Applying Nudge to Airline Pricing
Spirit Airlines and 'RECAP'
4 Mar 2009 in Regulatory Policy
Wall Street Journal airline columnist Scott McCartney reports that Spirit Airlines has established a "boundary-stretching usage fee" for buying a ticket. His story illustrates a number of practical applications of the principles set forth in Nudge, the recent book by Richard Thaler and Cass Sunstein, who has been announced as President Obama's choice to be the next administrator of OMB's Office of Information and Regulatory Affairs.
Nudge provides an easily accessible, non-technical tour of behavioral economics. It also offers a useful guide to the regulatory policies of the Obama Administration.
According to McCartney (link temporarily available to nonsubscribers):
Spirit Airlines Inc., an ultra-low-cost carrier that has pioneered many fees, says it has worked out an agreement with the U.S. Department of Transportation to begin charging a "passenger usage fee" -- perhaps $5 to $10 per ticket -- for the privilege of buying a ticket anyplace other than at Spirit's airport ticket counters.
The fee, designed to cover reservation-booking costs, will be part of Spirit's aggressive and edgy strategy, which doesn't always fly well with passengers. Spirit already has ruffled some feathers with its racy promotions, ads in airplane cabins and on flight-attendant uniforms, fees to reserve seats and the addition of travel insurance to tickets unless customers opt out.
The reason why Spirit Airlines must negotiate with the Department of Transportation is that under DOT regulations
airlines aren't required to advertise fees that only certain customers will pay, like those checking baggage. As a result, head-to-head price comparisons at booking sites like Expedia.com, Travelocity.com and Orbitz.com become more difficult, and prices listed in travel-agency computers won't tell the whole story. What's more, low teaser rates can lure fliers, even if the ultimate cost of the travel is higher.
Nudge (in several versions) proposes a general form of regulation that preserves, and indeed enhances, the ability of individuals to make decisions that better comport with their personal preferences. This system is summarized in the acronym RECAP:
Record: Require that customers be informed of every kind of fee that curently exists. "This would not be done by printing a long unintelligible document in fine print" but a publicly disclosed "fee schedule in spreadsheet format that would include all relevant formulas" (p. 93)
Evaluate: "[E]xisting travel sites would emerge to allow an easy way to compare services." Indeed, reservation system such as Kayak, Expedia, and Orbitz would find it very easy to ask customers to specific exactly what airline product they want across each of the dimensions that airlines now use to charge fees (e.g., checked baggage, seat selection at reservation, window or aisle seat, etc.). This is true even if the airlines themselves declined to do so., and the practical consequence of declining would be a loss of customers to the independent reservation systems.
Compare Alternative Prices: Currently, airline reservation system report only the cost of airfare and mandatory taxes and fees because they are charged to all customers. This makes price comparison very difficult. By ticking check boxes similar to the ones customers now use to choose airlines, airports, the number of slight segments and other important criteria, reservation system would provide customers with the true cost of the airline tickets they buy.
Airlines would compete for different segments of the travel business. From the perspective of consumers, it would be much more difficult to be fooled into buying an airline product that did not match their needs.
McCartney says Spirit Airlines and DOT have come to an agreement concerning how the airline can charge customers for buying tickets without violating the Department's existing rules. However, he does not understand how this arrangement will inform consumers:
But it's not clear exactly how Spirit will disclose its usage fee -- the company wouldn't yet discuss details. In a statement, the DOT says, "We have informed Spirit that they can charge a fee for buying tickets at locations other than ticket counters only if the fee is included in the price advertised on its Web site."
Another option for DOT is to revise its regulation in accordance with RECAP. There are other advantages to this approach. According to McCarthy, Spirit Airlines engages in a series of dubious business practices that apparently are legal under current DOT rules but inarguably are not in the best interests of most of its customers:
Another potential trap for consumers: Spirit's Web site automatically checks the box to accept travel insurance. To avoid the added expense, consumers have to un-click the box. "It's not like we snooker people into buying it because more than 50% uncheck the box," [Spirit Chief Executive Ben] Baldanza says.
Nudge discusses in great detail the meriits (and demerits) of opt-in versus opt-out defaults for what the authors call decision "choice architecture" (pp. 86, 109-110, and 248-251). Whether Spirit's use of an opt-out default "snookers" customers is a matter of opinion. It is almost certain to be true, however, that if the airline used an opt-in default, the proportion of customers buying travel insurance would be much lower.
Thaler and Sunstein argue that choice of default should be based on what is in the best interests of customers from their own perspective -- not the perspective of Spirit Airlines or, for that matter, government regulators. They recommend an opt-out default for payroll deduction of investments in 401(k) retirement plans, because saving for retirement is something that almost everyone agrees they ought to do even if they don't actually do it. It seems likely that they would favor an opt-in default for the purchase of travel insurance, a product that makes a lot of money for the airlines and the insurers but is rarely something that customers think they actually need.
