Many airlines, especially in the U.S., are moving to a two-class configuration for their international flights. Whether dubbed BusinessFirst, World Business Class, or BusinessElite, the idea is to meld the business and first class cabins into one premium product. International first isn’t being purchased as much as it once was, so the airlines are trying to concentrate on a competitive business class product.
This post by Alex Tabarrok on consumer behavior got me thinking about whether it may be individually rational for an airline to pursue this strategy, but collectively damaging if all airlines pursued this strategy because the existence of first class might make it easier to sell business class.
- When there are only two product qualities consumers are torn between two “extremes,” either of which makes them uneasy. Add a third quality and you create a happy medium. Simonson and Tversky (the cite is in the link below) report that when offered a low-end and a midrange microwave oven consumers chose the midrange 45% of the time. But when offered the same two ovens plus a high-end oven they significantly increased their purchases of the midrange. Even when few consumers buy the premium product the mere fact that it is offered can increase sales of the midrange product. Hal Varian calls this Goldilocks pricing
Does paying for business class seem more reasonable — whether ot individual consumers or more likely to corporate travel managers — when there’s a more expensive product that you’re choosing not to buy? And so does the existence of that more expensive product increase your sales of business class?
Continental Airlines may be better off only offering a business class cabin, but they may sell more of their business class seats because United and American offer a first class that consumers can choose not to buy.
As more airlines opt for a two-class product, will they not just be competing in the same space but diminishing the total pie as consumers and travel managers start to view that high end product as the extravagance?
This is all theoretical and can be countered either by data or a competing theory. But it’s an interesting proposition about consumer behavior.
Update: Alex Tabarrok responds:
- If I understand you correctly you are pointing out that a firm need not itself offer all 3 quality types – instead it can position its own product so as to be the mid-range product. I agree.
Consider, for example, a market that already has a high and low quality product then an entrant would certainly want to take advantage of extremeness aversion to position its product in the “middle”. This sets up a game very similar to the Hotelling model in which there is no equilibrium as each product tries to get to the middle!