Prediction Machines: The Simple Economics of Artificial Intelligence

by Ajay Agrawal

Uncertainty has an impact on a business’s boundaries.s1 Economists Silke Forbes and Mara Lederman looked at the organization of the US airline industry around the turn of the millennium.2 Major airlines like United and American handled some routes, while regional partners like American Eagle and SkyWest dealt with others. The partners were independent businesses that had contractual arrangements with the majors. Absent other considerations, the regional airlines typically operated at a lower cost than the majors, saving money on salaries and less beneficial work rules. For instance, some studies showed that senior pilots at the majors received 80 percent higher pay than those at their regional partners. The puzzle is why majors rather than regional partners handle so many routes, given that partners can deliver the service at lower cost. Forbes and Lederman identified a driving factor—the weather—or, more specifically, uncertainty about the weather. When a weather event is out of the ordinary, it delays flights, which, in the tightly networked and capacity-managed airline industry, can have ripple effects throughout the entire system. When the weather goes sour, major airlines do not want to be hamstrung by partners checking their contracts when they have to make fast changes with uncertain costs. So, for routes where weather-related delays are likely, the majors retain control and operation. The three ingredients we highlighted in the previous chapter suggest that AI migh...