O&D-Based Control Enhances Airlines’ Revenue Potential
Part 1 Of A Three-Part Series
O&D-based control can significantly enhance an airline’s approach to revenue management. But within that O&D scenario, human issues and behavior are paramount to success.
Revenue management is a critical activity for the profitability of any airline, which means that the methods of control applied by the revenue-management department are also critical.
Many carriers have switched from traditional control methods (such as leg-based control) to O&D-based control, a more holistic approach. Managing a cutover from leg-based control to O&D-based control carries risks, but the benefits justify the change.
The opportunity to learn considerable volumes from the experiences of many carriers that have already changed to O&D-based control can substantively assist those yet to make the change.
An airline must take into account certain O&D readiness considerations, including numerous human factors such as role differences, whether the staff has all the skills needed and new measures of success, or key performance indicators (KPIs).
Historically, airline revenue-management departments have used computer software to help maximize revenue, based essentially on optimizing the individual legs of a trip as opposed to O&Ds.
Algorithms drive the decisions to open and close availability of seats at different prices, with the ultimate objective of maximizing a flight’s load factor (a percentage derived by dividing the number of seats flown by total seat capacity).
The logic behind the algorithms was intended to maximize the yield (the return of each seat sold, as measured in revenue per available seat kilometer, or RASK). Therefore, the objective of the airline’s revenue-management department was to maximize the aggregate of the individual flights.
This means airline revenue-management software has traditionally looked at individual flights, not passenger journeys. Even more pointedly, the software has not been geared to maximize the airline’s revenue from its entire route network (including codeshare flights, or flights operated by another carrier but sold by the airline) as an entity.
The relative benefits of O&D versus leg-based revenue-management control have been argued at length. In this case, the objective is to present learning points based on the experience of switching from leg-based to O&D-based control, looking at items including the difference between leg-based and O&D theory; staff capabilities and training; measures required at individual and staff levels; changes required in organization design; and role differences.
Increased Connecting Traffic
O&D algorithms will actually favor the most optimal revenue passenger, which could be either connecting to point-to-point, but the expectation is that network revenue optimization will lead to more connecting traffic.
O&D-based control is founded on maximizing network revenue, meaning the value of revenue across an airline’s entire network, including codeshares.
It can be a difficult exercise for revenue-management professionals who primarily have expertise in leg-based revenue-management control, because O&D entails that a flight should sometimes be sub-optimized (such as a situation in which the load factor on one flight is sacrificed to generate greater network revenue on other flights), and this theory goes against previous leg-based best practices.
In leg-based control, the benefits of network revenue have sometimes been underesti- mated, and now they are the primary drivers of all the micro decisions made within the O&D software.
All revenue-management specialists need to clearly understand the theory behind O&D, and special care must be taken to ensure they understand why some flights may be sub-optimized.
To overcome this risk to successful O&D cutover, holding staff-refresher training on revenue-management theory is helpful, and going through the definitions of key revenue- management terms should serve to ensure that revenue-management staff understand why decisions are made and can, therefore, understand the tradeoff that, from time to time, is necessary.
Of course, there’s also a human factor. Individuals have different abilities to adapt to change, and different capabilities to learn and fully grasp new concepts, as well as “unlearning” what was previously considered best practice.
A beneficial method of helping specialists through this change is to use real examples they can relate to, and to look at “before-and- after” scenarios.
In an O&D environment, the entire revenue-management department is measured by its ability to achieve the “revenue opportunity,” which is defined as the difference between current/previous revenue and the maximum revenue achievable in an unconstrained market.
There are several measures of revenue, and all relate to total revenue from the network, as well as codeshares, including:
- The actual-revenue scenario is based on actual sales as measured from post-departure data.
- The optimal (maximum-revenue) scenario estimates expected sales assuming optimal revenue-management controls (overbooking and discount allocation) were used to manage reservations.
- The minimum-revenue scenario estimates expected sales with an assumption that no revenue-management controls were used to manage reservations (and low-to high-value-booking arrival order).
There are several measures of revenue, all of them relating to total revenue from the network, as well as codeshares, including minimum revenue (estimates expected sales with an assumption that no revenue-management controls were used to manage reservations); actual revenue (based on actual sales as measured from post-departure data); and optimal revenue, which estimates expected sales assuming optimal revenue-management controls were used to manage reservations.
One action in an O&D-based environment is to ensure the capability to measure, record, forecast and analyze revenue from codeshare flights (although codeshares and other scenarios are dealt with in other methodology, as well). Codesharing, then, is handled differently in different revenue approaches.
Naturally, the ability to plan and make a highly valid attempt to forecast codeshare, and offline demand, is extremely desirable. Consumer-protection statutes dictate that airlines cannot speak to each other and plan flows across their networks without having antitrust immunity. By collecting the history of these journeys, it is possible for each airline to make a forecast relating to its own sales.
Having an offline forecast, as well as a revenue plan (built up over time from historical data), enables an airline to leverage the connections offered by its codeshare partners and achieve revenue that was not previously visible.
A few of the most common revenue-man- agement measures used in both leg-based and O&D-based revenue-management control are:
- Buy up — The measure of how successful a flight analyst has been in driving sales up from one selling class to a higher one.
