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Fourteen years after the ground-breaking deal between Air Canada and United Airlines that laid the foundations for today’s global airline alliances, the world’s network carriers are still pursuing the holy grail of perfect pricing.

At stake is more than just who gets how much profit from the collaboration. Only once alliance partners can develop a mechanism for pricing seats to accurately reflect supply and demand on each of their routes will they be able to develop truly efficient combined networks, in which each seat is filled at the highest possible price.

The potential benefits are enormous. Since 1992, the world’s network carriers have invested a lot of time and effort to develop three global alliances: Star Alliance; SkyTeam; and Oneworld. By working together, airlines can offer passengers more destinations at lower cost. In theory, travellers should get lower prices, a wider choice of departure times, optimised transfers and more destinations, drawing additional passengers and, therefore, revenue, to partner airlines. Partner airlines should be able to fill more seats, optimise flights and routes, and be able to reduce sales, maintenance and staff costs. In other words, it should be a win for passengers and airlines alike.

Star Alliance, embracing United Airlines, US Airways, Singapore Airlines, Air New Zealand and 14 more, carried 425m passengers last year to 842 airports in 152 countries. SkyTeam, a nine-member alliance including Air France-KLM, Continental Airlines and Aeroflot, flew 373m passengers to 728 destinations in 149 countries. Oneworld, an eight-airline alliance headed by British Airways, American Airlines, Cathay Pacific and Qantas, carried 243m passengers to 600 airports in 135 countries.

“The fundamental idea is to expand an airline’s network in a way that is less expensive than buying planes or opening routes,” says Professor Robert Shumsky at the Tuck School of Business. He identifies two types of alliance. First, the alliances between full-service network carriers and the regional carriers that supply them with passengers for their long-haul and international routes. These collaborations have become much more important as full-service carriers have pared-back or cut their short-haul routes.

Prof Shumsky argues that the driving forces behind this trend have been the rise of low-cost carriers, and the financial tribulations of US full-service carriers, which have together encouraged network airlines to specialise on the long-haul routes where low-cost carriers don’t compete. Running a full-service airline with a wide variety of route types necessitates a large number of aircraft types, obliging carriers to tie up capital in spare parts, and creating huge operational complexity. Thus, many network carriers have concluded, in effect, that it is easier to outsource the operation of their short-haul route needs to the regional carriers.

This arrangement suits both parties. “Network airlines pay the regional airlines to fly the routes, usually at a fixed rate per mile flown,” says Prof Shumsky. “A regional airline passes all of the decision making on pricing and booking to the national airline, which must seek to maximise revenue across the alliance.”

This is a big win for the regional carrier, which gets paid – even if it flies with empty seats – and which doesn’t have to carry the costs of a large and complex booking system. Instead, its management can focus on minimising the cost of its operations by operating the minimum number of aircraft types over standard route lengths.

One result, says Prof Shumsky, is that “regional airline traffic has increased dramatically”. But, he adds, “There is a lot of risk for the national airlines, because they have agreed to this payment based on capacity.” Global alliances between network carriers are “much more complicated”.

The goal of the alliance is the same. But whether such alliances work as intended is less clear. For example, they will not gain the same decision-making power. “Continental will not allow Northwest to take over its reservation system. They are competitors on some routes and partners on others.” Thus, the airlines need to find a way to optimise capacity on a particular route they both operate, but neither may want to surrender the route to its rival. In other words, their interests can conflict. “Airlines can sometimes cheat the system,” says Prof Shumsky, to optimise their own revenues at the expense of an alliance partner.

The biggest challenge for partners in global network alliances is how to split up the revenue. “This is a cutting-edge problem,” he says. “Decision support systems for alliance yield management is something airlines are working on quite hard.”

He distinguishes four models for revenue sharing developed successively by airline alliances. The first generation of pricing packages, known as “Hard Blocks,” enabled one airline to buy blocks of seats on another. But the difficulty of predicting demand prompted many airlines to adopt a second-generation system, known as “Static Proration”, under which they would share relevant revenue, typically on a 30/70 basis. But neither of these systems allowed airline alliances to maximise revenues by sending the right pricing signals, for example when demand was strong on one leg of a two-stage flight, giving scope to raise prices on that leg. That prompted the rise of “Dynamic Proration”, which fixes revenue according to a combination of the numbers of seats and the forecast demand – but still relies on forecasting.

This is why airline alliance pricing buffs are now getting excited about “Soft Blocks”. Under this system, airlines will be able to dynamically buy and sell seats back and forth, so that prices on each leg of the journey, and overall, can take account of demand.

The most exciting promise of Soft Blocks pricing is that it could open the door to network optimisation and more efficient allocation of capacity – stabilising alliances and offering bigger cost benefits to partners. That could lead to intensified competition between airline alliances.

Of course, getting Soft Blocks pricing up and running will be challenging. Airline revenue management systems are notoriously bad at talking to one another. Nonetheless, Prof Shumsky believes “it will happen in the next few years”.

Airlines and passengers alike should then begin to see the long-dreamed-of full benefits of alliances materialise. Prepare to bid farewell to all those comfy rows of empty seats on overnight flights.

Copyright The Financial Times Limited 2017. All rights reserved.
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