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How economics 101 could have prevented United’s PR nightmare

The not so friendly skies? United plane via www.shutterstock.com

How economics 101 could have prevented United’s PR nightmare

On April 9, a passenger was forcibly removed from a United Airlines flight from Chicago O’Hare to Louisville after the carrier was unable to find volunteers to accommodate four of its employees on standby.

Dramatic videos of the incident have gone viral on YouTube and social networks, and I reckon the resulting cost of this PR disaster will likely make United’s CEO wish he had sent in a private jet to ferry those employees to Louisville (which the airline could easily have afforded, given its net income of US$2.3 billion in 2016).

Many articles have reported that airlines routinely overbook their flights, and sometimes passengers have to accept (voluntarily or not) the inconvenience of getting to their destination later than planned.

As an airline economist, I do not recall, however, such a situation ever escalating to the level it did on that United flight. The incident raises many questions, including why airlines overbook and what the carrier could have done differently.

Airline economics 101: Why they overbook

Overbooking is indeed something that the airlines routinely do, and it represents a rational behavior for a carrier that sells some of its tickets as fully refundable contracts (mostly to business customers who pay the highest rates).

While the last few years have generally been good for airline profitability, the brutal truth is that profit margins have been rather low historically. Airlines rank below most other industries in terms of return on invested capital, according to the International Air Transport Association.

An airline that does not overbook risks finding itself in a situation in which several cancellations from high-yield passengers flying on refundable fares (the most expensive airlines offer) can turn a profitable flight into a loss-making one. Airlines have quite a lot of information on cancellation patterns for different flights, and they decide on how many seats to overbook based on this.

Overbooking has likely contributed to the rising “load factors” in the U.S. airline industry. Load factors – the share of airline seats occupied by passengers – on U.S. domestic flights have gone up from just under 80 percent in 2007 to almost 85 percent in 2016. Keeping airplanes as full as possible clearly helps airlines stay in the black.

Of the major U.S. and European airlines, only Ryanair does not deliberately overbook its flights, to my knowledge.

To the best of my knowledge, the airline industry is the only one that practices overbooking. This is done mostly because it is comparably easy for the airlines to provide their passengers with alternative ways of getting to their final destination. For instance, United provides five daily flights from Chicago to Louisville, giving the airline quite a bit of flexibility.

Ins and outs of overbooking

So what happens if a flight is overbooked?

The airline starts by looking for volunteers, offering the passengers travel vouchers or sometimes cash for taking a later flight. U.S. and European airlines are technically not required to offer anything to the passengers for voluntarily giving up their seat (the law stipulates only that the airline and the passenger come to an agreement on conditions under which the passenger volunteers to take a different flight), but most airlines tend to offer travel vouchers.

If not enough volunteers are found, passengers will be bumped off involuntarily, in which case, both U.S. and EU laws require airlines to provide financial compensation to the passengers.

The airlines take your “status” and other factors into account, so you are less likely to be denied boarding if you are traveling on an expensive fare or hold an elite status in the airline’s frequent flier program.

Pro tip: In both jurisdictions, laws provide for compensation in cash. So if you are offered travel vouchers in return for being involuntarily denied boarding, it is your right to refuse and demand cash compensation instead.

UA3411 veers off course

Basically, this is where things went wrong for UA3411. Because United could not get enough volunteers, it started the process of removing passengers from the plane involuntarily, and chose four at random.

Since taking off with more than the maximum allowed number of passengers on board is a serious violation of safety rules, the airline has every right to ensure that there are no extra people on board when the aircraft taxis from the gate.

The issue in this case, in my opinion, is that United did not do all it could to prevent the situation from escalating to the point where it became what will likely be an expensive PR issue, if not a legal and political one.

Even if just 1,000 passengers decide over the next month to fly with a rival instead of United because of this incident, we are talking about a third of a million dollars in lost revenue, giving the current average airfare of about $340.

And that’s without factoring in the cost of repairing the airline’s image (which explains why its shares tanked on the stock market).

Simple economics

What could United have done differently?

From the point of view of economics, the airline’s inability to find volunteers means that the compensation offered was too low. Some accounts of the incident suggest that the airline offered $400 for the passengers to volunteer to take a flight on the next day, and the offer was later raised to $800.

While $800 seems like good money for the inconvenience, passengers apparently put a higher value than this on their desire to get to Louisville (recall that the flight in question was on Sunday evening). In fact, I guess your boss would be more sympathetic with you missing a day at work if this were due to the airline bumping you off a flight than you volunteering to spend a night away (especially since you will end up with a travel voucher or cash in your pocket either way).

Regardless, the airline would definitely have found volunteers if it had kept increasing the offer. Whether the airlines’ employees had the authority to do it is another matter, as the company may have put a limit on how much it could offer.

More generally, to reduce the likelihood of involuntarily denying boarding to passengers in the future on oversold flights, airlines could introduce some sort of auction system to look for volunteers. The airlines could either gradually increase their compensation offer or even ask customers to name their own price for volunteering. It seems that Delta is already doing this, as a matter of fact.

Such a system should not be too onerous to implement. Airlines these days have plenty of ways to contact passengers via text or app. The entire process could be run without creating much fuss in the airport, and even in a way that few even are aware the flight was overbooked.

A rare problem, big headache

Fortunately, denied boarding is in general not a major issue for airlines.

According to the Department of Transportation, less than one-tenth of 1 percent of all passengers are denied boarding, and only one in 10 of those are involuntary.

Still, airlines are well-equipped with all the data and related technologies needed to make sure that all the passengers on oversold flights are reaccommodated voluntarily – and are not involuntarily dragged off a plane in such a horrifying manner.

I hope the incident on April 9 will make them consider making the appropriate investment into tackling this issue.

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