Game Theory and the of Overbooking Airline Flights

Game Theory and the of Overbooking Airline Flights

Game Theory and the of Overbooking Airline Flights


Given the deep mess that United Airlines (NYSE:UAL) created for itself after a passenger was dragged off a full flight last week, Delta (NYSE:DAL) said it could increase the incentives for “voluntary denied boarding.”

Agents will now be allowed to offer up to $2,000 to entice passengers to give up their seats, significantly more than the previous limit of $800. If that does not work, the agents’ supervisors can authorize payments of nearly $10,000.

Delta’s aim is clear.

Use the price incentive to deal with oversold flights and, thus, avoid the social-media-fueled anger that would be sure to erupt again should there be another involuntary re-accommodation.

This approach is likely to work in reducing denied boarding situations for Delta, of which there were an estimated 1,200 in Y 2016. And once 1 major airline applies such a system, others major carriers are likely to follow.

The Big Q:  what if insights from game theory and, particularly, the greater potential for high collective payouts from credible collaborative collusion were to inform passengers’ reactions?

The Big A: They would consider ways to enrich themselves at the expense of the airline.

Here is an example as explained by noted economist Mohamed A. El-Erian. as follows:

“Once the airline calls for volunteers, those willing to respond would form a consultative group that would assign one passenger to miss the flight and then agree to collectively hold out until the airlines approaches its new $10,000 maximum. At that point, the one passenger would volunteer, collect the compensation, keep a good portion of it, and make smaller side payments to the other members of the group.

Of course, this is by no means a foolproof approach. Effective collusion and steadfast commitment are tricky for a plane full of strangers, especially when passengers arrive at the gate at different times and, after the flight, are unlikely to interact with their fellow travelers in future. The incentive for any one passenger to refuse to be a member of the group, or break away from it, is considerable — especially because there are no easy group discipline enforcement mechanisms.

Even if passengers were to overcome all these problems, such game theoretics are unlikely to allow for a “repeated game,” in which passengers repetitively benefit at the expense of the airline. After all, it wouldn’t take the airline long to realize that its highest net present value approach is now to lower its contingent exposure by reducing the overbooking practices.”

Does this then mean that Delta’s proposal is nothing more than clever public relations aimed at taking market share away from other airlines. Well, there probably is an element of this especially as other airlines are likely to follow.

The most probable outcome from this shift in the policy governing voluntary denied boarding is likely to materialize without headline-grabbing news of passengers successfully “arb’ing” the airline.

Rather than eye-catching payments, airlines will reduce the amount of seats they sell on oversold flights. And as some passengers will cancel at the last minute, some popular routes may even end up with empty seats, I have seen that happen throughout the years.

HeffX-LTN Analysis for UAL: Overall Short Intermediate Long
Bearish (-0.35) Bearish (-0.49) Bearish (-0.35) Neutral (-0.19)
HeffX-LTN Analysis for DAL: Overall Short Intermediate Long
Bearish (-0.48) Bearish (-0.44) Very Bearish (-0.50) Very Bearish (-0.50)
HeffX-LTN Analysis for AAL: Overall Short Intermediate Long
Neutral (0.03) Neutral (0.00) Neutral (0.11) Neutral (-0.01)

Have a safe and pleasant flight, Happy Landings!

Editor’s Note: Mohamed A. El-Erian is the chief economic adviser at Allianz SE and Chairman of the President’s Global Development Council.

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