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514 days ago
 

One step forward in airline pricing but a step back for revenue management

NB: This is a viewpoint from Alex Dietz, principal industry consultant for the SAS hospitality and travel practice.

American Airlines’ recent announcement that it has revamped its domestic fare structure is a big deal.

While American has previously tried to simplify domestic airline pricing (1992’s well-documented “value pricing” structure), I fully expect this latest move to take hold because it is a logical next step in airline pricing and revenue management – one that ties in with recent industry trends.

However, this type of pricing structure places further pressure on revenue management systems, which are desperately trying to keep pace with the industry’s structural price and distribution changes.

The Development of Airline Revenue Management

After decades of stability, the airline industry saw its first big change (from a pricing perspective) following the deregulation of the US domestic market in 1978.

Besides simplifying the process for forming new airlines, and allowing airlines greater flexibility in choosing where to fly, this act gave airlines control over how much to charge for their service. Airlines did indeed proliferate, and many new types of fares were introduced.

By the late 1980’s, the industry had begun to settle into a carefully-coordinated set of practices commonly known today as revenue management, which utilized analytics to forecast passenger demand and optimize pricing on each and every flight. Revenue management systems were developed based on sophisticated algorithms – and airlines with better technology in this area had a distinct advantage in maximizing revenues.

A New Era of Competition

The period from the mid 1990’s through the early 2000’s saw two significant trends that would begin to shake the structure of airlines that depended on sophisticated revenue management solutions:

  • Low fare carriers expanded aggressively. These carriers distinguished themselves from their grown-up counterparts by focusing on cost, rather than revenue. Their simplified services and fare structures set a significant challenge for the network carriers.
  • Internet distribution allowed customers to shop in a way never before been possible. Suddenly, every difference in price was visible to even casual buyers. This had an immediate impact on the leisure market – but the real long-term impact was on business travel. Business’ purchasing rules regarding travel became more stringent, enabled by fare visibility.

These changes resulted in reductions in the number of fare restrictions on many fares – and a resulting reduction in the overall number of fares in each market. Simplified fare structures had won the day.

The Hidden Cost of Fare Simplification

Lost to most consumers, but clearly recognized by airline revenue management practitioners, was the cost of these changes to airline revenue management. Airline revenue management algorithms were tightly tied to the older, more complex fare system of tight restrictions. Those restrictions had allowed revenue management systems to presuppose a certain level of independence between the purchase behaviors of customers on different fares – in essence, assuming that a customer for one type of fare was not really a customer for another type of fare.

In a simplified fare market, this assumption began to fall apart – and the more simplified fare structures became, the more ‘sticking plasters’  were required to enable revenue management systems to deal with these fare structures and attempt to optimize revenues.

The Unbundling Period and American Airlines’ New Approach

If the first post-deregulation period was about revenue management, and the second period was the “low fare” or “fare simplification” period, then the third wave is clearly the unbundling period.

Unbundling – charging separately for services like baggage handling and meals that were previously included with every fare – has swept the airline industry in the post-2008 recession period. According to the annual Amadeus Review of Ancillary Revenue Results, airlines produced $22.6 billion in ancillary revenues in 2011. Amadeus recently projected that this number would reach $36 billion in 2012.

From a marketing and revenue management perspective, there are a number of problems with airline unbundling, including:

  • Unbundling makes purchase transactions more complex – something that increases costs, which customers do not like, and will avoid
  • It opens up opportunities for carriers to differentiate themselves – based on the fact that they choose not to charge for ancillary services
  • Most unbundled services cannot be purchased via online travel agencies – a primary outlet of ticket sales

American’s approach to fare re-simplification is to simply re-bundle services that it had previously unbundled – but to do so with a fare structure that places explicit charges into the ticket for these services.

American is not the first airline to create branded “fare families” – other carriers have used common, branded fares to simplify their offerings to the customer. Other carriers have also dabbled in creating fare families using previously unbundled services. It is for exactly this reason – the overall approach is far more evolutionary than revolutionary – that I expect this move to stick.

The Revenue Management Impacts

From a revenue management perspective, this change has both benefits and drawbacks. On the positive side, allowing previously-unbundled services to be purchased at the time of ticket purchase will allow American to include those revenues when segmenting travelers and determining fare availability on each flight – something that is difficult when those purchases are made separately. Of course, some passengers will still purchase these services a la carte, so not all of the unbundled service revenues will be controllable.

On the other hand, while American’s fare structure is simplified from a customer perspective, it is actually quite complex from an analytic perspective. Just as earlier simplified structures offered the customer opportunities to choose from different options, rather than being pre-slotted into a specific segment, this new structure gives the customer choices.

The difference is that now those choices are going to be driven by a variety of incentives – baggage fees, frequent flyer points, seat choice and boarding priority, and so on. And once again, existing revenue management algorithms are poorly suited to the task.

