Airline Pricing: The Chess Match
Competitive Fare Evaluation And Dilution Management
To respond to competitive pricing changes, airlines should tailor their pricing based on market segments, market strength and product comparison to reduce the risk of dilution and achieve competitive pricing.
From outside of the industry, airline pricing looks random and complicated. Fares can be changed and distributed multiple times throughout the day. With so many pricing changes over multiple markets, quick and effective decision-making is imperative. So how does one determine how to react to a competitor’s pricing?
There are three key pricing concepts to keep in mind when talking about competitive fare evaluation:
- Dilution — Dilution is the difference between how much customers are willing to pay and what they actually pay. Effectively minimizing dilution is central to pricing success.
- Customer segmentation — Different customers have different travel needs. People traveling for business want more flexibility and less pricing restrictions, and are also willing to pay higher fares to meet their travel needs. Conversely, people traveling for vacations and visiting friends and relatives are willing to accept more travel restrictions (advance purchase, minimum stays) in return for lower fares. When evaluating a competitive fare, it is critical to know the type of market segment that is being targeted.
- Elasticity — Elasticity measures the sensitivity between changes in price and quantity of demand. When a change in a fare results in a high change in quantity demand, it is elastic. It is inelastic when a change in price has little effect on quantity of demand. Because airline fares change frequently, it is difficult to calculate the exact elasticity of a fare change. That said, there are some general attributes to determine elastic or inelastic fares:
- Business-type fares tend to be inelastic; lowering the fare does not result in an increase of demand to offset the discount.
- Small and remote markets also tend to be inelastic because the traffic base is too small to stimulate significant demand.
- Vacation destinations, visiting friends/relatives and student markets tend to be elastic. Lowering fares may spur more travel in general, and make some consumers shift between modes of transportation, such as from bus or train to airplane.
Competitive pricing activity comes from a variety of sources. The primary source of published fare information is fare distributors such as ATPCO and SITA. ATPCO transmits international fares on scheduled intervals through most of the day, seven days a week. Fare management tools, such as Sabre AirVision® Fares Manager, provide information on analyzing fare changes.
Time is of the essence when responding to a competitive fare, so the quicker a pricing change is identified, the more the impact will be limited.
When reviewing a competitor’s fare, there is more to consider than just the price. Analyze the associated rules, restrictions and distribution as well. Before responding to a competitor’s price, know and understand all information about the fare.
Know Your Markets
The first step to evaluating competitive fares is to understand your market. Not all markets are created equally. One way to determine and quantify a market is by relative yield and market share. Relative yield is how the market’s yield relative to the full fare in the market. To determine overall market strength, look at market share as the absolute market share. Quantifying markets in this manner provides a methodology to define the type of competitive pricing response to use.
Know Your Product
Once the market type is identified, another factor in the competitive analysis is how the airline product compares with the competitor. Many factors go into the airline purchase decision, and understanding these factors can affect how to price. Key factors include:
- Schedule — This is one of the most important factors to consider, especially in markets with a high component of business traffic. Airlines that have higher-frequency than their competitors and well-timed departures might be able to take small premiums on the higher business fares.
- Load factor — If markets are running a high load factor, there is little incentive to lower or undercut fares. If load factors are extremely high, implement small pricing increases.
- Loyalty/alliances — Loyalty programs provide incentives for frequent travelers to fly with a specific airline or global alliance. Some customers are willing to pay a pricing premium to accrue miles on their chosen airline/alliance. Airlines without a strong program may need to undercut the competitor’s fare to entice customers to change their travel habits.
- Airport/in-flight service — While schedule and price are the two key drivers in selecting a flight, an airline’s service can impact pricing. Airlines with poor service will not be able to extract a pricing premium versus a competitor that offers great service. Some airlines have a legendary reputation for customer service, and their prices reflect that reputation.
Unfortunately, there is no magic formula on how to weigh the above items, but it is easy to look at each of these factors and determine if an airline is better or worse than its competitor. If an airline is superior to its competitor in all items, it may be able to take pricing premiums in the market.
Know Your Competitor
The final component to consider is understanding a competitor’s pricing behavior. A good, experienced pricing analyst learns how a competitor airline will react to a pricing change. For example, if a fare is reduced and the competitor has a strategy to have the lowest price available, any decrease in fares will be matched. No advantage will be gained and it will cause dilution. If an airline has demonstrated it will not match a small undercutting of a fare, then taking small fare reductions might move some small market share and revenue gains.
Before a fare change is launched against a competitor, an airline must assess how the competitor will react to the pricing action. It becomes like a chess match where players not only think about their next move but their opponent’s next move, and then respond to that move. Anticipating the potential result in advance will reduce pricing churn.
When taking a competitive pricing action, it is important to measure the impact of the pricing change. One of the simplest and most-immediate measures is reviewing advance bookings. Another source is total and bookings by RBD to see if there is an increase in demand, or if demand is just shifting between RBDs. If the competitive pricing response was to increase market share, then analyze market share data to see if the share did shift.
Finally, analyzing revenue accounting data can determine yield changes. If the data is available at the fare-basis code level, measure the impact of a specific fare. Based on the result of these analyses, adjust competitive pricing changes accordingly.
Airline pricing is one part art and one part science. Blindly matching a competitor’s fare does not take into account the type of market, the market segment, or the airline’s advantages and disadvantages. Tailoring pricing based on market segments, market strength and product comparison positions competitive pricing appropriately and helps reduce the risk of dilution.