A PRIMER ON AIRLINE PRICING AND REVENUE MANAGEMENT
“How much did you pay for your ticket?” Passengers sitting next to each other are shocked to learn that their seat-mate paid a very different amount than they did. It’s a familiar tale on many flights. Airline pricing seems mysterious, ever-changing, and convoluted even to those in the business. Yet, there is a method in the seeming madness. Following is an overview of how and why airlines price as they do, along with a little bit deeper dive into the backroom of an airline’s Pricing and Revenue Management (PRM) group.
This primer is written for those in commercial aviation not directly involved with PRM who want to understand more about this function; as well as for anyone who just likes to know how things work. My apologies if you are seeking an answer to the airline passenger’s ultimate question, “how do I get the best fare?” That answer is not here. There are already innumerable articles about how to get the “best deal” on the Internet.
However, if you want to learn the basics of how airlines price and manage seat sales, read on!
BASIC PRM CONCEPTS
Two Groups Determine Prices then Make Fares Available for Sale through Distribution Channels. Airline ticket prices result from the interaction of two internal groups – a Pricing Team and a Revenue, or “Yield”, Management Team. Hence, the derivation of the “PRM” moniker. The Pricing Team sets fares, and fare rules; the Revenue Management Team manages the inventory of seats available for sale at the various prices for each flight. There is also usually a person, or group, within one of these entities that establishes ancillary revenue values; i.e., the add-on fees paid for certain types of preferred seats, bag fees, etc. These groups then feed the prices and terms for selling to the various sales channels – website, reservation center, Global Distribution Systems (GDSs) and travel agencies, and online travel agencies.
Prices Do Change Frequently. In fact, they can change multiple times a day in some of the more advanced selling environments around the world. Many thousands of fare changes are collectively made daily by about 1400 commercial airlines that carry 99% of the world’s passengers. In highly competitive regions, with advanced fare filing, fare monitoring and sales capabilities airlines can change prices multiple times a day. It doesn’t mean that they do, but the ability exists.
Airlines Set Their Own Fares, in Most Markets. The majority of the world’s airline passengers travel in pricing environments where market conditions rule and airlines can change prices to meet various conditions. It’s the free market. Government regulation of fares is diminishing globally, although it is still practiced in some countries where a regulatory body is trying to promote some social agenda. Governments, however, increasingly are regulating the process of overbooking and bumping of ticketed passengers from flights.
Pricing is a Complex Soup. Airline pricing managers would love to set fares in a manner consistent solely with their airline’s financial needs and objectives, and that reflect what their customers will pay. They do try; however changing demand, global economic trends, and competition always get in the way of a rational marketplace. Larger airlines are constantly bedeviled by smaller carriers that want to be disruptive, and either steal market share or stimulate demand with low prices and fewer travel restrictions.
Different Types of Airlines Price Differently. Traditional, full service carriers; low cost and ultra low cost carriers (ULCCs) , subscription service, and charter airlines price differently. Their business models range between higher frequency flights, multi-class cabins, higher service levels, to infrequent, very low prices, and a minimum of customer service. Traditional airlines use a wide variety of fares, multiple classes of service, with various restrictions in their pricing. Low cost airlines tend to price a bit below the traditional carriers and will remove some of the restrictions like a Saturday stayover requirement. ULCCs are the bigger disruptors. They charge very low prices, remove more of the restrictions but charge “a la carte” for checked baggage, larger carry-on bags, seat assignments, bottles of water, etc. ULCCs have shifted some lower priced traffic from the majors but they also seek to move passengers out of buses, cars and trains. Subscription (membership) carriers and charter operators have an entirely different approach which won’t be covered here.
However, Pricing Distinctions are Blurring Between Types of Airlines. Competition causes the lines to blur between the pricing behavior of various types of airlines. ULCCs in parts of Asia, the US and Europe are gaining meaningful market share. As such, some major airlines are starting to offer a limited number of seats at roughly comparable ULCC prices, albeit without certain frills like advanced seat selection or the ability to earn frequent flyer credit. LCC competition, which has made an even greater impact on the airline industry, sometimes compels the majors to drop advanced purchase or minimum stay requirements.
Effective Revenue Management Requires the Right Business Plan. Revenue management, done correctly, can generate several percent more revenue from an existing customer base. This incremental revenue can mean the difference between profit and loss on a flight and network. However, effective revenue management requires load factors, the percentage of seats sold, greater than 70%. Revenue management truly comes into play when there is higher demand for a flight that “encourages” passengers to buy the next highest fare when the lower fare classes are sold out. When an airline has the right business plan, load factors should be above 70%. Globally, commercial airlines’ average load factor is in the upper 70% range. If load factors are lower, your airline is somewhat compelled to take any customer at almost any price – a low price. Very little “up-selling” occurs. It’s very hard to be financially successful with subpar load factors and revenue managers with little to do. If this is the case, it’s time to rethink your business plan.
