Market Failure in Auctions?

Photo: Javier C. Hernandez/The New York Times

As did its recent acquisition, Northwest Airlines, Delta is doing on-line auctions of seats that must be vacated if the plane is overbooked. At online check-in, each passenger is asked what price s/he would require to be bumped to a different flight. Yet the results are apparently not acceptable to Delta: After his check in (where he refused to accept bumping), my son was offered $250 via a telephone call six hours before his flight to be bumped to an earlier or later flight. Did Delta not get enough offers online? Were the passengers’ reservation prices too high for Delta’s budget? Or is the airline simply playing games with its passengers, hoping to induce a few of them to accept a lower price? Other explanations? (HT: DJH)


Matthew

Delta's use of technology and pricing strategies to minimize the number of upset customers (who have to be bumped), stressed gate-agents (who don't like bumping folks) is great for all involved.

Good on them.

After 30 odd years, the airlines are still fine tuning their pricing strategies to fill seats, so the work on emptying might be subject to a few bumps along the way.

rforce

$250 is probably a lowball offer after no one signed up to be bumped. They'll be more generous at the gate as flight time approaches. I got $400 during the holiday weather chaos.

Bobby G

I'll guess... not enough activity within reasonable price ranges for Delta on the auction site. Suppose they have 5 seats they need to vacate, and of the 100 that put prices down for what they'd accept for a bump, only 3 were under Delta's hidden limit of (let's say) $300. So they accept the 3, but still need to vacate 2 more, so they call around offering $250 (or maybe 250 was their limit).

Just because someone says they'd accept a bump for $500 doesn't mean Delta still thinks it's a good deal for them.

Probably they would have offered $250 to the 3 that accepted their deal, but they might have gotten away with only having to give out $200 or something. That then reduces the pressure on vacating the remaining seats (since there are fewer of them) and there's no additional cost in the remaining offers (business as usual). Their only obstacle is that they can't make public offers much higher than the "buyouts" of the people that put down their own limit... if you find out Delta's offering $250 per vacated seat and you accepted $200, you're probably not gonna be too inclined to put a limit in the future.

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Jon

This would seem to be a no-brainer; if everyone says "$5 grand" then there's no way they can pay that price to anyone... and there's no incentive (unless you really don't need to be somewhere, and who's going to go through airport security unless they REALLY need to be somewhere?) to do anything but set an artificially high price.

Carl

The real market failure is that which allows the airlines to overbook in the first place.

Joe

Isn't there a federally set amount they must pay you (maybe $250?) if they bump you? Presumably they figure some people will be so flexible as to happily take $150, say, as they just don't care which flight they take. Therefore you have an opportunity to reach pareto efficiency, and if an inadequate amount of people are willing, give it a second shot on the phone (but with the full amount, getting people who might have been unwilling for less than full price but don't care so much that they forgo $250).

Tony

It's not really a hidden limit - if you put $800 and the cap is $250 then they will reject your bid and you can either put in $250 or choose not to accept.

Kind of annoying if you ask me

Jack

Information asymmentry at work.

US airlines must pay $800 to passengers involuntarily bumped; the airline knows this, many passengers don't.

The airline knows how much your son paid for his ticket, and knows how much more either 1) his replacement paid in cash or 2) his replacement is valued under the frequent flier program. Your son knows what he paid and the value of the incentive.

The max incentive offered to your son should be the lower of $800 or 1+2 (from above), with the offer for this seat much lower. The auction process gives the airline the tools to sell more seats since they will have all the necessary information to maximize profits. They know the value of buying out each seat, and they control the price offered to replacement fliers.

As for the phone call, perhaps the airline knows your son's demographic, perhaps knows he's a discount fare flier, and assumes he is more likely to take the $250. Maybe his fare was the lowest on the flight, therefore making replacing him more profitable. Either way, the airline assumed your son was the low hanging fruit for a lowball offer at less than 1/3 of what statute says should be paid.

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Richard B.

Through their frequent flyer database, Delta should be able to tell who the softies will be in their auction -- those people who would relish the opportunity for a $250 credit towards another flight for a slight inconvenience, based on the passenger's past behavior. So the younger Mr. Hamermesh may have been flagged as an auction softie by purchasing cheap tickets at the last minute, or by taking a prior offer, and thus the airline knows who to call when it wants to avoid having to pay more at the gate.

J.P. Steele

yet another reason to fly Southwest.....

