More On Airline Upgrade Auctions

When last we left our hero (me) we were talking about airline upgrade auctions, noting that Priceline already does this for seats.

Some of the problems that airlines would face with auctions would be these:

Upgrades are a huge perq for elite frequent flyers, where they either make or strongly influence their airline selection. Business travelers in particular make up the vast amount of revenue.
Inviting frequent flyers to use their miles as value to get these seats could imply that their miles in fact have value, and the IRS and SEC might like to know that. For years airlines have fended off attempts to view miles as any form of liability that would need to be written down. While I am sure that in recent times with the current set of passenger-hostile rules, this notion has at least been temporarily dispelled, one could easily envision governments taking a second look if they believed there was a logical monetization.

There are several approaches that may yet be available to airlines:

Run several auctions for the same seat, so that those in the same class are allowed to buy the seat first. This would be very close to how things are run today.
Provide elite members a discount on the final price. For instance, if you are a silver member, maybe you would get a 20% discount, but if you are a gold, perhaps that discount rises as high as 50%.
Reserve some seats for the Old Fashion methods of buying them in advance and using miles.

We may already be past the point where we could ever expect the auctions to be run in real money, simply because so many people have so many miles banked.

Potential Revenue of Business Class Upgrades

What this graph shows is normal business class revenue in red, and the potential for additional revenue in green. Note that the horizontal green line just indicates a random equilibrium. In reality that price would jump up and down based on the popularity of the flight, its length, and just how important it was to someone to get upgraded.

Again, this would need to be done in such a way as to preserve customer loyalty.

Airline Upgrade Auctions?

Bureau of Economics Those of you who know me know of my interest in economics, which started literally on my first day of college, thanks to a great professor named Joseph Seneca. He managed a lecture in 1983 of over 400 students in Scott Hall at Rutgers University, twice a week, for two semesters at 8:05am for an hour, covering Introductions to Micro- and Macroeconomics.

With that start in mind, I have learned to ponder my day-to-day issues with an eye on supply, demand, marginal benefit and cost, trying to understand profit maximization. It’s also why I like reading books like Age of Turbulance, by Alan Greenspan. While I do not subscribe the Greenspan’s anarcho-capitalistic approach to managing the economy, I haven’t been chairman of the Federal Reserve, so I’ll assume he knows a few things more than I do on the subject.

This brings me to two of the most remarkable Internet creations: priceline.com and eBay. eBay is remarkable not so much because of the vast amount of innovation that went on in its inception. Rather the founders applied very straight-forward economic doctrine to bring buyers and sellers together in a common market place so that goods could be sold at their optimal prices. eBay is elegant in its simplicity.

Priceline.com works along the same lines as eBay, but makes legitimate the grey market in airline tickets, hotel visits, and the like. And who can’t like a company that employs William Shatner as its spokesman? There are several limitations, however, to priceline that have often stopped me from considering them. One of the big ones has been an inability to upgrade to a higher class of service. This perhaps may sound snobbish, but sitting on an airplane with my legs cramped in front of me for 12 hours is not my idea of a good time.

And so I’ve wondered about an idea: why not let airlines auction upgrades? If the airline hasn’t sold a business class seat by the time of the flight, they could hold a pre-arranged auction that consisted of bidders who wanted the seat, complete with reserve pricing. Wouldn’t this maximize the airline’s profit? After all, people have done this on eBay without airline participation allowing individuals to maximize their profit, leading airlines to put many controls in place to prevent it.

There are of course a few problems. If you’re a very frequent flyer you expect to be upgraded all of the time without having to go through the hassle of an auction. And if you’re just a frequent flyer you expect to get upgraded some of the time. If you’re a business class traveler who normally pays the a factor of three more than the discount coach seat, you may instead decide that it’s cheaper to bid in the auction and get the same results, thus causing the airline to lose money on the proposition.

I’ll discuss mitigations to some of those problems in a future post. For those wondering about the picture, that’s the Bureau of Economics, which is part of the U.S. Federal Trade Commission, and not a Greek temple.

Off To New Hampshire

Many of us are geeks. We like to think that just because we have a good idea other people will like it as well. We’re particularly bad at user interface design and understanding the underlying economic drivers for technology. As a case and point, why is it that IPv6 hasn’t taken IPv4’s place, even thought it has been in existence for nearly fifteen years and solves a real problem of address space shortage? The answer can be found, I believe, in economics, which is to say that the motivations have not been there to spend the money to get people to move from one system to the other.

On Tuesday I am off to New Hampshire via Boston to attend the Workshop on Economics of Information Security (WEIS). In past conferences, WEIS has covered such topics as when to disclose vulnerabilities, the economics of the insurance industry and cyberthreat insurance, digital media protection mechanisms, and the risks of new technology introduction. One past paper that I particularly enjoyed discussed the risks of homo- versus heterogeneity in an enterprise. It has long been an axiom that if you wanted to protect yourself from systemic failure you used redundant systems that are built using different methods. In airplanes the rule is meant to keep passengers alive (although Airbus has flouted this idea, according to the Telegraph).

Cyberthreat insurance people take this to the extreme by not particularly liking even the idea of interoperability. Their logic goes that any interoperating system can continue a cascading failure, and that is potentially true. Of course, while an insurance salesman might want you to not have an accident, his management need some accidents to prove that insurance is necessary. The extreme case of a cascading failure, however, has insurance people shaking in their boots. They get away with insuring households and businesses against losses by (a) applying a reserve and (b) knowing that a fire or other natural accident can only cause so much damage in a local area. In the case of a computer virus, they have no reason to believe that there is any locality, and so the policies tend to be very restrictive.

I have a few economic questions of my own to ask. What will it take to motivate the adoption by a service provider of a new authentication mechanism that would provide benefit to OTHER service providers? In other words, how will service providers serve the common good? In general, by the way, they do. They recognize rightly that if they don’t cooperate on their own they will be made to do so under far less favorable terms. But here is something new, and not old. Introduction of new technology and new ways to cooperate is not exactly what they’re all looking for. I am. If we can find improved methods of authentication for end users we can surely reduce the value a PC represents to a criminal.

Of course this means we have to create a new authentication mechanism that actually does improve matters, but as my favorite theoreticians say, let’s assume that’s true, nevermind reality. What then has to happen for the mechanism to be adopted by consumers and providers alike?

Going back to that earlier question of what will it take for IPv6 to get deployed, in this year’s WEIS Jean Camp, Hillary Elmore, and Brandon Stephens have produced a paper that puts the question into a formal economics context. While the work is neither the beginning nor the end of the discussion, it is a very good continuation.

You can soon expect a post that discusses the outcome of this year’s conference.