Four issues to ponder regarding airline ancillary revenueNewsBy Viewpoints | June 3, 2011Share This article was originally published on NB: This is a guest article by Jodie Cohen, programme director at the Revenue Management for Airlines conference.Flight prices are being squeezed to an all-time low, and airlines from all corners of the globe are looking for ways to protect and enhance their revenue streams.At the same time, technology advances are making revenue management a more powerful tool than ever before.Revenue management is at the heart of all commercial airlines’ strategies, and the dynamics of today’s market makes it more critical than ever for you to have a robust understanding of your customer segments, pricing power and competition.We recently carried out an interview with Hugh Dunleavy, EVP for strategy and planning at WestJet, where part of his portfolio is the pricing and revenue management. He will be speaking at our conference in London on 22-24 June 2011.1. What do you feel are the major challenges for airlines in terms of implementing new revenue management (RM) initiatives?That is a tough question because so much depends on the local competitive environment. At the simplest level, the major challenge is isolating all the many market variables that interact to determine the outcome of an initiative.The next logical difficulty is being able to isolate the cause and effect from all the noise in the system (many moving parts) and being able to directly measure the impact of a specific initiative.2. How much of an effect is the low-cost carrier model is having on legacy carriers in terms of pricing and product offering?I believe the LCC model has and continues to have a huge impact on both the pricing and product offerings of the legacy airlines.Classically, the Low Cost carriers establish incentive fares (low prices) in the market to achieve a small profit margin.However the stimulating effect of the lower fares also leads (typically) to higher load factor operations that result in a significant PRASM that is sufficient to generate good profits for the LCC.The legacy carrier typically will match the LCC at the low fare end of the market and use revenue management to control the number of seats it sells at these deep discount fare levels.The legacy then protects a reasonable proportion of its seats for the higher fare segment (a segment that is not a traditional target of the LCC) and is able to capture a significant yield premium from the frequent business travellers.The net result is that the legacy carrier will in many cases transport as many guests after the LCC has entered the market than it did before the LCC entered the market. The stimulating effect on consumer demand grows the market for both competitors.In this environment, the legacy carrier may still generate a higher PRASM than the LCC but this higher PRASM is not as high as it was before the LCC entered the market.So although the Legacy carrier experiences similar loads before and after the LCC entered the market, the average yield extracted from the market is significantly reduced. In many cases the reduction in yield results in the Legacy carrier operating in a loss situation.Similarly, the LCCs have sometimes been able to utilise more advanced and sophisticated products on-board their aircraft that were far superior to the product and quality offering from the Legacy carriers. Some classic examples have been: Modern aircraft in the LCC fleet compared with aging (and tired) legacy fleetsImproved seat pitch on the LCC compared with the Legacy. This is probably a market specific phenomenon as many LCC’s have gone to very high density configurationsLive satellite TV at each seatOn-board services on a pay per use basis3. What tip would you give an airline looking to improve its revenue management strategy?Focus on the inputs (people, processes and technology). My experience across many airlines indicates that Organisations tend to be focused on the outputs such as daily sales and PRASM build which is largely impacted by market dynamics.It is vital that the airline really understands its own business model, what are the drivers of cost and revenue and ensure that the metrics are in place to measure those at the level of detail and frequency that is appropriate for that driver.If you don’t understand what drives your costs how can you control them? Similarly on the revenue side, does the airline really understand the nature of the business model?Is the airline an ultra LCC with an unrelenting focus on driving costs to the lowest possible level and then driving ever lower fares to continually stimulate demand and drive profits on the basis of low fares, low cost and high passenger volume?This means that the airline has to also operate at the highest level of efficiency to achieve a high degree of consistency in OTP.4. What one change or development do you believe will push revenue management forward more than any other?With the rise of the OTA market over the past ten years, the consumer has gained an increased measure of control in the market place that had previously been out of their reach.As a result, many of the tactics historically employed by airlines to maximise revenue are at best less effective and at worst not effective.Learning how to effectively operate in this environment of high transparency is one of the most critical skills that an airline can develop.This increased transparency will also force the airlines to consider the longer term impact of specific pricing actions; since the guest can now see how fares behave over time, they will learn which airlines are ready and willing to attempt to extract the maximum price from each ticket and as a result they may be willing to "punish" those airlines that prove to be too greedy.RM works best when there is surplus demand; however this is a factor that is largely outside of the control of the industry.Getting the world economy back onto a stable foundation with steady and consistent increases in GDP across all of the world economies is an obvious desired state. The recent volatility in the world economy (financial crisis of 2009, surges in oil prices, the geo-political crisis in 2011 and yet another round of oil price volatility) are not in the interests of any economy.The airline industry is unfortunately plagued by being a high fixed cost business with extreme sensitivity to external events that can quickly destroy consumer demand for air travel.Naturally certain emerging markets will grow quicker than more mature markets but this will be addressed by the growth of the local airlines to fill their increasing consumer demand. Rational behaviour by airlines focussing on return on invested capital and driving profitable operations rather than the traditional focus on market share will certainly help the industry.In this context the oversupply of airline seats that get parked during a crisis but rapidly come back into the market once the crisis is over is a classic demonstration of the profit-loss cyclicality in this industry.NB: This is a guest article by Jodie Cohen, programme director at the Revenue Management for Airlines conference. Organiser Hanson Wade is offering an exclusive 10% discount off the registration fee. Visit the conference website and quote "TNOOZ" when registering.