Inspired by this weekend’s story that you now pay a transaction fee to fly Ryanair even if you use a Ryanair credit card, which is apparently a thing that exists even if it sounds like it shouldn’t, I have been thinking about their business model. It is not what you may think it is.
This is one of those stories where there’s a business school whiteboard version, and then there is reality. The whiteboard version goes like this: they disaggregated all the service elements formerly bundled into the airline ticket, and priced them. As a result, through the wonder of revealed-preference, we know that people value some of them enough to pay for them separately. You then repeat the words “Southwest Airlines” several times, and ponies!
The cynical version starts off like this: ok sunshine, you expect me to believe a single write operation on their OLTP system costs £6? Seriously. If FR’s IT was that dreadful, they wouldn’t be able to run an airline.
Now, here’s the clever bit. Fares are prices; people mostly pick their carrier on fares. This is of course the point of running a low-cost airline. In case you doubt that low headline fares are the attribute of selection here, look at their website or adverts or airport presence. It says “The LOW FARES airline” everywhere.
You can’t choose to fly FR and be handled by some other company, so once passengers pick them, there is no competitive pressure on the fees. By transferring things from the headline fare into non-fare fees, part of the business has been removed from the domain of competition and moved into the domain of monopoly.
Now, as a rule, if something is more monopoly-like, do we expect its price to contain more or less margin? I think we know the answer to that one.
This may also create an opportunity for tax-dodging. Imagine a company that puts the IT systems that do its check-ins and credit card processing into a subsidiary that lives in, say, Luxembourg. You could move income from the operating business into the subsidiary. I have no idea if FR does this, and finding out would involve reading their report and accounts. Reading financial filings is something I do if people pay me, like enduring carols, riding, making PowerPoint slides, and going to Dubai.
However, they’re the airline that charged all its flying training candidates £50 to read their CVs, and then charged everyone who paid it by credit card another £50 three months later to “reconsider”, so…
Upshot! Disaggregating bundled products does not necessarily increase competition. In fact, it can actually transfer economic activity from the competitive sector to the monopoly sector. This creates opportunities for think-of-a-number pricing.
Think-of-a-number pricing is pricing that has no necessary link to economic reality, and is only constrained by a vague sense of plausibility. It is what happens when your electricity company decides to “estimate” your usage between two actual readings and sends you a gigantic bill, in the hope you’ll just pay it rather than calculating how much power over how much time that means and explaining to their call centre that this would have required quite an impressive industrial-grade circuit, and that a standard residential supply would have burned out in a giant blue flash, and as you aren’t speaking from beyond the grave, repeatedly threatening to change provider…until the enemy cracks and settles for a modest increase in the monthly payment.
Unlike normal prices, think-of-a-number prices convey no information whatsoever, other than the fact you’re being ripped off, which is only of use if you have alternatives. The informational function of prices is kinda important for the whole edifice of economics, and is the entire basis for the notion that tax-funded spending is by definition inefficient, so this is a non-trivial point.
From a business, rather than economic, point of view, this of course means that disaggregation creates margin.
In the last analysis, though, something very interesting is happening here. Weirdly, if you bundle all the services and sell them for a single sticker price, like a proper airline, they have a real price! Because, after all, you still compete on fares, so you need to keep costs down. The IT department has to contribute to the competitive effort. But if you break them out, they don’t, and because of think-of-a-number pricing, economic information is destroyed! And, as no competitive pressure is involved once you’ve sold the ticket, it is inevitable in a profit-maximising firm that an element of think-of-a-number pricing will happen!
And we have an existence-proof that people do actually behave in the way this requires, buying on headline price and then submitting to think-of-a-number pricing: it’s called Ryanair. Now, we could also go on to discuss their user experience design and the notion of “cooling out the mark”, but this blog post is long enough.