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Embry-Riddle Experts Reveal Airfare Secrets
Chances are, you'll come up with as many as 20 different fares. You also may risk starting a mutiny. The truth is, airline fares go up and down more often than planes at Chicago O'Hare. In fact, it's been estimated that airfares in the US change at least 80,000 times a day. Ever wonder why? My quest to find out started last July 15 with a call to Atlas Travel in Daytona Beach, Fla. I asked owner Don Franchi to find the best round-trip fare Aug. 12 16 from Orlando to Washington. His computer turned up eight airlines that could do the job -- offering a total of 208 different prices ranging from $166 to $1,960! An airline seat is a perishable item. If it's empty when the plane takes off, the chance to make money from it is gone forever. That reality keeps the airlines' attention very focused. Over the years, they've devised a complex set of marketing tools designed not only to help them sell seats but to make the most money possible on each seat they fly. The concept of yield (or revenue) management, the airlines' name for this practice, is as old as the haggling in a village bazaar. The objective is to maximize profits by selling products to the right customer at the right price at the right time. It's getting the most buck for your bang by targeting segments of a market.
Pressure to deregulateTicket prices used to be tightly regulated by the now-defunct Civil Aeronautics Board (CAB). All seats were "first class," and the same price was charged for comparable flights by all airlines. Then in the late 1940s, "coach" class fares were phased in, but price competition was still off limits. Airlines competed by offering extravagant services, and coach prices gradually crept up.In the early 1960s, the CAB approved new fares for time of day, length of stay, and tour packages. In the late '60s, airlines introduced midweek and weekend fares on certain routes to boost demand for less traveled flights, as well as different seasonal fares. By the early 1970s, low-fare travelers were filling the planes -- and the coffers -- of intrastate carriers in California and Texas that were exempt from federal fare limits. Pressured to allow more discount travel, the CAB let charter airlines offer new types of fares. In 1976, charter airlines offering fares as low as $99 in the busy New York-Florida market were lobbying the CAB to let them sell seats to the public without the required ground package. This mounting pressure for more low fares forced the government in 1978 to quit regulating prices. It also kept the big airlines' brass awake at night, worrying that they could never sell seats as cheaply as the charters. But then marketers at American Airlines realized that, with their planes flying half-empty on average, they already were producing seats costing close to zero. All they had to do was find a way of selling them at the prices the charter airlines charged, while preventing passengers who would have paid the higher fare from switching to the lower fare. Their plan for doing this was the first step in modern yield management.
Two kinds of travelersAirline customers come in two varieties: price-sensitive leisure travelers, who are willing to delay a trip until they've found the lowest price, and time-sensitive business travelers, who will pay a higher price to have a seat available for them at a moment's notice.Within these two categories, airlines have a price for everyone. They offer special fares for senior citizens and government and military employees. Other prices are pegged to when a flight is booked; fares rise steadily at 21 days, 14 days, seven days, and three days from departure. The steepest prices are charged for fares sold at the last minute, usually to business travelers, and for fares that are changeable without penalty. To stimulate demand during slow times or on less-traveled routes, carriers also run sales, which are quickly matched by their competitors. The cheapest fares are often limited to a few seats on the most popular flights. Airlines subsidize their leisure travelers by charging business travelers as much as possible. The ideal market has a good mix of business and leisure travelers. In fact, the business travel market can determine where an airline flies, and how often. Las Vegas and Orlando, the nation's top two tourist destinations, have each seen a recent decrease in the number of airline seats flying into and out of their airports. Daytona Beach was served by five major airlines until Martin Marietta pulled out of the area in 1990, taking its business travel with it. Now only two airlines remain. "When USAir pulled out, they had an above average load factor, but most seats were filled with leisure travelers," says Bijan Vasigh, associate professor of business at Embry-Riddle.
Juggling actsThe question airlines face is: how much is enough, how much is too much to charge?Airlines start by estimating the cost of each flight. They do this by tallying direct operating costs, such as crew salaries, maintenance, insurance, the aircraft, and fuel, and indirect costs, such as advertising, the reservation system, and travel agency commissions. "Add these up and you have the basis for what to charge customers," says William Cheek, associate professor of business at Embry-Riddle. Using data on how much each seat earned on flights as far back as three years, an airline's yield management software calculates the probability of selling seats at several fixed price levels, called "fare buckets." Starting 11 months from a flight's departure date, a certain number of seats are allocated at each price, and as departure draws nearer, they're moved from one bucket to another, depending on how well the flight is selling. "We try to manage our product scientifically, to go after passengers who will pay us the most for it," says Greg Naccarato (BSAA'92), a senior analyst at Northwest Airlines. "When an airline decides to move seats from one fare level to another, you can see it happening on the computer screen right before your eyes," says Franchi at Atlas Travel. An airline uses four basic tools to ensure that each seat earns the most money possible:
Although most flights match historical projections and are managed automatically, yield analysts regularly "educate" the system to allow for events, such as an upcoming convention in New Orleans or wildfires in Florida, that weren't in the forecast. Each decision affects only a small number of seats, yet the payoff can be staggering. American Airlines has estimated its yield management staff contributes $500 million a year in incremental revenue.
A complex puzzleTypically, 40-70 percent of the passengers on flights going into or out of a hub airport are traveling on multiple-leg itineraries. Yet standard yield management systems don't recognize that it could be more profitable to accept a lower-fare connecting passenger whose multiple flights add more revenue to the network than a "full-fare" high-yield passenger traveling a short distance or on a single flight leg.
"An airline can face a situation in which it would be better to sell a scarce seat to two local passengers than to a longer-haul connecting passenger," Belobaba says. "For example, on a Phoenix-Miami flight that stops in Dallas/Fort Worth, an airline would make more by selling the same seat on the two flight legs to two local passengers paying $320 and $370, respectively, than to a single connecting passenger paying $480." O-D programs are turning yield management into a complex puzzle. "On a Boston-Atlanta leg, a carrier may have only 10 fare classes to look at," Belobaba says. "But with O-D control, you're also looking at 50 itineraries connecting with other legs. Suddenly, you're faced with 500 seat allocation decisions. The challenge is to design systems that will calculate all these variables and respond quickly."
Frustrated with fares -- or choices?People find it frustrating to call one day and get one fare, then another fare the next day. They suspect discrimination. (The airlines prefer to call it "segmentation.") They feel they don't have any control. But in fact, competition among airlines has put consumers in control of the entire process."Before deregulation (in 1978), airlines were the vehicles of the business traveler and the rich," says Simon at USAirways. "In the 20 years since, the cost of most consumer goods has increased 150 percent, while the average airfare has increased only 60 percent." With so many different prices offered on each flight, there's a fare for just about everyone. Maybe what's really frustrating is choice. By Robert Ross
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Next time you're waiting to board a plane and you feel daring, ask your fellow passengers how much they paid for their ticket.
Airlines now are taking a closer look at travelers' actual origins and destinations, says Peter Belobaba, associate professor of aeronautics and astronautics at MIT and a visiting instructor in Embry-Riddle's Executive MBA program. He advises carriers on origin-destination (O-D) systems.
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