Authored by: Adrian Galano, Lanz Lebrilla, Ching Lolarga, Antonio Panis
Edited by: Jared Go, Andrei Dimaculangan, Elijah Soriano
Source: Google Gemini
Introduction
Ever noticed that whenever you’re booking a flight, you’re offered varying prices depending on many factors beyond your destination? Often, it’s a result of price discrimination or the practice of charging different prices to different consumers for similar goods and services. By charging different prices to different consumers, sellers can capture more consumer surplus, sell more of their products, and earn more profit.
Degrees of Price Discrimination
Sellers use varying degrees of price discrimination: first-degree price discrimination, by charging consumers their reservation or the maximum price they are willing to pay; second-degree price discrimination, by charging consumers based on the quantity or amount purchased; and third-degree price discrimination, by segregating consumers based on consumer demographics or traits and charging each segment differently according to their price elasticity of demand.
When it comes to airfares, airlines practice third-degree price discrimination the most often. Business travelers prioritize convenience and meeting their schedules. Their companies also pay for the ticket out of necessity, which makes airfares for business travelers relatively inelastic compared to ordinary travelers. Airlines know this and charge higher without discounts. On the other hand, leisure travelers pay for tickets themselves and are much more sensitive to prices, which makes airfares for leisure travelers elastic. As such, leisure travelers usually book tickets months in advance compared to business travelers. Airlines know this and charge lower prices and offer discounts (Jiang, 2021). Airlines such as the Philippine Airlines (PAL) offer special discounts from 20% to 90% for eligible passengers such as senior citizens, PWDs, students, infants not occupying a seat, Filipino nationals in active service, and national athletes (Philippines Airlines, 2024).
Pricing Strategies
In the business world, the traditional way that companies increase their revenues is simply through selling more goods or services. However, through time, various pricing strategies have been developed to maximize profit from a diverse market. Thus, a specific strategy has become prevalent among service-oriented companies— tiered pricing. It is a model that provides customers with a range of product or service choices, known as “tiers”, which respectively offer different benefits, features, and quantity per price point (Slingerland, 2023). The amount of benefit that consumers receive depends on the tier of the product and features offered (Šobak, 2023). Therefore, the kind of tiers offered depends on the customer mix of a company and their willingness to pay. All that being said, tiered pricing is a form of second-degree price discrimination.
Airline companies in particular implement these models to tailor to the various needs and preferences of their customers without losing out on revenue (Chargebee, 2020). Take for example Table 1 which contrasts national and foreign airlines in the Philippines in terms of their offerings in Economy and Business classes along with their price tag.
Airline | Economy | Economy | Economy | Business |
Philippine Airlines (PAL) | Saver | Value | Flex | Flex |
MNL (NAIA) 4:25 AM April 28, 2024 CEB (Mactan International) 5:50 AM | Checked in bag: 10 kg Choose seat chargeable Gain miles 50% (For PR Operated Flight) | Checked in bag: 20 kg Choose seat chargeable Gain miles 75% (For PR Operated Flight) | Checked in bag: 20 kg Choose seat chargeable Gain miles 100% (For PR Operated Flight) | Checked in bag: 35kg Choose seat: Free of charge Gain miles 150% (For PR Operated Flight) |
₱4,845 | ₱6,117 | ₱8,449 | ₱9,200 | |
Economy | Economy | Economy | ||
All Nippon Airlines (ANA) | Special | Basic | Full Flex | |
MNL (NAIA) Terminal 3 April 28, 2024 9:10
Tokyo (Narita Airport) 14:50 Tokyo (Haneda) Terminal 2 18:40 Nagasaki 20:35 | Advance seat reservation - Class: H Free baggage allowance: 23kg Changes: Permitted (with fee) Refund: Not Permitted | Advance seat reservation - Class: H Free baggage allowance: 23kg Changes: Permitted (with fee) Refund: Permitted (with fee) | Advance seat reservation - Class: M Free baggage allowance: 23kg Changes: Permitted Refund: Permitted | |
$532.60 | $572.60 | $682.60 |
NOTE: Based on data during April 21, 2024.
Table 1. Various Offers for Economy and Business Classes
Sources: All Nippon Airways and Philippine Airlines
The major difference between the tier of services offered is that on one end, passengers who prioritize need over quality, such that arriving at their destination with little to no luggage activity, are just priced at a minimum of ₱4,845 so that the airline may not discourage their purchasing intent. On the other hand, those who feel the need to travel and embark on a vacation have the option of increasing luggage capacity up to 35kg and the comfort of choosing their own seat. This set of consumers are usually those that have high purchasing power; thus the airline takes advantage. In addition, a point system is implemented through “gain miles” which essentially heightens the probability of buyers for business class through the elusive 150% rate.
Similarly, for ANA, the stark difference in prices across the Economy tier provides a high revenue margin. However, the marginal benefit is succeedingly low since the additions are simply the permissions granted for any changes or refunds. This is because the airline is aware of the purchasing power of those who avail the tickets to Japan in peak months, and therefore can split price points apart for as much as $100. Collectively, this situation represents second and third-degree price discrimination. The next table presents a temporal analysis of tiered pricing in the airline industry.
However, Cebu Pacific is an exception to heavily utilizing tiered pricing since it only offers economy-class flights. Its company slogan, “It’s time every Juan flies,” commits to providing low-fare flights with great value for everyone who wants to travel by air (Santos, 2011). It essentially operates under a budget airline business model in which it offers budget-friendly fares with no “frills”, which means less comfort that comes with affordable prices (Wijangco, 2015). Given this, Cebu Pacific’s target market is leisure travelers who prefer more affordable and simple flights. Higher classes for plane rides generally cater to higher-income travelers which is outside of the company’s target market and hence, why they only offer economy class.