A number of academics and revenue management scientists have postulated that the time series forecasting techniques that have driven revenue management systems would be better replaced by choice models – models that predict customer choices based on attributes (such as price and, in this case, the attributes of each fare) – and how consumers have chosen when similar alternatives have been presented in the past.

Choice modeling is very exciting and sophisticated – and a process that has already seen use by airlines in the context of setting flight schedules. But choice models are extremely data-hungry, and capturing the full complexities of airline fare choices in these models is not easy – nor is using such models to determine optimal pricing, even if the models could be properly calibrated.

I fully expect choice modeling to continue to dominate discussions regarding the future of airline revenue management – and I expect airlines to continue to innovate in the form of fare structures and bundling. These programs have already proven their value, and revenue management science will need to catch up to the realities of the market once again.

NB: This is a viewpoint from Alex Dietz, principal industry consultant for the SAS hospitality and travel practice

NB2: Shopping trolley image via Shutterstock

 
 
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  1. Murray Harrold

    Sorry to belabour this point, but no-one has explained to me why there is this need for “differentiation”. When I buy a new car, I choose a Volvo XC60 – but I have many choices of similar vehicle in that range. BMW, Land Rover and many others all make a vehicle that fit into that segment. I can understand the concept of “differentiation”. BUT if I want to go from A to B and need to arrive at 11:00 am, if there is only one flight that does that – what is the point of “differentiation”. Fine there is airline X and then Y – but Y arrives at 1.00pm, so no good. If there was a choice of 3 airlines, all arriving at 11:00am, I could get it… but there isn’t, so I don’t.

    I can see what is meant by this on the route of, say LHR to NYC – would I prefer AA, BA, DL or whatever – but then the choice may well be governed, ironically, by the airline that has not striven to “differentiate” – I can go on (say) AA but have to pay a load of irritating extras … or I can go on BA or VS (say) and know I have paid a WYSIWYG fare. I can put my bag on, will get fed, have a reserved sat and what-not – everything the “Man on the Clapham Omnibus” (or in some cases the “Man on the Boston Metro”) could reasonably expect to see covered. Worse, if airlines “differentiate” then all that will result is customer confusion – this airline I can do this, not that – I get this, not that etc etc… more irritated customers. Of course, you may say all airlines “differentiate” that is, they all charge extra every 100 yards you walk towards the gate … but then, you are back to square on – all are the same. So No, I don’t get it at all.

    As to the GDS, Air Extras have been a feature of Sabre (certainly) for some time now. Or one simply adds on the bits you need via the airline website. It really is not a big issue. As an agent, my task is to arrange an itinerary – that is, to get the client where he needs to be, when he or she needs to be there, in the most cost effective manner. The adding on of extra stuff (or not, as the case may be) does not help the decision process – if anything, it hinders it. But we work around that simply by adding on about £40 onto any fare quote, as one does with low cost airlines, before making a comparison. Failing that, it is just a question of fiddling with the fare database, as mentioned up top … no problem with that – as long as you do not lose Minimum Connecting Times and Interline capability, of course. Oh! and a few other aspects of fare contsruction :-)

    The AA version of “Main Cabin Extra” is a hindrance to decision making, not a help. Even United have seen the sense and make/ are making their economy plus product a seperate booking class. If I travel economy, and I can get a better seat by paying a bit more, then fine, I will book that service – but the concept of “book any cattle class seat and then hope the better ones are still there” is banal in the extreme. Business travelers, certainly, just won’t have it. Another irony is that people will quite happily pay that extra bit … so why make it so hit and miss?

    Too much of “this is how it will be presented” and not enough “what do our customers want” or even “what do those people that book people want”

     
  2. Timothy O'Neil-Dunne

    If I may add a note of caution about the AA fares. The fares that AA has put into the market via the agency channel are specifically tailored to the capability of the GDS. They are not the entire range of product offered by AA because not all product functions are available via GDS. The issue of how this is handled by the GDS remains a problem for airlines who are striving for differentiation. Not a happy situation and no easy resolution.

     
  3. Alex Dietz

    Timothy, Jim, and Murray,

    Thanks for your comments on the article. I’m glad that you enjoyed it.

    I agree that pricing of airline travel, like many other products and services, is moving to an increasingly dynamic model. This has been true for some time, but is a change that I personally see as more evolutionary than revolutionary. Unbundling and re-bundling is just another step along the path.

    It’s also always good to hear the agency side of any pricing discussion – I tend to agree with you that the agency world is not going to “fall by the wayside” – and I assume that American does, as well, given that they are indicating that they will support distribution of these new fares to agents.

    Regards,

    Alex

     
  4. Murray Harrold

    Well written and cogent piece. Agents are not against change. All I can do is present what I know from the perspective of a coal face agent who books, essentially, business travel.

