Consumer Protection in the Airline Industry—Posner

Last week the Department of Transportation announced a set of regulations that it calls “Enhancing Airline Passsenger Protections II,” the “II” referring to the fact that similar “protections” were imposed more than a year ago and are now being expanded. The new regulations are summarized in an article in the New York Times published on April 20. Accompanying the new regulations is a study by a pair of economic-consulting firms (one of them the well-known Econometrica) that purports to quantify the financial benefits of the regulations and concludes that they are modest but positive. Here is the study’s summary of the requirements imposed on airlines by the new regulation: 

“1 Expansion of tarmac delay contingency plan requirements and extension of EAPP1 Final Rule requirements to cover foreign carriers.

"2 Expanded tarmac delay reporting and application to foreign carriers.

"3 Establishment of minimum standards for customer service plans (CSPs) and extension of EAPP1 Final Rule requirements to cover foreign carriers.

"4 Extension of requirements to post contracts of carriage, tarmac delay contingency plans and CSPs on websites to foreign carriers.

"5 Extension of EAPP1 Final Rule requirements for carriers to respond to consumer complaints to cover foreign carriers.

"6 Changes in denied boarding compensation (DBC) policy.

"7 Full-fare advertising and prohibition on opt-out provisions.

"8 Expanded requirements for disclosure of baggage and other optional fees.

"9 Prohibition on post-purchase price increases.

"10 Prompt passenger notification of flight status changes

"11 Limitations on venue provisions in contracts of carriage." 

Do these regulations make economic sense? (They probably make political sense.) 

I won’t try to discuss all of them, but will sample each of the three kinds of requirement that the new regulations impose: (1) requirements that alter the contract between the passenger and the airline, ostensibly to make it more favorable to the passenger; (2) requirements concerning fuller disclosure of the terms of the contract; and (related to both other categories) (3) requirements designed to prevent exploitation of consumers by trickery. 

(1) includes requiring refunds for lost luggage and increasing the compensation required for passengers who are bumped from a flight because of overbooking; (2) includes such things as requiring that taxes be disclosed as part of the purchase price rather than separately and that baggage fees be more clearly disclosed to passengers in advance; (3) includes such things as post-purchase-price increases and limiting where a passenger can sue an airline (“venue”). 

(1) doesn’t make any economic sense. If airlines have to make refunds for lost baggage or increase overbooking compensation, they will have to raise prices to cover the higher costs resulting from these requirements. If passengers preferred to pay the higher price necessary to obtain these benefits, one would expect the airlines to revise their contracts with passengers accordingly. The same thing is true with regard to limiting the amount of time that an airline can keep a plane on the airport tarmac, awaiting clearance to take off, without giving the passengers a chance to leave the plane. The new regulations, in merely extending the limitations it has already imposed on domestic airlines to foreign ones, can be thought just to be closing a loophole; the economic question is why the matter of tarmac delay can’t be left to implicit negotiation between airlines and passengers, resulting in an optimal combination of ticket price, inconvenience from being stuck in a plane, and likelihood of cancellation of flights if the combination is weighted in favor of compensation for passengers inconvenienced by tarmac delay. 

(2) is another questionable category of regulations. Competitive firms don’t disclose negative features of their product (which can include price) unless there is a competitive advantage to doing so. Assuming airline taxes don’t differentiate among airlines, disclosing the taxes as part of the ticket price rather than in fine print unlikely to be noticed is not going to give any airline a competitive advantage, and it may reduce demand slightly by revealing air travel to be somewhat more expensive relative to substitutes than passengers may have thought. The effect is likely to be trivial, however. As for baggage fees, if an airline decides to compete by charging lower fees than its competitors, presumably it will advertise the fact; it will not need government prodding. 

(3) is really a variant of (2). Take the venue limitations. Venue (where the airline can be sued) is a term in the contract between the airline and the passengers, which the Department of Transportation is forcing the airlines to delete. But many consumes are unaware of the meaning or significance of such a provision, and requiring disclosure of it would merely burden the passenger with information that he doesn’t want or need—for how likely is he to want to sue the airline? So I don’t regard these provisions of the regulations as particularly objectionable on economic grounds. 

The issues become slightly more difficult when one takes account of the airline industry’s somewhat unusual cost structure. It can be argued that the airline industry would not really be very price competitive if left to itself because the provision of airline sservice has a high ratio of fixed to variable costs. Such a ratio makes price cutting a perilous method of trying to increase profits, since if prices spiral down to marginal cost the airlines are not able to cover their fixed costs. And price changes are necessarily published in advance and airlines cannot feasibly “steal” passengers from each other with secret discounts. So tacit collusion on price should be feasible, and one might expect therefore that the airlines would do anything to pack their planes, since the cost of adding a passenger in a plan that has empty seats is very slight—anything but offer a lower price than a competitor for a given quality of service. 

But if tacit collusion on price, coupled with the cost structure of the industry, caused the airlines to substitute nonprice for price competition, one would expect the quality of service to be too high (that is, that consumers would prefer a lower price at the cost of lower quality), as in the days when regulation by the Civil Aeronautics Board largely prevented price competition, resulting in extravagant nonprice competition in the form of ultra-frequent flights and lavish in-flights meals and even entertainment. The quality of airline service has of course been steadily deteriorating. Moreover, entry either of new airlines, or of existing airlines into routes they haven’t previously served, is easy, and must keep prices down. And the ratio of fixed to variable costs in the provision of airline service has declined because of rising fuel costs, a variable cost that now accounts for 40 percent of an airline’s total costs. 

Moreover, if airlines don’t want to compete on price, requiring fuller disclosure won’t have much, if any, effect. 

But the cost structure not of the industry but of the individual airliner—the high ratio of fixed to variable costs in the operation of a particular airliner—is relevant to the possibility of “market failures” that might, in principle anyway (always a vital qualification), justify regulation. I said that the airlines are desperate to pack their planes, because an additional passenger adds much more to revenue than to cost. But packing planes, necessarily with passengers have a variety of preferences, limits product differentiation. There is some: think of first class, and the recent movement toward varying the leg room of coach seats. But it isn’t feasible for airlines to offer passengers different waiting times on the tarmac when bad weather delays flight clearance; they’re all in the same boat. And when stiff baggage fees result in delays in boarding and deboarding, and difficulty in finding bin space for one’s carry-on luggage, because the fees have caused many passengers to substitute carry-on for checked baggage, all passengers (in coach) are in the same boat. The quality-sensitive passengers may incur a great deal of disutility from the degradation of quality that enables the airlines to attract a lot of quality-insensitive (in other words, price-sensitive) passengers, yet the former may not be willing to pay the very high price necessary to compensate the airlines for losing price-sensitive passengers deterred by the high price. 

This is not a genuine market failure, however— technological constraints, rather than collusion or externalities, prevent the industry from providing a level of service desired by many passengers—but it helps to explain the public pressure for quality-enhancing regulations. The Department of Transportation thinks or pretends to think that these regulations increase overall satisfaction with airline service, but this fails to consider that if passengers as a whole wanted better service at a higher price, the industry would provide it voluntarily. Service can’t be decoupled from price. 

The airline is providing a bundled or “one size fits all” product to most of its customers, and unbundling can increase demand by enabling a better matching of price to consumer preference. But except for the tiny sliver of flyers who can afford private planes, the cost structure of the airline industry, rooted in airliner design, prevents significant quality differentiation. 

I conclude that while regulations that forbid certain deceptive practices in the marketing of airline services may be justifiable, regulations that require more detailed disclosures, and in particular regulations that require quality improvements, are not justified, at least on economic grounds. The consulting report is wrong to think they’ll increase aggregate welfare, although they will modestly increase the welfare of the complainers—illustrating that the squeaky wheel is indeed greased first.

Comments

[essay]

“I’ve read them all and they seem unfiddled.” Seems Not quite good enough since the veracity, or the correct interpretation of the contents has not been established

[Jim]

The government leading the airlines? The blind leading the blind. Why don't we just have a national airline. Wow, I bet THAT would solve just about every problem. At the rate the United States is descending into fiscal chaos, we are all soon going to be travelling clinging to the top of vegetable trucks. Well maybe the government will regulate the mileage of the trucks.

[Xavier L. Simon]

The more you regulate an activity the bigger the maze or labyrinth through which both suppliers and consumers have to go through and in the end the exit will be exactly the same. When will the players learn? Government pretends that it can somehow dictate better outcomes. Yes, that is possible but always at a price. To pretend otherwise is to live in la la land. Posner and Becker went through a lot to arrive at this truism. They too got caught in the maze.

[NEH]

At one time there were many methods of getting from one place to another in a cost effective and timely manner. Planes, trains, buses and automobiles. These gave the users and consumers a broad spectrum of transportation and cost options. No longer. Buses no longer run to various pickup and drop off points, as for passenger rail, that, for all intents and purposes has died, automobiles are still a method of choice for short trips or long ones in some cases.

