Unbundling Airline Revenue Management

The science of revenue management in the airline industry rides on two key principles:

• There is a fixed number of resources that lose their value at a certain point (such as a seat on a flight when the flight departs)
• There are segments of customers that are willing to pay different prices in exchange for a higher (or lower) perceived value (such as price conscious vs. schedule conscious travelers)

Since their introduction (for a large U.S. carrier) in the early ‘80s, airline revenue management systems have assumed an increased level of sophistication. They have also blazed the trail for other industries such as hospitality, surface transport and cruise liners.

Most airline revenue management systems work on the principle of Expected Marginal Seat Revenues (EMSR). Simply stated, to optimally allocate the right number of seats against each passenger segment, they trade off the lower probability (and higher yield) of securing a higher segment vs. the higher probability (and lower yield) of a lower segment.

The sophistication of a typical revenue management system arises from its ability to accurately forecast (in an unconstrained manner) the future passenger demand for various segments (buckets) and use advanced operations research techniques to optimally allocate seats against each bucket using these forecasts.

Over the last 10+ years, airlines have become increasingly adept at gradual introduction of fee-based ancillary products and services. Standard offerings that used to be free with a number of carriers such as check-in baggage and seat selection now come at a price. Even mainline carriers derive up to 10 percent of their overall revenue from ancillary products and services.

The era of fare unbundling is now in full swing. But often ancillary services are offered based on a ‘one size fits all’ approach. The fees for the services do not vary by customer segment though the willingness to pay is different by segment.

But are existing revenue management systems geared to handle the granularity of options that are possible with unbundling? Will airlines be able to offer a unique product at a unique price to each customer or at least to each customer segment?

As we discussed in our earlier post, existing revenue management systems already deal with a great degree of complexity because of the number of variables that affect demand. Unbundling ratchets up the complexity several notches. Here’s how:

• When the price points are close, it is more difficult to forecast the demand against each segment
• The sheer number of products/services, multiple price points for each, and their interplay with the various passenger segments increases the complexity
• The backbone of airline bookings continue to be reservations and distribution systems that are several decades old

As revenue management becomes increasingly complex in an unbundled world, airlines could borrow a leaf or two from other industries such as banking and insurance. Leading banking and insurance companies are partnering with third-party analytics solution providers to develop effective strategies and optimize their revenues. While the sophistication of airline revenue management systems and strategies are perhaps unmatched, these other industries have leveraged analytics as an effective tool to construct their product portfolios. Acquiring or leveraging this expertise will serve the airline industry and its customers well and help create fare products that are revenue maximal and reflect the customer’s true willingness to pay.