Not all airlines overbook, with JetBlue (JBLU) being a notable exception. But most figure paying a few people to take the next flight is better than letting a seat go empty if somebody doesn’t show up.
Sunday, however, was a reminder that this doesn’t work all the time — airlines sometimes have to bump a paying passenger involuntarily. United makes this decision based on a number of factors including fare paid, frequent-flyer status, and time of check-in, as Rule 25 of United’s contract of carriage describes. (Though the contract doesn’t say anything about forcing off already-boarded passengers.)
Compensation for involuntary bumping is limited by federal regulations to 400% of a ticket price, or $1,350. However, airlines do not have limits to compensate volunteers. And with an auction, somebody will always volunteer—everyone has a price—if the auction is done correctly.
Every bumping could be voluntary with a well-run auction
“You could imagine all types of auctions being run here,” said Mohammad Akbarpour, a professor of economics at Stanford’s business school and a specialist in auctions. “You could ask people when they buy tickets how much are you willing to sell. You can run an ascending auction, or you can run a reverse descending auction.”
Airlines currently conduct an ascending auction, with gate agents yelling out offers to take a seat for $500…$600. But they could consider other options like a Dutch, or descending, auction. In that scenario, gate agents might offer offer $5,000 to bump. Many people would come forward, and the number would be lowered until the people left matched the seats required.
A third option could be a strategy that helped economist William Vickrey win the Nobel Prize, a second-price sealed-bid auction that’s one of the most efficient ways to sell something. In that scenario, passengers could put the number they’d accept to sell their reservation when they buy tickets. If the flight gets overbooked, the passenger with the lowest bid would get bumped.
Bob Crandall, former chair of American Airlines, told Yahoo Finance the industry is constantly examining different ways to improve how it runs bumping auctions. But on the whole, he says, things are pretty good. “You’re at a point that 90% [of bumpings] are voluntary,” he said. ”Now the trick is to refine the auction processes to get the involuntary still lower. They’re much better at it today, and there are a lot more sophisticated auction ideas.” According to Crandall, airlines like Delta are looking at Vickrey-style options.
The auction choice was okay, but United ran it poorly
A Dutch auction would have gotten a lot of attention, as people would clammer forward to accept the high amounts. But barring a more sweeping solution of a Vickrey auction at the ticket sale—a sealed auction would require passengers to trust the airline without transparency—the standard, ascending kind is probably the most efficient, says Akbarpour.
“Eventually the choice the between these auctions is a choice of which would work in practice,” he said. “It seems to me that ascending is the easiest because it’s the most clear and simple.”
This, however, is exactly what United did, but Akbarpour sees multiple ways the airline failed in its execution. It appears United had an internal $800 limit in compensation, a big no-no for an economist. “When you start an ascending auction, having a cap doesn’t make any sense. Having a cap is very inefficient,” he said.
United made an even bigger mistake by deviating from the standard practice of having the auction before boarding. The situation “perfectly illustrates” an economic phenomenon called the “endowment effect,” Akbarpour said. That happens when a person values a good higher when they own it—like an airplane seat. “[After boarding] they feel they’ve owned the seats. That number isn’t going to work. That was a big mistake in addition to using violent methods.”
There is one way a well-run auction could run into trouble, Akbarbour notes, which is very unlikely. “Some auctions are subject to collusion. If everyone decides [to collude] at the same time, the price goes up to infinity. I strongly suspect this wouldn’t happen with a plane of 100 passengers,” he said. “If the plane were reserved for a sports team, maybe you want to run a different mechanism.”