Everyone knows that humbling feeling when you boast to your neighbour on the aircraft how little you paid for the ticket and they smugly tell you they paid a lot less. An airline seat is the ultimate perishable commodity. So, predicting demand and optimising fares are critical activities for an airline and an area where technology now plays a crucial role.
Traditional airlines have employed revenue management systems for over a decade to determine how many seats to allot to different market segments on the same plane. In the 1990s a certain mystique developed around revenue management as the booking classes and tariffs proliferated and the techniques became more complex.
“Revenue managers got a bit ahead of themselves,” says Richard Clarke, director of Travel Technology Research, a UK consultancy.
The rise of the low cost carriers (LCCs) has shown there is a simpler way to price travel. Ironically, the big beneficiaries of the time and money spent developing cleverer revenue management systems are the upstart no-frills airlines, which are now using the technology as a weapon against incumbents.
“Traditional airlines have spent 20 years investing in this technology but the LCCs, who have spent nothing [on its development] yet need revenue management the most, can now pick it up for a song,” says Mr Clarke.
Contrary to popular perceptions, the aim of an airline is not necessarily to fill its aircraft but to maximise revenue yield. “Anyone can fill an aircraft if the price is low enough,” says Mark Darby, partner in the transportation practice of Unisys, the IT services giant.
Maximising yield is more tricky. The favoured technique of the LCCs is to hold back pricier seats to cater for business people and other “price insensitive” passengers who must travel at short notice. Michael O' Leary, outspoken head of Ryanair, Europe's leading LCC, once said his favourite passengers were those going to funerals at the last minute.
“The low cost boys have a simpler model of yield management based on two principles: the price goes up as the aircraft fills and as it gets closer to departure,” says Mr Darby.
That sounds simple but it is difficult to do in practice. For that reason, airline revenue managers study passenger statistics, computer models and a wealth of other information that may affect demand, including holidays, strikes and big sporting events.
“They will watch the Uefa [football] cup draw on the television and if any of the drawn locations match their route map they will immediately price the route at maximum,” says Mr Darby.
Most LCCs use the OpenSkies computerised reservations system from Navitaire, a wholly owned subsidiary of Accenture, the US consultancy. OpenSkies is tailored to the needs of LCCs and Navitaire has long dominated this market. The latest LCC to sign up for OpenSkies is India's SpiceJet.
Alongside features such as self-service reservations and e-tickets, OpenSkies has a revenue management system designed specifically for LCCs. OpenSkies is no longer the only option for LCCs, however. Sabre, the US reservations systems giant, recently unveiled its own revenue management product for the no frills market.
Called Low Fares Manager, it allows “restriction free pricing”, which analysts say is one of the keys to the success of the LCC model.
Traditionally, travellers had to meet numerous restrictions in order to get lower fares, such as Saturday night stays, round trip travel and minimum advanced booking. LCCs do not impose restrictions and the success they have achieved has encouraged many traditional carriers to adopt restriction free pricing, especially on routes with intense competition.
Restriction free pricing creates particular challenges and it is an area where established systems often fail.
“Traditional revenue management techniques do not work in the restriction free pricing market,” says Donna Clarkstone, head of business development for bmibaby, a UK-based LCC. It is one of the first LCCs to use Sabre's product.
The big difference between an LCC and a conventional flight is that demand is not segmented on an LCC. Business and leisure passengers pay the same price for the same product. Moreover, the higher priced seats on the LCC flight are sold only when lower-priced seats have gone.
While the LCC model attracts enormous attention, traditional carriers argue there is still plenty of mileage left in their market segmenation techniques.
Nevertheless, the rise of the internet and the growth of LCCs has increased pricing transparency and led to a decline in the number of passengers paying full fare. If not checked, this can turn once profitable routes into a loss-making ones.
“The US carriers have suffered from tremendous yield erosion because of this problem,” says Mr Clarke. Travellers know there are huge variations in fares and many will spend hours plugging different times and dates into airline websites in a quest for the best deal. “That kind of behaviour makes it very difficult to predict demand,” says Mr Clarke.
The one market that seems safe from yield erosion is multi-leg journeys, as the LCCs only fly point to point. Nevertheless, multi-leg journeys create particular headaches for traditional airlines.
Passengers trying to fly from Madrid to London with British Airways are competing for a seat with those trying to fly from Madrid to Tokyo through London on the same aircraft. If a Tokyo-bound passenger changes plans - a “no show” - the airline is left with an empty seat that could have been sold to a London-bound passenger and vice versa.
“The problem is how to allocate sufficient value to that first segment,” says Mr Darby. The Tokyo-bound passenger is more profitable than a London-bound one but traditional systems looks at individual segments rather than complete trips and fail to recognise this.
The solution lies in a new generation of origin and destination (O&D) revenue management systems that determine how many seats to allocate to different destinations at their varying fares and with varying demands and no-show rates. Malaysian Airlines recently converted to an O&D system to optimise flights through its Kuala Lumpur hub.
Mr Clarke says the ultimate goal of airlines is to use O&D techniques to move to “bid pricing” in which the ticket price is built dynamically based on demand for each flight segment. That raises the prospect of each passenger paying a unique price - and some interesting conversations as the aircraft taxis out.