Are super-low airfares for real?

You often see promotions for what seem to be unrealistically low airfares. And if you think what we see here in the U.S. is bad, try Europe, where airlines occasionally highlight fares as low as £1, €1, or even "free." If you're confused, you're not alone.

I recently received these questions: "What's behind airline marketing? Given the recent sales—$2 fares from Spirit and Ryanair's free flights—how can airlines afford to offer such seemingly outrageous prices? What's the business model, and does this really benefit consumers. Can they really get these fares? What are the caveats?"

The quick answers are straightforward:

• Airlines can afford to offer such seemingly outrageous prices because they apply to no more than around 10 percent of the seats, and because they sell the other 90 percent of the seats at much higher prices.
• Super-low fares do really benefit consumers, at least those who play the airlines' game skillfully.
• Consumers really can get these fares, at least in the U.S.
• The caveats are limited supply and possibly some restrictive "fences."

The business models

Although details differ, almost all airlines share a basic business model. They sell the same product to different customer groups at different prices—prices that reflect the differing values of air travel to those disparate customer groups. The complications arise in the techniques they use to discriminate their fares.

• All airlines' business models are based on a well documented economic principle that they can sell more seats—and generate more profit—by selling some seats at low prices and others at high prices than by selling all the seats at the same average price.
• The legacy lines add a second principle. They have optimized their systems to meet the needs of business travelers, from whom they demand top-dollar fares. Revenue from low-fare "fill up" leisure travelers can be almost pure gravy, as long as the airlines can keep the business travelers out of the cheap seats.

Whatever systems an airline uses to set its fares, the overall objective is to generate the highest possible average per-seat revenue. The process of trying to meet that objective is called "yield management."

Capacity control

One of the simplest forms of yield management is called "capacity control." On each flight, an airline allocates the total number of seats into several different fare "buckets." The first seats sold initially come from the lowest bucket. When that bucket is empty, subsequent travelers must buy from the next higher bucket, and so on up the line, until the last seats sell at the highest possible bucket.

Airlines often reallocate seats on each flight among the fare buckets, depending on the rate of sale. If the cheap seats seem to be going quickly, they bump some of the remaining seats into higher buckets. If sales are slow, they make more cheap seats available.

Peak/off-peak

The other simple approach to yield management is peak/off-peak pricing. Many airlines vary their prices depending on (1) season, (2) day of the week, and (3) time of day. Sometimes they vary list prices; sometimes they just adjust the number of seats in various fare buckets.

Many low-fare lines use nothing beyond capacity control and peak/off-peak as their yield management tools. But even the legacy lines' more complex yield management systems employ a big dollop of capacity control and peak/off-peak.

Fences

In simple capacity control systems, some business travelers find it relatively easy to take advantage of the lower fare buckets. To prevent "leakage" of those travelers from the higher fare levels, legacy lines historically added "fences" to their lowest fares—artificial restrictions designed to make them unattractive to business travelers: