Latest / Pricing Power Podcast with Fexingo: How Businesses Set Prices, Raise Margins, and Win Customers / How Airlines Master Price Discrimination
Transcript
- Lucas: So you book a flight from New York to London. Economy seat, nonstop, same airline. You pay eight hundred dollars round trip. And then you get to your row and the person next to you mentions they paid sixteen hundred. Same plane, same destination, same class of service. Luna: And you immediately start wondering — did I overpay, or did they? Lucas: Right. And the frustrating answer is: you both paid exactly what the airline wanted you to pay. That's price discrimination in its most refined form. And airlines are arguably the best in the world at it. Luna: So let's be clear — price discrimination isn't necessarily illegal. It's just charging different customers different prices for the same product, based on their willingness to pay. Lucas: Exactly. And it's everywhere in travel. Hotels do it. Car rental companies do it. But airlines have turned it into an absolute science because they have the data, the technology, and the legal cover. The key insight is that a seat on a plane is a perishable asset — once the plane takes off, that seat is worth zero. So the airline's goal is to sell every seat at the highest price each individual passenger will bear. Luna: But how do they figure out what I'm willing to pay? They don't know me personally. Lucas: They don't need to know you personally. They know your behavior. And they've built models around three classic levers. The first is advance purchase. A business traveler booking a flight two days out is less price-sensitive than a leisure traveler booking three months ahead. So airlines charge more for last-minute tickets. That's the simplest form of segmentation. Luna: And then there's the Saturday-night stayover requirement — that classic rule where a round trip is cheaper if you stay over a Saturday. That's designed specifically to separate business travelers from leisure. Lucas: Exactly. Business travelers want to be home for the weekend. So if you're willing to stay over Saturday, you're probably traveling for fun, and you get a lower fare. That rule has been around for decades. And then the third lever is fare classes — what the airlines call booking classes. There might be twenty different fare classes on a single flight, each with different rules, different prices, and different availability. Luna: So when you search for a flight online, you're not just seeing one price for economy. You're seeing whichever fare class the algorithm decides to show you. Lucas: Exactly. And that algorithm is constantly adjusting. It's called yield management or revenue management. The airline's system looks at how many seats are sold in each fare class, how many days until departure, historical demand patterns, even what competitors are doing on the same route. And it updates prices in real time. Luna: I remember reading that American Airlines estimated its revenue management system added something like one point five billion dollars annually in extra revenue. That's a massive number. Lucas: It is. And that was years ago. Today, the systems are even more sophisticated. They're using machine learning to predict demand at a granular level. For example, they can segment passengers not just by how far in advance they book, but by what device they're using, whether they've visited the site before, what search terms they used. All of that feeds into the price you see. Luna: That sounds like it could get creepy. Is there any regulation around this? Lucas: Not really, as long as it's not discriminatory based on race, gender, religion — protected classes. But pricing based on willingness to pay is generally legal. And airlines have been doing it openly for decades. The real constraint is competition. If a route is highly competitive, the algorithms have to be more careful because if you price too high, the customer just clicks over to another airline. Luna: So the more competition, the less price discrimination works? Lucas: To some extent. But even on competitive routes, airlines use price discrimination. They just do it within a tighter band. And they also use product differentiation to justify price differences — things like basic economy versus regular economy versus premium economy. That's not pure price discrimination, because the product is slightly different. But it's a related strategy. Luna: Let's talk about an example. Say I'm flying from Chicago to Orlando. I book two months ahead, on a Tuesday, and I'm staying a week including a Saturday. I might pay two hundred dollars round trip. But the person next to me booked three days ahead, on a Friday, and they're flying home Sunday. They might pay six hundred. Lucas: And that's totally rational from the airline's perspective. The person who booked last minute has higher willingness to pay — they need to be there. The person who planned ahead has lots of options and is price sensitive. The airline captures surplus from both. And the key is that neither customer can easily resell the ticket to the other — that would destroy the price discrimination. So airlines make tickets non-transferable, and they charge change fees. Luna: Right, because if I could buy a cheap ticket and sell it to the business traveler at a markup, the airline would lose that revenue. So they block arbitrage. Lucas: Exactly. That's a crucial condition for price discrimination to work — you have to prevent resale. Airlines do that with non-transferable tickets, change fees, and cancellation penalties. And that's why you can't just buy two tickets and scalp one. Luna: So what does this mean for the average traveler? Any tips for gaming the system? Lucas: The honest answer is: the airline knows more about your behavior than you know about theirs. But there are a few things that can help. Booking far in advance is generally cheaper, especially for leisure routes. Being flexible with your travel dates — flying Tuesday, Wednesday, or Saturday is often cheaper. And clearing your cookies or using incognito mode might prevent the algorithm from seeing that you've searched the same route multiple times and assuming you're desperate. Luna: I've heard that clearing cookies can help, but I'm not sure how much difference it actually makes. Lucas: The evidence is mixed. Some studies show airlines do use browsing history to adjust prices. Others say it's mostly about demand and time to departure. But it can't hurt. The bigger point is that price discrimination is a feature, not a bug, of airline pricing. And it's not going away. If anything, it's getting more sophisticated. Luna: And it's not just airlines. We see it in everything from Uber surge pricing to Amazon's dynamic pricing on certain products. Lucas: Right. But airlines are the textbook case because they have such a clear perishable product, such clear customer segments, and such a long history of using data. The principles they've developed — segment, block arbitrage, adjust in real time — are now being applied across industries. Luna: It makes you wonder how much of what we pay for anything is actually based on what the seller thinks we'll pay, rather than what the thing is worth. Lucas: And that's the fundamental question. In economics, there's no such thing as intrinsic value — only willingness to pay. Price discrimination is just sellers getting better at figuring out what that number is for each of us. Luna: Speaking of economics — and this ties back to what you just said about sellers figuring out willingness to pay — I want to mention something. This show is ad-free and listener-supported. A few people chip in each month at buy me a coffee dot com slash fexingo, and that's what keeps us going. If these conversations have helped you think differently about pricing — maybe at work, or just as a consumer — that's exactly why we do it. Lucas: Yeah, it's a small group, but it makes a big difference. And it means we never have to answer to advertisers. We just get to follow the interesting questions. Like this one — how far can price discrimination go? Are there limits? Luna: And I think there are limits. Consumer backlash is one. When Uber surge pricing spiked during emergencies, people got angry. Airlines have faced criticism for things like charging more for identical seats. There's a reputational risk. Lucas: Absolutely. And there's also regulatory risk. The European Union has rules around price transparency that limit some forms of price discrimination. In the US, there's been talk about requiring airlines to show full prices upfront. But so far, the industry has managed to keep its pricing flexibility largely intact. Luna: So where do you see this going in the next five to ten years? Lucas: I think we'll see more personalization. Airlines are moving toward offering you a fare that's tailored to you based on your purchase history, your loyalty status, even your social media activity. It's basically the same model Amazon uses for product recommendations, but applied to pricing. And it's going to be harder to tell what a 'fair' price is, because you'll never see what other people are paying. Luna: That sounds like a future where the price you see is already optimized for you, not for the market. Lucas: Exactly. And the question is whether that's efficient or unfair. Economists tend to say it's efficient — it allocates seats to the people who value them most. But it can also feel unfair when you realize your seatmate paid half what you did. Ultimately, price discrimination is a tool. It's up to companies — and regulators — to decide how aggressively to use it. Luna: And it's up to us as consumers to understand it. Thanks, Lucas. That was a great breakdown. Lucas: Thanks, Luna. Next time you're on a plane, take a look at the person next to you — they might have a story about their fare.