So many markets, not enough time…
I’ve recently been doing some work for a client looking at the future of air transport, mainly from the point-of-view of how new information and communication technologies will permit - and drive - a complete transformation of the existing industry paradigm over the next 2-3 decades (given the existing ‘installed’ infrastructure - aircraft, navigation systems, airports, etc. - and the very high safety tolerances, ie the 80/20 rule doesn’t cut it, the timescales for change are necessarily longer than in many other industries or systems.) In a nutshell, managing the air transportation system is ultimately about managing (and optimising) a complex network, analogous to a communications network for example where rather than traffic in electronic bytes, it is aircraft (and even more fundamentally people and packages) that are travelling through the network.
In this context, optimally allocating the scarce network resources (airspace, taxiways, gates, etc.) is the name of the game. Of course this being the Park Paradigm, you won’t be surprised that I believe that - building on the possibilities afforded by innovative and state-of-the-art technologies and algorithms - one of the best tools for allocating scarce resources (in any system) are markets. And so it was with great interest that (pointed there by the always eclectic Boing Boing feed on my netvibes page) I was excited to see Clifford Winston’s take on the question asked by the Freaknomics team:
(The question: The U.S. airline market is a mess right now, with unhappiness increasing among customers, employees, and executives. While certain companies have become profitable again, the future looks murky. What will the U.S. airline industry look like in 10 years in terms of prices? Customer service? Safety? Technology? The economics of the business itself?)
The U.S. airline industry is a victim of its own success — intense competition and low fares that have contributed to steady growth in air travel — and a victim of poor government policy toward airports and air traffic control that has prevented runway and airspace capacity from staying ahead of passenger demand. The results are mounting congestion and delays that raise airlines’ costs, infuriate passengers, and demoralize employees.
The solution requires the following: 1) to charge all aircraft for the delays caused by their takeoffs and landings, as well as the delays caused by their use of airspace near airports (my emphasis); to increase the number of runways at congested airports; 2) to introduce technological aids that would facilitate additional operations on parallel runways and reduce the separation between aircraft when they take off and when they land; and 3) to implement a satellite-based air traffic control system that, among other things, would give pilots the freedom to choose the most efficient routing, altitude, and speed of their flights.
By using the price mechanism to reduce peak-period demand for runway and airspace capacity, by expanding runway capacity at the most congested airports, and by adopting new technologies to enable more aircraft to use available runway and airspace capacity, air travel delays would be substantially reduced. In the process, competition would flourish, and the nation’s exceptional air safety record would get even better.
Unfortunately, congestion pricing is perceived by policymakers to be a political loser. And, based on experience, the time that it takes to build new runways and introduce new technologies is most accurately measured in decades.
Ideally (as opposed to than say London’s static and low-tech implementation of its congestion charge) you would have a real time risk exchange pricing congestion on-the-fly: aircraft operators could then trade their flight contracts in real-time and dependent on what they have sold to their passengers (or cargo) optimize along the price v. time continuum. (Clearly this is constrained by needing to land before the fuel runs out if the plane is already in the air.)
Think of it this way: “We are going to circle Heathrow for an additional 30min but will be refunding each passenger £25…” (ok a bit trite but hopefully helps to illustrate the possibilities…) Or “Buy a ticket on XYZ Airways from [Boston to Chicago] [today] for travel on [November 15th at 2pm] and we will rebate you < $2> for every minute the flight is late…” (with the [] variables determining the <> specific payout depending on the prevailing market conditions - congestion and weather pricing - and the expected load factor of the plane (which btw might also be traded: think of a more dynamic exchange version of Farecast…); very complex algorithms but simple conceptually. Or alternatively let the customer fix the rebate <> and set the upfront ticket price as a function of that, ie the customer can price his own time…the possibilities are endless.)
Furthermore, given that alongside congestion, weather is the most significant factor causing disruptions to flight schedules, you could combine this with dynamic weather markets to further optimize the risk pricing and network resource allocations. (Technology like this could provide real-time airborne weather data for such an underlying market.) The aircraft operator of the future would in fact have a dedicated team of traders/risk managers dynamically hedging their risk (the transportation contracts sold to their customers) against the market. I would imagine - like in other risk markets - there would be both long term hedging and spot/real-time markets.
