Options Have Value, Even If DOT Doesn’t Get It

Michael Sykuta —  2 February 2012

Last week Thom posted about the government’s attempt to hide the cost of taxes and regulatory fees in commercial airfares. Apparently Spirit Airlines is highlighting another government-imposed cost of doing business by advertising a new $2/ticket fee that the airline has imposed. According a CNN report yesterday:

Spirit Airlines says a new federal regulation aimed at protecting consumers is forcing it to charge passengers an additional $2 for a ticket.

The fee, which Spirit calls the “Department of Transportation Unintended Consequences Fee,” has been added to each ticket effective immediately, according to Misty Pinson, a Spirit spokeswoman.

The new DOT regulation allows passengers to change flights within 24 hours of booking without paying a penalty. The airline says the regulation forces them to hold the seat for someone who may or may not want to fly. As a consequence, someone who really does want to fly wouldn’t be able to buy that seat because the airline is holding it for someone who might or might not end up taking it.

In short, DOT is requiring airlines to give consumers a real option to change their flight plans at zero cost within a 24 hour window. Spirit rightly recognizes that options have value. Not only is there a value to consumers in ‘buying’ such an option, there is a cost associated with providing the option; in this case, the opportunity cost of selling seats that may be held for someone that will exercise the option to cancel without a fee.

Obviously, DOT head Ray LaHood is unimpressed.

“This is just another example of the disrespect with which too many airlines treat their passengers,” Department of Transportation Secretary Ray LaHood said in an e-mailed statement. “Rather than coming up with new and unnecessary fees to charge their customers, airlines should focus on providing fair and transparent service — that’s what our common sense rules are designed to ensure.”

Perhaps Mr. LaHood doesn’t understand the concept of options and option value. The right, but not the obligation, to undertake an activity (particularly under pre-specified terms) is clearly an economic good.  The very notion that DOT’s new regulation is touted as “consumer friendly” recognizes that it creates additional value for consumers. That is, it’s giving something away that is of value…a property right to change one’s mind at zero cost. However, it is disingenuous of Mr. LaHood to object to the idea that giving away value imposes a cost on the one providing the value (and I don’t mean the DOT, but the airlines who must honor the consumer’s exercise of the option).

A better solution might be to require airlines to explicitly offer the option of a no-penalty change within a 24-hour window. Then consumers could choose whether to pay the fee and airlines might discover the true market value of that option. Spirits’ $2 may be too high. More likely, it’s too low. Many airlines already do offer the option of a no-fee cancellation and the fare differential is much higher than $2, but that option typically has a much longer maturity…any time after booking up until departure. A shorter maturity window should command a lower option value.

Spirit Airlines may be the epitome of nickle-and-diming air travel consumers, something many consumers (myself included in some cases) don’t appreciate. However, there is no denying that Spirit understands the nature of options and their value. And there’s also no denying that, based on its stock price over the past year, Spirit is doing at least as well as industry leaders in providing consumers value for the options they choose. Perhaps instead of casting aspersions, Mr LaHood and his staff should invite Spirit to teach them about this fairly fundamental concept of options and option value rather than imposing regulations with so little regard for their true costs.

One response to Options Have Value, Even If DOT Doesn’t Get It

  1. 

    Another option, if DOT wants to ensure the 24-hour option is available, is to make that the default, with a corresponding fee. We could use $2 as the example. Make it so that every ticket includes the $2 option, but have the regulation allow passengers to affirmatively opt out. A little Libertarian Paternalism here would recognize the value of the option in creating DOT’s default preference, while still maintaining consumer choice.