Egalitarian airlines

Jules Dupuit gave the classic account of the indignities of second class travel, and the economics behind them:

It is not because of the few thousand francs which would have to be spent to put a roof over the third-class carriage or to upholster the third-class seats that some company or other has open carriages with wooden benches … What the company is trying to do is prevent the passengers who can pay the second-class fare from traveling third class; it hits the poor, not because it wants to hurt them, but to frighten the rich … And it is again for the same reason that the companies, having proved almost cruel to the third-class passengers and mean to the second-class ones, become lavish in dealing with first-class customers. Having refused the poor what is necessary, they give the rich what is superfluous.

For anyone who has experienced the almost cruel service meted out to those at the back of the plane by supercilious flight attendants, or the (comparatively) lavish food and drink in the business class cabin, Dupuit's explanation seems compelling. Yet there are a few problems with using it to explain the existence of executive class on flights within Canada.

First, if business class cabins are simply a means to persuade those who can afford more expensive tickets to pay more, why don't all airlines have them? Why are there egalitarian airlines like WestJet, which (for now) offer all passengers the same seats and service?

Second, airlines have many means of inducing some passengers to pay more than others. Why bear the expense of maintaining a business class cabin when there are cheaper-to-implement price discrimination schemes available, such as higher charges for last minute, flexible or refundable tickets? 

Finally, from my admittedly limited experience, it seems that only a fraction of those who fly Executive Class within Canada actually pay for their ticket. The SuperElite - those who fly more than 100,000 miles a year - are routinely upgraded to executive class, as are some members of the lesser Elites. So, too, are Air Canada employees. The differential treatment of executive and economy passengers cannot be explained as soak-the-rich price discrimination when a good proportion of Executive Class passengers are not paying higher prices.

So what explains the existence of Executive Class on Air Canada, the non-existence of business class on WestJet, and WestJet's recent announcement that they will be introducing new "premium economy" seats? 

The comfortable seats at the front of the plane are part of the "refined, personalized travel experience" Air Canada offers as part of "exclusive Privileges" available to those flyers with "Top Tier status". They aren't there so that Air Canada can charge frequent flyers more. They exist so that Air Canada can give frequent flyers better service, even those who haven't paid for an Executive Class ticket. 

Frequent travellers make up a disproportionate share of an airline's business. It makes sense to buy their loyalty with Maple Leaf lounge passes, priority boarding and free upgrades. Booze on planes is simply another thing that (some) rich people pay less for than other folks.

So why doesn't Westjet have a business class cabin? When Westjet began operations in 1996, it had to take passengers away from Air Canada in order to be successful. Trying to persuade Air Canada's SuperElite to give up their lounges and upgrades to fly on an upstart discount carrier would have been difficult - especially since frequent flyers often don't pay for their own tickets, so are less sensitive to price, and more sensitive to comfort and convenience, than other travellers. 

Westjet chose, instead, to target those in the middle and the back of the plane, telling them "just because you pay less for your flight, doesn't mean you should get less." Air Canada has long been  vulnerable on the service front, so that's where WestJet took them on: "our entire corporate culture has been built around caring for you, our guests, by providing a great guest experience."

Part of that guest experience is attitude, for example, flight attendants who pay attention to the passengers while serving tea and coffee, instead of chatting with each other. It's human nature, however, to care about relative status. No matter how comfortable my seat is, I will feel irked if someone else has a better one. Eliminating business class removes that nagging feeling of inferiority economy class passengers experience, giving egalitarian airlines a competitive advantage in the plebian travel market.

Yet Westjet's egalitarian philosophy is being undermined by its very success. Westjet now has a loyal customer base. To keep the base faithful, it has to reward their loyalty, and give them a reason not to stray. Westjet announced in August that it is introducing "premium economy" seats at the front of the plane - what's the betting that frequent travellers will be routinely upgraded to those premium economy seats?

