Thursday, 4 October 2012

EasyTrain and RyanRail: Airline Pricing For Rail?

The guys at Loco2 have been running a poll asking whether UK rail should follow airline style pricing. A straightforward question, but one which turns out to be more complicated than it first seems. Following are a few thoughts.

There are two ways to look at the question: normative (should it happen?) and positive (will it happen?). What consumers want is only one of the factors which drives outcomes in an industry - what actually happens results from a complex mix of factors on the supply side and the demand side, like the industry structure, conduct and incentives. Even the service itself is less comparable than at first sight: planes normally fly one class of passenger from point to point without intermediate stops and without complications like walk-on passengers or season ticket holders. Unlike trains.

“Airline pricing” resulted from market entry by low cost operators with disruptive business models. The new entrants use yield management systems where ticket prices vary in relation to the business of the plane and how far in advance the ticket is booked. An economist would describe this as price discrimination. To a non-economist it’s another way of asking whether the supplier can get away with charging different people different prices for the same thing? Which sounds terrible to a consumer, unless you’re the lucky one who benefits from the cheaper products and services (which, by the way, are already available on trains, where a form of yield management is already happening - see my earlier posts about cheap train fares). So the question to ask may not be the normative, “should it happen?” but the positive, “will it happen?” Which means comparing the economic characteristics of railways and airlines. An initial checklist might include (among other things):
  • Is the industry a natural monopoly?
  • Are there significant barriers to entry?
  • Is there over-capacity in the sector?
  • Do industry regulators support new market entry?
  • Can new entrants bring innovative and disruptive business models to the sector, especially by challenging the cost structures of existing players? Or is most of the cost base outside their control?
  • Are prices subject to regulation?
Without undertaking the major study needed to answer these questions, it seems that there are large differences between airlines and railways. (And note that the US, the home of airline competition, is littered with carriers that are in, or have been through, bankruptcy proceedings). Many low cost carriers in Europe are currently profitable, but the pressure on prices and the resulting destruction of value in the basic product (flights) means that carriers are increasingly looking to non-traditional elements of the service to make money – food, drinks, toys, lottery tickets on the flight, as well as processing fees, charges for luggage, and even for printing a boarding pass. An economist would say that the best way to ensure effective competition between and within markets is for prices to work properly, and that efficiency and equity are best served by prices which cover not only the costs of operation (fixed and variable), but also the externalities (noise, pollution, climate changing emissions etc) – which airlines typically don’t cover. So maybe the best way to ensure that prices for rail and air tickets are fair, comparable, and truly competitive, is to ensure that both cover the true environmental costs. Best not hold your breath on that one.

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