Andy

I'd be more inclined to take an airline's bribe if it was paid out in cash. But what they do is give you a credit that's as good as a bunch of frequent-flier miles. Which means that it comes with the same restrictions as frequent-flier miles -- blackout dates, limited number of seats for rewards fliers on most flights, etc etc. If you've used miles for travel, you know that it's a royal pain.
So suffice it to say I am never inclined to take the airlines up on their supposedly generous offers.

A. Gillespie

Huh. And here I'd have thought that nobody would accept less than a completely free flight to have their plans changed under duress at the last minute.

Bob E.

Andy is simply incorrect. I received a $300 voucher from Delta for a voluntary bump on a 2-hour flight and it has NONE of the restrictions that frequent flyer miles have. There are NO blackout dates NOR are there a limited number of seats allocated to the voucher. The voucher is equivalent to cash and can be applied to ANY Delta ticket purchased within a year of issuance.

david

Without overbooking, tickets would cost more. I find that hard to call a market failure.

The airline compensation is not a straight 800 dollars. It is 0 dollars if they can get you there with in a hour, 400 if can get you there in 2 hours and 800 if it is longer. International flights and small planes have different rules.

People whine about overbooking all the time. For a college student it was a goldmine. I could make 100/hour (back in the good old days when vouchers were for a free trip) for reading a book in a airport for a couple of hours. That was a heck of a lot more than I made TAing a class.

EdTheEd

I'd say that's exactly what you should expect, isn't it? Let's say you know only one person will not be allowed on the plane. Rationally, you'd bid a price equal to your willingness to accept (reservation price) plus an amount equal to your estimated probability that no one else has a lower bid, times the estimated difference to such expected second-lowest bid. Since there is always a chance that you're the lowest bidder, you never enter your true reservation price.
The airline, knowing that, has an incentive to call people to make them a credible-sounding take it or leave it offer - in this simple model everyone is bidding more than their reservation price after all. True, in the beginning people might believe refusing the offer or trying to bargain gives you a higher pay-out, but if the airline sticks to the plan of never offering more to a person who turns down an offer (which may entail some costs in the beginning), people should start accepting any offer at or above one's WTA.
Add to that (i) (very) different estimates about the probability of someone else under-bidding [which must be true - how should an average traveller know] and (ii) uncertainty about how many more people show up than places are available, the different estimates of people could create even higher spreads between WTA and the actual bid.
After an initial, potentially costly, period of learning about people's discount factors, airlines should fare well with a "let them bid and then call them" strategy. Essentially, all they're doing is saving costs by filtering out the most promising passengers to approach with a low offer..

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D. Wells

Seems like an issue with a relatively simple solution. At the gate, the gate agent could tell the customers that they were overbooked by "X" amount of passengers. Then the agent simply starts the auction for the voucher and allows it to run up to the amount established by Delta as the price point where it is more responsible to anger a passenger or two by cutting them than by continuing to run up the voucher price.

Sure, there is always the chance that you anger a passenger with this approach, but the openness of the system should generally create a solution without having to target individual passengers.

Christopher Strom

I'll echo Bob E.

Last year, my wife and I took a voluntary bump (resulting in a four-hour layover instead of one) from Delta for a pair of $350 vouchers. Valid for one year, no restrictions.

We just used them over this last Thanksgiving holiday.

Josh

I think Delta tried a new thing. They're eventually not going to like it. Auctioning for airline tickets is stupider than QE 2.

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José

As other posters have mentioned, $800 (in real money, not airline vouchers) is generally the cost of an involuntary bump, recently raised from $400. In my recent experience, $400 in airline credit is the absolute minimum offered for volunteers on other airlines; UA even gave me $400 on LAX-SAN last fall for taking a flight 90 minutes later.

Voluntary denied boarding is not subject to any limits--if a passenger is willing to take $5 to fly later, the airline is within its rights to pay him $5 and fly him out later unless its contract of carriage states otherwise.

Vouchers for dollar value have become standard in the last couple years because free domestic round trips have the potential to screw everyone: you, if there are plenty of seats but no award availability, and the airline if you use it to fly from Miami to Adak Island after getting bumped from a $50 flight.

brazzy

@Carl: Not a market failure at all. Overbooking happens because business passengers (or rather, their employers) are willing to pay a hefty premium for the privilege of choosing their flights freely on short notice (making exact preallocation of seats improfitable), and because empty seats incur almost the full operational cost. Both of these together mean that paying out compensation for overbooking and dealing with irate passengers is worth it for the airlines.