Coping With High Price Elasticity of Demand: Transparency in Pricing Has Exacerbated the Commoditization of the Airline Business

Published: 25 Jun 2009

Transparency in price has certainly contributed to a partial commoditisation of airfares. It is very simple for a potential customer to find the lowest fare in the market with a few clicks on the Internet.

The Internet also delivers more complete product information – particularly with respect to schedule.  For instance, consumers can compare fares and can also quickly recognise the difference between non-stop and connecting flights offerings.
 
From revenue management’s perspective, fare transparency has forced airlines to redouble efforts to stay competitive.
 
“The web has certainly brought about a transparency in pricing that has exacerbated the commoditisation of the business. In fact, it has been made even worse by the typical web travel site interface that emphasises price, de-emphasises schedule and carrier, and mostly ignores other elements of service quality or included (vs. fee-extra) services,” says Scott Nason, who recently retired from American Airlines, where he was VP – revenue management. He is currently a freelance consultant at SDN TT&H Consulting.
 
This has made the cross-elasticity of demand very high, meaning that the customer’s willingness to pay more for one feature or another (preferred carrier, preferred departure time, nonstop flight, onboard amenities, etc.) is very low, added Nason, who is scheduled to speak at EyeforTravel’s Revenue Management and Pricing in Travel USA 2009 to be held in Chicago (September 16-17) this year.
 
RM System Optimization
 
It is believed that today virtually all RM systems deal with current (vs. long-term) profitability and those same systems are functionally unable to differentiate among individual customers. Other than basic point-of-sale controls, the inventory allocations offer up an agnostic display that offers the same inventory levels, regardless of viewership. Current price tends to be the sole arbiter and thus determines priority access to inventory rather than long-term profitability.
 
On whether loyal/long-term profitable customers are evaluated in isolation of their lifetime contribution, Nason said this is “mostly true”, but not entirely.
 
“There are many subtle, behind-the-scenes machinations that result in providing better access or lower fares to some customers,” he told EyeforTravel.com’s Ritesh Gupta.

“These can take the form of corporate deals, travel agency arrangements, waivers/favours and inventory overrides, etc. In addition, airlines commonly recognise the lifetime value of some customers by giving them priority upgrades, waitlist clearance, etc. And at least one airline has announced its intention to implement “dynamic pricing”. So, while RM systems optimisations are probably typically guilty of the “one size fits all” current profitability maximisation accusation, many airlines are not. And I think it is reasonable to expect that “customised pricing” will only grow over time,” Nason added.
 
Optimal selling prices
 
The key to setting optimal selling prices or optimal inventory allocation– in addition to good mathematical modeling – is intimate understanding of demand, says Nason. It is necessary to do the very best job possible of statistically analysing the historical data, but also making the nearly-constant adjustments to the forecasts, as conditions change.
 
With sophisticated data repository integrated with the corporate data warehouse, it is also vital to assess to what extent this architecture simplifies revenue information management and provides a solid foundation for future, revenue-related applications.
 
“While it simplifies the IT somewhat versus the alternative, and clearly provides a good data platform in order to compute the desired inventory controls, it is probably a stretch to say that it “simplifies revenue information management”,” according to Nason.
 
“The simple truth is that these problems are so big and so complicated that the more data you have, the more you can do … but it is never simple,” said Nason.
 
When it comes to measuring performance across various channels and streamlining processes to effectively implement revenue management, one needs to consider that different channels can have varying demand characteristics, competitive environments, and/or distribution costs, any of which can alter the optimal RM strategies.
 
“Therefore, it is necessary to develop individual channel models, and to measure loads/yields/RASM/customer trip characteristics/etc., separately for each, in order to continuously update the models and to measure results,” concluded Nason.
 
Nason, along with other 25 speakers including ones from Continental Airlines, Wyndham Hotel Group, InterContinental Hotels Group and Hilton Hotels Corporation, are scheduled to speak at Revenue Management and Pricing in Travel USA conference, to be held as a part of the Travel Distribution Summit N. America 2009.

Revenue Management and Pricing in Travel USA 2009

For a full agenda and a list of speakers click here: http://events.eyefortravel.com/tdsusa/revenue-management/agenda.asp

Or contact:

Helen Raff
VP North America
+44 (0) 207 375 7582 (UK)
helen@eyefortravel.com

Comments

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MilindPuri said on 29 Jun 09:

Some interesting points made here.

There are ways to tap into the customer's willingness to pay through systems that can interact with new market segments - time rich / cash poor travellers - who may otherwise not travel with your airline. Please contact me on www.linkedin.com/in/milindpuri for details on how to exploit the use of such a system.

Revenue Managers are also invited to take my poll on the Challenges faced by RM Managers in filling empty flight seats / hotel rooms" at http://polls.linkedin.com/p/21373/xrdyi

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