Would you be willing to gamble on the price of your vacation? Specifically, would you buy an airline ticket now — paying some cash upfront — but not know the final price of the ticket until you actually are traveling in, say, two months? That is what Allegiant Travel is proposing (This Airline Wants You to Buy the Jet Fuel, Businessweek, Sep 25).
Allegiant CEO Maurice Gallagher Jr. would let travelers choose whether to lock in a set, higher fare or pay a lower ticket price in exchange for shouldering any changes in fuel prices before their travel date. Those dice-rolling fliers would, based on fuel prices, pay an additional amount or receive money back if energy costs fell in the period between booking and flying. …
Unlike the major airlines, Las Vegas-based Allegiant is disproportionately dependent upon leisure travelers, who often plan and book their trips to vacation cities like Las Vegas, Phoenix, and Orlando months in advance. The no-frills airline has virtually no business travelers, the kind of passengers who buy a full-fare ticket a day or less before traveling. That’s one reason Allegiant—which does not hedge any of its fuel purchases—is willing to risk regulatory resistance and consumer confusion with a “variable pricing” mechanism aimed at recovering some of its fuel costs. At Allegiant, 80 percent of an average month’s ticket revenue is sold by the start of that month, Gallagher said. That leaves the discount airline more exposed to fuel price increases than many carriers.
So Allegiant’s dependence on leisure travelers clearly matters here. Currently, they get a pile of cash months before they have to provide a service but then are exposed to risk in the cost of provision. The question is whether it is efficient to shift that risk to customers.
I am not convinced that is so. Allegiant may not hedge its fuel purchases but it has to have better information about the price trajectory of jet fuel than the average customer. At a minimum, it would know seasonal patterns. I have been buying gasoline for most of my life but I would be at a loss to estimate a distribution of gas prices — let alone jet fuel prices — in two months.
There is also the question of how high these price adjustments would have to be in order to make a difference for Allegiant. The article says that the average ticket price is only $89 while they collect on average nearly $34 in ancillary fees. If the adjustment were, say, $10, that would be a sizable increase in revenue. (Alternatively, it would be a sizable risk to place to on budget travelers.) Perhaps even more relevant would be that the possibility of a $10 charge could induce most people to spend an extra $5 to avoid the risk.
A final point. This may never happen since it is currently against FAA regulations.
Marty:
Interesting questions!
First, does Allegiant have superior information compared with its customers? This is certainly true for some customers. However, if “wisdom of crowds” works and markets are efficient, collective customer group is as good as or better than Allegiant at predicting future fuel prices. Or a better way to say this: all of them are equally bad at timing the fuel market.
Second, Allegiant is less risk-averse than customers and has deeper pockets. This argues for it being able to stomach the fuel price risk better. However, for Allegiant the main risk is the fuel risk, whereas for leisure travelers this is a fairily small part of their overall risk portfolio. So, leisure travelers are better diversified and hence can take a little bit of fuel risk. Maybe the latter effect is enough to offset all prior reasons against Allegiant’s new policy.
Third, if Allegiant had a cheap way to hedge its fuel risk exposure in financial markets (e.g., futures or options), then it should not be doing this. It must be that Allegiant figured out that collateralizing fuel risk (because this is effectively what this new scheme does) is the cheapest of all risk-management options it has.
As I said, interesting questions!