Cancellation charges in the airline industry

So seat 2B in flight number I5 1322, Air Asia flight from Bangalore to Goa this morning, went unfilled. I wasn’t on this flight, but perhaps for that precise reason I can assure you that the above statement is true. For that seat belonged to me, as I had booked my tickets to go to the Goa Project.

So I initially decided to go to the Goa Project, and booked my tickets for it (on AirAsia). And then work and other things meant that I decided against going, but when I went to the AirAsia website to cancel my ticket, I realised that I wasn’t able to do it! Essentially AirAsia has no concept of cancelling a flight!

This is option pricing taken to one extreme, where the entire price is taken in the form of an option premium! The airline industry was at the other extreme not so long ago – where options weren’t priced at all. In other words, until a decade or a bit more back, you could change or cancel your bookings at little extra cost, though this optionality (and other things such as regulation) meant that the ticket was  quite expensive!

Now it seems like some of the “extreme low cost carrier” (such as AirAsia or RyanAir) have moved to the other extreme – where there is no concept of cancellation. And I’m not sure of the wisdom of this strategy. For I believe that this strategy does not maximise either the social utility or the airline’s profits.

The social utility bit is easy to see – I ended up paying full price for a ticket that I didn’t travel on, so I’m hurt. The marginal passenger who wanted to travel on today’s flight to Goa but didn’t find a ticket was hurt (this person could’ve flown had I cancelled my ticket). And the airline missed an opportunity to resell my ticket to someone else (potentially at a much higher price) and make money on it! So it’s a lose-lose situation all round.

The commercial aspect follows from the above – in case demand for this flight was low, then it perhaps made sense to not refund any of my money, for now the airline would not be able to sell the ticket to another passenger. However, if demand were higher (a very probable event), the airline missed an opportunity to make much higher revenue on this seat than what they did by making me not cancel it. I wave my hand here a bit, but it is easy to see that the airline is letting go of potential profits by not letting me cancel my ticket!

I’m not saying that the airline refund my full amount, or anything close to that – that doesn’t make sense for them since they’ve sold me an option. All I’m saying is that the price of zero (between total cost and option cost) doesn’t make sense. Even if the airline were to refund a thousand rupees (I paid around 6000 for the two-way fare) if I cancelled it, and the cancellation procedure were smooth, I would have cancelled it. And the expected revenues on this one seat would definitely exceed this kind of refund, you would expect?

Possibly it’s time for airlines to indulge in dynamic pricing for cancellations also. If the flight is near full, the airline can resell my cancelled ticket for a fairly high amount, so they can induce me to cancel by offering me a decent refund. If at the time I want to cancel, however, demand is low, then they need not offer me much. These things are not at all hard to price!

So by going extreme on the cancellation charges Air Asia and its ilk are leaving money on the table! If only someone were to tell them to pick it up!

3 thoughts on “Cancellation charges in the airline industry”

  1. The airline can offer your cancelled ticket for a high amount but will anyone buy it? Unless there s a genuine case of urgency, you will stay away from overpriced near term flights. So it comes down to measuring the number of cancellations vs the number of “urgent flight requests” they receive. And if they realise that they’re losing out on the cancel option on average, they might as well leave it out of the bundle and undercut a lot of competition?

    An interesting thought on your dynamic pricing bit. What if airlines were to buy an option from you to cancel the ticket, with a certain notification period. So within 48 hrs of ur flight, if they feel there s lot of demand for seats in a particular sector, they reserve the right to kick you off the flight / put you on a later flight and sell your seat to someone else for a higher amount.

    I think as a result , passengers travelling on traditionally crowded sectors / timings will have an incentive to book sooner as the option has high value and this will cheapen tickets. If indeed it’s very crowded then passengers will like to have the luxury of postponing their flights. And if you are confident enough that a flight will be less crowded then that option helps you monetise this view !

    Also I wonder if similar logic can be applied to sell passengers an option to upgrade to premiere class for instance. instead of the standard “up sell” they do on the check in counter where they provide you upgrade at a random nominal cost.

    1. Yes of course! They need more people like you and me – people who can think in terms ok optionality and stuff! That’s my endeavour in terms of doing what I’m doing now – taking financial markets thinking to other sectors and helping them build these efficiencies etc! 🙂

      So yes I broadly agree with everything that you’ve mentioned here!

  2. One of the reasons why low cost service providers ( atleast outside of India ) dont really allow you to cancel tickets or have steep penalty for cancellation is that the sales organization needs to be really sophisticated to sell these last minute tickets.. You may be able to sell a few tickets to ‘go-show’ passengers.. But, realistically, if you have to sell a lot of these last few days cancellations, the reach of sales organization has to be really broad and deep. Often, low cost carriers don’t have that.

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