    I know that:

    1. One must differentiate twixt the USA (where there are more often then not, a range of (flight) options to get from A to B) and the rest of the world – especially the less developed/ emerging world economies – where such options do not exist… and in some cases may only have one or two flights a week from A to B.

    2. I am not getting involved in revenue management. I know nothing about that. How the machinery works in the background is a total mystery and how it is changed, I care not. What I do care about is:

    - That I must have a system that will get a client from point A on the planet to point B, safely, securely and 110% accurate. It must work 24/7.

    - I cannot pi** about waiting for airlines to decide on what fare to offer. Many times, one has a client on a dodgy line from the back of a taxi… the flight needs changing and I must fix it. Now. It is strange, but the American corporate directory does not contain the words “urgent” or “now”.

    - Differentiation in terms of, if airline A gives you a free bag or a bigger seat is neither hear not there. The thing arrives at the right time, in which case it gets booked, or it does not, in which case it doesn’t. Of all the suggestions re “differentiation” this seems to be the biggest issue. What is the point of having a free bag … if the thing arrives 2 hours too late for a meeting?

    - I need the fare now.

    - I need to have answered the questions I ask, the way I want them answered. I want to see the whole picture on one screen. No point and click …. All major CRS systems tried point and click and in all cases they were told what they could do with it. “You asked for this but Hey! We would like you to think about this instead …” is not an option.

    Cheapest is not best. It never has been and never will be, not in business travel, anyway. In fact, cheapest is invariably very expensive.

    Agents are quite happy with change. What we are not happy with, is any crackpot ideas that are going to make business travel unworkable … and some of the mooted ideas are pointing in that direction. That said, it would be best if someone came up with something and we can see what it does for a living. Put up or shut up, basically. Agents will not fall by the wayside, we will just go off and do something much more profitable and a lot less grief. We agents do not owe airlines a living. At present, we not only take a lot of flack for the airlines, but, with the help of GDS systems, do a lot of stuff airlines simply cannot do and a lot they do not wish to do – or if they do do, then airlines do it in a way which costs the customer an awful lot of money. I will not tell you what sort of things I mean, suffice it to say I have already seen examples of tech-led rip offs.

    By all means fiddle about as much as you like, but as mentioned in the article, unbundling is rapidly becoming bundling… We (probably) do not mind what you do but I am always surprised agents are never consulted about changes and how things could work. (From an operational perspective) The approach is not “Let’s find out how this works and see how it can be improved” (get lots of support for that) more: “Well, this is what we are going to do and if you don’t like it, tough” Fine, get on with it. Me? My wife has a very profitable skincare business which I help her with. People in that business actually want you to sell their products ….

     
  5. Jim Davidson

    Be careful…we just may find ourselves in a world of true dymanic pricing, which IS the ultimate RM dream!

     
  6. Timothy O'Neil-Dunne

    This is a worthy piece to the ongoing debate in TNooz on the topic of Distribution changes on the air side. It does however also affect the non-air businesses particularly Hotels and Cars. While the former is very fragmented – for Cars in the space of 6 years we have gone from 6 companies down to 3. My point in raising the issue of Cars is to point to the fact that a tighter supply market enables a different set of models for distribution and pricing. This is the underpining of the reason why Air is changing now.

    I agree that we are likely to see a change from the older complex RM algorithm driven models to flexible pricing. Indeed I believe if some airlines had their way – ATPCO would be history and that no fares would be filed – everything would be driven around a Demand model. (My term for what the article called Choice). We are headed to a different world order.

    Under the covers the airlines are radically changing their product structures. What is happening in the US market is going to be something closely watched by the rest of their industry brethren. For the monolithic structures of programmatic pricing systems – these are the sunset years. Thus anyone who perpetuates the myth of traditional pricing mechanisms needs to be looking either for a new job – or join this revolution. yes – you know who you are. This is no longer a question of IF, but how soon is WHEN.

    As I noted last week in my PSS article – I believe that the traditional “one size fits everything” PSS model is counter intuitive to this new world of on-demand pricing. Anyone now reviewing their PSS decision has to consider the absolute requirement for on DEMAND pricing as a core building block for their business. Sadly few of the PSS providers actually do this. But they sure hide it well!

    I am sure Murray Harrold will be on my case about the “cheap is bad” sentiment. But I do believe we are at a seminal moment when the change is coming. Agents will probably have to bear a portion of the brunt of this change and some of them will fall by the wayside. That we don’t have ways to deal with the complexities of things like interlines and other issues remains ONE of the elephants in the room. There are others. Let me assure you this change WILL be painful.

    That we have to look elsewhere outside of the traditional GDS and PSS market for solutions for getting our customers from point A to point B via routings that are unserved (or underserved) is a fact of life.

    Welcome to the new world order. And yes – the inmates are about to take over the asylum.

    Cheers

     
 
 

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