Overbooking with Endogenous Demand

54 Pages Posted: 31 Jan 2019

See all articles by Rowena Gan

Rowena Gan

Southern Methodist University (SMU) - Information Technology and Operations Management Department (ITOM)

Noah Gans

University of Pennsylvania - Operations & Information Management Department

Gerry Tsoukalas

University of Pennsylvania - The Wharton School; Boston University; Luohan Academy

Date Written: January 23, 2019

Abstract

Using airlines as a backdrop, we study optimal overbooking policies with endogenous customer demand, when customers internalize their expected cost of being bumped. We first consider the traditional setting in which compensation for bumped passengers is fixed and booking limits are the airline's only form of control. We provide sufficient conditions under which demand endogeneity leads to lower overbooking limits in this case. We then consider the broader problem of joint control of ticket price, bumping compensation, and booking limit. We show that price and bumping compensation can act as substitutes, which reduces the general problem to a more tractable one-dimensional search for optimal overbooking compensation and effectively allows the value of flying to be decoupled from the cost of being bumped. Finally, we extend our analysis to the case of auction-based compensation schemes and demonstrate that these generally outperform fixed compensation schemes. Numerical experiments that gauge magnitudes suggest that fixed-compensation policies that account for demand endogeneity can significantly outperform those that do not and that auction-based policies bring smaller but still significant additional gains.

Keywords: airline revenue management, overbooking, strategic customers, auctions

Suggested Citation

Gan, Rowena and Gans, Noah and Tsoukalas, Gerry, Overbooking with Endogenous Demand (January 23, 2019). The Wharton School Research Paper, Available at SSRN: https://ssrn.com/abstract=3321409 or http://dx.doi.org/10.2139/ssrn.3321409

Rowena Gan

Southern Methodist University (SMU) - Information Technology and Operations Management Department (ITOM) ( email )

Dallas, TX 75275
United States

Noah Gans

University of Pennsylvania - Operations & Information Management Department ( email )

Philadelphia, PA 19104
United States

Gerry Tsoukalas (Contact Author)

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

Boston University ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States

Luohan Academy ( email )

No. 556, Xixi Road, Z Space
Xihu District
Hangzhou, Zhejiang 310013
China

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