Transcript Revenue Management Pricing Considerations

Airlines Industry
Yield Management
Ken Homa
Airlines Industry
Challenging Environment
• Complex, interconnected network
• Thousands of dynamic prices
• 90% discount prices
20% pay less than half of average
2/3’s big companies get 35-45% off
• 50% cancellations
• 15% ‘no shows’
Airlines Industry
Passenger Info
• Business / leisure split 50/50
• Business: 50% passengers, 60% profits
…25% of passengers pay more
than 2.5 times average fare
• Heavy users: top 5% = 40% of trips
• No brand preference
…for 50% of leisure and 25% of business travelers
Airlines Industry
Fundamental Economics
• Very high investment and fixed costs
…Equipment & maintenance
…Computer systems ( reservations)
…Flight Fixed: fuel, crew, airport fees
• Low variable cost
…Agent commissions (8-10% on 85% of volume)
…In flight food & beverage, incremental handling
• Empty seats: nil incremental cost
…Fixed, highly perishable inventory
Airlines Industry
’Low Frills’ Economics
• Variablize the fixed costs
…Source services & personnel
• Streamline offerings
…Precisely match segment’s value function
• Accept lower margins
…Lower relative investment
Anybody Remember PeopleExpress?
• Simple strategy: low frills, low price
• (Too) rapid expansion
• No infrastructure (I/T, res system)
• Very low average cost, but …
• AA killed PeopleExpress
AA marginal cost < PE average cost
AA attacked with ‘laser fars’
Airlines Industry
Performance Metrics
• Available Passenger Miles (APM)
…Gross measure of capacity
• Revenue Passenger Miles (RPM)
…Number of passengers weighted by distance flown
• Load Factor
…RPM divided by APM
• Yield Factor
…Revenue per RPM
Fly full with high paying passengers
Airlines Marketing
• Network routing
• Capacity planning
• Flight Scheduling
• Yield Management
Network Routings
• Point to point
OD pairs (origin - destination)
• Originating & continuation flights
• Hub-and-spoke connections
…Roughly 2/3’s passengers arriving
at a hub connect to other flights
Capacity Planning
• Aggregate
Seats and configurations
• Route-specific
Through flight considerations
• Load factors
The performance metric
Flight Scheduling
• Customer preferences
…Peaks & valleys
• Connections
• Planes & crews
• Disruptions
…Weather, equipment
Yield Management
• Overbooking
• Fares Allocation
• Traffic management
Sell as many seats as possible at full fare, then fill otherwise
empty seats with discounted fares that exceed variable costs.
Jargon
Displacement
High price customer rejected in favor of low price customer
Usually undesirable, but not always
Dilution
Price insensitive customers pay lower prices
Diversion
Customer is shifted to an alternative available flight
Spillage
Customer turned away because of capacity limits
Spoilage
An empty seat on departure
Jargon
Cancellation
Roughly half of all confirmed reservations
are ultimately cancelled
‘No show’
Roughly 15% of confirmed passengers neither
cancel nor show up for the flight
Overbooking
Accepting more reservations than seat / fare
capacity on a flight
Oversold
Confirmed passengers are denied boarding
on a sold out flight
Overbooking
The ‘No Show’ Issue
• On average 15% of confirmed
passengers don’t show up for a flight
…Changed plans (without cancellation)
…Double-booking
• Spoilage: very high opportunity cost
…But only on flights with denied reservations
• Objective: sell-out the flight
…Take more reservations than capacity in
anticipation of ‘no shows’
Overbooking
• Overbooking only applies to a portion of
all flights
• Overbooked not the same as oversold
• Overselling results from stochastic
nature of ‘no show’ pattern
Overbooking Costs
• Volunteer Inducements
• Rerouting costs
• Hospitality concessions
• Loss of goodwill
(involuntary denials)
Volunteer Inducement
• Magnitude of inducement Increases
with number of seats oversold
• Ultimate cost depends on the method
of fulfilling the incentive
… Space available …negligible cost, except
possible fare dilution (to free)
… Space constrained … displacement /
opportunity cost … unless controlled
• Credit certificates ...
…Dilutive or stimulative?
Rerouting
• Cost dependent on fulfillment method
Space available …negligible cost
Sold out … displacement / opportunity cost
2nd round oversale
Competitor flight … cash cost (at premium fare)
Overbooking
The Number
• Ceiling to limit goodwill impact
• Estimate (and re-estimate) no show
probability function
• Calculate expected cost of overselling
…Probability of occurrence
…Cost of remedial action
• Calculate expected opportunity cost of
possible spoilage
• Marginal cost = marginal benefit
Fares Allocation
Pricing Considerations
• Dilution
Price insensitive customers pay lower prices
• Displacement
High price customer rejected in favor of low price customer
Usually undesirable, but not always
• Share Shift
Movement of volume among competitive carriers
• Stimulation
New demand in response to lower prices
Fares Allocation
Fundamentals
• ‘Fence’ to minimize dilution
Advance purchase, minimum stay, etc.
• Equalize expected marginal revenue
Restrict ‘inventory’, ‘nest’ reservations access
• Dynamically re-estimate probabilities
• Link to overbooking policies
… and to traffic management
Traffic Management
• Maximize system revenue (global optimum)
… not specific segment (local optimum)
• Tied to inventory availability (vs. sold out)
• Can create favorable displacement ...
Desirable Displacement
• A to B: full = $100, discount = $50
• B to C: full = $250, discount = $125
• A to C: full = $350, discount = $175
• A to B is full, and B to C is available
Accept discount reservation A to C
since $175 > $100
Yield Management
• Overbooking
• Fares Allocation
• Traffic management
Sell as many seats as possible at full fare, then fill otherwise
empty seats with discounted fares that exceed variable costs.
Airlines Industry
Yield Management