June, 2010

A-La-Carte Pricing in the Airline Industry: Drivers, Consumer Effects, and Policy Options

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In 2008, a number of commercial airlines separated from the long-established industry standard of allowing customers to check two bags at no additional cost and began collecting fees for both the first and second checked bag. This initiative in a-la-carte pricing is not unique to checked bags, however, these charges have been part of a broader expansion of non-ticket fees for new and existing products and services in the airline industry in the mid–late 2000s. This paper will provide some theoretical background for unbundling and ancillary revenue efforts in the airline industry and will utilize data from interviews at a large air carrier along with economic theory, and various sources to analyze the ancillary revenue trend of the 2000s from an economic perspective.

In particular, the paper will evlauate the incentives and drivers that caused this trend to occur when it did, analyze the effect on airlines’ business structures and industry profitability, and spell out the consumer effects arising from this trend. It will also evaluate the merits of potential government restrictions on these fees that would limit airlines’ ability to charge for checked baggage and other services. Ultimately, this paper finds that a-la-carte pricing in the airline industry is a price differentiation technique that rose out of revenue pressure in the 2000s. While some consumers may experience a welfare loss, others are potentially made better off by the elimination of a sort of subsidy that comes with lower base fares. Ultimately, policy action to rein in fees may do more harm than good because they potentially reduce total welfare in the airline market.