Why mixing up products is the path to airline profitability

Tom Bacon explains why a multi-dimensional approach and product mix is so important for airlines

Product mix has been calculated to represent about one-third of the opportunity for increased profitability in most industries. At airlines, however, its value can approach 100% of profitability. For example, even when, on average, ‘industry supply’ is in balance with ‘industry demand’ there are markets suffering from over-supply and some airlines have more capacity in those markets. As another example, across-the-board price increases are rarely practical given the price sensitivity of different segments – and such increases rarely determine overall airline profitability.  Mix – of markets, of origin & destinations (O&D), of fares and ancillary fees - is key to profitability.

Mix of markets

After a period of retrenchment a few years back, many legacy airlines touted that 95% of their flights were into or out of their hubs. Their ‘mix’ of markets had eliminated point-to-point flights where they lacked market dominance on either end. With industry consolidation, many airlines eliminated smaller hubs that represented lower profitability and relied more heavily on mega-hubs.

Unlike many other industries, airlines regularly adjust their market mix, in response to individual market supply and demand factors. They will reduce flying to Europe, for example, if there is an oversupply and they will move planes to China in response to growing demand.  The most successful airlines respond quickly to changes in individual markets, regularly adjusting  ‘mix’.

Mix of O&Ds

Airlines have the choice to allocate a seat on the particular flight to either ‘local’ passengers (passengers flying only on the non-stop segment) or ‘connect’ passengers connecting to/from other flights at either end. In fact, the airlines further allocate space among the various connecting opportunities on the flight. For example, on a Dallas-to-Chicago flight, how many seats should be allocated to ‘local’ Dallas-to-Chicago passengers? How many seats should be set aside for San Antonio-to-DFW-to-Chicago passengers versus San Diego-to-DFW-Chicago passengers?  Airline revenue management systems take into account both the fares paid by the different O&D’s and the differing demand for each of the feeder legs (San Antonio-Dallas versus San Diego-Dallas). The RM systems forecast demand for each individual origin-destination – along with the expected revenue – and allocate seats accordingly by flight by day.  Having the right mix is crucial to overall profitability.

Fare mix

Airlines, of course, are famous for their mind-boggling variety of fares. Revenue management techniques focus on fare mix (more higher fare passengers) as a way to increase profitability on each flight. Sophisticated analytical models forecast demand by fare level and allocate seats on each flight according to the optimal mix. Any individual flight is likely to have passengers paying both $79 fares and $700 fares. Optimal allocation of capacity across fare levels is projected to increase overall revenue by over 5%. In addition to market mix, O&D mix and fare mix, airlines now are pursuing new dimensions of ‘mix’ related to ancillary services. These include:

  • Sell-up: With the new ancillary fees, ‘mix’ now needs to reflect propensity to purchase additional services. The variable margin on bag fees is often estimated at well over 50% so airlines are earning a higher margin on bag fees than on their base transportation.  Passengers who check bags may represent higher profit than those who do not. Profitable “mix” now must include such sell-up options in addition to the base fare level. This is particularly true for airlines whose business strategy is built on ancillary: airlines that average over 30% of their total revenue in ancillary fees cannot afford too many passengers who do not choose to buy-up.

  • Bigger Seats/Economy Plus: Airlines have long offered different cabins: first class, business class and coach. Many airlines have now expanded this offering to a section of coach with bigger seats (sometimes named economy plus). Offering economy plus is a new ‘mix’ opportunity, potentially driving incremental revenue not available for airlines limited to a traditional Economy product.

Product mix is even more important for airlines than for other industries. At airlines, ‘mix’ has multiple dimensions, including market selection and pricing. And there is a need for airlines to regularly adjust mix along each of the dimensions. Overall market mix can be adjusted regularly as airlines move capacity from weaker markets to strong markets. In addition, airlines allocate their capacity on a highly dynamic basis between O&Ds, between fares and between customers who buy-up and those who don’t. Given the dynamics of the industry, an airline that is not exploiting ‘mix’ properly is not likely to be successful for very long.

Tom Bacon has been in the airline business for 25 years and is now an industry consultant in revenue optimisation. Email Tom or visit his website for more insights

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