Can Airlines Read Each Other’s Minds? Airlines aren’t allowed to collude on pricing in many regions of the world. They are not supposed to talk to each other on fare setting. However, why is it that airlines seem to act in concert when fares increase or decrease? Part of the answer has to do with experience and part with technology. In the days of telegraphs, one telegrapher could tell who the other one was on the line without them sharing their identities. A good telegrapher could interpret the rhythm of the dots and dashes being sent by another telegrapher and know who it was. Similarly, experienced airline pricing managers can read subtle changes in fare filings that another airline is making and gain a sense of what the competitor is doing, or is planning to do. Additionally, in those areas where multiple daily fare changes take place, a fare change made in the morning by one carrier can be matched in the afternoon or evening fare filings by others.
Demand Drives Price Differences on Flights the Same Day in the Same Market. Have you ever looked at an airline’s website in a market with multiple nonstop flights on the same day and seen different fares for each flight? It’s all about demand for a given flight on a given day. The more seats sold on a flight, the higher the prices. Several decades ago, the airlines came up with the science of “yield management” – what is now known as “revenue management”. Airlines price based on a ladder-like fare structure. They sell from the bottom of the ladder up – cheapest fares sell out first. Airline pricing analysts set the fares that they believe will sell based on a variety of analyses. Revenue managers determine how many seats will sell, at a given price, on that flight, on that day. They are charged with increasing revenue from existing customers by getting them to buy a higher fare. Effective revenue management can increase revenue by at least 3%-5% from existing customers. Fare classes, designated by letters have different restrictions with higher classes – more expensive fares – having fewer restrictions. Airlines may have 15-20 fare classes just in the economy cabin alone. Prices between fare classes may vary by just $20 to $50, but getting a dozen people to buy the next higher fare on a flight with high demand means incremental revenue for the airline. Its supply and demand. Thus, fares can vary between the flight leaving for City A at 8am and the flight leaving at 1030am just based on demand.
With these basic concepts in mind, here is how airlines conduct day-to-day pricing and revenue management.
A DEEPER DIVE INTO PRM
Airlines pursue pricing with different organizational structures, processes and tools. Over many years of overseeing PRM functions, and providing advice to airlines on same, the following is a good generic representation of how pricing and revenue management work.
Most airlines have several distinct teams of experts focused on key functions within PRM. Collaboration between the teams is essential to obtaining an airline’s financial goals. Obviously, larger airlines have more specialization, smaller airlines less. PRM apps are essential as the data management task is massive. The amount of monitoring, adapting and setting of prices, forecasting future demand on a flight, and seat inventory optimization required, far exceeds the capability of the human mind. Thus, PRM apps are essential even for a modest-sized airline.
Pricing Team – The Pricing Team must first and foremost recognize the type of customers in a market, by route, flight time, and season. What is the mix of business, leisure, and VFR (visiting friends and relatives) traffic? They then construct fares and the associated travel rules that are attractive to customers, meet financial objectives, and are responsive to competitive threats. Constant interaction with Revenue Management (RM) is critical in order to determine what’s selling and what’s not. A Pricing Team member will usually monitor conditions in a group of markets that have a similar geographic focus or that have similar customer segmentation characteristics; e.g., business routes. Constructing and filing fares is an extremely complex endeavor as the rules and file structures that have evolved over time are not typically “user friendly”. Once a set of fares is “constructed”, most are filed with a clearinghouse called ATPCo, then are made available for sale via various channels with the assistance of the airline’s E-Commerce Team.
Pricing Apps – There are a number of vendors that offer pricing software packages. Most pricing software facilitates construction of fares and fare rules, filing of fares for various sales channels, and monitoring competitive pricing moves. The volume of pricing transactions made by even a small airline necessitates digital solutions.
