The Department of Transportation, in its infinite wisdom, has announced new rules for airlines to compensate passengers who are involuntarily bumped from an oversold flight. We have a better idea—or, more precisely, the late economist Julian Simon had one 30 years ago.
In the first quarter of this year, some 23,380 passengers were forced to give up their seats, a 17% increase over last year and the highest rate in at least a decade as airlines try to serve passengers with fewer flights. Bumping only affects two of every 10,000 passengers, but that is small consolation for those who miss appointments or family obligations. Southwest was recently fined $200,000 for its bumping policies. The feds want to raise payments for those involuntarily bumped to $600 from $400 for short delays and to as high as $1,300 from $800 for lengthy delays.
Which brings us to Simon, who in 1977 proposed an auction system in which airlines would offer passengers on overbooked flights a gradually rising reward for giving up their seat. For example, if 115 passengers showed up for a flight with 100 seats, the airline would start to offer, say, a $300 voucher to passengers who agreed to take a later flight. If there weren’t enough takers at $300, the airline would increase the offer to $400, then $500, a free round trip ticket, etc., until 15 passengers volunteered. Auctions like this are highly efficient ways of allocating a scarce resource.
Airlines resisted this idea at first, fretting about “administrative practicality” and arguing that passengers would collude. The latter seemed implausible since 115 passengers who have never met and have individual agendas are unlikely to form a spontaneous bidding cartel in an airport terminal. Starting with American Airlines in the late 1970s, a version of the proposal was widely adopted. Studies demonstrated that airlines saved money and the rate of bumping was reduced by more than 80%.
So why are there still so many involuntary bumpings? Because many airlines offer one take-it-or-leave-it deal—say, a $500 voucher—and if there are not enough takers, the random bumping begins. A real auction would prevent this and optimize the welfare of all parties. Those who take the payment for a later flight are better off because they have freely chosen this option. Passengers who cannot afford at nearly any price to miss the scheduled flight are guaranteed a seat.
The airlines also benefit because an auction may save them money over a set price or a government penalty. More importantly, United, American and the rest are assured that fewer passengers are unhappy at the end of the process. That’s no small matter given the reputation for poor service that most airlines have with the public.
When economist Milton Friedman heard of Simon’s auction solution, he wrote that he was “utterly baffled” that “opportunities for large increments of profits are being rejected [by the airlines] for wholly irrational reasons.” It is doubly baffling that 34 years later many airlines are still acting irrationally to the detriment of passengers and shareholders. Auctions make more sense than fines.