Thread by @econnaturalist

Economic Naturalist Question #20. 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?
@mhhighered

In an earlier thread, I explored why introductory economics courses appear to leave little lasting imprint on the millions of students who take them each year:

https://twitter.com/econnaturalist/status/1091461433487953924

Students learn more effectively when they pose interesting questions based on personal experience, and then use basic economic principles to help answer them. This exercise became what I call my “economic naturalist” writing assignment.

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 hotel rooms and many airline tickets.

If you don’t show up for your flight, your ticket becomes worthless. Or 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 on the day you’re supposed to arrive.

But rental car companies follow a completely different practice. You don’t even need to 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 any rental car company that did 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 be even more 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. But wouldn’t rental car companies face the same pressure?

They would! Their failure to impose cancellation fees may be rooted in the simple 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 is likely 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 those customers who are forced to cancel, because the cancellation policies of hotels and airlines ensure that there will be so few such customers.

Being sandwiched between their customers' airline and hotel transactions becomes, in effect, a natural insurance policy against cancellations for rental car companies.