Revenue Management Basics aka [What is Revenue Management?]

There was once a time when it was so easy for airlines to establish pricing strategies. The industry was regulated, domestic lines were owned by the government an there was minor competition on the international destinations. I hear many former airline executives say “those were the days my friend” and even though we thought that they would never end, they surely ended. The change was rapid and brutal; the cost of deregulation could be named by couple of bankruptcies and broken dreams but this has all been for the benefit of the passengers, who, in return of high competition, now receive lower ticket prices.

On top of all that, the deregulation forced airlines to compete against each other in terms of many services but mainly in terms of price.

Revenue management surfaces here, enabling airlines to compete effectively in markets where pricing restrictions have been removed due to LLCs and many other forces.

The ways airlines sold tickets changed fundamentally in the early  2000s. Prior, airline tickets were mainly sold through travel agencies. Based on the agreements between global distribution systems (GDSs) and airlines, the passengers usually received limited information about the price availability and fare rules. There were two major conditions to change this situation. First, well-established LLCs entered the market and changed the pricing environment completely. Secondly airlines moved primary distribution to the internet and this allowed passenger easier and richer booking opportunities.

All these improvements divided demand into several categories. Namely, into two main streams; priceable and yieldable.

Yieldable Demand:

Yieldable demand is the traditional demand driven based on schedule, product characteristics, brand image and loyalty. This demand utilizes traditional booking channels such as travel agencies and the internet. This demand could be seen as independent of the availability of the demand in lower fare levels. If the particular product is not available the demand “will walk” away without a purchase. This is the demand where airlines enjoy hefty profits.

Priceable Demand:

There are two types of priceable demand, airline and market priceable. Airline priceable demand is the demand that is price-sensitive but still loyal to a certain airline. A good example is a business traveler who also prefers to fly that particular airline on leisure purposes due to the frequent flyer programmes. These passengers usually book through the airline’s website, typically without investigating other airlines and fare options. These passengers would book the lowest available class that particular airline has to offer.

Market priceable passengers however are wanderers. They are extremely price sensitive and have no real loyalty to any airline. They could prefer to fly with any carrier since the price is right. This is the most extreme case of priceable demand. Consider university students flying to Las Vegas for spring break. They would search for the lowest available fares online because they are ready and willing to fly on inconvenient hours for the sake of saving money for their Las Vegas expenses. They do not care if the flight is scheduled inconveniently or if the seats are very narrow. They are market priceable. They typically book through online travel agencies or third-party websites as Expedia.

Theoretically we are able to distinguish between types of demand from a revenue management perspective and between segments of passengers from a marketing standpoint. But, life is not that simple. Airlines have to employ very complex revenue management systems with the purpose to maximize their revenues. A full-service airline must have the capability to serve as many segments as it could, must extend its reach in order to survive. We all know that many major carriers that failed to reposition and restructure ceased operations during the last two decades. It is clear that ignoring one segment of the consumer won’t help in the long run; this is why nowadays many full-service carriers have second operations as LLCs and are offering very low prices and seasonal promotions.

As closing this brief essay, I would like to give two airline specific terminologies that are used in revenue management:

Spoilage: The loss of revenue caused by no-shows when a plane has departed. In other words, seats that could have been sold but spoiled. To prevent this many airlines have specific overbooking strategies based on the passenger characteristics of particular destinations.

Spillage: This is the loss in revenue when seats that could have been sold with a higher fare have been sold cheaper. This means that the capacity of the aircraft was not properly utilized and better forecasting models should be used.

This is the short basics of revenue management, further to come with more detail and complexity.

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