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pjeby comments on How to save (a lot of) money on flying - Less Wrong
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Can you comment on whether the existence of the loophole does or does not indicate that the airline is charging more than it needs to / why the destruction of the loophole does or does not eliminate some sort of market inefficiency and/or undermine a price gouging strategy?
My intuition says that loopholes like this aren't supposed to exist in an idealized model of an efficient market, but I haven't properly worked out any reasoning either way so I am curious if someone has. I can't see any moral objection either way to using price gouging or destroying price gouging either way and just see them as strategies, and eliminating market inefficiencies seems like a positive.On the other hand, breaking contract in general breaks the rules for an idealized market, so I'm open to the idea that a true harm exists.
So if there is a harm...what precisely is the nature of the harm? And can we show that there isn't a benefit / the existence of whatever mechanisms allow this loophole to exist aren't a harm?
I've bowed out of the thread as a whole, but since this is a technical question and not a moral one, I'll go ahead and reply. ;-)
First, a bit of background. Under standard cost accounting assumptions, you can say that a seat on an airplane "costs" a certain amount, based on taking the total cost of staffing, maintenance, fuel, etc. Each of these cost allocations is largely arbitrary, however: the truth is that the airline has certain fixed and variable overheads, period, and if the flight is happening at all, the vast majority of those costs have nothing to do with how many people actually travel on the flight. But let's say that we arbitrarily assign costs equally for every seat on the plane, and call that the "fair" price.
(Or, more precisely, the "equal cost allocation" or ECA price, since this "fairness" is just a System 1 intuition that breaks down under closer inspection.)
If airlines asked the ECA price for every seat on every flight, it would be a fairly high amount. This would be more "fair", under some intuitions, but would result in lots of travel not happening at all. People who found the ECA price too high for their intended use, would not buy the ticket. This would result in ECA prices rising, because the airline still has fixed costs for the flight as a whole. When we divide those costs by the (new, lower) number of people actually flying, the cost goes up. Indeed, the airline has to charge an amount that's enough to cover the flight if only a few people show up, or it has to have the option to cancel the flight as underbooked, or it has to offer fewer flights to raise the demand for each flight.
Now we have a market inefficiency:
Under this condition, everybody loses!
Price discrimination solves this problem by decoupling "price" and "cost". The truth is, there is no such thing as how much a seat on a plane "costs": the allocation of fixed overheads and flight overheads is arbitrary and made-up. What really matters is the total revenue brought in by the flight. Our ECA price is a fiction, and discarding that fiction allows us to offer better prices for everybody.
As long is there is some way for the airline to sell at different prices to different people, they can get closer to selling out their flights, by offering the ECA price only on average, rather than by asking everyone to pay it. A business traveler who could afford an ultra-high ECA will actually pay less than under the inefficient-market ECA condition, because the flight is full of vacationers paying smaller amounts to make up for the difference. The vacationers get a lower-than-current ECA price, because there are business travelers making up the difference (though still not paying the inefficient-market ECA price).
This is why the airlines have all the weird fare rules, like roundtrips being cheaper if they cross over a weekend. It's why they want the name of the person traveling, and charge for changes. These are all things designed to separate vacationers from business travelers, so that the plane can be filled and the costs all covered.
The problem is, if business travelers succeed at pretending to be vacationers (e.g. by using half of a pair of round-trip tickets, or wrapping round trips so as to create a fake weekend stayover), then the flight fills up, but at a below-current ECA price. The airline loses money, because they can't make up in volume what they're losing on every seat. That's why they have all sorts of gotchas and enforcement on these loopholes.
Unfortunately, human beings' System 1 intuitions tell them that if somebody is paying $X for a seat, then that must be the "fair" price for any seat on the plane, and that the airline ought to charge everybody that price. So the fare rules are widely despised, even though the result of not having them would be everybody paying a higher price, for fewer seats on fewer flights, if they can fly at all.
