Airlines Industry Yield Management Ken Homa

Airlines Industry Challenging Environment Complex, interconnected network Thousands of dynamic prices 90% discount prices 20% pay less than half of average 2/3s big companies get 35-45% off 50% cancellations 15% no shows

Business / leisure split 50/50 Business: 50% passengers, 60% profits …25% of passengers pay more than 2.5 times average fare Heavy users: top 5% = 40% of trips No brand preference …for 50% of leisure and 25% of business travelers Airlines Industry Passenger Info

Very high investment and fixed costs …Equipment & maintenance …Computer systems ( reservations) …Flight Fixed: fuel, crew, airport fees Low variable cost …Agent commissions (8-10% on 85% of volume) …In flight food & beverage, incremental handling Empty seats: nil incremental cost …Fixed, highly perishable inventory Airlines Industry Fundamental Economics

Variablize the fixed costs …Source services & personnel Streamline offerings …Precisely match segments value function Accept lower margins …Lower relative investment Airlines Industry Low Frills Economics

Anybody Remember PeopleExpress? Simple strategy: low frills, low price (Too) rapid expansion No infrastructure (I/T, res system) Very low average cost, but … AA killed PeopleExpress AA marginal cost < PE average cost AA attacked with laser fars

Available Passenger Miles (APM) …Gross measure of capacity Revenue Passenger Miles (RPM) …Number of passengers weighted by distance flown Load Factor …RPM divided by APM Yield Factor …Revenue per RPM Airlines Industry Performance Metrics Fly full with high paying passengers

Airlines Marketing Network routing Capacity planning Flight Scheduling Yield Management

Network Routings Point to point OD pairs (origin - destination) Originating & continuation flights Hub-and-spoke connections …Roughly 2/3s passengers arriving at a hub connect to other flights

Capacity Planning Aggregate Seats and configurations Route-specific Through flight considerations Load factors The performance metric

Flight Scheduling Customer preferences …Peaks & valleys Connections Planes & crews Disruptions …Weather, equipment

Yield Management Overbooking Fares Allocation Traffic management Sell as many seats as possible at full fare, then fill otherwise empty seats with discounted fares that exceed variable costs.

Jargon Displacement Displacement High price customer rejected in favor of low price customer Usually undesirable, but not always Dilution Dilution Price insensitive customers pay lower prices Diversion Diversion Customer is shifted to an alternative available flight Spillage Spillage Customer turned away because of capacity limits Spoilage Spoilage An empty seat on departure

Jargon Cancellation Cancellation Roughly half of all confirmed reservations are ultimately cancelled No show No show Roughly 15% of confirmed passengers neither cancel nor show up for the flight Overbooking Overbooking Accepting more reservations than seat / fare capacity on a flight Oversold Oversold Confirmed passengers are denied boarding on a sold out flight

Overbooking The No Show Issue On average 15% of confirmed passengers dont show up for a flight …Changed plans (without cancellation) …Double-booking SpoilageSpoilage: very high opportunity cost …But only on flights with denied reservations Objective: sell-out the flight …Take more reservations than capacity in anticipation of no shows

Overbooking Overbooking only applies to a portion of all flights Overbooked not the same as oversold Overselling results from stochastic nature of no show pattern

Overbooking Costs Volunteer Inducements Rerouting costs Hospitality concessions Loss of goodwill (involuntary denials)

Volunteer Inducement Magnitude of inducement Increases with number of seats oversold Ultimate cost depends on the method of fulfilling the incentive … Space available …negligible cost, except possible fare dilution (to free) … Space constrained … displacement / opportunity cost … unless controlled Credit certificates... …Dilutive or stimulative?

Rerouting Cost dependent on fulfillment method Space available …negligible cost Sold out … displacement / opportunity cost 2nd round oversale Competitor flight … cash cost (at premium fare)

Overbooking The Number Ceiling to limit goodwill impact Estimate (and re-estimate) no show probability function Calculate expected cost of overselling …Probability of occurrence …Cost of remedial action Calculate expected opportunity cost of possible spoilage Marginal cost = marginal benefit

Fares Allocation Pricing Considerations Dilution Price insensitive customers pay lower prices Displacement High price customer rejected in favor of low price customer Usually undesirable, but not always Share Shift Movement of volume among competitive carriers Stimulation New demand in response to lower prices

Fares Allocation Fundamentals Fence to minimize dilution Advance purchase, minimum stay, etc. Equalize expected marginal revenue Restrict inventory, nest reservations access Dynamically re-estimate probabilities Link to overbooking policies … and to traffic management

Traffic Management Maximize system revenue (global optimum) … not specific segment (local optimum) Tied to inventory availability (vs. sold out) Can create favorable displacement...

Desirable Displacement A to B: full = $100, discount = $50 B to C: full = $250, discount = $125 A to C: full = $350, discount = $175 A to B is full, and B to C is available Accept discount reservation A to C since $175 > $100

Yield Management Overbooking Fares Allocation Traffic management Sell as many seats as possible at full fare, then fill otherwise empty seats with discounted fares that exceed variable costs.

Airlines Industry Yield Management