Revenue Management Team – The RM Team attempts to increase revenue from an existing customer base by controlling how many seats are sold at each fare level on a given flight on a certain date for different types of customers. They also ensure that flights have neither too many empty seats nor too many oversales. This is done by forecasting demand using sophisticated forecasting technology. RM analysts can monitor advanced sales trends by fare class for any given flight. They can then open or close the fare “buckets” (classes) depending on demand. Lower fare buckets sell out first. If the analyst believes there is adequate demand for the flight, the lower bucket(s) will be closed, compelling passengers to purchase the next highest fare class. Whether it’s done automatically or manually, the process involves accepting the “best” passengers; i.e. those passengers willing to pay the most. There’s a lot of art and science involved in knowing how many seats to allocate to each bucket so that up-selling occurs on higher demand flights. The “art” of RM requires that an analyst possess a deep understanding of each market’s sales characteristics. The “science” involves evaluating and trusting (or not) the RM system’s forecast of demand for the flight and the many variables that influence it. It’s a tricky problem because each flight has different demand patterns by day-of-week, season and for special events.
The RM analyst measures results of their actions through a series of metrics. Some, but not all, of the key metrics are:
- Revenue target attainment – Is the forecast revenue being obtained at the route and network levels?
- High yield spill – The selling of too many discounted seats early in the booking process and turning away high yield (or full fare) passengers later on because the flight is sold out.
- Low yield spill – The protection of too many full fare seats early in the booking process and turning away low yield passengers with the result that the flight departs with empty seats which could have been filled.
- Spoilage – Flights departing with empty seats even though the flight had zero seats available for sale at some point on the booking curve prior to departure.
- Overbookings and Overbooking Rate – Ticketed passengers bumped from a flight because not enough seats were available at departure due to overbooking. The rate is often measured as denied boardings per 10,000 enplanements. Regulatory authorities are cracking down on this practice with stiff penalties, especially in Europe. Nevertheless, airlines overbook flights, in a very measured way, to prevent spoilage.
- Posted Leg Load Factor measures the load factor on flights that sold out at any time prior to departure.
- Managed Leg Load Factor measures the load factor on flights where a discount bucket was closed at any point in the booking curve thereby turning away low fare passengers.
RM Apps – There are also a number of excellent RM systems available to airlines from a variety of vendors. Automated processes are critical in RM. No person(s) can reasonably track and forecast the booking trends by flight, fare type, day of week, and season. Most RM analysts manage a group of like markets, often with multiple daily flights on a route, and with schedules filed as much as 11 months in advance. RM systems are designed to handle this task. Most RM apps are “learning systems.” That is, they can track and learn trends over time at a very detailed level and make forecasts of the expected bookings. The systems recommend actions for the analyst to consider based on booking trends. The analyst can accept or override the recommendations. This does not make the analyst’s job easy as no forecasting system is perfect and frequent intervention by an astute analyst who understands their markets is often required. It’s important to note that there are two basic types of RM systems – leg-based or origin-destination (O-D). Leg-based are typically older RM systems that help manage bookings looking only for what occurs on a given flight segment, or leg. These systems do not adequately handle the impacts of connecting passengers or passengers on multi-stop flights. The newer O-D systems are designed to handle this by considering the revenue impacts of the passenger’s complete booking from origin to destination. The systems also help determine if a given fare should be offered for sale to a customer at a point in time or whether it is likely that a higher yielding customer will buy that seat at a future date.
OTHER KEY FUNCTIONS IN THE PRM PROCESS
In addition to Pricing and RM, the PRM Team requires resources dedicated to other key functions:
Revenue Forecasting – Any good airline must have a detailed operating plan and budget that builds up a revenue forecast from the proposed flight schedule for the coming year. The PRM and Planning-Scheduling teams need to manage their performance against this plan. More advanced PRM groups will dedicate resources to developing revenue forecasts at a very detailed level, tracking performance against budget, and making adjustments to the forecasts when the inevitable changes to plan occur, or unforeseen external events transpire.
PNR Cleaning – Yes, every PRM group needs a cleaner. In this case, it’s a resource to ensure that the inventory of seats available for sale is not contaminated with spurious bookings. Passenger Name Records (PNRs) are the electronic records created when a passenger books a flight. Believe it or not, with all the sophistication in the booking process, there are still ways for entities to book and hold seats that do not conform to the booking rules; i.e. they are not valid PNRs. Several types of cleaning software are available that must be frequently run against all the PNRs held by the airline. Improper PNRs are either cancelled or moved to a queue for manual review and intervention. This action ensures that the RM team has as clean a record of seats available for sale as possible. Too many improper PNRs give RM analysts a false picture of a flight that could result in excessive spoilage and reduced revenue.