Also, some of the common folk who have been with Westjet since the beginning are starting to climb the corporate ladder, and fly more and more often. They may be philosophically committed to Westjet, but who doesn't yearn for the comforts of the Maple Leaf lounge? If Westjet hopes to keep those customers, it has to step up the luxury a little.

Westjet's choice not to offer business class was dictated by its position as a new entrant in the airline market. Air Canada's decision to keep its first class is likewise a product of its own history. Before the days of internet booking and complex fare structures, the first class/second class distinction would have been a relatively more important form of price discrimination (On long-haul flights, it's still the case that some people are willing to pay a considerable premium for a seat that is comfortable to sleep in.) 

Once an airline has first class cabins, however, it is difficult to eliminate them. The SuperElite might switch to an alternative airline if they had to travel in the economy cabin. Air Canada is also a unionized airline, with a history of somewhat fraught union/management relations. Air Canada's employees might become seriously disgruntled if they had to fly at the back of the plane. Part of the reason why Air Canada planes have segregated executive class compartments today is that it seemed like a good idea thirty or forty years ago.

Of course, I might be entirely wrong in everything I've said here - I don't have any hard data to support my speculations. The important point is that the obvious economic explanation is not necessarily the correct one. Something that looks like a way of charging the rich more may, in fact, be something entirely different.  

Comments

[Max]

Isn't part of the story that seat upgrades are a legal form of bribery for people spending other people's money, i.e. business travelers? If the airlines offered cash rewards instead, the benefit would go to the business rather than the employees.

[Frances Woolley]

Max, yup, it's basically a kickback.

Who keeps the frequent flyer points generated by business travel is a hugely contentious issue in quite a few workplaces. The federal public service for a while had a policy that all miles were the property of the employer. If you thought that morale in the public service couldn't possibly get lower... I think, but am not 100% sure, that the employer backed down on this.

[Leigh Caldwell]

The non-existence of business class on WestJet doesn't in itself show that it's not a price discrimination method, but you're right that the other main function of premium classes is to ensure loyalty.

Loyalty tactics are a relatively cheap/high-return form of promotion because the cost of the promotion is partly borne by the competitor who loses a sale to you. Thus you can offer relatively high rewards for an apparently low price. This would be less likely in an industry with higher variable and lower fixed costs than airlines.

I'm sure there is a price discrimination benefit for Air Canada too - highly stable business strategies such as premium classes are likely to have multiple causes.

[Determinant]

As a rail buff, Frances, Third Class never existed in North America. It was always two-class, First and Second, and First Class was often a sleeping car.

Further to Max, I thought business class depended on Other People's Money, specifically expense accounts and business expense deductions from taxes. Coach is for people spending their own money.

First, if business class cabins are simply a means to persuade those who can afford more expensive tickets to pay more, why don't all airlines have them? Why are there egalitarian airlines like WestJet, which (for now) offer all passengers the same seats and service?

Again, the rail industry gives an excellent example. Not all customers are equal. Starting in the 1880's in the US and culminating in 1900 or so, railroad rates were heavily regulated. Previously a shipper in Chicago could negotiate a lower rate based on volume for shipping to New York, the main port then and now on the East Coast. A shipper in Cleveland with lower volume would pay a higher rate, even though they were half as much closer. Railroad regulation ensured that all customers were equal in law and paid an identical rate per ton per mile. Contracts with special terms based on volume or performance incentives were illegal for freight.

Then in 1980 the railroad industry was deregulated. The heavy rate regulation disappeared overnight. Complete freedom of rate contracting was restored, shippers could demand volume discounts, railroads could offer them and performance incentives and penalties were made legal. The US railroad industry underwent a dramatic turnaround. The 1960's and 1970's witnessed some large bankruptcies and in general the US rail infrastructure was decrepit. The industry was dying. Profits soared in the 1980's.

For instance the Santa Fe, the main route between Los Angeles and Chicago made a bundle specializing in intermodal and container traffic. Because that was the customer they wanted and that was who they catered for. Interestingly the Santa Fe merged with Burlington Norther which specialized in coal and grain to form BNSF Railway, one of the four mainline railroads in the US.

