Track: Operations Management

Abstract

The airline industry derives a substantial portion of its ancillary revenue from baggage fees. However, it has not utilized a controlled and structured approach to baggage pricing. Airlines have been using different pricing strategies, such as flat rate pricing or weight-based pricing, without considering the actual cost allocation for providing those services, resulting in overcharging or undercharging scenarios.  This study discusses the application of non-atomic game theory in pricing strategy for a joint cost setting in passenger baggage transportation. Cost allocation-based pricing can provide a “fair” approach to pricing these services and will be widely accepted by the passengers. Aumann-Shapley price is an application of non-atomic game theory that involves finding fair prices for divisible goods where each infinitesimally divisible good is considered a separate player in the game. We demonstrate that this pricing approach for baggage services will be helpful in generating prices based on the weight and volume consumption of a passenger, which are the players in the continuum for this game. The concept of “Chargeable-capacity” is adopted in our research to postulate axioms that will generate prices that are cost-covering, positive, and aggregation invariant. Although the prices are calculated only on a portion of the total capacity, they satisfy the budget-balance requirement by charging a penalty to the capacity consumptions beyond the free limit. Pricing functions can be considered linear functionals and satisfy the absolute continuity property to represent an integrable function. This idea is used to prove that the pricing mechanism proposed by us satisfies all the pricing axioms. To differentiate between the prices of pre-booked and on-site baggage, we extend the axioms further to provide an Advance-purchase discount and ensure the pre-booked excess baggage is charged lower as compared to the on-spot bookings. Various cost functions are examined to support our claims and establish the robustness of the pricing mechanism. We also compare the weighted value prices with the Ramsey-Boeitux rule to establish the relationship between the weights and the price elasticity of demand for pre-booked and on-spot baggage services. It is justifiable to assume that pre-booked baggage is more price elastic than spot-booked baggage, as pre-booked baggage is usually purchased well in advance, giving customers more time to compare prices and make informed decisions. This gives us the idea that the weight for pre-booked baggage is less than the spot bookings. Any differentiable joint-cost function satisfies the rules stated in our research, and findings imply that prices will rely on consumption patterns and the proportion of chargeable capacity selected by the airline. The pricing mechanism encompasses all aspects of baggage price and permits airlines to offer variable weight and volume allowances. The proposed method is extendable to comparable cases such as railway and road freight services.