But due to the general degrading of competitive transportation options, more and more users have taken to the air. Yet still hanging onto the low cost, low price mindset, which the Airlines have tried to cater to. Much to the detriment of their bottom lines. So we recently have seen much of the cost of a ticket broken out and set up as an independent cost. Much like a restaurant ala carte menu. Ahh... the joys of marketing and trying to masquerade the true cost of flying and maintaining what appears to be a low cost ticket price in a free for all competitive market.

This all ties back into the initial deregulation of the Airline Industry and the loss of various favored pricing procedures that led to a profitable industry and reasonably low prices (but then they did not have to deal with the incredibly unstable fuels market that they have to do today; more deregulation at work or a massive increase in ridership by a poor consumer looking for the cheapest airfare). So now we're stuck trying to develop a "Transportation Consumer's Bill of Rights". Pricing is Pricing and a business exists to realize a profit. But how much and how much does the consumer have to give up? Flying cattle cars anyone? And oh! BTW, the hay, feed and water is extra. And remember to carry extra quarters, the toilets have gone over to a pay per use plan. Not only in the planes, but in the Airport as well...

[Xavier L. Simon aka Xavier]

Careful NEH, don't go giving the government ideas lest they now try to regulate a la carte menus. There are millions of bureaucrats that need to be kept busy.

[Mike Hunter]

What about the issue of fraud or misrepresentation? Using deception to gain access to goods or services is the dictionary definition of fraud.

When the an airline hits you up with $150.00 in extra fees, that they disclose after you've already bought a ticket, they're engaging in a fraudulent transaction. They can get away with it because they know Joe Blow doesn't have the time, money, or; inclination to sue a gigantic corporation for misrepresentation.

Just because airlines can get away with false advertising, collusion, and misrepresentation; which are all illegal, as long as they stick to beating up on the little guy, doesn't make it right. The parts of the regulation addressing that problem were totally justified.

[Jim]

Well NEH, Glad you view it the same way. My practical solution is not to travel at all unless absolutely necessary and if then, and it is less than 500 miles, I drive and usually get there sooner than the plane I would otherwise have taken. My attitude is to make personal decisions which minimize the consequences of unnecessary complexities foisted upon the nation by well-meaning but destructive policies.

[David W. Drake]

The airlines should let you check bags for free and should charge for carryon luggage, perhaps with priority boarding for people who had paid for carryon. That would eliminate the scrum in the boarding area and in the aisles.

[NEH]

David, Now where's the profit in that? Most carry-ons are small and light weight and really don't contribute much to the weight load that the plane has to deal with as compared to checked baggage. Contibuting to increased load time and fuel consumption; which translates into much higher operating expenses. The objective is to cover costs and make a profit. From some of the baggage I've seen, I'm surprised they're not charging thirty dollars or more a bag. As for the "scrum", that's just part and parcel of Air Travel today.

Jim, My limit on auto travel is about eight hours, sometimes more, depending on the situation.

[Christopher Graves]

I see these regulations as simply enforcing contracts or providing the customer with more information or more leverage in dealing with airlines.

I do agree that there are hard trade-offs due to the conflict between quality and price. As Judge Posner pointed out there might be a market-failure in the airline industry, but there is in general a tension between consumers who are either not very discerning in judging quality or are passive and more astute, more vocal customers. I see nothing wrong with giving more bargaining power to the latter category of customers.

[Jack]

I'm with NEH and Mike in that most of this is a long needed improvement in contract disclosure. I can't think of a biz with more maddening "gotchas" than the airlines. When traveling from AK it's typically a long and spendy trip. They want a much longer lead time for an affordable fare than seems reasonable, replete with knowing your return date. It's OK to pay a small fee, but these days it's one chunk for the leg using one airline and another for the leg using another, AND they're likely to come forth with "That fare's no longer available" on some dates with no suggestions on which dates aren't the new improved gouge dates, so we commence with "try Sat, try Monday". And! they've knocked my former GREAT travel agent out of biz, so I'm stuck with the nasty task!

Posner kinda of toys with one of the airlines's REAL problems but doesn't quite tackle it. He mentions "quality-sensitive" travelers, by which I assume he means first class traveling on expense account etc. Well, THE problem in these days of high rates of fuel price gouging and manipulation is that the airlines could not maintain their routes and biz class travel w/o the cattle car occupants.

It really is a tough problem as leisure travel is, as Posner notes and we all know, very price sensitive. But if many of them stay home, or pile in a car, then there's not enough revenue to maintain the route for the more profitable biz travel and a downward spiral begins....... or continues. My guess is that's the reason airlines seem to be in or near bankruptcy so often. They are right at the price equilibrium where, as we often see, a price rise "doesn't stick" and is rolled back - $10 or $20 on a trip halfway across our nation is enough that they lose too many customers.

