Innovation

Typically, airline ticket prices are determined by a very complex algorithm. In addition to the costs incurred by the airline on account of the flight, this takes into account a lot of factors like the airports being connected by the flight, the date of the journey, date of booking, time of flight, availability of options/competition etc. These help determine the current demand and hence maximize profits based on what a customer may be willing to pay.

A key part of the algorithm boils down to this: To a customer who is currently looking for flight tickets, a seat on a flight tomorrow is much more valuable than a seat on a flight thirty days from now. Tomorrow's ticket will likely solve a more pressing need, and has to be selected from a narrower pool of options especially on routes with high ratio of passengers to seat availability.

This scarcity therefore results in a higher price, reflecting the customer's willingness to pay. The flight thirty days or later from now (in the absence of very specific requirements for the customer) will have more suppliers competing to serve that need, hence giving the customer more choice and the option of paying a lower price. 

​There are other less common pricing methods for air tickets, such as auctions, and dedicated platforms offering these. Auctions can happen in two typical ways:

1. Bids can start at a reserve price and then potential customers can bid upwards, in competition with other customers. Traditionally, this model is called the English auction.

2. Dutch auction model, in which bids start from a high upper limit, from where the supplier (or a group of suppliers) may bid downwards until the price matches what a customer is willing to pay.

The objective here is to grab a ticket at a good price, and this typically targets the casual traveler because of the inherent unpredictability. The shortcoming is that there is no guarantee that the bidder will receive the ticket if his bid isn't the highest. For a business traveler, this would be unacceptable under normal circumstances. Usually, a business which attaches a billability and revenue to each instance of travel would prefer to pay more for predictability than save a few dollars and run the risk of the trip not happening at all.

This means there is potential to turn the model around and squeeze additional revenue from passengers who approach from beyond a certain threshold of time. The demand based on the level of urgency can be depicted by:

​Towards the right end of the graph, you see a point beyond which the urgency for a ticket is cost-agnostic. For a commercial airline, this is typically populated by business travelers who are on critical missions, or individuals flying on a personal emergency or other such time-sensitive objective. These are the customers who are willing to pay hefty premiums for making use of the airline's service – similar to surge pricing in a ride sharing app like Uber. Traditionally, the airline may utilize surge pricing principles on its conventional distribution channels. But there is a clear market for last minute sales of a smaller pool of tickets, based on genuine urgencies.

The right platform, such as a mobile app to notify and engage the potential target customers in a bidding process, would help extract the right value from the left over inventory. Once again, this would follow a typical English auction model. The difference between such a mechanism and the conventional auctions is in the target market they aim at. Here, the customers are not seeking a bargain price for their ticket, but rather hoping to get their hands on a ticket at any price possible (within an extended budget of course) and often at the last moment possible.

Granted, there is again a very low level of predictability in this model. A customer is not guaranteed a ticket until a specific point of time ahead of the actual flight, and that too assuming he/she places the highest bid. This is an extended version of surge pricing, because such an auction is driven by the presence of a great amount of demand for a relatively limited supply of tickets.

As the price goes up, the demand goes down as per classic economic theory. In the airline retail business, this converts to the elimination of casual travelers and retention of serious ones in the chain (assuming some consistency in the capacity to pay). That means the willingness to pay, even within each such group, is higher as we approach the actual flight time. Offering such passengers a platform to demonstrate their willingness to pay for a ticket even in the closing hours ahead of the flight could be a good revenue generator for airlines. Time, therefore, adds the third dimension to the curve!

Is there an issue with ethics, because you are given the opportunity to use a scarce service exclusively on your ability to pay as opposed to genuine need? Interestingly, an economist would connect this to the Ramsey rule, which advises an increased level of taxation on goods with a low elasticity of demand – which means, if people cannot do without it, then the tax on these goods can be increased for maximum output. So from an economic perspective, this just maximizes efficiency!