Specialty Functions – the rest of the PRM Team –– other key functions requiring dedicated resource typically include:
- Ancillary Revenue plus Bundled and Unbundled Fares – Ancillary revenue options have become so important that they must be linked to overall pricing strategies. Ancillary revenue now accounts for, on average, 5% to 15% of total revenue generated. Like it or not, ancillary revenue is here to stay and requires careful consideration in an airline’s revenue plan. Two pricing strategies evolved as ancillary revenue became a major revenue source – bundled or unbundled fares. Bundled fares resemble traditional pricing. The passenger pays one price and gets access to a variety of benefits such as preferential seating, early boarding, etc. Advocates claim that this is an easier, less-hassle approach for the passenger. Unbundled pricing involves paying separately for each of those items. Unbundled pricing advocates tout the fact that the customer pays only for those features that they truly want. Thus, ancillary revenue compels an airline to adopt a strategic pricing philosophy.
- Group Sales – Can account for a small, but meaningful, amount of revenue. Groups usually travel at low yields and can be used to build booking volume on lower demand flights, if managed properly. RM and Group Sales must constantly ask each other if the seats a low yield group would take can be sold individually at a higher yield. Groups should rarely display higher paying customers.
- Vacation – More airlines are offering their own fly-drive-stay packages. Customers can self-package all the elements of a vacation on the airline’s website and often with a discount. Again, vacation packages must be carefully fit into a PRM strategy so that they do not displace higher yield bookings.
- Convention/Meeting and Corporate Sales – Many airlines operate in markets where providing incentives for passengers to travel to conventions or large business meetings merits attention. The degree of discounting is closely linked to the timing and location of the event; i.e. an event held in the low season for a particular destination will likely be offered deeper discounts than an event at a high demand period. Corporate Sales and Support is typically a help desk for business and individual travel agencies with which an airline has a relationship.
- Revenue Accounting – this function typically resides within an airline’s finance group but it must be closely linked to PRM. I once managed a PRM Team where Revenue Accounting was integrated into our organization. Here’s why. Simplistically, revenue accounting reviews all sales activity, accounts for the revenue once a ticket is flown, audits sales processes, and ensures that the revenue is posted to the airline’s general ledger. Revenue Accounting not only serves a financial function, but it becomes a repository of key revenue data. Airlines that recognize the power of the “revenue cycle” also recognize the power of information from the accounting system that can be used by the PRM Team. The revenue cycle is simply the process of setting prices, selling tickets, flying the itinerary, accounting for the revenue and measuring what types of fare products are selling well. The resulting data is provided to the PRM Team to make pricing adjustments that facilitate better sales. The faster this revenue cycle “spins”, the faster the Pricing and RM groups knows what is, or is not, selling. They can then adjust their sales strategies. Astute airlines can compress the revenue cycle down to a few days, or perhaps even a few hours. Unfortunately, many carriers don’t understand the power of timely information and have revenue cycles of several weeks.
PRM also maintains close ties to other commercial functions. Network and schedule planning determines where and when to fly. They establish how many seats will be available for sale in any given market. Thus, it is critical for PRM and the Planning-Scheduling Team to stay closely aligned so that appropriate amount of capacity is deployed. Too many seats in a market generally means that fares will be set low to fill seats. Too few seats, and potential revenue may be turned away.
PRM also works closely with the E-Commerce, Distribution and Sales Teams. These teams manage the “store-fronts” through which sales are made. The E-Commerce and Distribution Team takes the pricing and seat inventory data from PRM and makes it available for sale in various channels. The typical sales channels include the airline’s website, the reservation center, Global Distribution Systems (GDS) with links to travel agencies and corporate travel departments, and Online Travel Agencies (OTAs) such as Expedia, Travelocity, Opodo, etc.
Interline and Codeshare groups also interact heavily with PRM. These functions maintain the complex strategic and digital linkages between airlines so that the partners can sell each other’s seats on the flights covered by codeshare and interline agreements. Alliance-driven codeshares represent a powerful means to generate meaningful incremental sales. Codeshares apart from an alliance, as well as interline relationships, generate lesser levels of revenue and need to be carefully analyzed before they are implemented. Codeshare revenue quality (higher or lower yielding) is heavily driven by the skill of the PRM groups from the participating airlines. In many codeshare arrangements, one airline tends to have greater PRM capabilities than another and can take advantage of the situation by earning commissions as the “marketing” airline selling a lot of low yield seats on their partner’s flights. This results in lower yielding revenue for the operating airline unless they carefully manage their inventory and codeshare relationship. The selling, or marketing, carrier gets the “commission” on the sales and does not have exposure to low yield traffic on its own flights.
So, how much did you pay for that ticket? Hopefully, you now see why airline pricing, though appearing chaotic, is driven by strategies and processes designed to boost results. PRM is a very powerful tool for an airline to generate incremental revenue and profits. It’s well worth the investment in the right people, processes and systems.
As always, please feel free to contact me with questions and comments: email@example.com