At risk of being Ha! repetitive, surely stagnant wages for most folks results in discretionary dollars to soak up the cost of a price increase or an increase in quality (like fresh peanuts?) being too scarce.

[Marketing Services]

Great job. Expansion of tarmac delay contingency plan requirements and extension of EAPP1 Final Rule requirements to cover foreign carriers. The same thing is true with regard to limiting the amount of time that an airline can keep a plane on the airport tarmac, awaiting clearance to take off, without giving the passengers a chance to leave the plane. The new regulations, in merely extending the limitations it has already imposed on domestic airlines to foreign ones, can be thought just to be closing a loophole; the economic question is why the matter of tarmac delay can’t be left to implicit negotiation between airlines and passengers, resulting in an optimal combination of ticket price, inconvenience from being stuck in a plane, and likelihood of cancellation of flights if the combination is weighted in favor of compensation for passengers inconvenienced by tarmac delay. Buses no longer run to various pickup and drop off points, as for passenger rail, that, for all intents and purposes has died, automobiles are still a method of choice for short trips or long ones in some cases. Really you have done a good job. The written style is very prompt and the highly practical manners. So fruitful for us. Your blog is refreshing, but I wish one could find more content, though. Thanks for sharing..

[an observer]

Posner is wrong, as usual, on every count.

Of oourse, Posner probably never faces the problems faced by the average public when he flies, since, being part of the Elite, he is likley "comped" by special interests with NetJet cards or space on private jets or military planes.

Instead of re-writing press releases from CATO, Posner ought to look at how businesses operate. Look at the rules imposed by the NFL, NCAA, and MLB upon owners. All three recognize, especially MLB, that owners are, at best, incompetent and most often far worse.(Montreal, Houston, and now the Dodgers have been seized by MLB in the last 10 years). Since being seized the Dodgers have improved on-field performance.

As for it not making economic sense to steal from passengers by refusing refunds for lost baggage or increase overbooking compensation, why don't we apply the same logic to the criminal law. After all, it doesn't make economic sense to steal when faced with the prospect of going to prison either.

Oh, I forgot, if one doesn't go to prison,it makes economic sense to steal.

Thus, Posner has rationalized stealing. The more they steal, the cheaper life will be for you.

And, lets now forget the conspiracy between the airlines. If all refuse refunds, then passengers have no economic choice.

Spare us

[NEH]

Oh, But Jack! You can schedule your flight on the Internet by yourself! Isn't it wonderful!!! ;( Great!

One issue about "tarmac delays" that no one has seemed to address is the issue of "Weather" on the flight path. From a safety standpoint, I'd rather be sitting on the ground waiting for a weather window to clear than flying through a major storm waiting for a wind shear event ripping the wings off the plane or icing up and loosing control of the rudder, elevators and airelons. There is a lot more than just getting on a plane and flying someplace in a timely fashion.

Then there is the issue of mechancial/electrical/hydraulic maintenance...

[Xavier L. Simon aka Xavier]

I have no quarrel with the analyses of Becker and Posner. The first knows more economics than I do and the latter has forgotten more about the law than I’ll ever learn. But I do note that their analyses tend to focus on the detail and perhaps not enough on the bigger picture and the wisdom and purpose of regulation more generally, and thus concretely on how much regulation is enough.

Consider, ultimately our objective is to get from point A to point B at the lowest cost, least time, minimum inconvenience, and maximum safety. These can be rephrased, with differing consequences but let’s take them as such for the purposes here. Obviously getting from A to B is ultimately the most important if the others are within a reasonable range.

For the airlines the key objective is to do the above at a profit. If we accept that markets work and optimize performance, then for government the objective should merely be to enforce contract and correct for clear market failures. My problem with much of the regulation is that it injects judgment about what you and I desire into the way that the airlines run their business, and by doing that it adds to the management complexity and limits the degrees of freedom of the airlines.

It should be obvious that in the airline industry the balancing that the airlines have to do is working effectively. The major objectives, transport and safety, are being met with internal airline regulation normally exceeding government norms. The real problems with which we mere mortals are most concerned rear their ugly head mainly in the narrower objective of convenience at a reasonable cost.

I travelled many hundreds of thousands of miles before retiring and I never encountered a single “unreasonable” inconvenience, but then I did mostly travel first and business class and even when travelling coach my company was paying the full fare. And, then, I quite literally spent quite a few months of my life living on board an airplane, including at least 50 if not 100 overnight flights, so convenience was no small matter. Today convenience is entirely another matter. I have to decide how much I want and what to pay for it, including for insurance if something nasty happens.

