Airlines Industry Yield Management

1. Airlines IndustryYield Management Ken Homa

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

3. Airlines IndustryPassenger Info • 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

4. Airlines IndustryFundamental Economics • 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

5. Airlines Industry’Low Frills’ Economics • Variablize the fixed costs • Source services & personnel • Streamline offerings • Precisely match segment’s value function • Accept lower margins • Lower relative investment

6. 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’

7. Airlines IndustryPerformance Metrics • 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 Fly full with high paying passengers

8. Airlines Marketing • Network routing • Capacity planning • Flight Scheduling • Yield Management

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

10. Capacity Planning • AggregateSeats and configurations • Route-specific Through flight considerations • Load factorsThe performance metric

11. Flight Scheduling • Customer preferences • Peaks & valleys • Connections • Planes & crews • Disruptions • Weather, equipment

12. 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.

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

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

15. OverbookingThe ‘No Show’ Issue • On average 15% of confirmed passengers don’t show up for a flight • Changed plans (without cancellation) • Double-booking • Spoilage: 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’

16. 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

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

18. 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?

19. 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)

20. OverbookingThe 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

21. Fares AllocationPricing Considerations • DilutionPrice insensitive customers pay lower prices • DisplacementHigh price customer rejected in favor of low price customerUsually undesirable, but not always • Share ShiftMovement of volume among competitive carriers • StimulationNew demand in response to lower prices

22. Fares AllocationFundamentals • ‘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

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

24. 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 availableAccept discount reservation A to C since $175 > $100

25. 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.

26. Airlines IndustryYield Management