Through the ability to treat differently customers differently BNSF was able to do two years ago something which hadn't been done in decades: post a higher return on invested capital than the cost of said capital. Investing in US rail capacity is now profitable.

BTW that's also why freight rates are so cheap; the cheapest way to ship long-haul in North America is to put the truck or container on a train and only use the road for terminal delivery at the end points.

[Patrick]

People like the idea of being better than the common rabble. But you know,I used to travel quite a bit for work, and I never once had a flight ruined on by anyone in coach (where I was always seated). Not even the mythical screaming child (and this before I haf my two so I was not sympathetic to the plight of travelling parents). But there were a couple of times flying home late on a Friday when yobs in suits in business class hit the Scotch too enthusiastically and really made a nuisance of themselves.I'd have much rather had a screaming baby to deal with.

[Frances Woolley]

Determinant - "I thought business class depended on Other People's Money"

That's the common perception, that people fly business class because they've bought an expensive ticket with someone else's money. That's not necessarily the case, however. A good chunk of the people in business class are airline employees, people flying on points, or people cashing in their free upgrades.

Of course, this doesn't mean that there isn't price discrimination going on. It's just that the price discrimination might take the form of giving frequent flyers bulk discounts, say.

[Jacques René Giguère]

Ownership of points: the airlines stood fast that they wouldn't create multiple accounts for each passenger. And courts ruled that points seats were the empty ones and thus had no value.Someone has to divide up the Shapley value.
Though that's not totally true, as Air Canada showed when it went from booking the points as liability to selling them as an asset in "fidelizing customers". That's how they could sell Aeroplan. Selling the invoice...
Frances: to have enough points to cash and upgrade, you need to travel a lot. Usually on other's people money. In the last 40 years, if I paid 10 tickets on my own... My vacations are allpaid by points, tickets and hotels...

[bankster]

Is not the traditional micro story is that price discrimination by a quasi-monopoly is socially good since it brings the society ("social surplus") closer to a Pareto efficient equilibrium by removing dead weigh,t granted in favor of the monopolist, but still :) ?

[Frances Woolley]

Jacques Rene - "you need to travel a lot"

the minimum for Prestige is 25,000 status miles, Elite takes 35,000 miles. It's a slog to earn that flying within Canada, but it's not hard to do with 3 or 4 trans-Atlantic or trans-Pacific flights. Those tiers come with free upgrade certificates that one can cash in for upgrades to executive class (or maple leaf lounge access). Also an Executive Class 'classic reward" is 40,000 aeroplan points - which is actually a better deal than buying a flight with the 'anytime rewards".

True, there aren't a lot of people who travel enough to make to Elite status. But I'd be willing to bet there's more of those people than there are employers willing to pay for executive class tickets.

The number I really want though is the % of executive class travels who are airline employees.

Bankster -"it brings society..close to a Pareto efficient equilibrium"

Interesting observation.

This is, I think, where the point that a number of people have made - that frequent travellers are on someone else's dime - is relevant. There's a moral hazard problem here - a responsible traveller should book the cheapest available ticket, but it's very very tempting to book on the airline that gives the most valuable points, or for which one has lounge access....

[genauer]

off topic, for Frances, a "I know my place" reference, I found interesting (I liked that video a lot !)

http://www.hoocoodanode.org/node/17104#comment-2694539

and some related comment on "business climate": When people describe German SME, remarkably often, there comes some story, that the apprentice goes to the boss, and tells him something is wrong. It is clear who the boss is, but the apprentice also cares about what is right for the enterprise, he doesnt have a direct share in. And this comes from the gut (feeling).

[Phil Koop]

Frances: your example set is too parochial. If you are willing to look abroad, you will find that airline business models are remarkably heterogeneous. Which is interesting in itself, I suppose.