- Spill — Points up when a flight has been sold out too quickly as a result of underestimating the volume of late-booking high-yield demand (resulting in a reduced yield).
- Spoilage — A measure of the reverse situ\ation, in which the late-booking high-yield demand has been overestimated, thereby leading to a reduced load factor.
- Overbooking — Points up situations in which more seats have been sold than the true number of seats in the cabin, which is a common practice to maximize load factor when high numbers of passengers fail to show up and board the flight.
Individual Performance Management
In individual-performance management within the revenue-management department, a primary objective is to ensure that individuals are provided KPIs and targets that relate to what they are actually able to control. Some roles have control over the demand forecast (usually referred to as a demand analyst, and others over the bid price (usually the pricing executive).
With that in mind, let’s look at organization design and the primary drivers of an O&D- based control environment.
In measuring inventory-management performance, the general criteria are to:
- Protect inventory for late-booking higher- revenue passengers,
- Avoid spilling low-fare passengers with spoiled seats,
- Overbook flights while minimizing denied boardings and spoiled seats.
The Flight Analyst Role
There are seven specific KPIs that are easily measurable and directly under the control of the flight analyst. If the analyst is successful, the results of all seven KPIs will improve, which will contribute to the department goal of optimizing network revenue. KPIs No. 1 through No. 5 are measured using historic data, while KPIs No. 6 and No. 7 are designed to be forward looking.
Organization design is different under O&D-based control, a new role (labeled the “demand analyst”) is required. Each demand analyst is responsible for a number of O&D passenger flows, and he or she manages demand forecasts for these flows.
In addition, the demand analyst is responsible for:
- Understanding the importance of forecasting (instead of allocation) via a new set of command levers and influences within O&D,
- Maximizing network revenue in assigned areas to established department KPIs and goals,
- Creating demand forecasts and short and long-term strategies for all assigned O&Ds,
- Providing accurate proactive planning for special events and holidays in forecasting and demand adjustments,
- Consistently reviewing reports to identify shifts in demand and communicate across the revenue-management team.
Then there is the role of the flight analyst, who is responsible for managing the performance of a range of flights, seeking to maximize the “mix” of business that is allocated seats, overbooking and the flight’s load factor, as well as occasionally making artificial adjustments to the bid price (which acts as an availability-control tool). The artificial adjustments must be kept to a minimum because they risk corrupting future demand forecasts, as well as corrupting the true bid price.
Other primary responsibilities of the flight analyst include:
- Creating overbooking strategies for all legs within the analyst’s market scope,
- Implementing overbooking strategies in the revenue-management system,
- Monitoring and adjusting no-show, group utilization and cancellation rates, as well as monitoring spoilage and denied-boarding reports,
- Accuracy of no-show and cancellation fore- casting,
- Working with airport staff to develop com- mon understanding of overbooking issues.
As a result of the different roles under O&D- based control, there is greater need for close cooperation among flight analysts, demand analysts and pricing executives. Actions and accountability are literally (and fairly evenly) spread across the three different roles.
Under leg-based control, the flight analyst has been responsible for both the demand forecast (essentially a booking curve) and the opening and closing of availability at the indi- vidual selling-class level.
Under O&D-based control, the demand analyst is responsible for the demand forecast of O&Ds that include one leg that is the responsibility of the flight analyst. There are many O&Ds across most legs. Thus, the flight analyst is required to work with several demand analysts, and vice versa.
Pricing executives under O&D-based control are generally responsible for several O&Ds (not dissimilar to a pricing executive’s leg-based role).
The pricing executive is responsible for setting price points and restrictions for all O&Ds, as well as for filing fares (and thus for the fares used by the O&D system). In this process, the O&D software or the pricing executive uses an average of relevant fares, as well as applies a hierarchy which, when demand exceeds supply, creates a threshold price, or bid price.
A booking with a fare at or above this bid price will get access to the seats and be able to complete the booking, whereas a booking with a fare below the bid price will be denied access and, therefore, will be unable to complete the booking.
The quality of the teamwork across the staff group will determine how successful the O&D- based control can and will be.
Under leg-based control, a flight analyst could theoretically work in isolation (not a good practice, but it could happen). But under O&D, working in isolation is impossible, and would inevitably trigger serious loss of revenue.
Moving Forward With O&D
In summary, there are numerous invaluable lessons to be learned when managing a cutover from leg-based revenue-management control to O&D-based control, relating particularly to:
- Salient differences between the theories of leg-based control and O&D-based control (e.g., O&D-based maximizes network revenue while leg-based maximizes yield and load factor),
- Staff capabilities and training,
- Different measures that are required (at department and individual-staff member levels),
- Organization design changes that must be made, particularly as it relates to the demand analyst’s role.
As in every other truly meaningful set of business functions, managing the process of a cutover from leg-based control to O&D-based control carries risks, but the benefits justify the change. Learning from the experiences of many carriers can assist those yet to make the change.
People constitute a vital part of that change, and being able to nimbly and positively manage the human factors is a key future learning point for any airline performing a cutover to O&D- based control.
This is part 1 of a three-part series. Watch for part 2 in the next issue of Ascend, which will discuss tools and working methods in O&D revenue management control.