Love, Hate, and Reason in Low-Cost Airlines

The Objective, December 8, 2024

Low-cost airlines have transformed air travel by offering cheap fares in exchange for providing basic services and charging separately for extras. These extras include the right to cancel or change tickets, in-flight refreshments, seat reservations, or luggage transport. Each passenger can choose to purchase these extras based on their needs and preferences. This system avoids waste and ensures that some passengers are not forced to subsidize others.

Of course, what counts as basic service and what is considered extra—as well as their prices—have changed over time. Years ago, prices were state-regulated, and airlines competed primarily by offering “free” extras to passengers. As competition increased, prices began to fall, and airlines started charging for extras. This reduced cross-subsidization among passengers, leading to more efficient resource use and lower overall prices. However, it has also caused disputes, especially when less-informed users think they have purchased a full-service ticket but have only bought a basic one.

In Spain, a record fine of €179 million imposed by the Minister of Consumer Affairs on several airlines has sparked controversy. The fines focus on practices the Ministry considers abusive, such as charging for hand luggage, assigning adjacent seats for minors or dependents, and printing boarding passes at the airport. Airlines have announced legal challenges, arguing that their policies are protected under the freedom of businesses to design their products and set their prices.

The Ministry has also questioned the lack of clarity in the pricing on some companies’ websites, accusing them of deliberately misleading users. This issue seems less ambiguous: if a company deceives customers, it should face penalties—both reputational and legal. Regulatory bodies should also act. However, it’s not easy to determine what information is sufficient or how diligent users must be in reviewing it.

Other aspects of the case are even more complex. It’s not just two ways of structuring services—more or less customizable to suit the parties—but also different types of users and companies valuing these models differently, creating conflicting interests. Passengers opting for the basic service don’t want to subsidize the luxuries of others. To complicate matters, preferences and efficiencies shift over time. Users who accept a basic service today may claim tomorrow that they thought they purchased a full service. Similarly, both business models’ effectiveness and user preferences evolve as they learn about standard practices and what the basic service includes. Companies’ long-term incentives tied to reputation may also conflict with their employees’ short-term focus.

Ideally, companies and passengers should have incentives to discover and meet their true preferences, not just at a single point in time but over the long term. This requires considering how airlines learn how different types of user value various service attributes and how users learn to use and purchase these services.

For low-cost air travel, key questions are: Who knows more, and who is better motivated to make decisions? Is it Michael O’Leary, CEO of Ryanair, the airline that introduced the low-cost model to Europe? The Minister, who seems to view contractual relationships through a simplistic lens? Or a judge tasked with ruling on alleged deception or abuse? Similarly, who has better incentives? A CEO who stakes his company’s reputation with every transaction? A minister serving voters with conflicting interests and imperfect information? Or a judge whose qualifications were gained by memorizing sometimes questionable laws?

These questions apply to all service components. For example, when condemning high fees for printing boarding passes at the airport, it’s overlooked that fixed costs make unit costs soar when the volume of printed passes drops significantly. Shouldn’t we also consider the positive externality of encouraging passengers to use mobile passes?

Generally, to find solutions aligned with users’ true preferences, we need a broader and more dynamic perspective. Unfortunately, consumer authorities often take a narrow, static, and short-term view. This risks stifling innovation and freezing practices in productive sectors. A long judicial process will test the fine’s validity. Authorities—and sometimes judges—often forget that competition ensures that if the service is poor, the price will be low. As Ryanair’s architect remarked, “For years, Ryanair has used baggage and boarding pass fees to change passenger behavior and pass on those savings through lower prices.”