The “price” of airline pricing schemes

Technology has been the impetus for many of the most innovative changes in airline management in the past 50 years, including the advent of central reservation systems, the development of automated scheduling systems, and the observed dominance of electronic tickets. Sophisticated yield management systems surely belong in the airline pantheon of technology-driven innovations as well, so as airlines are re-thinking reservations systems, and updating their scheduling systems, perhaps they would do well to put yield management under the microscope too.

Yield management is the term given to the set of systems and processes used to set and adjust prices according to constantly changing set of demand variables such as class of service, fare flexibility, time of day, week, month and year. This effect is brought about by controlling the number of each type of seat available for sale on each flight as well as the prices and promotions for each class of inventory. In economic terms, yield management is the technology enabled magic that helps an airline extract the maximum possible willingness to pay from each customer to optimize the airline’s overall yield, or profit, for each flight.

In addition to the finite costs of yield management organizations, including yield management staff, their tools, and the corporate overhead needed to support them; yield management also takes a toll on customers. Travelers spend an inordinate amount of time in the travel search and booking process, and few would suggest that this makes customers more satisfied with their final purchases. IBM’s Travel 2020 study that focuses on travel distribution confirms both of these assertions.

But customers don’t see neatly managed buckets of inventory, an endless string of yield modifiers, and fancy algorithms used to predict the number of no-shows on a given flight. Instead they see prices that seem to change every 10 minutes, and fare rules that read like their mortgage application. What is more, as the result of constant advertizing about fare sales, and available discounts, customers are often left with the feeling  that no matter how little they paid, someone on the flight got a better deal.

Customers may see airline pricing schemes as a game in which the rules are either too obscured, or too complex to understand. Prices seem to change continuously, and seats that look available often vanish before payment has been made. Fare rules are rarely user-friendly, and using frequent flyer miles to purchase a ticket can prove frustrating even for the seasoned traveler. But like any game, once the rules are understood, players often adjust their behavior.

Playing the yield management game well improves revenue at many airlines, and it might even push profitability in the right direction from time to time, but it does so with an impact on the customer experience.

A precise tally of the full costs of yield management are, of course, specific to each individual carrier, but considering that the revenue management department (a substantial portion of whom are typically involved in yield management) is often among the largest non customer-facing departments at most carriers, it is clear that yield management activities are costly. It is entirely possible that yield management costs and airline between one and two dollars per sold seat. Add to that the less tangible costs associated with customer dissatisfaction cased by the uncertainly and complexity yield management demands, and it becomes clear that the benefits of yield management have an increasing high cost justification hurdle to clear.

 Economic theory suggests that a firm should rely on the market to provide services that they cannot provide or obtain more efficiently, so as the travel distribution market continues to get more efficient, airlines must reassess the return on yield management. Executives must be sure that the efficiency of yield management-driven pricing compares favorably to market-priced airfares that are generated by travel distribution intermediaries.

Consider the example of the search engines that use predictive technologies to partially expose the ‘yield curve’ of an airline by estimating how prices will change over time and by helping customers zero-in on the best time to buy. This enables search engine users, who might never visit the airline website, to make more optimal purchase decisions based on current pricing as well as forecasted price fluctuations. In response, customers  may opt to accelerate or delay purchases to get the best deals, and this activity of course gets factored into the yield management process. In time, this cycle may continue to reduce the return carriers get from their yield management investments.

In this scenario an airline might consider selling larger buckets of inventory on a wholesale basis to travel intermediaries and reducing the direct investments in the yield management function. Sales to intermediaries might generate less profit, but they might also help produce happier, less frustrated customers. More satisfied customers might also be willing to spend more on lucrative airline products, services, and upgrades. In any case, this is an important enough set of decisions that the assumptions about positive returns on yield management should give way to mathematical models that prove (or disprove) this value.

To industry traditionalists these suggestions will no doubt sound like heresy, but to the industry innovators, and more importantly the mass of customers whose needs are not well serviced by the current pricing mechanisms used by most carriers, these are questions worth asking. Because  some members of travel distribution marketplace might be pondering these possibilities right now, it might be better for airline executives to answer these questions as soon as possible.

IBM Institute for Business Value, Global Travel & Transportation Lead

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