Anyway, the specific loophole discussed in this article ("Hidden city ticketing", per Wikipedia) doesn't come from this particular form of price discrimination. It's a different form that basically is done to compete with airlines offering direct flights between two cities, A and B. The airline offering the deal seeks to serve A<->B passengers without adding a direct flight, by using excess capacity that's available on the A<->C and C<->B routes. The airline can offer these seats below the A<->C ECA, because it expects not to fill them with other A<->C or A<->Wherever passengers anyway.
The problem is that if lots of people who were paying something close to the full-flight ECA price for an A<->C ticket, now switch to using hidden city ticketing, they are now losing the airline money on the A<->C flight, because there are more people paying less, instead of some people paying more and others paying less. The airline now has to start raising the direct A<->C price in order to make up the difference, creating more price instability.
tl;dr: Price discrimination is efficient in a market sense, even though it often feels "unfair" to System 1 (because different people are paying different prices for the "same" thing), thereby motivating people to try to work around the discrimination. But successfully working around the discrimination increases the actual unfairness, since the price you get is now discriminated in part by how much extra work you're willing to do to game the system, and because the business is then motivated to make things more discriminatory or is forced to change what offerings it makes available.
(This is what makes loopholes anti-inductive and the use of loopholes a prisoner's dilemma "defection", because you are defecting against your fellow consumers in a game where if everyone defects, everyone loses. That's why talking about such a loophole is so foolish: you are encouraging more people to defect, which reduces the number of co-operators whose cooperation you're exploiting. Even assuming you're going to defect in a PD game like this, telling other people about it is probably the stupidest thing you can do, from a game theory/policy perspective, and that principle applies to a lot more things than airplane tickets.)
Thanks for answering!
This does fall under "price gouging" just as I suspected (though you use the more morally neutral term "price discrimination", which I aught to have used but I didn't know the term. Price discrimination is not unethical. However, I'm not certain that avoiding price discrimination is unethical either.
Price discrimination operates in coffee shops too - most of the cost is the building and the employee, and the actual drinks don't really effect anything - the differential pricing of the drinks is price discrimination. Similarly at the grocery store, using coupons is price discrimination - only people who put in the time and effort to use coupons pay less, and people who don't use coupons subsidize that. Would it be unethical to have a device that automatically generates coupons for everything? It certainly "defects" in that it raises prices for everyone and lowers prices for yourself.
...yet, it's not the same thing, because you did sign a contract with the airline to take the entire flight, not to mention the empty seat. It is morally gray to break contract. I do find it ... counter-intuitive ... to morally chastise defection strategies fighting price gouging on the part of consumers, because of how incredibly often businesses defect against consumers. Businesses break unenforceable contracts constantly, so it's hard to be persuasive when appealing to the "little guy" consumer's honor against the airline industry as a whole.
Unenforceable contracts in general create an incentive structure (What Yvain describes as "Moloch") where defection means winning and cooperation means losing. I haven't yet determined my position on whether or not moral people aught to allow themselves to lose within incentive structures rewarding immorality... on one hand, morality means being willing to lose self-interest to win community interest, but on the other hand this stance naturally causes moral people to lose and immoral people to win, and that shifts the good-evil power balance in a dangerous way. (I realize that's a really simplistic way to put it).
I'm curious as to whether you in-general support that "moral" people should allow themselves to lose and cede power to those who are willing to be "immoral" in these incentive structures, although I suppose you've tapped out on discussing the moral aspects on this.
In any case, I guess the upcoming court case will soon decide whether or not these contracts are enforceable, and that avoids the philosophical debate.
These aren't synonyms. "Gouging" implies that somebody is raising prices in order to make extra profit than the usual. Price discrimination is generally someone lowering prices to a market segment in order to pick up extra business, without lowering all their prices, in order to get the advantages I described above. AFAIK, the airlines didn't actually raise their rates when they were deregulated -- they lowered some of them to get more business. (I could be wrong about that though.)
