Decisions Galore

How do airlines determine the optimal price for à la carte ancillaries? What about for branded fares? Should either be revenue managed? As airlines start to think like retailers and become more sophisticated in selling and fulfilling ancillary offerings, the next evolution is to take a more methodical approach to applying commercial planning decision support to their merchandising strategy.

During the last 10 years, airlines have continually evolved the way they earn revenue and compete. Downward pressure on profits from rising fuel prices, the growth of the Internet sales channel and the continued emergence of new low-cost carriers as well as other factors have, in many ways, forced airlines to consider acting more like a retailer. This means not only offering flights to the right place, at the right price and at the right time, but also focusing on smart merchandising, striving to offer the best additional or complementary products and services, and putting the right set of products and services at travelers’ fingertips.

In the beginning, this meant unbundling what had traditionally been offered as part of the fare and, instead, offering these items for an additional charge. As airlines continued to progress, the types of ancillary revenue streams grew from ticket-related ancillaries (such as booking and change fees) to flight-related ancillaries (like checked-bag fees and premium seats) to even offering third-party ancillaries (non-air travel or co-branded travel offerings such as travel insurance).

But how do airlines determine what should be offered, and what to charge for these new services? The addition of these new revenue streams means exponential growth in the number of products and services offered by airlines. As a result, already complex commercial planning decisions become even more complex due to the growth in data surrounding these offerings. This, combined with the fact that many industry standards are still being defined and adopted, is leaving many airlines without the ability to optimize this rapidly growing piece of revenue.

The Opportunity

As an industry, a surge in ancillary revenue continues, both in terms of the overall monetary amount and in the number of carriers that are identifying and including it in their annual reports. Unfortunately, airlines currently only have limited manual control and optimization of this important revenue stream. Billions of dollars are not being optimally revenue managed in terms of the price presented to the consumer.

Optimizing this new source of revenue is a complex, multi-dimensional problem for many reasons. It’s not only critical to offer flights to the right place, at the right price and at the right time, but also additional products and services to the right customer, at the right price and at the right time during the travel experience.

The expansion of merchandising and the retail movement within the airline industry offers carriers new opportunities to grow their revenue. While at the same time, the tools and data to maximize these opportunities are not yet readily available. Many airlines are still experimenting with their ancillary offerings, which means new products are continually being introduced and existing products are evolving at a rapid pace. Airlines are also limited in their ability to monitor competitors in this area, which can make market responses untimely or uncoordinated. In addition, merchandising touches many parts of both the airline and the customer experience, further adding to the complexity.

When looking specifically at pricing and revenue management of this new source of revenue, the problem can be especially challenging. Creating a demand forecast for revenue managing ancillary offerings is a different, more complex mathematical problem from what has traditionally been solved. To tackle this new problem, airlines must consider many more interactions and components.

Decision-support Problems And Solutions

Airlines face an array of merchandising-related decision-support challenges from strategy through reporting. Sabre AirVision will address these issues to assist airlines with their end-to-end merchandising strategy.

Despite the challenges, there is an opportunity to take a more methodical approach to merchandising that can deliver even more revenue.

Decision-Support Continuum

As airlines advance their level of sophistication around merchandising and their expanded role as retailers, there is a logical continuum they should follow. In the beginning, they will focus primarily on defining their merchandising strategy. A carrier needs a coordinated and planned merchandising approach with buy-in and support from all areas of the airline. To define this strategy, they should determine which:

  • Ancillaries to offer (including product, pricing, etc.),
  • Merchandising model to use,
  • Systems, processes and organization should be in place.

This foundational information will help guide airlines in determining their strategy for merchandising. It’s critical to get it right in the beginning. Without an effective strategy that defines which ancillaries to offer and the merchandising model that will be used to present them to the market for sale, the optimization of these offerings will be critically flawed.

The next logical step is accessing and utilizing data. As already discussed, the introduction of these new merchandising offerings has exploded the amount of data now available for carriers to consider and analyze. Data is required to build decision-support models, and industry standards, such as EMD enablement and ATPCO’s Optional Services formats, will help drive better data standards. This allows airlines to benefit from the insights that can be gained by looking across all sales channels in their planning activities. Airlines should think about:

  • How to properly account for ancillaries and leverage that data,
  • Which ancillaries their competitors are offering, and how they are priced,
  • How demand will likely fluctuate given marketplace changes.

With access to this industry standard data, reporting is the next reasonable advancement. Standard and ad hoc reports and alerts using business intelligence will then allow for some foundational types of decision-support optimization and answer specific questions, such as:

  • Does the data available give insight into the success of the merchandising model?
  • Are there opportunities to drive additional revenue?

With the building blocks of strategy, data and reporting in place, an airline can then progress to true merchandising decision support such as forecasting, modeling and the optimization of ancillary revenue. At this point, the objective would be for airline executives to address more-sophisticated questions, such as:

  • How much should they charge for branded fares, and what should the price differential be between brands?
  • How should they price à la carte ancillaries?
  • Should they revenue manage branded fares the way they revenue manage traditional fares?
  • How should they revenue manage ancillaries? Does the price vary closer to the departure date or for different types of customers or markets?
  • Do they need new inventory and revenue management systems?
  • How do they plan for enough onboard inventory to support their strategy?

Merchandising Continuum

As airlines advance their level of sophistication around merchandising, there is a logical continuum they should follow. Sabre AirVision has defined decision-support capabilities across the commercial space to help airlines follow the continuum.

