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Frank Friday: A Bonus Economic Naturalist Post

Editor's note: From time to time, we get questions here at the Business Desk that feel designed for our frequent guest blogger Robert Frank, author of The Economic Naturalist: Why Economics Explains Almost Everything. Today, we're happily giving him the floor.

Question: Why do rental car companies impose no penalty for canceling a reservation at the last minute, whereas both hotels and airlines impose significant cancellation charges?

Robert Frank: If you buy a ticket to the theater and then miss the performance because you got stuck in traffic, you don't get a refund. It is the same with some airline tickets. If you don't show up for your flight, your ticket becomes worthless. At the very least, the airline will charge you a stiff cancellation fee. Similarly, most hotels will charge you for your room if you cancel your reservation after 6:00 P.M. on the day you're supposed to arrive. But rental car companies follow a completely different practice. You need not provide your credit card number when you reserve a rental car. And if you don't show up to claim the car you reserved, there is no financial penalty at all. Why this difference?

Car rental companies, like all other sellers, want to keep their customers happy. Customers don't like cancellation fees, and a rental car company that does not charge them would have a competitive advantage over other companies that did. Airlines and hotels, of course, have the same motive to avoid cancellation fees. Presumably they charge such fees because allowing customers to cancel without penalty at the last minute would also be costly. Airlines would have many more unfilled seats on each flight, and hotels would have many more empty rooms. In each case, it would be necessary to charge substantially higher prices to stay in business.

In principle, rental car companies should face the same pressure. Their failure to impose cancellation fees may be rooted in the fact that their typical customer's transaction happens to be immediately preceded by an airline transaction and immediately followed by a hotel transaction. Because both hotels and airlines impose cancellation fees, the typical rental car customer has a strong incentive to show up for his car at the assigned time, even in the absence of rental car cancellation fees. Rental car companies may thus be able to avoid alienating customers who are forced to cancel, because the cancellation policies of hotels and airlines ensure that there will be few such customers.

-- Posted October 16, 2009 | Comments (0) | Permalink