Airlines IndustryYield Management

Ken Homa

Airlines IndustryChallenging Environment

• Complex, interconnected network

• Thousands of dynamic prices

• 90% discount prices20% pay less than half of average2/3’s 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 IndustryPassenger 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 IndustryFundamental Economics

• Variablize the fixed costs…Source services & personnel

• Streamline offerings…Precisely match segment’s 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 PeopleExpressAA 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 IndustryPerformance Metrics

Fly full with high paying passengers

Airlines Marketing

• Network routing

• Capacity planning

• Flight Scheduling

• Yield Management

Network Routings

• Point to pointOD pairs (origin - destination)

• Originating & continuation flights

• Hub-and-spoke connections…Roughly 2/3’s passengers arriving

at a hub connect to other flights

Capacity Planning

• AggregateSeats and configurations

• Route-specific Through flight considerations

• Load factorsThe 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

DisplacementDisplacement High price customer rejected in favor of low price customer

Usually undesirable, but not always

DilutionDilution Price insensitive customers pay lower prices

DiversionDiversion Customer is shifted to an alternative available flight

SpillageSpillage Customer turned away because of capacity limits

SpoilageSpoilage An empty seat on departure

Jargon

CancellationCancellationRoughly 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

OverbookingOverbookingAccepting more reservations than seat / fare

capacity on a flight

OversoldOversoldConfirmed passengers are denied boarding

on a sold out flight

OverbookingThe ‘No Show’ Issue

• On average 15% of confirmed passengers don’t 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)

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

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

Fares AllocationFundamentals

• ‘Fence’ to minimize dilutionAdvance purchase, minimum stay, etc.

• Equalize expected marginal revenueRestrict ‘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 availableAccept 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 IndustryYield Management