Pricing And Revenue Managing

The existence of ancillaries and branded fares changes traditional pricing and revenue management models. The optimization of à la carte ancillary pricing is approached slightly differently than that of traditional fares. Approaches to pricing can vary from less-sophisticated, judgment-based approaches to more-sophisticated, data-driven approaches. These include:

  • Expert judgment — Estimate initial prices based on experience and intuition.
  • Competitive match — Monitor competition and evaluate, based on market share and market position, which price to offer.
  • Test and learn — Launch product pricing and monitor and adjust based on customer behavior.
  • Data-driven optimization — Utilize customer segmentation, customer surveys and other tools to optimize products and their pricing.

By taking a more methodical and data-driven optimization approach, airlines can realize the maximum amount of revenue benefit from their merchandising strategy. A separate pricing model for ancillaries optimizes the pricing of individual offerings and ensures the price structure remains optimized over a period of time, or whenever a new ancillary is introduced. A simple example of this would be for a carrier to vary the checked-bag fee charged to a customer based on the time of day, day of week or O&D market.

As well, the pricing of branded fares provides new challenges for airline merchandising strategies. The key challenge is how to best price a “base” branded fare, ensuring that the individual ancillaries or attributes that make up the branded fare are not offered at a lower price if purchased individually. In addition, the integrity of price points from one branded fare to another is a significant issue. As the price for one branded fare changes, it’s critical to have a method in place to adjust other branded fares accordingly.

To more closely analyze these issues, the research team at Sabre Airline Solutions® has created a tool to optimize the pricing of individual ancillaries as well as the grouping of branded fare bundles. It utilizes customer surveys and historic buying behavior to determine a customer’s stated preference, or “willingness to pay,” for an ancillary based on attributes such as customer type (business versus leisure), flight length, current seat usage on the flight and the number of days until departure. The data points gathered are then used to calibrate a willingness-to-pay model that provides a calculated estimate of what consumers would potentially pay for certain ancillaries. Based on experience consulting with carriers, the research team estimates that developing effective branded-fare product design and pricing can improve an airline’s profitability by 2 percent or more.

Like pricing, inventory-control decisions also require a different approach for ancillaries and branded fares. Inventory control decisions for one branded fare need to be coordinated with other branded fares to maintain the pricing integrity between the different branded-fare levels. In addition, a carrier’s revenue management practices should recognize the revenue contribution of ancillaries to make optimal inventory management decisions.

Using data generated from the model, airlines can forecast demand for an ancillary, such as an aisle seat, and calculate the optimal price based on that demand, price elasticity, days to departure and remaining inventory. This approach is similar to how airlines revenue manage their current seat inventory and is a natural extension into the merchandising of ancillaries today.

However, distributing ancillary pricing information to the market in bulk has been difficult at best. New capabilities will enable the automated uploading and downloading of ancillary pricing data, as opposed to the manual individual process today. In addition, Sabre Airline Solutions has been working with ATPCO on enhancements that will make possible high-volume modifications to Optional Services records. Other capabilities would permit airlines to evaluate the structure and pricing of competitors’ offerings.

Partnering For Success

With so many options available in the pricing and revenue management of ancillary and branded-fare offerings, airlines need an experienced IT partner with a comprehensive understanding of commercial planning, such as Sabre Airline Solutions , to optimize their opportunities. Merchandising touches many areas within an airline, and having a partner with the same holistic view is incredibly valuable.

The partner should also have a global view and level of experience. Airlines around the world are evolving their business models in a variety of ways based on offering à la carte ancillaries and branded fares. Carriers can leverage that experience to approach problems in new ways.

It is critical that a partner also possesses expertise in formulating and solving complex decision-support problems in pricing and revenue management.

This includes a thorough understanding of customer choice-based modeling, which breaks any decision down into multiple attributes. By combining these attributes and weighing them differently in varied environments, choice models can mimic passenger preferences and simulate the entire decision-making process that customers experience. In the airline industry, it is a very useful technique to figure out why passengers choose specific flights and itineraries.

Sophisticated Data-Driven Approach

Approaches to pricing ancillaries can vary from less sophisticated judgment-based approaches to more sophisticated data-driven approaches.

Solution In The Making

An increasingly large portion of airline revenue comes from ancillary offerings. Today, this revenue is not being optimized through traditional pricing and revenue management activities.

Optimizing ancillary revenue means undertaking the planning, pricing and revenue management of these revenue streams in a smarter way. Similar to traditional fares, science must be applied to ensure an airline gets the most out of its merchandising strategy and products.

Sabre Airline Solutions is continually working to help airlines meet the new challenges presented by merchandising and their transition into retailing. The Sabre AirVisionMarketing & Planning team is investing in decision-support capabilities across commercial planning to help airlines in this area. New capabilities will be developed and introduced in the areas of strategic commercial planning, pricing, revenue management, revenue integrity, and onboard catering and provisioning.

Much like what happened 30 years ago, when the principal of revenue management was introduced to help airlines decide what prices to offer, the optimization of ancillary revenue will become foundational and required to effectively run an airline in the months, years and decades to come.

Despite the complexities, airlines are beginning to think and act like retailers. As technology and business processes evolve to support this new strategy, the optimization of ancillary revenue and the introduction of decision support for à la carte ancillaries and branded fares provides a substantial opportunity for capturing a larger share of revenue in an increasingly competitive market.

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