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This is part one of a two-part series. Read part two, Airline Pricing, Revenue Management AND Ancillary Pricing – 3 Processes that Need to Work Together.
The most recent issue of the Journal of Revenue and Pricing Management (JRPM) features multiple articles on the relationship between “pricing” and “revenue [or inventory] management.”
In my experience at U.S. airlines, “inventory management” received much more attention than pricing (rules, etc.).
At international airlines, however, pricing seemed much more important than relying on algorithms to optimize seat allocations.
Obviously, the two roles work together. Nevertheless, each becomes more useful than the other in certain circumstances:
Pricing: Sophisticated segmentation using fare rules. Defines low fares to fill seats with restrictions that limit purchase by less price sensitive passengers (dilution risk). Defines high fares that exploit higher price insensitivity by certain customer segments. Can lead to confusing or complex fare proliferation.
Revenue/Inventory Management: Allocates seats to low fare passengers only up to the point that higher fare passengers are not expected to fill them. Reserves seats for forecasted high fare demand. Generally results in gradually increasing selling fares in days and weeks before a flight.
The two must work together on both the lowest fares (proper restrictions, limited inventory) and the highest fares (maximum fares, “just enough” inventory).
When One Process Overrides the Other
Perhaps one way to see the unique value each process provides is to focus in on when each “trumps” the other.
For example, a fare rule might be 21 day advanced purchase – at 21 days, the fare is $99 while at 20 days it rises to $149. This happens whether or not inventory controls projects all of the remaining seats will be full; the selling fare rises independent of remaining demand.
"U.S. airlines often operate with fewer restrictions given the competitive presence of low cost carriers. They seek high load factors and rely heavily on inventory controls to optimize the allocation of seats. Some international carriers face lower LCC competition and apply fare restrictions more strategically."
On the other hand, the $99 21-day fare might not actually be available at 21 days if inventory controls indicates all of the remaining seats can be sold for higher fares; with strong forecasted demand, the selling fare could jump to the next fare level even before the advanced purchase rule prevails. Pricing may file multiple 21 day fares, for example $99 and also $109 and $129 -- additional “sell-up” fares -- that can be used by the inventory management system in high demand situations.
- In lower demand situations, pricing is critical.
- In high demand situations, inventory controls is more important.
U.S. airlines often operate with fewer restrictions given the competitive presence of low cost carriers.
They seek high load factors and rely heavily on inventory controls to optimize the allocation of seats. Some international carriers face lower LCC competition and apply fare restrictions more strategically.
How They Work with Greater Demand Uncertainty
Each process adds different benefits in a highly uncertain demand environment when demand forecasts are unreliable (like the past 18 months).
Pricing’s work on segmentation translates into fares charged to different market segments with different degrees of price elasticity independent of total demand; Pricing likely adjusted its estimates of price elasticity somewhat over the past year but still filed business fares that are multiple times that of the lowest leisure fares.
Inventory Controls can use more simplistic inventory controls when demand is uncertain, raising fares when booked demand hits different thresholds.
For example, they can impose a business rule that low fares disappear at a 50% booked load factor and only the highest fares are available when the booked load factor reaches 90%. In this way, prices fluctuate even without an explicit, precise demand forecast.
When They Don’t Work Well Together
The above describes how each process works together in different ways to drive more revenue for airlines. There are two situations, however, when Pricing and Revenue Management appear at odds:
- Too granular pricing: "unforecastable" subsets of demand.
- Not granular enough pricing: clustering subsets with differing elasticities
When Pricing is separate from Inventory Control, Pricing may establish a fare that is never actually made available by the system.
Say, Pricing determines, based on its analysis of elasticity, there should be multiple levels for 14-day advanced purchase fares, including multiple sell-up fares.
If the observed demand for the sell-up fare levels are small and volatile, however, the inventory control system tends to bundle all of the “buckets” of demand into the demand for the lowest 14 day fare -- and never offer the sell-ups to customers.
Pricing’s more granular sell-up analysis is ignored. Ideally, Pricing would include “forecastability” in fare segmentation – which is possible if machine learning is incorporated in setting fares.
Another example of a disconnect is when Pricing is not granular enough. Passengers who book between one and two weeks out from the flight-date could easily be either business or leisure passengers; as such, they are likely to exhibit a range of elasticities or willingness-to-pay.
In many cases today, the systems would offer the same fare to both types of passengers.
"When Pricing is separate from Inventory Control, Pricing may establish a fare that is never actually made available by the system."
If, on the other hand, Pricing could establish “rules” that differentiate business bookings from leisure bookings in this period, perhaps the fares offered could vary within a range, say from $109 to $139 based on certain booking or passenger attributes, instead of a fixed $129.
(Many airlines are now exploring a process for charging a range of fares based on artificial intelligence; studies of “continuous, personalized pricing” have shown that the mid-booking range, including 7 to 14 day advanced purchase, has the most potential for improved airline results).
The JRPM issue highlights an ongoing issue – and a new opportunity for Pricing and Inventory Controls to work even more closely together. Each process plays an important role in optimizing airline revenue.
Of course, there is now a new tool for revenue optimization in addition to Pricing and Inventory Controls – Ancillary Pricing. Ancillary pricing can be used to solve each of the disconnects described above as well as add completely new customer segmentation possibilities. In modern airline commercial operations, Pricing, Inventory Controls, and Ancillary all need to be integrated.
Tom Bacon is an airline industry consultant based in Denver, Colorado. With 30 years experience in a variety of travel companies and business situations, he has a track record of dramatically improving profitability through innovative revenue strategies.
