Airlines Unbundling Leads To Further Differentiated Pricing

Unbundling of airline services enables them to offer further differentiated pricing, hoping to extract more of the consumer surplus from those with higher Reservation Price (RP). Take the case of extra fee for baggage. Airlines forever had allowed passengers to check-in two bags. Now this service is unbundled from the airline ticket and passengers are charged  separately for their bags. Once unbundled, now airline can practice differentiated pricing by charging increasingly larger fee for second and third bags.

Citing volatile fuel prices, United Airlines has announced it will double the fee for checking a second bag from $25 to $50 beginning Nov. 10. The fee won’t apply to first or business-class flyers, or those who have “premier” status with United or Star Alliance.

I have not looked in detail at airline cost accounting, but I tend to believe that cost of the a trip is all fixed cost and does not vary with number of passengers or checked in bags, significantly. So it is not entirely true that fuel prices is the reason for charging for checked in bags.

But once they introduced the additional fee of $15 for the first bag, charging $25 (or even more) is the logical next step. For those with a combined RP of $40, this pricing scheme will capture more of their consumer surplus.  Those with RP lower than $40 will stick to one bag or no bags. The latest news now is that United doubled this $25 fee to $50.

If there is indeed a variable cost component to fuel costs that is tied to weight of bags, United will get to recoup this cost from the differentiated pricing. Since the cost is most possibly linear, the non-linear increase in baggage fees implies a higher contribution margin to capture more consumer surplus.
Progressive non-linear pricing  is clearly an advantage of unbundling.

Another key point to note that United is unbundling only for the coach class and still offering the superior all inclusive service to the business class. This goes back to Singapore airlines discussion in a previous post.