The secrets behind crazy air-travel prices

Roughly two-thirds of that $56,400 is for fixed costs, such as equipment, labor and facilities, which must be paid whether that particular plane flies or not. Next, consider that because the plane is scheduled to fly, the airline is already committed to additional spending for fuel, landing fees and maintenance.

At that point, any additional costs associated with taking an extra passenger -- the marginal costs -- are extremely small, mostly just the tiny bit of extra fuel needed. Industry analysts have put that cost at less than $30.

Now a low-cost competitor, able to shrink costs through new planes, lower salaries and a small route system, steps in and offers tickets for $250 a passenger.

"What would you do?" Nason said. "I really need to cover the seat at $300. My choice is getting $250 or nothing. I'm better off getting $250."

"That is a philosophy . . . that drives the industry to lose money," Nason said. "There aren't 188 people willing to pay over $300 for each of those seats.

"As long as the cost is above your short-run marginal costs, you're better off lowering your fare than having that seat go empty. But if you do it everywhere, then you lose money."

The answer: Product segmentation

Because a single price scheme doesn't work, the airlines have pioneered an elaborate system to create different products, or fares, within a single flight, for which they charge different prices. Your seat might look the same as the guy's in 15F, but he actually bought a different product. Most likely, so did everyone on the plane.

Yield management, or, as it's now called, revenue management, uses three general techniques:

• Entice passengers who are willing to pay to pay more for attractive amenities, such as comfort (extra legroom and bigger seats), speed (priority check-in and boarding), services (meals, beverages and additional flight attendants) and perks (lounge access and entertainment).

• Keep passengers who are willing to pay from buying discounted fares by imposing unattractive restrictions on those fares, such as prohibiting one-way combinations and layovers, adding stops, requiring advance purchase and minimum stays, and charging penalties for changes and extra amounts for peak seasons, days or times.
• Price remaining seats low enough to stimulate demand among those who otherwise might not fly, thus filling seats that would otherwise remain empty.

This is not a complete list of restrictions and perks. A single ticket's fare conditions might run nine pages. Carl de Marcken, a co-founder of ITA Software, which writes airline shopping software for Orbitz and major airlines, computed 25.4 million possible fare combinations for one round-trip American Airlines route by allowing travel within one day on each end.

Open the possibilities -- here's where a math degree comes in handy -- and it is considered effectively mathematically impossible to find the lowest available fare for a trip. There are simply too many combinations to multiply.

Why so many fares? Because each fare comes with its own supply-and-demand curve that helps the airline fetch the highest price. Powerful software tools forecast demand for each seat, then automatically recalibrate the flight, and those around it, when a ticket is purchased. This is why fares appear to change within days or even hours. Such revenue management is credited with helping the industry finally generate profits in the 1990s.

"If you can figure out how to get an extra buck on a seat you're going to be doing well," said Petree, of Embry-Riddle. "It's actually down in the cents, the fractions of cents. That's how tight the margins are."

Cheap ticket? Thank a businessman

Any question you've ever had about why tickets are priced differently can be answered by asking not how much extra that fare cost the airline -- maybe nothing -- but by considering the demand for that seat. If someone else is willing to pay more for it, then it's priced higher. Simple as that.

Take a particularly odd example: It can cost more to fly from Boston to Chicago than from Boston to Chicago to Los Angeles. Why? Because the demand is greater for the Boston-to-Chicago flight; it's a popular business route.

Same for the old Saturday-night-stay requirement, which served no purpose other than to push business travelers toward the higher Friday fares, said MIT's Belobaba.

Internationally, business class generates 3.5 to 4.5 times more revenue than coach, where 5% to 20% of seats might be sold under cost, said industry analyst Henry Harteveldt of Forrester Research.

Continued: Thank first-class fliers

< previous |  1 | 2 | 3 | next >