Now, here is the key question, who should define and decide what convenience is for me, for my particular circumstances? The airline, the government, myself, or a combination of these? Right now it is mainly decided by a combination of the airline and myself, for which the airline gives me a whole bunch of choices (having to travel cross-country for the birth of another grandchild, I am going through that very process even as I write this). If instead the government messes around with that question it is a certainty that the cost will increase without my having the options I now have.

Ultimately, whether we like it or not, the airlines function by providing cross subsidies from those that can afford paying for higher fares to those that are not as able, as is the case for me today. Any time the government adds regulation to something the airlines would not have done driven by market forces it is going to cost all or most of us more.

Sounds familiar? The government taking from the rich to give to the needy? Is it not convenient that it can do it by decree, that is, through regulation? But does it really satisfy my particular needs? I usually find that no matter how inconvenient and frustrating it may be to find the right balance, the airlines do give me a lot of flexibility and choices.

Ultimately who knows more about running an airline and my travel related needs, the government or the airline? Sure, they will, both the airlines and government, occasionally screw up, it is only human. But do I, you, really want the government to chose for us how to satisfy our individual needs, and do it in a way that adds to cost but doesn’t really add choice and flexibility? No, not for me.

[Dennis Tuchler]

I wonder what would happen if the airlines (1) offered all the things that consumer protectionists want and then (2) offered discounts from the fare for each feature that is waived? My guess is that most people would prefer bare-bones service for bare-bones cost.

[Jack]

NEH -- Ha! I remember being STUCK in Houston traffic with a tornado behind and weather ahead, listening out the window indicated nothing moving, a quick call to my great travel agent -- in those days earning about $20/ticket - and we were all on a later flight, and making a turn on the first offramp to where a delightful Mexican Cafe revived our soggy spirits with fine food and excellent margies.

We were returning from the Home Builders Show -- and those on the plane we missed did sit for an hour -- and take off into lightning filled gusty skies.

But....... today, I think a lot of the tarmac waiting is due to TIGHT scheduling on some airports such that any delay has a domino effect.

Many don't know that airline dereg took place on Carter's watch, not Reagan's.......... and one flaw (among perhaps many!) was that airports were not deregged. Unless something has changed very recently the landing fees for the most desirable times are the same as for the arrival times no one wants.

Xaiver -- the changes in the consumer contract is hardly the government running the show. As ALL airlines will be subject to the contractual changes they are as free to run their deal as ever and compete where they will. Nothing even in there about providing subsistence level food! Once coming out of Alaska, a routine delay gave not time to buy food at the next connection -- I think I was seven hours w/o a chance to have more than stray peanuts that remained -- glad I didn't have the kid with me on that one!

I read somewhere that Alaska Air spends more per meal than other airlines, and that figure was less than $10 -- perhaps $7?? For my part I see NO advantage in being funneled into airport cafes, and/or arriving at the destination having to stop for food after flights of a couple hours duration. But............ that's my pref and apparently airline execs see it differently.

[Jack]

Xavier sez: "Ultimately, whether we like it or not, the airlines function by providing cross subsidies from those that can afford paying for higher fares to those that are not as able, as is the case for me today"

The truth is it's a symbiotic relationship. Those, much fewer, "full fare" and F/C passengers have to have the cattle car passengers to fill out the plane. If not, many routes would have to be dropped.

It's a REAL tough nut for airlines when oil price gouging soars. As we've all agreed here, the MANY are very price sensitive with a few bucks meaning the trip for parents and kids headed for a reunion are delayed or cancelled. The biz class traveler's higher ticket price doesn't compensate for too many empty seats.

From seeing price increases "fail" is seems to me the airlines operate on a thin equilibrium point where both lowering prices and raising prices fail to improve revenue and, often elusive, profits.

[bestmishu]

see these regulations as simply enforcing contracts or providing the customer with more information or more leverage in dealing with airlines.

I do agree that there are hard trade-offs due to the conflict between quality and price. As Judge Posner pointed out there might be a market-failure in the airline industry, but there is in general a tension between consumers who are either not very discerning in judging quality or are passive and more astute, more vocal customers. I see nothing wrong with giving more bargaining power to the latter category of customers.

[Jack]

Best -- it's largely a situation in which the individual has virtually NO market power, which both of our Profs should know.

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[bestmishu]

Well NEH, Glad you view it the same way. My practical solution is not to travel at all unless absolutely necessary and if then, and it is less than 500 miles, I drive and usually get there sooner than the plane I would otherwise have taken. My attitude is to make personal decisions which minimize the consequences of unnecessary complexities foisted upon the nation by well-meaning but destructive policies.

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[NEH]

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