Anyway, considering cases: the Air Canada service between Toronto and London (UK) works the way you describe, with business class functioning in part as a kickback currency. But British Airways runs its business and first-class service on strictly economic grounds. The seating sections for these classes are a larger proportion of the aircraft than on comparable Air Canada aircraft and upgrades are rare to non-existent. And, in my opinion, economy service on BA is noticeably inferior to that on AC. Coincidence?

[ezra abrams]

This post shows everything that is wrong with economics
Theory, without one shred of empirical evidence, and, worse, not even a clue or a care that there is not empirical evidence.
Or, perhaps not so bad, there is evidence, but the poster fails to give a citation or ref.

Its not that theory is bad; quite the opposite; what is wrong is the disproportionate emphasis on theory

[Stephen Gordon]

Did you read the last paragraph? Relax. This is a blog post. Thinking out loud is part of what blogging is.

[Jacques René Giguère]

Frances: it's a slog. Yep. Sometimes tou have to game the system. I sometimes make a stop in QC on my way to YUL so as to have two flight numbers ( segments) because miles don't accrue. Given what they charge for internal flights, I am probably way more profitable than a guy on a long -distance flight. They game you back: flights that give you bonus but not Privilege ( status) miles or 50% of the points. When you redeem, they take into account your current flying. Retirees suddenly discover that having 300 K points or more let them still subject to "windling", the practice of giving priority to those who currently fly heavily as compared to those who flew last year but not now.

A good organizing principle when dealing with airlines is that they lie all the time, on everything, for no particular reason. Even used-car dealer are more trustworthy. U.S. airlines are even worts...

[Frances Woolley]

Phil "your example set is too parochial"

I explicitly framed this post as a discussion about Canada: "Yet there are a few problems with using it to explain the existence of executive class on flights within Canada."

Canada's airline market is very different from the US airline market or the European airline market. Unlike the US, we have only two major airlines - an incumbent and an entrant. This changes the nature of competition. Unlike European countries, we're really big. I live in Ottawa, my family is out West. Flying is the only practical way for us to meet. Again, this changes the nature of competition, as bus and train services do not offer significant competition to air for internal travel

Does the Canadian experience generalize to the US or Europe? Probably not. Likewise, the US and European experience don't generalize to Canada. That's why it's important to have a blog like this one, where Canadian issues can be discussed.

Ezra "Theory, without one shred of empirical evidence,"

Lighten up. It's a blog post. You can call it "participant observer" research - I've flown one heck of a lot within Canada. You'll notice that not one person has commented "you're wrong - I for one pay for an Executive Class ticket whenever I fly Executive Class."

As a matter of fact, I do care about evidence. The lack of publicly accessible data about any aspect of firm behaviour is a serious issue in this country. All of the publicly available data sets (or data sets available to university researchers without major difficulty) - the census, the labour force survey, the Canadian community health survey, etc - are all surveys of individuals, not firms.

[Frances Woolley]

Jacques Rene - I see I'm not the only one obsessing about my frequent flyer miles! ;-)

[Phil Koop]

Frances: OK, OK, I'm all for Canada. Go Argos!

But: while there are many European business models that are not found in Canada, the converse is not true. So I am not persuaded that you can gain special insight into Canadian conditions by ignoring the global context.

[Frances Woolley]

Phil - "So I am not persuaded that you can gain special insight into Canadian conditions by ignoring the global context."

For most markets, I would agree with you. But the internal airline market is afforded special protections: only Canadian carriers can operate flights within Canada. Search on expedia for Toronto/Vancouver flights. The only two carriers operating regularly scheduled flights are Air Canada and Westjet.

The global context matters to some extent, even in a completely protected market. For example, Air Canada's system of upgrades and other rewards for loyalty is a way of persuading people to fly Air Canada to international destinations, as opposed to an airline outside of the Star Alliance.

But as a first approximation, because the Canadian internal airline market is largely insulated from international competition, one can ignore the global context.

