Revenue management systems generally offer two types of inventory controls: leg-based or origin-and-destination (O&D). There are also “hybrid” options that offer airlines some of the benefits of O&D without all the complexity.
O&D vs. Leg-Based
As discussed in our introductory article, leg-based optimization uses a demand forecast by fare class for each nonstop flight, also known as a leg or segment. O&D systems forecast demand by itinerary (not flight) origin and destination, as well as fare class.
The key advantage of a leg-based RM system is that it’s easy to implement and manage. Revenue management analysts, especially less experienced ones, should have a clear line of sight between their inputs and the system’s outputs (i.e., fare availability).
Demand forecasts are easier to understand and modify, simplifying analysts’ workflow and reducing response time to demand or competitive changes.
Such simplicity makes leg-based systems ideal for start-ups, small carriers, and those selling mainly point-to-point (nonstop) itineraries.
Airlines focused on maximizing aircraft utilization are also usually better off with a leg-based system, because their scheduling may make it difficult to sell competitive connecting itineraries.
An O&D system is designed to maximize revenue across the entire route network, not just on each individual flight. O&D helps an airline select the highest-yielding mix of itineraries on a given flight, boosting the airline’s total network revenue.
"Simplicity makes leg-based systems ideal for start-ups, small carriers, and those selling mainly point-to-point (nonstop) itineraries."
O&D control also makes it easier to surgically implement market share strategies. In other words, an airline can capture more demand on a specific traffic flow without offering unnecessarily low fares to other travelers on the flights or routes involved.
O&D is also useful where the fares vary widely by point of sale, e.g., because passengers in certain regions generally have a lower ability to pay. But this means implementing an O&D system often requires significant changes to revenue strategies and targets.
RM analysts responsible for flight performance must sometimes sacrifice their routes’ performance for the good of the overall network, and sales teams in lower-yield regions must adjust to seeing their demand deprioritized in favor of higher-paying traffic.
O&D System Complexity
System complexity is probably the most significant downside of O&D. There is less “if A, then B” transparency between inputs and outputs, making it more difficult to implement a revenue or traffic strategy.
This makes it even more important for RM teams to consider potential second- and third-order impacts of any strategy change.
The revenue benefit of O&D may also be offset by increased data capture and reporting requirements and – most importantly – increased RM staffing. O&D optimization requires a larger team because flight availability and O&D traffic flows must be managed separately.
"System complexity is probably the most significant downside of O&D. There is less “if A, then B” transparency between inputs and outputs, making it more difficult to implement a revenue or traffic strategy."
Accordingly, O&D is generally better suited to large network carriers where its revenue benefit is greater than the associated costs, or airlines with lots of connecting journeys – even if those connections are distributed through a diverse network instead of a few large hubs.
The revenue benefit of O&D may be reduced if an airline feeds much of its traffic to interline or codeshare partners. This is because most carriers don’t share demand forecast or bid price data with their partners, some of which may not use O&D on their flights.
Also, most O&D systems aren’t set up to accurately estimate how much revenue an airline will ultimately share with a specific partner, as interline agreements have a wide variety of revenue-sharing rules.
The Hybrid Approach
So-called “hybrid” RM systems are supposed to offer the best of leg-based and O&D systems. These estimate the value of each O&D and fare class and compare these to the expected value of each incremental seat on a specific leg.
If a specific itinerary in a given fare class is worth more than the sum of expected values of the next seat on each applicable flight, a seat is made available in that fare class on each flight.
If not, the passenger must buy up to a fare class that compensates the airline for all the other traffic it would turn away by accepting the connecting passenger, known as “displacement cost.”
"None of these systems is a 'silver bullet' – each one must be evaluated in the context of a specific airline’s strategy and capabilities."
This approach provides more tailored availability to each O&D traffic flow according to its relative value, while retaining the administrative simplicity of a leg-based RM system.
It’s sometimes cynically referred to as “poor man’s O&D” but can be effective for an airline that has lots of connecting traffic but isn’t ready for the complexity of O&D.
None of these systems is a “silver bullet” – each one must be evaluated in the context of a specific airline’s strategy and capabilities. An airline’s commercial and technology leadership teams must be involved from the early days of system selection, and all must be fully aware of the implications before a final decision is made.
Revenue management strategy impacts many other parts of the airline organization, and it’s vital that all affected stakeholders are involved in major changes like RM system selection.