The airlines also benefit because an auction may save them money over a set price or a government penalty. More importantly, United, American and the rest are assured that fewer passengers are unhappy at the end of the process. That's no small matter given the reputation for poor service that most airlines have with the public.More than this, airlines are guaranteed to save money by selling bumps to the lowest bidders. In particular, if an auction is held to elicit five passengers to give up their seats, certainly the passengers who face the lowest cost for getting bumped will be the ones to accept the airline's offer first. This means that the airline will pay (at best) a total amount equal to the sum of the five lowest values of flying. However, if people instead know before they purchase a ticket for a flight that on average, some people are forcibly bumped, then they will shave the amount that they are willing to pay for a ticket by the probability that they are bumped times the cost of getting bumped. This means that the price of tickets falls from the marginal value to the marginal value minus the probability of getting bumped times the marginal cost of getting bumped. In general, this marginal cost will exceed the lowest costs of the passengers and so the airline will receive less total revenue when it randomly bumps passengers than when it holds an auction to buy back overbooked seats.
Monday, June 7, 2010
Auctions for Overbooking
Wall Street Journal article "Auctions for Overbooking" (June 6th, 2010) suggests (wisely) that airlines have auctions for bumped seats--that if they overbook a flight by five people, they offer increasing amounts of money to someone who gives up their seat until five people have given up their seat.