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What’s On The Table: Revenue Management And The Welfare Gap In The US Airline Industry

The past decade has been a difficult one for the US airline industry. On the one hand, airline profits have been highly variable with net losses over the last ten years standing in the tens of billions of dollars. On the other hand, consumers continue to complain of predatory pricing and other such tactics. Our goal here will simply be to get an estimate of what is possible moving forward. We approach this task from an econometric perspective: we produce a status-quo dollar estimate of total welfare in the US airline industry. We then compute a number of benchmarks that we posit are conservative estimates of what optimal welfare in the industry. The key feature that admits the plausibility of these benchmarks is that the mechanisms that achieve them resemble existing dynamic pricing practices from airline revenue management (RM). In fact, it is the structure of these benchmark mechanisms in particular, and RM practice in general, that inform our modeling choices. Our benchmark estimates will leverage a unique, proprietary dataset set on ticket purchases via the ‘micro’ BLP approach Berry et al. [2004]. We will show that the welfare gap is surprisingly large, raising the possibility that a combination of innovative selling mechanisms, legislation and network capacity allocation can make a dramatic difference to airline profitability and consumer surplus alike.