The airline industry’s relentless focus on costs is understandable in a low-margin business. It’s also the stuff of legend, like the story of former American Airlines president Bob Crandall removing one olive from salad plates to save $40,000 a year, and replacing a guard dog with a tape recording of a barking dog to keep costs down at a Caribbean station.
This focus on costs still permeates every facet of airline operations, even those behind the scenes, such as Global Distribution Systems (GDS) - the reservations systems that generate bookings and ticket sales.
But a focus on distribution costs alone has – and is – preventing airlines from getting the most out of the revenue side of the equation. As the industry has evolved, so must its distribution strategy.
A bit of history might be helpful.
History of Distribution
Distribution 1.0 (in the 1990s time frame) was about fixing cost-guzzling inefficiencies – reconciling data to invoices, finding ways to reduce transaction fees, issuing debit memos for passive segments and other inefficient booking practices, and finding ways to further “modernize” GDS capabilities (e.g., e-tickets, which, by the way, removed the paper, but kept everything else around it exactly the same).
The industry moved into Distribution 2.0 (starting in the early 2000’s) with a focus on developing B2C e-commerce platforms, such as Travelocity, Expedia and Orbitz, introducing new B2B2C channels into the distribution network, and finding ways to deliver more self-service capabilities to customers through kiosks, mobile apps, and other tools.
Distribution 3.0 is evolving the focus to revenue optimization.
"Distribution 3.0 creates opportunities to assert the power of airlines in the distribution system by walking away from both MFN provisions and FCAs. This will enable them to get closer to the goal they have always stated, but never achieved—the goal of offering the right price to the right customer at the right time."
In 1.0 and 2.0, the airlines’ cost focus handcuffed (and continues to handcuff) revenue management teams in ways that sub-optimize revenue production.
Contract clauses such as Most Favored Nation (MFNs) and Full Content Agreements (FCAs) require airlines to make the same offers available on all channels despite their inferior economics, and/or cannibalize their own opportunities to get a direct customer, thereby losing some control of the overall customer experience.
By focusing solely on unit cost, airlines have been, and are today, missing out on the opportunity to truly optimize revenue and passenger mix, along with the opportunity to direct marginal customers away from higher cost channels and on to direct channels with not only the lowest cost, but full ownership of the customer and every aspect of their journey.
Distribution 3.0 creates opportunities to assert the power of airlines in the distribution system by walking away from both MFN provisions and FCAs. This will enable them to get closer to the goal they have always stated, but never achieved—the goal of offering the right price to the right customer at the right time.
That’s crazy, airline managers might say. If we walk away from MFNs and FCAs, our unit costs will go up. In the absence of leveraging revenue management strategies and tools, that’s true.
But by walking away from MFNs and FCAs, airlines can unleash the capabilities that revenue management systems have (or can have) and will end up with better overall channel contribution.
Channel contribution can and should be the new KPI in distribution rather than the per booking transaction cost. Airlines need to perform a detailed cost of sale analysis by channel that lets them know what each channel costs, and this is more than just looking at transaction fees.
It includes a whole host of costs such as credit card fees, commissions, reservations handling fees, and more, and these need to be factored into the pricing/inventory access decision.
Rather than giving each channel credit for the gross revenue value when a shopping request is made, each channel can be granted access based on its contribution (i.e., revenue minus all of its direct costs).
This KPI is something that should be regularly tracked and adjusted each time there is a change in contractual terms with distribution technology partners or distribution partners.
How can revenue management improvements be achieved by walking away from MFNs and FCAs?
Leverage Point of Sale Controls
Point of sale controls allow airlines to make different prices and/or inventory levels available by point of sale at various levels of aggregation (e.g., by country, by GDS, by agency and/or pseudo city code, booking dates, travel dates, all the way down to the origin and destination level).
Using point of sale controls makes overall pricing more efficient. In today’s world, pricing departments, in conjunction with marketing departments, must create unpublished offers in order to comply with the terms of a full content agreement.
This requires those teams to develop an offer, try to find the right target audience, send communication pieces to them (likely with multiple reminders), and hope that they’ve created the right offer and targeted the right people so that they can fill the number of seats they want to sell.
Imagine if airline managers didn’t have to do that. Imagine if they could just put prices out in the market with the knowledge that point of sale controls would ensure the right level of contribution. Point of sale controls, by virtue of how they work, will ensure that a wider audience is reached and that customers are steered to the right channel.
"Using point of sale controls makes overall pricing more efficient. In today’s world, pricing departments, in conjunction with marketing departments, must create unpublished offers in order to comply with the terms of a full content agreement."
Customers already shop on multiple sites when they are planning their trip. By relying less on unpublished offers and measuring channels on their contribution, customers can be steered to the channels that give airlines the best contribution and minimize the need for special offers.
An airline’s direct site will always be the best-priced channel—the ultimate best price guarantee without the hoops and hassles that typical best price guarantees require.
Migrate to Dynamic Pricing
Once airlines have taken the step of evaluating the contribution of each channel, they can then move to the next step of dynamic pricing, that is, moving from the constraint of 26 inventory buckets that they use for product/customer segmentation.
With dynamic pricing, airlines generate an infinite number of fares. Every booking (along with other inputs in the revenue management system) enables airlines to determine a new price based on bookings that have been taken, dynamic displacement costs, and other factors.
Airlines can move from managing buckets of inventory to pricing that is robust, dynamic, and tailored to the correct channel based on that channel’s contribution.
"Leveraging point of sale controls and dynamic pricing in all of an airline’s distribution channels allows airlines to optimize that in ways they cannot today."
Flexibility is important. Airlines should be able to determine which customer they want and in which channel on a case-by-case basis.
In some instances, where a flight or market is significantly underperforming, airlines can open the floodgates and take traffic from every possible source, but in other cases airlines may want to be very targeted because the situation isn’t as dire.
Leveraging point of sale controls and dynamic pricing in all of an airline’s distribution channels allows airlines to optimize that in ways they cannot today.
This approach gives revenue management teams a greater opportunity to manage the inventory and respond to the full demand set in the market, not just a limited selection set which may or may not be the right audience.
We at Hospitio can help evaluate the value of the channel, negotiate the deals that give airlines the flexibility they need, and set up revenue management systems to guarantee what every airline wants: The right price, the right customer, and the right channel.
Please feel free to reach out to us at hospitio.com.