Before business school, I worked in sales for a software company. I typically traveled at least once a week, flying around the U.S. to various companies to pitch our software product. Living in Atlanta, Delta Air Lines was normally my airline of choice because I liked accumulating the
SkyMiles. On many
occasions, I had to visit a company in Cincinnati. To get to Cincinnati, I had two options: fly between Atlanta (ATL) and Cincinnati (CVG) or fly into Dayton (about a 45 minute drive from downtown Cincinnati). Tickets to Dayton (DAY) were often as low as 1/3 the price of those to Cincinnati! Why? What could cause such a difference? Answer:
Prisoner's Dilemma.
ATL-CVG: only Delta flew the route so they could charge as high a price as passengers would pay
ATL-DAY: Delta & AirTran compete; result was lower ticket price, explained by Prisoner's Dilema
To explain what I mean, consider the game table below.
If there isn't an Airline #2, Airline #1 will select 'High Price' to maximize their revenue. Once Airline #2 enters the picture, the competitive equilibrium is for both airlines to select 'Low'. The only way the airlines can reach the higher payout is by colluding on prices, which of course is illegal.
Given this dilemma, it's no surprise that the airlines struggle to remain profitable!
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