Airline Baggage Fees and Negative Externalities on Airport
Congestion
Changmin Jiang a,b,*
a
Asper School of Business, University of Manitoba, Winnipeg, MB R3T 2N2, Canada
b
Transport Institute, University of Manitoba, Winnipeg, MB R3T 2N2, Canada
*Corresponding author
E-mail: [email protected]
1.
Research question
In summer 2016, Democratic Senators Richard Blumenthal from Connecticut and
Edward Markey from Massachusetts sent a letter to airline executives asking them to stop
charging bag fees during the busy summer travel season. Wait times at airport security
have grown substantially in recent months as more travelers hit the skies. At some
airports, passengers are complaining of wait times of at least an hour. The senators claim
the baggage fees are contributing to the problem, and that cutting them will help alleviate
some of the long lines. The letter noted that there's been a 27% increase in roller-bag
carry-ons at checkpoints for carriers that have baggage fees compared to those that don't
charge extra.
Although airlines rebuffed this claim aggressively, some industry practices actually
confirm that they are not unaware of such negative consequence of baggage fees. For
example, Spirit Airlines, an US low cost carrier (LCC), charges an even higher fee for
carry-ons than for checked bags, alleging that carry-ons entail a higher cost by slowing
down the boarding process. It is far from being alone in this practice. NewLeafs, an ultra
low cost carrier (ULCC) based in Canada, has similar policies.
It is therefore interesting to study how baggage fees influence airport congestion and its
implication on the socially optimal market structure of airlines. Airline baggage fee has
drawn very little attention from previous literature. Some treat it as a type of “add-on”
service and study consumers’ willingness-to-pay (e.g., Geng and Schuman, 2015). As far
as we know, there is only one paper investigating the operational impacts of baggage fee
(Nicolae et al., 2016), which focuses on airline instead of airport operations. In this paper,
we will build a theoretical model to incorporate the impact of baggage fee on airport
congestion and study the discrepancies between the market equilibrium number of
checked bags and the social welfare maximizing number of checked bags under various
airline market structures.
2.
Methodology
1
Assume that there are two types of products, the base product and the add-on product. As
is standard in the literature (e.g., Geng and Schuman, 2015), the add-on can only be
purchased with the base good.
Assume that there are a total of 𝑄 consumers in the market. Consumer i has known
reservation utility 𝑣! (which is common to all consumers) of consuming the base good
and reservation utility 𝑣!" from the add-on. The base good reservation utility is
sufficiently high such that all consumers buy from one of the firms in the market. There
are two types of segments. Base consumers do not value the add-on (i.e., 𝑣!" = 0). A
proportion 1 − 𝛼 of the consumer population falls into this segment. A proportion 𝛼 are
non-base consumers who value the add-on but have a heterogeneous valuation, i.e., 𝑣!" is
uniformly distributed on (0, 𝑣! ]. Therefore, the demand function of the add-on service is:
𝑄! =
𝑣! − 𝑃!
1−𝛼 𝑄
𝑣!
And the inverse demand function of the add-on service is:
𝑃! = 𝑣! −
𝑣!
𝑄
1−𝛼 𝑄 !
On the other hand, the equilibrium price that the companies can charge for the base good
is:
𝑃! = 𝑣! − 𝑇 + 𝐷(𝑄! )
where 𝑇 is the non-monetary travel cost including the airport congestion cost and 𝐷(𝑄! )
is the decrease of congestion cost caused by the add-on service. In particular, we assume
that for the non-base passengers, baggage is essential and everyone in the group prefers
to check their baggage instead of taking a carry-on. However, if the valuation of baggage
check is lower than baggage price, the passenger will bring a carry-on, which will slow
down the security check and boarding processes and cause a higher level of congestion at
the airport and thus a higher congestion cost for all passengers. Based on this rationale,
we assume that 𝐷! 𝑄! > 0 and 𝐷!! 𝑄! ≤ 0.
Assume that the price information of the add-on service is transparent and consumers
take that into account when purchasing the base good, so it does not make sense for a
company to charge a low price for the base good to attract consumers and then charge a
high price for add-on. The profit function of an airline 𝑘 is thus given by:
𝜋! = 𝑃! − 𝑐! 𝑞! + 𝑃! − 𝑐! 𝑞!"
where 𝑐! and 𝑐! are the operating costs of offering the base product and the add-on
product, respectively; 𝑞! and 𝑞!" are the amounts of total passengers and passengers with
add-on consumption served by airline 𝑘. Meanwhile, the social welfare function is
2
𝑊 = 𝑃! − 𝑐! 𝑄 + (
3.
𝑣! + 𝑃!
− 𝑐! )𝑄! 2
Main results
With the model setting, we examine the pricing strategies for the baggage fee and the
corresponding social welfare implications under different airline market structures. In
particular, we expect that when there is only one airline in the market, the airline will
have fewer checked bags than the socially optimal level, due to the market power effect.
When the number of the airlines competing in the market grows, the number of checked
bags will reach the socially optimal level at some point and then become too large. This
is because other than the decrease of market power, there is also a congestion externality
effect that encourages the airlines to increase their number of checked bags. In particular,
when an airline increases its number of checked bag, it receives all the benefits but not
the full cost, a part of which is reflected by the increased level of airport congestion and
shared by not only itself but also its competitors. In other words, when carry-on baggage
increases airport congestion, allowing too many airlines competing in a market might not
be a socially optimal strategy.
References
Nicolae, M., Arıkan, M., Deshpande, V., & Ferguson, M. (2016). Do bags fly free? An
empirical analysis of the operational implications of airline baggage fees. Management
Science, in print.
Geng, X., Schuman, J.D. (2015). How costs and heterogeneous consumer price
sensitivity interact with add-on pricing. Production and Operations Management, 24(12),
1870-1882.
3