Saturday, March 06, 2010

High ticket price for peak travel - thanks to a low cost airline?

Dynamic pricing or yield management or revenue management helped airlines charge higher price from consumers booking seats at the last minute or flying a popular route at a peak period. It is interesting to note that all of this originated in response to a survival threat to the airlines from a low cost carrier!

PEOPLExpress started a low-price airline in April 1981 leveraging a lean-workforce, low cost structure, and "low-frills" - even for snacks and checked luggage. In 1983, it started a Newark-London flight for $149 each way and all flights sold-out for several months within a day. PEOPLExpress reached $1 Billion in sales in just 4 years and had become the 5th largest US airline starting from scratch. The high growth rate and the popularity were a significant threat to American Airlines and other "full-service" airlines with their high cost structure and hence high ticket price.

The typical response in this environment is predatory pricing. For example, American could have dropped the price to match or beat PEOPLExpress prices in each of the routes where they were competing with PEOPLExpress and make up the losses their with profits on other routes where they were not under threat from the low cost carrier.  But given the size that PEOPLExpress had reached, that would have been a pretty ruinous competition for the "full-service" providers.

American Airlines's response to the threat to survival was extraordinary and revolutionary.  PEOPLExpress and most carriers at that time were charging the nearly the same price for all the seats in a class in a route. In January 1985, American introduced deep discount fares across its  network without taking a significant profitability hit. American's secret was, of course, dynamic pricing or yield management.  Yield management involved the careful calculation of how many late booking, high fare, profit producing customers would come through, charging them higher, and then discounting the rest of the seats (which was significant percentage of seats in the plane) to maximize revenue. PEOPLExpress had to cut their cost (to get the mass of the flying public) or improve their "frills" (to attract the profit producing high expectation customers) or get into their own "differentiated pricing."  They tried improving their service but failed to maintain their profitability and growth and the PEOPLExpress went out of business in February 1987. In those three years (1985 to1987), American attributed 1.4 B$s in increased revenues to yield management.

The low cost airline disappeared but the higher prices for some travelers and lower prices for others that it engendered is with us even now. Yield Management has been successful in other industries but has been a challenge in others like supply chain management.

Karthik

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