I think it's a mistake to think this is a you-vs-the-airline scenario, precisely because the airline has more power than individuals. The airline can't be forced to do business at a loss, which means that non-cheaters will -- one way or another -- be paying to subsidize the cheaters. (Whether it's in higher cost or lower availability.)
That's not the standard definition. Price discrimination is all about capturing consumer surplus as revenue. See e.g. Wikipedia:
Those look equivalent; one is defined in terms of intention, and the other in terms of mechanism.
Pretty much. Except that the type of discrimination I've been discussing is capturing low end surplus, by making use of a seller's excess supply that would go to waste unsold at a higher price. For example, if a factory can produce X many widgets a month, but the market will only support Y widget sales at their full price, then they can sell X-Y widgets at any price higher than the truly variable costs (i.e., consumables only) and receive the difference as pure profit. This is extremely lucrative for the company, and benefits consumers who would or could not have bought the widgets at the higher price. But it only works if the company can prevent its full-price buyers from getting them at the lower price.
And every real-world example of price discrimination I know of works like this. Coupons, loss-leaders, rebates, special fares, sales, closeouts, last-minute vs. advance prices, factory outlets/seconds... heck, I just saw a real estate agent's ad offering to sell your house at no commission... if you use him to buy your next house. Granted, that's not exactly a tiny market segment, and is probably a bit more like a specialization than it is true price discrimination.
Anyway, the idea that a business raises prices to squeeze more money out of a select group is mostly silly; only a poorly managed business would establish its going rate any lower than what the top end of the market can bear in the first place! Ergo, any other prices offered for the "same" widgets are going to be lower, and any new higher prices will be justified by added value in the new offering, or else the market won't pay the higher price.
(Absent monopoly power, of course. Comcast keeps raising the rental rate for its modems, for example, without providing any new benefits. And that is price gouging, not price discrimination. In a market with real competition, you can't price discriminate by raising prices for a select group without some sort of justification, if you want to keep making sales to that group.)
That might be availability bias, though. If you deliberately try to not waste money, you're probably avoiding many of the ways that you can price discriminate up. Software as a service has many examples of price discrimination the other direction; here's Patrick MacKenzie on the subject. (It's a recurring subject, there might be a better place to jump in, but that'll get the idea across.) Many people in companies are willing to pay 10X in order to say they're getting the Enterprise version of software instead of the Hobby version of that software, even if the hobby version covers their use case entirely, for signalling reasons.
As I said, if you charge somebody more for something, there has to be some added value. Making a deluxe or enterprise version of something where the customer freely chooses to pay more for the extra goodies isn't price discrimination, as I understand the term. That's just "having a range of products".
To be price discrimination, you need to be offering something that's substantially the same, but you want to get more business by not selling it at just one price. Airlines, coupons, etc., as I mentioned above.
You can quibble whether this is the "true" definition of price discrimination, but at that point we're arguing the meaning of words. This is what I mean by price discrimination in this discussion. I consider raising prices without adding extra value to be either "monopoly price gouging" or "correcting your dumb mistake of not charging enough in the first place". ;-)
Enterprise versions of software generally come with support contracts or SLAs, not to mention features that require more support (such as API access, single sign-on, integrations, etc.) that justify the higher price because they come with higher ongoing costs for the service provider.
Even if the software itself is otherwise identical, an enterprise offering is different, speaking from having personally been on both sides of that particular business. Even if most of the "enterprise" users don't actually end up needing that extra support on a regular basis, it's a legitimate added value to have the protection of choosing the more expensive plan that comes with those guarantees. They're basically paying more for the option to get more help when they need it, or to sue you if something goes wrong.
But even if it were entirely for signaling reasons, that still wouldn't make it price discrimination. It's the buyer's choice whether to take a lower-priced offering, and if the seller adds an enterprise package, it's usually not because they're trying to squeeze more money out of customers they already have. They're doing it because they wouldn't get the enterprise customers at all with their existing offer. (It'd be price discrimination if they needed some way to prevent the enterprise customers from buying the hobby offering.)
