This paper discusses the practice of price differentiation in the airline industry and how airlines use yield management systems to control their different prices.
Consequently it is explained how price differentiation is realised. Emphasis has been laid on discussing whether price differentiation is discriminatory and why it should be acceptable, even if it is discriminatory. In the second part the principles of yield
management are explained and the major challenges with regards to the latest developments in electronic commerce are reviewed.
Page 4
1. Introduction
Since its deregulation in 1978 the US airline industry has been a forerunner in the use of price differentiation to maximise revenues. Robert Crandall, Chief Executive Officer of American Airlines, is credited with having coined the term 'yield management' (revenue management is often used synonymously) for the initial inventory management process put in place at American Airlines. All other major carriers followed American in the subsequent years, and today the principles of yield management are applied in the tourism industry for hotels, car rental companies and even many restaurants. Recently also consumer good manufacturers and service providers have developed interest in the practice of yield management.
2. Pricing Strategies
Pricing is one of the four key issues in both tactical and strategic marketing. Three different generic approaches, cost-based, value-based and competition-based pricing strategies exist.
Prior to the deregulation of the domestic airline market in the US, pricing was not a major concern for airlines. Tariffs were regulated and had to be authorised by the Civil Aviation Authority. In many other countries the international flag carrier received major subsidies and the rational for pricing was not directly related to profitability. For instance, some national carriers are required to stimulate incoming tourism through low airfares. Only with privatisation profitability became the key concern of most airlines and pricing strategies with a new set of objectives were developed (Doganis 1991). The most important objectives across airlines are to ensure an adequate return on assets and an attractive return to shareholders as well as to generate sufficient reserve for self-finance.
In this respect it is crucial for airlines to be explicit about short-term and long-term performance objectives, as their achievement usually requires different strategic
4 Aviation Management, Sem. 2 - 1998 U of Sydney - Paul Freudensprung
Page 5
pricing decisions (Holloway 1997). However, even in a deregulated environment pricing strategies not always are determined to maximise profitability. Other objectives like growth and increase of market share or the scope to even out fluctuations in demand might impinge on the profitability goal. A couple of sixthfreedom carriers used pricing to capture market share on international routes via their home base (Doganis 1991). In the immediate post-deregulation phase of the domestic airline market in the US, competition, particularly of new entrants was the major driving factor for airlines in their pricing decisions.
The two basic pricing strategies are differentiated in aviation are cost-related and demand-related pricing. Their rational is critical to the understanding of price differentiation and yield management employed by airlines (Doganis 1991):
For efficiency reasons most governmental and regulatory bodies are in favour of the cost related approach. This has been stipulated both by the Commission of the European Communities and the US Civil Aviation Authority. However, in practice airlines follow a demand related strategy. The reasoning behind this choice and a wide number of issues related to this approach will be discussed in the following chapters. Whatever kind of principles carriers decide to follow, it is an advantage if the pricing structure remains simple and easy to use. Otherwise the costs to train their sales staff and travel agents might reach an unfavourable magnitude (Holloway 1997).
3. Price Differentiation and Price Discrimination
In order to be able to implement demand-based pricing strategies, airlines must differentiate their customers according to what they are willing to pay for the service provided. The price of an airfare is driven by the individual customers value 5 Aviation Management, Sem. 2 - 1998 U of Sydney - Paul Freudensprung
Page 6
perception of the service (Holloway 1997). In the literature price differentiation and discrimination are often used with a different meaning, sometimes synonymously.
3.1 What are the Reasons for Price Differentiation?
There are two main reasons behind airlines differentiating the price of their services. Firstly, carriers try to shift demand from peak to non-peak periods. Secondly, carriers try to stimulate demand, which otherwise would not have been available to consume the service produced (Holloway 1997). Airlines try to exploit the different price elasticities among customers to reduce the consumer surplus and transform it into revenue for themselves (Hanlon 1996).
The service provided by airlines is perishable by nature. As soon as the door of the aircraft is shut, any seat not filled with a passenger is lost. Airlines try to reduce this 'spoiled inventory'. As a couple of authors state, airlines are willing to carry extra passengers for a very low price, as the marginal cost of this extra passenger is a meal, airport passenger charges and a little bit of fuel (Doganis 1991, Hanlon 1996). Therefore price is the incentive used to convince potential passengers to come forward and use these available seats.
However voices have been raised that the marginal costs of an extra passenger are considerably higher than the famous meal and extra fuel. Also this kind of passengers use check-in facilities, their baggage has to be handled and they incur security costs as well as purchase administration costs (Lucking 1994). Hence, it has been suggested that the variable costs for airlines are in fact higher than often calculated. This leaves the general principles of price differentiation undisputed, but it affects the magnitude of the difference of prices being charged.
3.2 How is Price Differentiation Done?
Holloway (1997) and Doganis (1991) have identified a couple of conditions that have to be fulfilled for the successful implementation of price differentiation.
6 Aviation Management, Sem. 2 - 1998 U of Sydney - Paul Freudensprung
Page 8
However, many business travellers claim that they do not value the flexibility of their tickets to the extent of the differences in fares, which can be up to a factor of seven within a class depending on the route. Therefore it is very important that each airline has a pro-active communication strategy in place to demonstrate their customers that indeed they receive fair value for money.
- Quote paper
- Paul Freudensprung (Author), 1998, Price Differentiation and Yield Management in the Airline Industry, Munich, GRIN Verlag, https://www.grin.com/document/186328
-
Upload your own papers! Earn money and win an iPhone X. -
Upload your own papers! Earn money and win an iPhone X. -
Upload your own papers! Earn money and win an iPhone X. -
Upload your own papers! Earn money and win an iPhone X. -
Upload your own papers! Earn money and win an iPhone X. -
Upload your own papers! Earn money and win an iPhone X. -
Upload your own papers! Earn money and win an iPhone X.