Let me start by saying that dynamic pricing isn’t something new. In fact its origins go way, way back to the midst of time, when pricing was simply influenced by supply and demand.
It was a rigid model, when high demand coincided with short supply (either supply in the total market or for that particular product) then the more you could charge for the product. Easy.
The basic principles of dynamic pricing haven’t really changed since then but the variables available using advanced data and technology are starting to cause a seismic shift in the way airlines operate their business.
Dynamic pricing looks at more than just the traditional factors, and online retailers like Amazon and eBay have used this strategy to help them become the retail behemoths they are today. Hotels today also do dynamic pricing to a certain extent.
So what about the airlines? What are they doing?
Historically, airlines have always been keen to adopt revenue management technologies.
Even as far back as the early 80s they were actively bundling together customers according to various attributes - separating leisure travellers from business travellers for example.
This strategy generated additional revenue for airlines and played a big part in their success.
We know that airlines are not averse to change in technology but their revenue model has always focused on ticket pricing.
The pricing is based on RBDs (Reservation Booking Designators) and Fare Basis (an alpha or alpha-numeric code used by airlines to identify a fare type and allow airline staff and travel agents to find the rules applicable to that fare).
Airlines file the fares in ATPCO (Airline Tariff Publishing Company) according to the RBDs and fare basis. The distribution channels mostly pick the fares from this external third party to construct an offer to the customer through a Travel Agent (they generate 60% to 65% of the airlines overall business).
Airlines also file fares according to point of origin or point of sale. They tend to charge high prices to passengers who search for tickets close to their date of travel because they’re likely to be business travellers and are more willing to pay.
They adjust prices from day-to-day as capacity is limited and the future demand for flights is uncertain. Fares may rise to avoid selling out in advance, or in reverse may fall if demand drops. There are myriad options.
The ticket pricing approach however is changing, and for good reason. Who remembers the guy being dragged off the plane in Chicago last year because there wasn’t a seat available?
It made global news and was very bad PR for United Airlines.
In actual fact, in 2016 United Airlines removed nearly 4,000 passengers from their planes because of overselling. It’s not good but it’s a practice that every airline is allowed to do.
They do it is because they know that some people fail to turn up for their flight and they don’t want empty seats. They use a proprietary algorithm that guesses how many passengers are likely to miss the flight, and provides a number that fills the plane as close to full capacity without having to kick passengers off.
The algorithm takes into consideration what airlines must spend to compensate passengers who are bumped from a flight ensuring that compensation costs don’t exceed how much more they make for double-selling a seat.
It is because air travel is an extremely low profit margin business that this is allowed to continue, but it looks like things are changing.
Dynamic pricing and clever ancillary items
We are seeing a shift in the industry model and it’s being driven by dynamic pricing. An increasing percentage of revenue now comes from ancillary items. Things such as checked baggage, in-flight food, premium seat selection, extra leg room and so on.
South Korean low-cost carrier Jeju Air came up with a clever, hands-on, way to generate last-minute ancillary income at low cost.
They introduced a Side Seat offer, similar to Option Town’s Empty Seat Option (adopted by airlines such as AirAsiaX, and Spicejet).
It lets travelers purchase one or two seats next to their own in an effort to sell last-minute seat inventory. Jeju Air’s passengers can only book the additional seats at their departure airport on the day of travel and the Side Seats are priced at $10 for domestic routes up to $30 on flights between South Korea, Southern China and Taipei.
The fee for a last minute extra seat is $50 on routes to and from Southeast Asia (Philippines, Vietnam, Thailand) and Oceania (Guam, Saipan). It’s a great system.
In 2016, sales of ancillary products grew to more than $28 billion, according to research by IdeaWorks and CarTrawler. As we know, this channel is growing in importance and making a big difference to airline revenues.
The next step
Airlines need to optimize total revenue by taking this a step further. Airlines should consider each and every seat in an aircraft as a product and consider individual pricing for each seat according to the passenger preferences and capability to pay.
They should consider dynamically changing the fare according to the demand, available capacity, cost and market dynamics.
Opportunities to adopt bundling tactics and product suggestions enable bespoke recommendations for extra purchases like what is being practiced in other industries.
Once prices are dynamically changed, they should be able to report those transactions (bundled or unbundled) in to the Revenue Accounting system or Billing and Settlement Plan (BSP), the system designed to facilitate and simplify the selling, reporting and remitting procedures of IATA Accredited Passenger Sales Agents.
IATA’s NDC and One Order program will make things simpler and more efficient.
As I mentioned earlier, these tactics are used in online retail and if you add other factors such as number of checked bags, size of party, and past ancillary purchases airlines can create offers reflecting what travellers value and are willing to pay for.
With data like this, airlines are able to profile customers in much more sophisticated ways that were simply not possible a few years ago.
As in many other industries, the teams responsible for revenue management in airlines work in isolation, usually away from other departments, notably sales and marketing.
By working together they can gather the data needed to optimize revenue, but they need to make these internal changes quickly.
Some startups, are already building these solutions and working with legacy airlines to introduce dynamic pricing in 2018. They can see that dynamic pricing, granular data and customer analytics are game changers.
If other legacy airlines don’t move quickly they’ll be in danger of falling behind.
About the author...
Rajendran Vellapalath is the CEO of TPConnects