Expert: Matthew Smith - 11/10/2010

Question

Hello, Matthew Smith,

I was wondering what are the factors that determine the price of an airline ticket.

I'm very curious about this because I've seen that a ticket's price can vary significantly, and I could make better travel plans based on your answer.

Thanks,

Regards,

Jay

Answer
Hi Jay,

Pricing basically boils down to supply and demand, but the airline goes through great lengths to manipulate the supply and demand to ensure that planes are near-full and to maximize profits.

An airplane seat is not an easy thing to sell.  It is known as a "perishable commodity" just like fruits and vegetables.  It is a common thing (one seat is virtually indistinguishable from another) that must be sold and used in a certain time frame or else the sale/profit is lost forever.  The seat cannot be used before the flight and it can't be used after the flight.  It can only be sold for that flight and that flight alone, so the window of opportunity is small.  If an airline need to be 85% full to make a profit, they cannot load up on plane 105% to make up for a flight that only goes out at 80%.  If it misses that 85% mark on that particular flight, that opportunity is gone forever.

Let's say that an aircraft has 100 seats.  An airline does not want to sell them all at the same price because then people will wait until the last moment to buy their ticket.  The airline needs to know it will make money on a flight well ahead of the time the flight leaves.  It can only do that by giving people an incentive to buy tickets early.  They do that by discounting some tickets, while selling others at a premium...and several steps in between.

In order to sell seats on a flight, an airline "inventories" seats into "buckets."  A bucket is a set of seats, that the airline prices at a certain level.  The bucket is represented by a letter.  It is the first letter on your "fare basis code".  Look at your ticket/reservation. It may say something like MX3N21.
M is the bucket.  It is the first bucket available.  There are probably 2-5 seats available 11 months ahead of the flight.  The X may mean something like is exempt from the fuel surcharge. 3 is another inventory marker.  N is non-refundable.  21 means you have to buy the ticket 21 days in advance.  Chances are that this bucket would be closed well before 21 days anyway.
Let's say that airline also has a V, L, K, P, W and H buckets.  These letters are random.  I chose them because letters like B, F, N, R, and X usually have other meanings that you don't want to confuse with buckets.

OK, so the "M" bucket may sell for $49.  Obviously the airline doesn't want many of those to sell, so they close the bucket and that forces people to then buy the next bucket up, and that keeps going until they are either in the higest bucket, or the sale of tickets is going at the expected level.  Airlines know how many tickets are sold on a flight in real time.  The databases are phenomenal.  By the way, controlling the bucket is handled by the Yield analyst.  In some airlines, analysts handle both yield and pricing, while others split the tasks.  (I worked in an airline that split the task.)

Buckets have sub-levels.  For example, you may have a tikcet in the B bucket that is coded such that if you buy it 14 days before the flight the price is $349, but if you buy it 7 days before the flight it is $449, and if you try to buy the ticket 3 days before the flight, it is automatically bumped up to the next bucket, W, and that may be priced at $549.  Finally, if you buy it tht day--like you walk up to the ticket agent and ask to get on the next flight available, it will be $699 one-way.

So now we have not only added in the number of seats available (supply) but also "time preference".  People with high time preference ("I need a ticket for tomorrow") pay out the wazoo because they essentially have a high demand based on their time preference.  Leisure travellers tend to have a low time preference.  That is, they buy tickets well ahead of time, and they don't care if they leave on Tuesday or Wednesday, or the third weekend rather than the second.
There's an economist, Hans-Herman Hoppe who has written a lot about time prference, although I have never seen 'time preference' refered to overtly in any of the aviation textbooks or courses I took.  But the airlines have a very strong sense of time preference even if they don't call it that by name.

I'm firing this off the top of my head, so I'm not really covering it all.  Let me add that an airline wants to have MOST of its seats sold before the flight.  They always hope for a couple last minute arrivas who are willing to shell out big bucks for the walk-up ticket.  So a yield/price analyst who allows his plane to get sold out will likely get in trouble.  It means he priced too low or kept his lower inventory buckets open for too long.  A plane that goes out with a low load factor will also get the analyst in trouble. It means he priced too high or closed the lower buckets too early.  It's a cat-and-mouse game and the analyst has to always troll his database for competitors' pricing and for his own sales.  The way people are these days, they will switch airlines just to save five bucks.
Now if I had a non-stop from New York to Los Angeles, I can price the itinerary higher than my competitor who has a one-stop from New York to LA.  why? because my flight is much more convenient, so people are willing to pay an extra $20~30 so that they don't have to get off a plane, sit in the concourse, and get on another plane.  I know I'd pay.

Some markets are priced high simply because competition is lacking.  Take an airport like Syracuse.  Ticket prices are rather high because it's in the middle of nowhere and the only low-cost carrier is Jet Blue, which has rather limited service. Albany, on the other hand, has Southwest Airlines so the ticket prices there have dropped significantly; SWA forces the other airlines to compete on pricing.

I guess the easy answer is that it is based on supply, demand, location, schedule/service, and time preference.

As a general rule of thumb, try to buy tickets as far ahead in the future as possible, and fly on a Tuesday, Wednesday or Saturday.