I'm not sure how you can say with such confidence that there are no (or few) Canadian business models that are not found in Europe (if that is indeed what you mean by "the converse is not true.") Can you name a European country that has an airline market similar to Canada's?

[Phil Koop]

"... how you can say with such confidence that there are no (or few) Canadian business models that are not found in Europe ...?"

It's easy, because there are only two*, which you have identified. Examples of both are found in Europe.

It seems to me that your remarks on cabotage are a side issue. But even if that were not true, Europe also regulates the practice. There remain, of course, many differences between Canada and Europe.

* Porter and WestJet have the same model, and I am not bothered by airlines that are even smaller than Porter.

[Wendy Waters]

Re: "There's a moral hazard problem here - a responsible traveller should book the cheapest available ticket, but it's very very tempting to book on the airline that gives the most valuable points, or for which one has lounge access...."

I'm not sure there is moral hazard. Business travel becomes old really quick--it sounds glamorous until you're on a plane every month or even 4 or 6 times per month. Being away from family is tough. (I did 4 trips in 6 weeks this Fall instead of my usual 1 per 6 weeks--it was draining).

For employers to attract and retain people willing to travel regularly, they have to allow for a certain level of comfort. If someone wants to fly Air Canada for the points, or because of the lounge, that's a small price to pay. You need to keep these employees happy. Similarly, most corporate travelers don't stay at the cheapy motel in suburbia, they stay somewhere nice downtown and usually have some choice. Again, alternative is losing those employees or having people be very resistent to travel.

[Jacques René Giguère]

Wendy: so right. You come back drained. The evening or Saturday morning you spend in the air is the one you would have used for laundry ( at least going to the cleaner to collect it).
You have to stay in the downtown hotel nearyour meeting , otherwhise you will lose so much time.
The first lesson in land-use economics I gave was to a boss a few weeks after beginning my first fulltime job. He asked me why I had booked someplace and not elsewhere. Showed him how the difference in hotel tarif , ceteris paribus , is the difference in transport cost. That mathematician was happy to understand and never bothered me. We became as much friend as can be between a boss and his underling.

[Frances Woolley]

Wendy, Jacques Rene -

I agree with you that it makes sense for employers to pay for travel upgrades that increase worker's productivity enough to compensate for the extra expense. "I get far more work done in the Maple Leaf lounge and in Executive Class" is the rationale everyone who wants a first class ticket gives. And, to some extent, it is true - the Maple Leaf lounge has electrical outlets and much better wireless, for example, which makes it easier to get work done.

On the other hand, if I see a ticket on Air Canada that costs $650, and ticket on Westjet that costs $600, the fact that I collect aeroplan points might be enough to tilt me towards Air Canada. (If I had a free upgrade I could cash in, I'd definitely opt for Air Canada). Whoever is reimbursing my flight will know if the fare is way out of line, but not if it's $50 more than the fare Westjet was offering on the day that I bought the ticket.

That's the moral hazard problem. It's relevant because I'm pretty sure it undermines the argument Bankster was making about the efficiency of price discrimination.

Phil - now I understand what you mean by business models.

This post isn't about business models, it's about the dynamics of competition in the airline industry. Can you think of a *market* in Europe that has the same structure as the Canadian airline market?

[Twofish]

Interesting discussion. Something that I noticed is that while the airline industry in the United States may be very different than Canada, I think the economics of particular routes may be similar. I'm thinking in particular of the airline routes between NYC and Austin Texas, in which there are two basically two airlines Continental and JetBlue, one that offers standard first class seating and one that doesn't.

I think this can be explained in terms of economics. The first class market between Austin and NYC isn't large enough to support two airlines fighting for it, so JetBlue has conceded it to Continental. However, there is a huge coach market that both airlines fight over. JetBlue is the challenger so that by having newer planes and things like on seat television, JetBlue offers better service for coach passengers without competing for first class ones.

[Twofish]

One other issue with first class tickets is taxes. Company travel expenses are not counted as income so all other things being equal, an executive would like to have $100 better hotel than $100 cash.

