Pricing Optimization

The Next Chapter Of Total Revenue Optimization

The airline industry has made exceptional progress in revenue management; however, it lags behind in terms of pricing. Today, many other industries are more effectively leveraging pricing to better market to their customers and compete in dynamic environments. Airlines need to capitalize on better pricing strategies to remain competitive and, ultimately, achieve total revenue optimization.

By Kartik Yellepeddi

Airline pricing is often treated as a reactive afterthought; however, setting a price for a product is one of the most important decisions an airline can make. Too often, airlines adopt the “me too” approach to pricing, basing fares solely on what competitors are doing and often in an extremely reactive way. But airlines are missing a key piece: how much value do customers believe the products actually deliver?

In an industry constantly pressured by how to increase revenue, pricing is a lever that has seemingly been untapped. Today, if airlines truly want to achieve total revenue optimization (TRO), they must look beyond traditional revenue management. They must tap into adopting mature pricing practices that consider a more scientific and strategic approach.

Ultimately, if airlines engage in their pricing strategies and let it take a lead in telling their story of who they want to be, they have the opportunity to increase customer satisfaction, discover unique points of differentiation and achieve total revenue optimization.

THE IDEAL SCENARIO IS TO SELECT TOOLS THAT WORK COLLECTIVELY TO SOLVE THE INDUSTRY’S MOST CRITICAL AND CHALLENGING PRICING PROBLEMS WITH A COMBINED APPROACH THAT INCLUDES BOTH STRATEGIC AND TACTICAL PRICING.

The Pricing Problem

If an airline wants to serve a new destination, cater to a special event or grow an existing market, where does it start? How does it determine fares for the various trip options across different markets, travel dates, products and points of sale? Equally important, how will it constantly monitor existing fares and determine how they are performing?

To address these questions, many airlines control their prices by monitoring the competition and conducting ad hoc analyses. They also use manual processes, which are prone to human error and don’t provide necessary data to make effective pricing decisions. Moreover, this method don’t always take into consideration customer segmentation and willingness to pay.

Many would argue this has been the problem for decades. So, why now? Why should pricing be top of mind for chief commercial officers today?

The answer: Big Data. While Big Data has been talked about and used for quite some time, it hasn’t always been taken into account or used effectively in airline pricing. Even more so, Big Data isn’t just about computing large amounts of data, it is essential to predictive analytics and user behaviors. That’s where change and new pricing practices are essential for competitive airlines.

Airlines need to better determine where they want to be competitive and where they have a competitive advantage. While this may sound daunting, Big Data should enable analysts to easily perform these types of analysis and make data-driven recommendations with confidence. If an airline can identify where it wants to have a strong differentiated product and where it can charge a premium for that product, it can begin to more easily compete and win.

Furthermore, an airline’s pricing strategies need to tell a story ... one that conveys the value of its product and product differentiation. Most importantly, it should be a story that caters more to its desired target customer segments.

Moving forward, there is another element of strategic pricing that must be considered — how does an airline learn from what it has implemented? Airlines need to be able to test the market beyond where they have been historically operating to ensure their strategies are working and they learn from the competition.

Once an airline has the strategic product and price in place, then it must consider it’s close-in, tactical decisions. Today, airline customers can quickly and easily access almost every airline itinerary that is available for the destination of their choice. Technology has enabled the modern consumer to shop much more often, most of the time, using multiple devices before completing a transaction.

That said, this trend has also increased the ability for customers to efficiently comparison shop. In turn, both of these factors have driven the need for airlines to be competitive in real time. The problem is tools do not exist today that allow airlines to effectively compete in real time.

In addition, Sabre studies have estimated that the number of varying price points are growing by 28 percent year over year, while most airline-pricing departments’ manpower clearly doesn’t grow at that rate. The growing complexity of varying price points can no longer be easily handled by people alone — new technology and processes must be put into place to automate and combat this rising trend.

While data, technology and automated processes will begin to unveil pricing opportunities, airlines cannot lose sight of the importance of a pricing analyst who will be able to lay out well-defined pricing strategies that will allow an airline to win in the marketplace.

Implementing these strategies will not only allow airlines to practice in the same vein and with the same success as retailers such as Amazon, Google AdWords and Uber, it will empower them to be as smart as these well-known retailers in using the power of data to make better decisions, something a lot of airlines struggle with today.

Pricing optimization uses mathematical analysis that must take into account both external factors and internal drivers including customer-demand forecasting, competitive insights, operating costs, inventories, and historic prices and sales. Capitalizing on pricing optimization enables pricing analysts to make better strategic and tactical pricing decisions. Strategic pricing proactively and scientifically considers passenger segmentation and willingness to pay, while tactical pricing continuously monitors market dynamics, an airline’s performance and its competitors’ actions so it can react to its most valuable itineraries – both of which are important to fully taking advantage of this revenue lever.