If you think this is crazy stop and consider that another huge (though rarely seen by the general public) network industry basically operates along these same lines - the wholesale electric power network. (Which btw is set to undergo its own transformation with the introduction of ’smart metering’ over the coming decade; see here for an interesting take on this subject.) Clearly every major electric utility has a team of traders managing their long and short term risks in order to balance their generation and distribution capacities to the signals of constantly changing supply and demand; why should air transportation providers not have the same?
The falling cost of implementing market-based exchanges and pricing tools will in the future drive any resource allocation problem towards a market based solution and in so doing improve the efficiency of our economies by orders of magnitude. Think Moore’s law only applied to the productivity of the whole economy rather than a chip. Call it the coming “Age of Markets.” (The sixth paradigm.)
October 18th, 2007 at 4:01 pm
(while I’m in a commenting mood — waiting for a large database to process..)
My understanding is that one of the biggest problems with US air travel is that all flights need to pass over known waypoints so that the FAA can track position. Essentially, point #3 in the quoted article.
This has caught me out a number of times on the NY->SF route. You can easily lose or gain 30min depending on the FAA assigned flight path. Routes, for safety reasons, can only sustain a certain number of planes. With only a small number of available flight paths, they can become congested quickly. If GPS based flight path tracking were in place, planes would be free to travel more optimally while still maintaining a safe distance between planes.
After the roll out of GPS - will there really be a need for complex mechanisms to price delays? After my current job finishes on the aforementioned database, I’ll load up FAA data and see what I can find.
October 19th, 2007 at 11:52 am
I’m glad to see that I am not the only one who reads this blog while waiting for database operations to complete.
Sean, glad to see you making the electric market analogy. While reading the top half I was thinking of all the similarities with electricity.
I can think of a number of B2B contracts where prices change based on timing delays or other parametric triggers. For example a service level agreement (SLA) where a supplier has to provide 99.999% up time or pay a penalty. I can’t think of any examples of this at the consumer level, however. Of course I have not had breakfast or coffee yet and it is Friday, but it has me thinking… I think these types of air trans markets will most likely be lead, not by the consumer market, but rather by the air freight market. Air freight already has parametric triggers for delivering their goods (be there by 10 AM or its free). They should be able to dynamically calculate the cost of taking another lap around Heathrow or even sitting on the tarmac for another 20 minutes while they trade their place in the queue to a passenger air line. The big disadvantage of these… um… “structured air deals” to passenger airlines is that everyone’s time has a different value. If I have a business meeting I may not be willing to be delayed an hour for only $15 compensation. But naturally one would expect that the airlines would offer adjustable tick sizes as well as different strikes if they get into selling calls on travel time. Oh… I see a swap market developing!
May 2nd, 2008 at 11:26 am
[…] You may recall I touched on this subject (dynamic outcome-driven air transport pricing) previously; and while weather risk management would be a good start in terms of bringing airlines into the 21st century, in my opinion a much deeper and more fundamental reappraisal of their business model is called for. Fundamentally, airline seats (or on any carrier for that matter) are substantially fungible - ie a ticket gives the right for one person to travel from point A to point B. Ok, Ok … before you get the pitchforks out - yes there is a difference in value between a seat on a Gulfstream V and the middle seat in row 34 on DiscountAirways… but the differences are relatively easy to understand and so I believe would be (mostly) efficiently priced in an open market. But ok, for the sake of simplicity, let’s set aside private or charter operations for the moment, and concentrate on scheduled commercial airlines. What you have today is a fragmented and reasonably opaque primary market* and no real efficient secondary market. (*Although the advent of the internet generally, and a number of innovative start-ups specifically has vastly improved the situation from that of a decade ago…) Why is this? Practically speaking it is because the airlines don’t want to allow transferability - they are unable or unwilling to embrace the fact that what they are selling is a commodity. That they are selling the transport of packets on a network. It’s an ego thing. They think they would lose out. Putting aside the fact that most of these companies have lost billions of dollars over decades (so I’m not sure what they think they have to lose), I am convinced that by encouraging a robust and complete secondary market in airline seats, not only would consumers win (through more transparent and rational (supply/demand) driven pricing) but the airlines - at least the well-managed ones - would be huge winners. First they would be able to save money by eliminating (or redeploying more productively) the boffins they currently pay to build ridiculously complex and customer un-friendly pricing schemes in the vain hope of optimising a priori load factors and revenues, and instead be able to focus on managing their assets, optimizing their routes and schedules and making their customers happy (insofar as they could see a return on this investment from a structurally higher secondary price for their seats.) […]