Price Discrimination: Case of Airfare Tickets

Saints of Market MBA I B Group 4 Shishir Chaudhry (34161)

Divya Kapadia (34175) Sinlo Kemp (34178) Debadatta Mishra (34182) Anupam Mukherjee (34187) Hari Om (34188) Aniket Shah (34198) Rahul Sharma (34200) Rishi Sinha (34206)

Price Discrimination
Charging of different prices for different quantities of a product at different times to different customers or in different markets Examples : Telecom tariffs, Public utility such as gas, electricity, airlines, hotels etc.

Conditions to be met
Imperfect competition Price elasticity of demand must differ Quantities, times, customers groups must be separable

Types of Price Discrimination

Perfect Price Discrimination or First degree price discrimination Second Degree Price Discrimination Third Degree Price Discrimination

Price Discrimination in the context of Airline tickets

Customers booking early normally pay lower prices Closer to the date and time of the scheduled service, the price rises, on the simple justification that consumers demand for a flight becomes more inelastic the nearer to the time of the service This has led us to model a simple scenario based on Second Degree Price Discrimination

How does an airline determine the optimum number ?

Booking limit
Maximum no. of seats that can be booked at discount price. Once the booking limit is reached, all future customers will be offered the full price.

Protection Limit
The protection level is the no. of seats that will be booked by those customers who come in late (mainly business people) at full price.

Assumptions
Seats - 120 (all economy class). Only 2 fare rates considered (discount rate i.e. Rs. 2500 & full price i.e. Rs. 3500). Booking limit = 120 the protection level.
Demands at full fare (Q) No. of days of demand Cumulative probability F(Q) = Prob{D<= Q} 0.0667 0.1444 0.2889 0.4222 0.6556 0.8667 1.0000 1.0000

0-60 61 62 63 64 65 Above 65 Total

6 7 13 12 21 19 12 90

Historical data of airline over a 90 day period

Calculation and Findings

We can calculate the value of lowering the protection level from Q+1 to Q. Lowering the protection level results in selling the (Q+1)th seat at a discount which guaranteed return of 2500. Protecting the Q+1 seats has an expected (chance) value equal to: (1F(Q))(3500) Then, we can lower the booking limit to Q as long as:
(1-F (Q)) * 3500) <= 2500 F (Q) >= (3500-2500)/3500 = 0.285714

On referring from the conditional probability table the value of Q comes out to be 62 Hence, Discounted no. of tickets = 120 - 62 = 58

Other Scenarios:
Versioning One can buy an expensive, flexible ticket or one can buy a cheap ticket, with many restrictions. Since a passenger can choose between different versions of an air ticket, it is natural to consider the theory of versioning when analysing the price discrimination Discounts to large costumers Another common characteristic in many national markets is that large firms that demand airline tickets write a contract with an airline, where the firms employees receives a certain discount on each airline ticket Frequent flyer programs Frequent flyers programs are important in the airline industry. It implies that those who are loyal members of such a program can earn member points for each flight and later redeem the points to claim a free bonus flight. It can be seen as a kind of discount Also discounts are given for round trips travel too

Other Untouched Scenario: Overbooking

As there is a chance of customer not showing up for the departure, the airline routinely overbook their flights, as in this case the airline stands a chance of losing revenue. The airlines determine the optimum level of overbooking. If all customers turn up then the airline is forced to bump to other flights. This calculation is similar to that of above scenario. The optimal overbooking level balances
Lost revenue due to empty seats Compensation to bumped customers Loss of customer goodwill.

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