There *is* a moral hazard problem, and this can result in lots of fights between employees and the travel office. If it's a difference between $100 and $1000, then the company is going to force you to get the $100. However if it's the difference between $600 and $700, the fight is going to be more of a productivity killer than $100 you save. It's pretty easy for the travel office to know when the employee is booking a more luxurious airline, because different airlines have different reputations.

The other thing is that if you are going to send someone in person, then you aren't going to quibble over a few hundred dollars, since the general expense of sending someone on a business trip is so high over a phone call, that people aren't going to sweat the details. Also if you are giving a presentation, you don't want to look half aspect. The upshot is that when a business wants to cut expenses, they likely won't look for a cheaper airline, they'll cancel the trip completely.

There's also a signalling issue. Cuts in travel are usually a sign that more cuts are along the way and that can kill morale.

[Rachel Goddyn]

My husband, Luis, has family in Mexico and travels there for work. It is dangerous to drive between cities. The bus companies pay off organized crime so they do not get held up so taking the bus is an option. But as Frances has pointed out before many folk think of the bus as the "looser cruiser." The result is that a robust and competitive internal air travel system has sprung up within the county. Luis is there now and taking some of these short flights. I will quiz him about the first class arrangements when he gets back.

[Frances Woolley]

Rachel - the environmental cost of crime, eh?

Twofish - interesting observations. You're absolutely right about the size issue - whether or not the first class market is large enough that both airlines can have a piece.

[Wendy Waters]

To go back to the original blog post on WestJet planning to offer Premium Economy seating....I wonder if they are losing market share for business travel to Air Canada (or US carriers if the desination is American)?

My story: I used to fly West Jet for trips from Vancouver(home) to Calgary or Edmonton because West Jet generally had more flights and was more reliable than AC in terms of on-time, not cancelling flights, etc.. Plus, if you were done early you could just go to the airport and WestJet would put you on the next available flight--no extra fee, no hassle.

I flew them earlier this Fall round trip to Calgary. Both flights were delayed with no explanation. (Meanwhile others attending the same events and flying Air Canada had no issues). Other flights (besides mine) were delayed even worse making for crowded gates. The staff and crew seemed clueless and incompetent. I also found out that the no-hassle flight-change option no longer exists--the change now costs $50 (as opposed to Air Canada's $70).

The ticket price for AC vs WJ was about the same.

So, they've lost my business travel business. But it's not because they don't have premium economy seating--it's because their performance has slipped significantly.

If they want to be a business airline (rather than a vacation provider) I don't think this will be enough.

[Kaleberg]

Joe Brancatelli who writes a business travel newsletter at joesentme.biz often notes that most of the business class section is for upgrades. This is pretty standard in the hospitality business. Restaurants will comp a favored diner a dish or drink. Hotels will offer a room upgrade. Airlines will move you to the front of the plane.

I've flown WestJet from Victoria to Calgary and back. The CEO was on board one flight cracking jokes and welcoming us aboard. The cabin crew was gung-ho, just like the old PSA or Southwest in the US. Still, I'm not surprised that WestJet is moving to premium economy. A lot more people can afford a small upgrade like that, so it is going to be a money maker, especially as the baby boomers age.

Down in Chile, LAN does not have business class on any domestic flights. Granted, their air travel system is heavily subsidized by the government, and it lives in a sort of time warp. The female flight attendants looked like something from the 1960s in their gray skirts and high heels, but they switched to work shoes once aboard.

[Steve]

Air Canada does not allow employees to travel in Executive Class. The airline I work for does.
If you remember a short lived airline called Skybus, they sold ten seats on each flight for $10.
Know what that did? Pissed the remaining 90 passengers off because they felt they got gypped.
I've been flying for 28 years and trust me, the wealthy are flying first class and it's not on any
mainline carrier either. If an airline offers executive, first, business elite or you name it, it's to
keep the frequent travellers happy. Why should they care about the passenger who bases their purchase on
a $5 difference?