Is Overbooking a Cost-effective Airline Business Practice?
Is Overbooking a Cost-effective Airline Business Practice?
In the previous edition of Airline Profits, we highlighted why selling seats is not a sound economic way for an airline to become profitable. In this article, we are going to review the widely spread practice of overbooking, which is a natural by-product of selling seats.
Indeed, if you followed the United saga about overbooking and the outrage that has caused, you would agree that the timing of this discussion couldn’t have been more opportune.
The concept and practice came as a result of airline passengers either showing up too late or canceling their seat or not showing up at all. In which case, airlines are forced to fly empty seats. The emptier seats the lower the load factor. And the lower the load factor, the greater the probability of operating unprofitable flights. So, said differently, overbooking is some sort of in-house insurance policy against unprofitable flights. Legally speaking, the practice of selling more seats than actually available is allowed by law.
Then what happens when more passengers do show up for the flight than anticipated. In such a case, the airline’s gate agents will call for people who would like to give up their flight on a voluntary basis in exchange for a perk and a reservation on another flight. This rebooked flight could be on that same day or a later date. If there are enough volunteers to keep the flight within the assigned aircraft’s seating capacity and weight limits (including the flight crew), then the problem is solved. In some cases, there may not be enough voluntary denied boarding, in which case additional passengers would be chosen at random and removed from the flight. These are involuntary denied boarding. Ideally, the denied boarding process takes place at the gate, well before any passengers are allowed to board.
Side effects of overbooking
From an airline standpoint, overbooking is perceived as a necessary evil in order to ensure and sustain profitable operations. From a customer standpoint, however, the practice of overbooking has two side effects. The first side of the story is that of the voluntary denied boarding. In which case, the customer is happy for getting extra perks that sometimes may equate to a free flight and probably some extra cash for the journey.
The second side of the story is that of involuntary denied boarding. In most cases, this turns out to be a terrible experience, especially when considering all the travel arrangements made probably weeks or months in advance. In some instance, there is just no way the customer can make-up for the missed opportunity of arriving at his destination as initially planned. Consequently, customer satisfaction is seriously damaged and some time for good.
The cost of overbooking (tangible and intangible)
The tangible cost of overbooking
In talking about the costs of overbooking, it would be interesting to note that there are direct and indirect economic impacts.
The direct impacts of overbooking in terms of cost can be assessed by summing up the monetary value of each item included in the perks offered to convince some passengers to voluntarily accept to forego a given flight.
When it comes to perks, they generally comprise some cash value and some type of vouchers (e.g. to cover a night stay at a hotel, meals or taxi fares) depending on when the next flight is scheduled for. In some instances, passengers can be booked on flights operated by other airlines serving the same destination. Generally, the total value of the perks is greater than the ticket price to appeal to a given passenger.
In any case and regardless of how this can be framed by the airlines, every denied boarding, whether voluntary or involuntary, equals to loss of revenue. Furthermore, in some rare cases, the cash portion of the perks has to be raised to a substantial level before it can appeal to passengers. In those cases, the cash value is not only double but can substantially exceed the average economy airfare. So that means not only is the airline losing on denied boarding, it is actually eating up a significant chunk of the revenue from passengers remaining on the flight. Therefore, although that flight might depart with all passenger seats sold, the net revenue (total revenue from seats sold minus the total value of perks) may not reflect the near 100% passenger load factor. In other words, the airline may have succeeded in filling up the plane to maximum capacity, yet may end up with a tiny margin or even a financial loss on that flight, depending on the case.
The intangible costs of overbooking
The intangible economic impact of selling more seats than necessary for a given flight comes as a result of the negative customer experience inherent to this practice. Just imagine that you plan some family vacation months in advance and booked your flight. Finally, the day comes and you get to the airport with your spouse and children. You are all excited about the journey and you can’t wait to get to your destination, only to be told than one of your children or your spouse cannot board the flight. Regardless of how you or the given airline manage to solve that mess, chances are you will probably think more than twice before you contemplate flying with that particular airline again in the future. Chances are also that you will tell all your friends and relatives, probably colleagues too about how unfriendly and disorganized that airline is. Hence, the intangible cost related to the common practice of overbooking is the opportunity cost due to a bad reputation in the marketplace. It directly or, indirectly affects the goodwill of an airline, although the specific monetary value of such a negative economic impact may be difficult to assess.
Just like the ineffective airline business model of selling seats, the common practice of overbooking makes in reality very little economic sense. If the vast majority of airlines frequently resort to that tactics to fill up airplanes, the basic rationale behind it is that it has been used by other airlines in the past. And just like selling seats, it seems that not many airline executives and strategists have actually taken the time to examine its soundness, at least from an economic standpoint. Following the recent United overbooking incident, which cost nearly a billion dollars (in share value and probably more due to various actions to boycott United Airlines), maybe it is about time the airline industry revisits this highly questionable and detrimental practice. As far as Airline Profits is concerned, we hope that airline CEOs will seize the opportunity to rethink the airline business, because the basic airline business model, some practices, and the existing airline technology clearly appear to be outdated and unfit for the 21st-century airline business operations.
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