raise, they rather buy the tickets immediately in order not to pay more in the future; but on the other hand, they tend to cancel more expensive tickets for cheaper ones if possible.

This is why airline firms control prices or formulate policies not only through economics, but also through predicting consumers’ psychology. For example, they impose a percentage of cancellation fee, which often keep rising until the departure date. From consumers’ perspective, this restricts their flexibility by increasing sunk cost. In the US, every major airline except Southwest Airline charges penalty fee for a change or cancel in flight (Mendel, 2023).

Of course, it cannot always be reasonable. Citizen Advice mentions the Consumer Law to state that it is not compulsory to accept the charge just because it’s written in contract you signed. But if passengers are not aware of the regulations, they may give up defending their rights or requesting compensation. This leads to a problem called “adverse selection”.

“Adverse Selection”, “Moral Hazard” & Airline Quality

So, what specifically is adverse selection? Well, it refers to information asymmetry between sellers and buyers. Here when buying tickets, we know that not all the passengers are familiar with the Consumer Law. Most people just accept to pay cancellation fee, and such lack of information makes firms—the price maker, take advantage of them. Similar cases often take place on low-cost airlines. They impose large amount of penalty to overweight baggage, or not completed online check-in. Ask around and see if your friends have been fined for extra money at the departure gate.

Another issue arising from asymmetric information is “moral hazard”. But it is a more selfish act of maximising own utility as they know another party will bear most costs. For example, the unlimited flight packages service promoted by AirAsia allows passengers to fly as many times as they want on various routes within a year. Sounds like a great deal right? But put another way, buying this package means you are signing a long-term service contract with the airline. Thus, airline can be emboldened to save costs and reduce the service quality on these flights.

Flight pass “SUPER+” created by AirAsia (Source: airasia.com)

Other than that, niche routes operated by a single airline will form a monopoly, making your elasticity of demand largely inelastic. When the airline knows customers will stick to them regardless of poor conditions and services, they will not only raise price, but also be less motivated to improve the quality of consumer services.

“Endowment Effect” & Consumer Loyalty

While talking about quality of services, you may think that the additional welfare and point accumulation scheme offered by large-scale airlines are impressive, especially for passengers with frequent business travel needs. Why racking up those frequent flyer miles makes us so satisfied? Here the “endowment effect” plays a major role—consumers value what they own more instead of its market value. Every time you choose to fly with the same airline, they make you feel you are attached importance to. Moreover, it sounds attractive that the more miles you accumulate, the more VIP services you will enjoy.

Take Singapore Airlines' KrisFlyer programme as an example. The miles passengers earned can offset part of price when buying tickets or upgrading to a higher-level class. You can also use the points for free entry to VIP lounges. All the “unexpected welfare” contributes to a more enjoyable journey without paying more. That’s why consumers are willing to choose it.

KrisFlyer Programme (Source: singaporeair.com)

So now think about why an airline keeps drawing you in like a magnet—they build consumer loyalty and reputation through reward schemes and gaining your trust. Unconsciously, your opportunity cost of choosing another airline increases.

 

In short, airlines attract more consumers and earn profit by making full use of behavioural economics and human psychology. From the fluctuation of airfares due to loss aversion to the appeal of flyer miles reward due to endowment effect, we explore how airlines cater to our psychological preferences. But at the same time, consumers may face problems like adverse selection and moral hazard, and airline service quality stays uncertain. As passengers, knowing the logic behind these strategies may be helpful to choose most cost-efficient flight, while it’s also important to be careful about terms and conditions, enjoying worthy services. Safe travelling ahead!

 References

https://www.shutterstock.com/image-photo/passengers-commercial-airplane-flying-above-260nw-1573918030.jpg

Citizens Advice (no date) Cancelling goods or services: Tips for consumers. Available at: https://www.citizensadvice.org.uk/Global/CitizensAdvice/campaigns/ncw15/ncw15-Consumerinformationnote.pdf (Accessed: 16 April 2024).

Get unlimited flights subscription: AirAsia Super+ Unlimited (no date) Get Unlimited Flights Subscription | airasia SUPER+ Unlimited. Available at: https://www.airasia.com/aa/campaign/en/au/superplus.html (Accessed: 15 April 2024).

Krisflyer (no date) Membership Benefits | KrisFlyer PPS Club | Singapore Airlines. Available at: https://www.singaporeair.com/en_UK/gb/ppsclub-krisflyer/krisflyer/krisflyer/?gad_source=1&gclid=Cj0KCQjw2uiwBhCXARIsACMvIU1ddhib4dfnMe9t2GuI5925GWh-IjFqHZDXD7oYh3K0l8D5TKjEzEYaAplgEALw_wcB&gclsrc=aw.ds (Accessed: 14 April 2024).

Mendel, S. (2023) How much does it cost to change or cancel a flight in 2024?, LendingTree. Available at: https://www.lendingtree.com/credit-cards/articles/cost-to-change-or-cancel-flight/ (Accessed: 15 April 2024).

When to book cheap flights in 2023: The best time to buy domestic airline tickets - cheapair (2024) The Best Time to Buy Cheap Flights. Available at: https://www.cheapair.com/blog/the-best-time-to-buy-flights/ (Accessed: 14 April 2024).