Monetising uncertainty: a logical next step?

Managing and mitigating risk is something all businesses must do to stay afloat. But can airlines make money from risk management? Former airline executive and revenue management consultant thinks this is one way forward in a tough environment.

Risk is a given in any business. There is the risk of delays, the risk of defects and of products not meeting the customer’s needs.  In recognition of this, many manufacturing companies have adopted ‘Six-Sigma’, a set of tools developed in the 1980s by Motorola to help businesses reduce uncertainty and produce a highly consistent product on a timely basis.  In many cases, this approach actually reduces the average cost.  However, there is another approach that recognises different customers value uncertainty differently.

Risk in financial markets has been studied at length – and investors have many vehicles for accepting different levels of risk.  Financial markets have developed puts and calls, collars, and floors, all of which are designed to manage risk.  However, ‘risk management’ doesn’t exist in the same way in most commercial markets.  Travel companies, in particular, are beginning to offer some new risk management tools for their customers.

Travel companies are exposed to tremendous uncertainty – with respect to demand, ‘no shows’, as well as operational challenges.  Travellers face uncertainty with changing fares and service unpredictability (long lines, security hassles, seat availability and so on) not to mention unexpectedly long meetings or last-minute changes.

Given the potential uncertainty surrounding a customer’s travel arrangements airlines offer a range of ‘fully refundable, fully changeable’ versus ‘non-refundable, non-changeable’ fares.  If customers want to retain the flexibility to change travel plans without fees, they must pay a premium.  So-called ‘full fares’ are often double or triple the level of non-refundable fares.  Customers must assess the probability that they will travel as planned – although given the difference in fares, they often could change their plans (for up to $150) and still pay less than the full-fare.

In addition to varying fare levels with customers’ appetite for risk, travel ‘risk management’ offerings come in two categories:

1. Sell an uncertain product at a discount 

In this scenario the customer is sold an uncertain product at a discount versus the equivalent secure product.  The travel company is not obliged to provide the additional service if it cannot or chooses not to.

Priceline revolutionised the industry with ‘pay your own price’ for white-label travel products.  Obviously this appeals to customers who don’t require the certainty of a specific flight or hotel location. 

Optiontown now brings a new dimension to this – selling the possibility of an ‘upgrade’ or ‘an empty seat next to you’.  Instead of the certainty of the service enhancement – for which the airline charges a significant premium – Optiontown charges a discounted fee for the service should the airline ultimately provide it.  Getgoing is another new travel alternative where customers select multiple destinations for a discounted fare – and the airline decides where they are going!  All of these are designed to provide discounts for travelers without diluting the airlines’ normal fare structure – in effect by selling uncertainty!

2. Sell greater flexibility or certainty

As with the fare structure itself, airlines charge a premium for greater certainty or higher priority. Here again, ‘full fares’ are offered to travellers to provide the greatest travel flexibility – fully refundable, no change fees and so on.  However, travel companies are beginning to offer other ways to package degrees of ‘certainty’.  Earlier this year, United launched FareLock as a way for its customers to lock-in fares for three or seven days for a fee ranging from $5 - $50.  And, in another risk-mitigation initiative, many airlines now offer versions of expediting boarding or a faster security line as a way to provide greater ‘peace of mind’ to travellers who can’t bear the thought of long queues.

Looking forward

As airlines continue to struggle to gain consistent profitability, selling ‘risk management’ is a logical tool.  It brings new revenue, it recognises the different risk profiles of different customers, and it affords better asset management without fare dilution.  From the customer perspective, it can make certain travel more affordable and improve the overall travel experience.  I expect to see more such options for customers in the years ahead.

This guest post is by Tom Bacon, a former airline executive and industry consultant in revenue optimisation tom.bacon@yahoo.com.

comments powered by Disqus