Leverage External Examples

While the airline industry is vastly different from the sharing economy platforms and online retailers of the world, there is much to be learned from these players about effective pricing strategies. In fact, the majority of leading Internet marketplace companies use dynamic pricing as a solution when confronted with a scarcity of supply.

What, exactly, can airlines learn from these retailers, and how can they incorporate some of these pricing practices into their own strategies?

Amazon

Amazon is at the forefront of dynamic pricing. The company knows exactly where it wants to compete and where it does not. The Seattle, Washington-based company is basically an icon for pricing because it wins its consumers over with the most popular items, and it charges more for ones with less turnover.

Google AdWords

Google AdWords is a great example that should hit close to home with airlines. Google AdWords is a form of perishable inventory. For instance, if a keyword is not being bid on, Google is not realizing any revenue from that item. This represents a continuously perishable inventory where demand can be incredibly dynamic and, hence, the need for an automated algorithm that tracks demand is critical to maximizing the revenue potential.

Uber

There are both positive and negative lessons that can learned from the experiences of Uber. While Uber can arguably be seen as a leader in demand-generated pricing, there is also a clear need for checks and balances in such an environment.

In 2016, Uber was criticized for its well known “surge pricing.” According to a CNBC news article, after an explosion occurred that injured dozens in New York City, people began to request Uber to get them to safety. However, the reaction that came from these requests was less than optimal. Due to the quick influx of demand, and the apparent lack of human context to the system, Uber’s surge pricing went into full effect, nearly doubling its fares from normal rates.

While Uber quickly tried to recover and later announced it had suspended the surge fares and offered refunds for those who were affected, it was too late. Customers had taken off with the news, and it turned into a full-blown public-relations issue.

While this is a great example of algorithms that can perform a majority of the pricing tasks with little to no intervention from users, there is some risk associated with it. Being completely unsupervised, for instance, could easily lead to unreasonable economic or emotional decisions.

While these three examples use vastly different business approaches, there are some key takeaways for the airline industry.

For example, airlines should understand that a pricing strategy doesn’t necessarily mean a race to discounts, promotions or offering the lowest fare. Today, a pricing strategy means being methodical about who an airline wants to be. It should clearly understand the customers it wants to serve and compete well to win and retain those customers. Airlines cannot get caught up in trying to be everything to everyone while competing head-to-head with every airline and still expect to achieve success.

THE IDEAL SCENARIO IS TO SELECT TOOLS THAT WORK COLLECTIVELY TO SOLVE THE INDUSTRY’S MOST CRITICAL AND CHALLENGING PRICING PROBLEMS WITH A COMBINED APPROACH THAT INCLUDES BOTH STRATEGIC AND TACTICAL PRICING.

Solving With Pricing Optimization

Airlines need new pricing tools that combine innovative technology with revamped pricing processes and practices. The ideal scenario is to select tools that work collectively to solve the industry’s most critical and challenging pricing problems with a combined approach that includes both strategic and tactical pricing. That’s something the industry doesn’t have today. However, it’s well within reach.

A robust pricing model can leverage large amounts of real-time data and proactively consider all of the factors to successfully enter new markets and retain a competitive foothold in those markets.

In addition, it is critical to continuously monitor market dynamics, an airline’s performance and its competitor’s actions so it can quickly adjust its most valuable itineraries. This is where tactical pricing comes into play, which is the optimal response that takes into account the competitive position, quality of services and an airline’s revenue-management strategies.

Scale and speed is equally important to ensure the airline doesn’t leave money on the table. In other words, it should be able to quickly gain access to current information and quickly make educated pricing decisions. As a result of modern pricing practices, airlines can realize substantially more revenue. In fact, preliminary studies done by Sabre expect up to a 1.5 percent increase in incremental revenue from adopting strategic and tactical pricing practices.

Furthermore, while the industry is moving toward a new way of retailing with initiatives such as New Distribution Capability (NDC), the time to enter the next generation of pricing is now. Current distribution capabilities can begin to enable airlines to benefit from some of the opportunities laid out. There is no doubt NDC will provide further opportunity to increase relevancy of offers and maximize revenue; however, airlines will not be able to make the switch over night. The industry will have to operate in both worlds, and so will any advancements in pricing decision-support.

When it comes down to it, one of the most important ways of improving an airline’s gross margins is to make pricing management a strategic priority. As competitive pressures continue to rise, airlines need end-to-end pricing decision-support capabilities working in a dynamic environment to stay ahead of their top competitors, while thinking beyond seats and taking into account the overall retail strategy.

An innovative, unique set of high-end pricing capabilities is on the horizon, and it will prove to be an industry game changer.