Saturday, March 26, 2011

Seat Allocation, Price Discrimination and Loyalty

On my recent spring break getaway, Shanna and I flew Southwest. As this was the first time we had traveled on Southwest Airlines, I was exposed to a new way to allocate seats on a plane: open boarding with seat priorities.

If you are unfamiliar with how it works, each Southwest passenger receives a ticket with a boarding priority number. Just prior to boarding, passengers are encouraged to line up according to boarding priority (in groups of 30). The airline even went through the trouble to install markers to assist passengers in lining up efficiently.

Upon entering the aircraft, passenger A1 gets to pick his/her most preferred seat. A2 gets to pick from what is left, and so on. This continues until A60, starts over at B1 through B60 and starts over again at C1 until the flight is full. In the study of mechanism design, this type of mechanism is called a serial dictatorship, which are known to produce quite unequal outcomes.

Why would Southwest choose to produce unequal outcomes among its customers? After all, Southwest must know what it is doing. There must be some way to profit from this.

A partial answer is that Southwest can exploit the inequality and uncertainty of open boarding to charge for access to special clubs that get better boarding numbers, effectively using the boarding strategy as a method of price discrimination. Passengers who care enough about boarding priority pay extra to join the club. Those who don't care that much about seat selection get boarding priority C1.

In actuality, the program is (disguised as) a loyalty program. Book 25 one-way tickets in a calendar year or earn 75,000 Tier Qualifying Points and you get priority. You could earn (cash) rewards from using some other credit card, but you forgo those rewards for priority on your Southwest flights.

This cost and the 25-flight requirement is enough to screen the different types of customers. Priority types go through the hassle and forgo other credit-card rewards while low-cost types do not. And, the priority types' hassle earns Southwest some profit because they will be less price sensitive when it comes to the 22nd, 23rd, 24th and 25th fare. With this knowledge, Southwest can obtain a higher average price. After all, the boarding priority is worth something.

Here's one passenger on the A-List program (from back in 2009):
Now since I joined the A-List program, I’ve typically gotten boarding numbers in the A20s-A30 range. I’ve also been higher or lower than that. It’s worked well. I’ve never had a middle seat. I’ve usually gotten the exact seat I want, even.

But yesterday, I was taken aback. I checked in and got a B1 boarding spot. While I know the A-List program doesn’t guarantee an A spot, I still wondered how this could happen.

This was our first time on Southwest and we booked the flight because it was cheapest among all of our options. Guess what our boarding priority was. That's right. We were C1 and C2.

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