When my recent flight was canceled unexpectedly, Delta Air Lines, its operator, gave no reason for the cancellation, only, “Sorry that your flight was canceled.” The aftermath of my travel disruption offers a hands-on lesson in sound economic thinking — if we choose to see it.
The airline industry is highly regulated. Laws and regulations affect practically everything they do. Those regulations create high barriers to entry, meaning incumbents are largely protected from the competition of innovative entrepreneurs. Without that pressure, airlines can (and do) impose rules that do not seem to serve their customers.
Many of those rules limit or minimize the airline’s expenses but do not provide any value to customers. The rules are well aligned with what is legally required of the airlines. Airlines are required by law to compensate travelers for delays or cancellations within the airlines’ control, but the mandate exempts delays due to weather. Millions of passengers each year are left stranded this way, and receive neither a meal nor a place to stay. Coincidentally, this had happened to me earlier the same week, after a thunderstorm forced me to spend the night in the Atlanta airport (Delta generously provided blankets, at least).
After canceling my flight, Delta offered me several options in the airline’s app: a full refund, a five-year e-credit with the airline, or rebooking on a later flight. For the airline’s bookkeeping, these are essentially equal options. But this is not how customers see it.
From an economic perspective, this makes complete sense: no voluntary trade is an exchange of equally valued options. The very reason my fellow travelers and I chose to pay the fare to fly was that each of us valued flying (getting to the destination) more than we valued the fare paid. So it should be no surprise that flying (arriving) would still be of more value than the money we chose to exchange for a ticket, unless circumstances have changed due to the delay. The 20 or more passengers choosing to stand by for the next flight strongly suggest that this is so. Their ranking of flying, even with the delay, was still higher than the amount paid, and so, more than a full refund.
In other words, the options offered as solutions to the canceled flight are not equal to the airline’s customers.
Firms are in economics understood as value-neutral, because for them a dollar is a dollar. As profit maximizers, it does not matter to them how the dollar is earned or from whom. But for customers, who give up dollars for a service, that decision is based only in terms of the opportunity cost: whether the amount can buy more value elsewhere. Theirs is a subjective value ranking of available alternatives.
Businesses should not expect that offering to pay the customer back in full makes the customer whole. Of course it doesn’t: customers chose to pay for the product or service because they considered it to be of higher value. The value of what they bought, or at least the value they anticipated receiving and that motivated the purchase, is higher not only than the dollar amount, but also than whatever alternative goods and services that sum could have bought instead.
Getting the money back, then, is definitionally of lower value than getting what they paid for. Certainly, it is a nice gesture to return the customer to their position before the exchange, but that is a loss in the customer’s eyes. Business managers and entrepreneurs should not be surprised if their customers, when paid back in full, might still be disappointed. They have ended up with less value than they expected from the exchange — in their own terms, albeit not in dollar amounts.
A canceled flight is, to travelers, a clear loss. The money back puts them back at square one, without the expected value. Even if the airline manages to find seats on a later flight, the delay is still a loss of the anticipated value.
Decisions about refund procedures are often made in C-suites, by MBAs armed with Excel spreadsheets, far removed from the point of contact with the customer. Their proper goal is to maximize profits for the business, but this can become risky. From that distance, it is easy to forget that behind every canceled flight are broken promises and people waiting in line, waiting overnight, trying (or failing) to get where they are going. Flesh-and-blood customers act on personal valuations of Delta’s offerings. That valuation can and does change over time, across situations, and in response to how the business operates.
Failure to recognize that customers choose to become customers because of the value they expect rather than the product itself is a competitive disadvantage for any firm. And it is a mistake that can be exploited by innovative entrepreneurs and new entrants who find better ways of serving consumers. But highly regulated businesses are insulated from competition, and major airlines are more so every day. Competitive pressure to satisfy customers is weakened, the product becomes standardized, and profit comes down to cost-cutting. And as a result, customer value is not a top priority in earning profits.
This failure to recognize that customers pay for something they personally value, which is often not the product per se, is essentially a failure to understand the role that the business plays in the economy. Travelers rarely value only getting to the destination, but place value in how, when, by what means, with what comforts, and so on. And they are traveling for a reason. Canceling a flight may make economic sense for the airline, looking at only money in and money out, but it can undo the value that customers originally saw and that motivated them to purchase the ticket. A full refund, or even being rebooked on a later flight, can still leave the customer at a loss. The result is customer disappointment and damage to the firm’s reputation.
In the open market, firms are kept in check by the threat of entrepreneurs who better serve consumers. But not so in regulated markets, which protect incumbents from competition — and therefore also from the need to reliably serve and satisfy customers. Firms in such industries can easily turn into mere production units of standardized products, and focus shifts to cutting costs instead of creating value.