Air Asia (Economy) | |
April 28, 2024 (00:00 MNL → 1:20 CEB) | May 5, 2024 (00:00 MNL → 1:20 CEB) |
NAIA (Terminal 2) → Mactan Cebu International Airport (Terminal 1)
| NAIA (Terminal 2) → Mactan Cebu International Airport (Terminal 1)
|
₱2,943 | ₱2,078 |
Cebu Pacific (Economy) | |
May 1, 2024 (21:45 MNL → 6:10 IAO) | May 8, 2024 (21:45 MNL → 6:10 IAO) |
NAIA (Terminal 3) → Mactan Cebu International Airport (Terminal 1) → Siargao Airport
| NAIA (Terminal 3) → Mactan Cebu International Airport (Terminal 1) → Siargao Airport
|
₱6318 | ₱5185 |
NOTE: Based on data during April 21, 2024.
Table 2. Time-based Differences of Domestic Flights.
Sources: Airpaz Cebu and Airpaz Siargao
Two domestic flights from Air Asia are compared from one week apart. The prices on April 28 are significantly higher due to being nearest to the current time. Leisure travelers tend to purchase plane tickets in advance and given that they are relatively price elastic, airlines charge lower prices on these types of tickets. On the other hand, business travers are likely to purchase closer to the departure date and due to being relatively price inelastic, airlines charge higher prices on these types of tickets (Aldrich, 2019). This illustrates an example of third-degree price discrimination.
In essence, some people see travel as a need, and some people see travel as a luxury. If an airline had offered only a single rate for their flights, there is a chance that those who seek comfort would switch to other travel options or those who prioritize affordability will resort to cheaper flights from other companies. Thus, the airline would incur an opportunity cost on potential revenue maximization. In the same sense, tiered pricing would help the airline retain a large customer base (FasterCapital, 2024) since competition in the industry is tight.
When buying airline tickets, it is commonly noticed that prices differ based on the month, day, and duration of travel. On dates wherein there is higher demand, airlines often increase their prices due to the limited capacity of plane seats. Examples of this would be during the Christmas season, New Year’s Day, and summer. This is called dynamic pricing, wherein companies create their own prices based on demand and supply fluctuations. This does not only apply to airlines but can also be seen in other businesses such as Grab, that have a presence in industries such as food delivery and transportation. Two forms of dynamic pricing are surge pricing and off-peak pricing. Surge pricing is when companies increase their prices due to high demand. On the other hand, off-peak pricing occurs when companies charge lower prices due to low demand.
Conclusion
Knowing and understanding how price discrimination as well as the different types of pricing works can be highly beneficial in grasping the economics of many industries, such as airlines. Airlines commonly practice price discrimination by charging business travelers higher fares without discounts due to their preference for convenience and punctual flights while providing leisure travelers with lower fares and discounts due to their elastic demand. Another price discrimination practice includes tier-pricing which involves charging different fares based on the various needs and/or preferences of the customers as well as the timeframe of flights. Airlines would also implement price discrimination practices like dynamic pricing, surge pricing, and off-peak pricing based on the peaks of supply and demand for their flight services, which are typically affected by certain months and/or days of the year as well as the duration of travel. Being aware of the different pricing models and tactics of airlines helps one choose airlines and flights that would best align with their own needs, preferences, budget, and schedule.
References:
Alfelor, Jangaile (2013). Strategic Marketing Plan for Cebu Pacific Air Inc. Retrieved from https://www.scribd.com/doc/151819049/Strategic-Marketing-Plan-of-Cebu-Pacific-Air
Aldrich. (2019, July 12). The Science And Truth Behind Flight Prices. Retrieved from
Chargebee. (2020, December 8). Tiered pricing model vs tier pricing strategy: Definition & Examples. https://www.chargebee.com/resources/glossaries/tiered-pricing-model-strategy/
Cebu Pacific. (n.d.). Seat Sale. Retrieved from https://www.cebupacificair.com/en-PH/seat-sale
Jiang, X. (2021). Analysis on Price Discrimination in Airplane Tickets. Advances in Economics, Business and Management Research/Advances in Economics, Business and Management Research. https://doi.org/10.2991/aebmr.k.210712.023
FasterCapital. (2024a, March 20). Tiered pricing: The benefits of tiered pricing for your business. https://fastercapital.com/content/Tiered-pricing--The-Benefits-of-Tiered-Pricing-for-Your-Business.html
Petersen, S. (2023, April 11). Cebu Pacific or Philippine Airlines? Airline Ratings. https://www.airlineratings.com/news/cebu-pacific-or-philippine-airlines/
Philippine Airlines (2024). Special Discounts Philippineairlines.com.
Santos, E. (2011). Cebu Pacific Air (A Case Study in TQM). Retrieved from https://www.scribd.com/doc/58378438/Final-Paper-Cebu-Pacific
Šobak, P. (2023, July 21). Tiered pricing: What it is and how to use it. Better Proposals. https://betterproposals.io/blog/tiered-pricing/
Slingerland, C. (2023, December 5). What is tiered pricing? 5 tiered pricing examples (2022). CloudZero. https://www.cloudzero.com/blog/tiered-pricing/
Wijangco, P. (2015). Cebu Pacific Strategic Management Paper. Retrieved from https://pdfcoffee.com/cebu-pacific-strategic-management-paper-pdf-free.html
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