Advance payment is a practical requirement in a range of sectors that enables companies to offer a wider choice of services and lower prices. It is essential for the functioning of the airline industry and the global standard for the wider travel and tourism industry.
Regulating this practice would be highly disruptive for the industry and counterproductive for consumers. Airlines would have less planning certainty and ability to optimise the use of their aircraft capacity, coupled with a higher risk of no-shows and non-payment. This would lead to higher average fares, reduced choice and competition, and lower connectivity in Europe. It would also disproportionately affect price sensitive or lower income social groups.
Less predictability to plan operations would also be expected to have counter-productive effects on the environment, as airlines would no longer have the same ability to achieve high load factors and hence lower CO2 emissions per passenger.
While consumer groups have pointed to the challenges related to passenger refunds and airline financial risks during the COVID-19 crisis, these were caused by unprecedented circumstances that should not be considered as a baseline for policy. The pre-payment model has benefitted consumers by making a wider variety of air fares available in the market, many of which are lower than they would be in a static, regulated market.
The mass flight cancellations caused by the COVID-19 pandemic have led some travel intermediaries and consumer groups to propose that pre-payment of air tickets should be limited (i.e. paying a certain amount at the time of booking and the rest closer to the time of departure) or abolished (i.e. deferring payment until the date of travel) to address any challenges related to customer refunds.
Customer payment at the time of booking is the global standard for travel and tourism services as well as a range of other sectors (e.g. hotels, car rentals, cultural or sporting events). It benefits consumers by enabling businesses, including airlines, to offer lower prices and wider choice in return for upfront payment, with the delivery of the service at a later date.
Challenges related to airline refunds during the pandemic were caused by an unprecedented set of circumstances that led to the shutdown of the entire global air transport industry for the first time in history. It should not be seen as a baseline for setting policy.
In normal times, the pre-payment model works well and there were no issues related to the 7-day reimbursement period under Regulation 261/2004 before the crisis. It was also not identified as an issue in the planned revision of the EU’s air passenger rights framework.
Regulating pre-payments would have a severe impact on airline costs, pricing, and revenue management, which would ultimately be to the detriment of consumers. With less planning certainty for airlines, it would lead to higher average fares and disproportionately affect price sensitive consumers, reducing choice and connectivity and lowering operational efficiency. A higher rate of no shows would be expected, which may result in lower load factors and affect CO2 emissions per passenger.
Pre-payment of tickets and consumer impact
The global travel value chain, including the airline distribution system that encompasses travel intermediaries and agents, is based on advance payment. It is also a widely accepted practice in other sectors, including direct competitors such as rail.
Advance payment has benefits for all parties involved, first and foremost consumers. It is an important component in making a wide variety of air fares available in the marketplace, including discount fares, many of which are considerably cheaper than they would be in a static, regulated market in which pre-payment was limited or prohibited.
Regulating this practice would essentially affect the flexibility and refundability of all tickets. It would undermine the ability of airlines to optimise operational efficiency, capacity or use of revenue management to generate predictable load factors. The risk of no-shows would be expected to increase, especially if advance payment were prohibited altogether, as passengers would have a lower incentive to take the booked flight if payment were only due at the time of departure.
Airline pricing models would need to adapt to price in the higher risk factor, which would not serve the interest of consumers:
- Average air fares would increase substantially to enable airlines to break even on a less predictable basis. This would disproportionately affect price sensitive and lower income consumers by limiting availability and choice among the cheapest fare options.
- It would lead to reduced connectivity for consumers in Europe, as higher fares would affect demand and the commercial viability of some routes. This may have a particular impact on routes that provide connectivity to remote or peripheral European regions.
- It would also affect competition between European carriers and between the European market and the rest of the world, with a particular impact on low-cost business models. Lower overall demand would affect the level of competition, and hence choice available to consumers, at a route and network level.
- It would reduce airlines’ operational efficiency which has led to consistently higher average load factors on flights. If all tickets became semi-flexible, airlines would have much lower visibility of demand and ability to predict load factors and deploy capacity accordingly. The combination of higher average fares and the greater risk of no-shows would lead to lower load factors, which would not only have a severe economic impact on airlines, but also negative environmental consequences by reducing fuel efficiency and increasing the emissions per passenger.
As recognised by the German Federal Court of Justice (Bundesgerichtshof) in a ruling on pre-payment of flight-only tickets, the system does not disproportionately disadvantage the consumer and also works to their advantage in the form of a lower price when booking early.See: https://juris.bundesgerichtshof.de/cgi-bin/rechtsprechung/document.py?Gericht=bgh&Art=pm&Datum=2016-2&nr=73705&pos=7&anz=22&Blank=1 It should also be noted that airlines today are free to make use of different payment models and so it is not excluded that market players may decide to request payments at a later stage than at booking. Moreover, consumers can decide to mitigate any potential risk (if they wish to do so) by booking closer to the date of departure.
Potential impact on industry and wider economic implications
Pre-payment is a practical requirement for the performance of air transport, as it supports airline planning (e.g. deployment of capacity), and because it is impossible to collect the money at check-in or after the flight without exposing the airline to the potential insolvency of the passenger, the risk of payment default or the risk of fraud. Any such change would significantly increase operational costs, which would need to be covered via other financing options that may not be available. It would also affect airlines’ capacity to execute some of their legal obligations towards consumers (for example refunding passengers for cancelled flights within 7 days).
Regulating pre-payments would have a major cost impact and be completely unworkable in a cash-flow intensive business with high fixed costs, where air carriers are required to pay a range of charges and costs upfront, including on a per passenger or per flight basis (e.g. airport charges). It would simply not be possible for carriers to keep reserved seats for flights over several months without full payment coming through. It could undermine the financial stability of the entire air transport value chain by disrupting liquidity cycles on which the system is based, which may have serious consequences for the economic viability of some carriers and lead to less choice and connectivity.For example, it would make it much more difficult, if not impossible, for airlines to avail of fuel hedging, lease rentals and debt repayment terms. It would also raise concerns about distorting competition and a level playing field, especially vis-à-vis non-EU competitors. It could ultimately lead to some parts of the airline industry not being able to operate at all.
There would be far-reaching implications for the economics of air passenger services and the interaction between the EU market and other markets for air services, given the international nature of the industry. For example, international airline journeys often involve several airlines (interlining) and tickets for flights to, from or within the EU can be sold in combination with other flights by agents or airlines worldwide. This gives consumers greater flexibility and choice among travel options.
Changing the system because of the unprecedented COVID-19 crisis would be disproportionate and majorly disrupt airline business models. Such regulation would likely infringe airlines’ freedom to set prices as per Article 22 of Regulation (EC) No 1008/2008, the foundation of the European single market for aviation. It is also likely to contravene commitments in bilateral air services agreements, such as the EU-US Open Skies agreement.
The costs are highly likely to significantly outweigh the benefits both for consumers and the industry. Any future policies must be carefully considered so as not to negatively affect existing, valid, and beneficial business models that make use of pre-payments, ultimately to the detriment of consumers, and to safeguard the level playing field in the travel industry.
Advance payment is a practical requirement that is essential for the functioning of the airline industry and has benefitted consumers through lower fares and greater choice. Regulating this practice would be highly disruptive for the industry and not in the consumer’s interest, as it would to lead to higher average fares, reduced choice and competition, and lower connectivity. The higher risk of no-shows and lower load factors would lead to less predictability of load factors and non-optimised aircraft capacity, with counter-productive effects on the environment. Challenges related to passenger refunds and airline financial risks during the COVID-19 crisis were caused by a unique and unprecedented set of circumstances that should not be considered as a baseline for policy.