While SaaS and PaaS vendors may also have price-discrimination offerings in their lineups (closeouts, old servers, "free" tiers, etc.), their mainline plans are usually priced so that the vendor is indifferent to which pricing plan you buy: they're making a decent living even if everybody picks just one plan, whether it's the lowest or highest priced one.
Again, "price discrimination" as I'm using the term is something used to eke additional revenue out of excess supply without destroying your ability to get your regular price for your regular supply. Merely having a range of products isn't. Even Wikipedia says:
This is a bit tricky, because as I explained earlier, "production cost" is a bit of a chimera, due to the question of allocating fixed costs and semi-variable costs. But if you offer an enterprise package with support, you have to pay for some extra support staff capacity just to have them available in the event that this is the month the customer decides to use it. Few of a business's production costs are truly variable, unless you're somebody like Uber, who can instantly hire/fire their drivers. (And they still have lots of fixed and semi-variable costs.)
Anyway, the point is that most SaaS/PaaS companies' pricing tiers are based on varying costs between the tiers, which makes them product differentiation, not price discrimination per Wikipedia.
That being said, the Wikipedia article is actually pretty vague about the distinction at times and notes that only "some" economists argue that signaling premiums make something price discrimination rather than product differentiation. My personal opinion is that perceived value, not "production cost" forms a relatively bright line between price discrimination and product differentiation. If the buyer considers the higher-priced product more valuable, IMO that's product differentiation. If they consider it the "same thing" (e.g. DVDs, airline flights), it's price discrimination.
I think this is symmetric, though. The 'added value' of paying the non-coupon price is that you get the time you would have spent managing coupons and to conspicuously consume non-coupons; the 'added value' of paying the enterprise price is often just the conspicuous consumption of non-hobbyism. But if I want coupons to represent price discrimination, then it makes sense to see the enterprise tier as also price discrimination.
And if we use the 'capture as much consumer surplus as possible' definition, both of those are clearly serving the same general function.
The Kalzumeus response to this is that it leaves immense amounts of money on the table to sell software based on varying cost rather than capturing consumer surplus by price discrimination. When he sells Appointment Reminder, he encourages people to pick a tier based on the cost of one missed appointment rather than based on their particular needs (i.e. the cost of serving them).
No, I don't think so. For one thing, pjeby thinks that price discrimination "is generally someone lowering prices" and I don't think this is true. Price discrimination involves charging different amounts to different people, depending on their reserve price, and the seller, of course, tries to make the total/average amount as high as he can, to the best of his ability. Even if you take the seller out of the equation and look only at the buyers, price discrimination amounts to a wealth transfer from the high-reserve-price people (the wealthy and the desperate) to the low-reserve-price people (the poor and the meh, whatevs).
Agreed, but pjeby's already established that he's making the comparison to a state where price discrimination is impossible, and relative to that it does seem reasonable to expect that the mean price under discrimination will be lower, often significantly so, and especially in the context of airlines.
Only under particular certain conditions. Under other conditions this is not so.
For example in businesses where variable costs dominate the cost of the product and the economies of scale have already been realized, price discrimination will not lower average prices. Ditto for supply-constrained products.
In real life the situation is complicated because most price discrimination involves slightly different products so deconstructing the demand curves is not trivial. As an example consider deluxe game editions. You get a bit of added value (a soundtrack, maybe a printed booklet or a figurine), but the price premium is typically much larger than the value of the add-ons. What's happening? Price discrimination.
I edited my post before I checked to see if you had commented--remember that this is in the context of airlines, in which case it is absolutely true. We only have the modern air industry at the size and level of connections that it is because of the sophisticated price discrimination.
Hmm...would you consider it "okay" if you somehow were able to sell the second leg of the flight to another person, to occupy the empty seat? I know you can't, just for the sake of argument. - That removes the empty seat issue, reduces this to a situation precisely equivalent to coupons, and services two people...it does take money from the airline, but so would an increase in coupon use.