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Pricing and Revenue Management

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Abstract

Modern revenue managers understand, anticipate, and react to market demand to maximise their businesses’ revenues. They often do so by analysing, forecasting, and optimising their fixed, perishable inventory, and time-variable supply, through dynamic prices. Hence, the objective of pricing and revenue management is to stimulate demand from different customers to earn the maximum revenue from them. The essence of this discipline is to understand the customers' perceptions of value and to accurately align the right products to each customer segment. Therefore, this chapter suggests that revenue management systems combine data mining and operational research with strategy. Essentially, this involves maximising revenue from a combination of high-yield and price-sensitive customers; as these systems are intended to reduce seat spoilage and to increase load factors; thereby filling excess capacity. Moreover, these systems also manage overbookings, and are intended to minimise denied boarding.
Pricing and Revenue Management
By Mark Anthony Camilleri1, PhD (Edinburgh)
This is a pre-publication version of a chapter that was accepted by Springer Nature.
How to Cite: Camilleri, M. A. (2018). Pricing and Revenue Management. In Travel
Marketing, Tourism Economics and the Airline Product (Chapter 9, pp. 155-163). Cham,
Switzerland: Springer Nature.
Abstract
Modern revenue managers understand, anticipate, and react to market demand to maximise
their businesses’ revenues. They often do so by analysing, forecasting, and optimising their
fixed, perishable inventory, and time-variable supply, through dynamic prices. Hence, the
objective of pricing and revenue management is to stimulate demand from different
customers to earn the maximum revenue from them. The essence of this discipline is to
understand the customers' perceptions of value and to accurately align the right products to
each customer segment. Therefore, this chapter suggests that revenue management systems
combine data mining and operational research with strategy. Essentially, this involves
maximising revenue from a combination of high-yield and price-sensitive customers; as these
systems are intended to reduce seat spoilage and to increase load factors; thereby filling
excess capacity. Moreover, these systems also manage overbookings, and are intended to
minimise denied boarding.
9.1 Introduction
1 Department of Corporate Communication, Faculty of Media and
Knowledge Sciences, University of Malta, Malta. Email:
mark.a.camilleri@um.edu.mt
Pricing and Revenue Management 1
The role of pricing and revenue management systems is to optimise the product for different
kinds of customers. Pricing and revenue managers use data-driven, yield management
systems to allocate adequate and sufficient capacity to profitable customers. At the same time,
they also meet the needs of price-sensitive customers. Hence, customer-centric, yield
management systems forecast demand and availability, to maximise revenue by using
differentiated prices, at the right time. Such price optimisation strategies suit each individual
customer. For instance, the purpose of the airline revenue management systems is to optimise
the passenger mix on each flight. In this light, this chapter explains the concept of yield
management. It sheds light on the various factors which influence the pricing of travel
products to different customers.
9.2 Defining Yield Management
Yield management is a variable-pricing strategy which anticipates and influences consumer
behaviour. It is intended to maximise revenue and profits from a fixed, time-limited resource
(such as airline seats or hotel rooms). Pricing, revenue and yield management systems will
support travel and tourism businesses as they sell products to the right customer, at the right
time, for the right price. Very often, the yield management processes could result in price
discrimination, as customers who are consuming identical goods or services are usually
charged different prices.
As the customers demand for seamless, personalised travel experiences, airlines and many
hotels are increasingly implementing pricing strategies that are aligned with their revenue
objectives. Their revenue management systems provide accurate, real-time information in the
right format (Chase, 2007). They will enable them to improve their retailing, whilst
responding to the shifting market dynamics (Talluri, 1999). At the same time, yield
management systems could help businesses to maintain and expand their market share, and to
increase their profits, on a day-to-day basis (Cross, 1997).
Yield controllers use highly-sophisticated computer systems to forecast the consumers’
behaviours (Chase, 2007). Specifically, they could identify when customers purchase certain
products, and determine at what prices they are purchasing them. This allows businesses to
protect enough space for late booking, high-yield passengers or guests, whilst at the same
Pricing and Revenue Management 2
time, allocating the remaining space to discount fares. Effective yield management systems
provide differentiated fares to meet the needs, wants and expectations of different customers;
whilst simultaneously ensuring that the business gets the highest possible revenues from each
and every customer. Hence, yield management involves; setting differential pricing, as well
as adopting non-pricing strategies, including overbooking management.
9.3 Differential Pricing
The raising or lowering of the price is the most basic task of a revenue manager. At times, the
higher prices may usually result in fewer bookings. However, if there is adequate and
sufficient demand, the setting of a high price could result in profitable business transactions
with high-yield customers. Very often, businesses may use specific marketing
communications to target affluent customers. Conversely, a decrease in price could easily
generate demand from price-sensitive customers. Therefore, yielding may also involve
turning away less attractive customers. To do this, businesses could resort to tactics, such as;
introducing restrictions, utilising particular marketing channels, et cetera. For example,
setting a minimum length of stay (for a hotel accommodation) is one way of achieving this
objective. Adding or removing inventory for a channel, is another option.
9.4 Fare (Seat) Mix Management
The correct implementation of the yield management systems could improve the airlines’
revenue, whilst enabling them to better meet the needs of their marketplace (Belobaba,
1987). Yield management increases the possibility of seats being available to profitable, late
booking business travellers. The airline product could also be aimed at price-sensitive
customers, as revenue management systems allow for a wider variety of discounts,
particularly to advance purchasers. The lower fares have the effect of both stimulating
demand, and filling excess capacity; without decreasing unit revenue. Yield management
systems use dynamic pricing that is based on current demand in order to optimise the
passenger mix on each and every departure; so that the revenue on each flight is maximised.
Pricing and Revenue Management 3
Consequently, a broad range of fares will usually target different customer segments. For
instance, an airline sells 100 seats for $50 and generates $5,000. However, if it offers four
fares of $80, $60, $40 and $20 and it sells 25 seats at each fare, it generates the same figure.
However, in the latter case, there are both high yield customers, as well as price-sensitive
customers who are travelling with the airline. An increase in the number of high-yield fare
passengers will increase the profitability of the airline. However, if an airline will only
provide high fares, eventually, it would lose some lower fare customers. Either passengers
would be driven to buying from lower-priced competitors; or they would be driven
completely out of the market. Therefore, airlines need to find a satisfactory balance between
yield and load factor. Such a trade-off is extremely difficult to create, as every single flight
has its own individual booking pattern.
The technical definition of ‘yield’ is; revenue per revenue passenger kilometre. This can be
calculated from the net fare (after discounts and commissions), which is divided by the
number of kilometres flown. For example: When the fare is $200 and the distance is 800
kilometres; the yield is 200/800 = $0.25 per kilometre. This can also be defined as; ‘an
amount yielded’ (i.e. the return of a financial investment, usually calculated with reference to
the cost and dividend).
9.5 Non-pricing Strategies
Frequently, travel businesses will have no-shows. No shows are those customers who make
reservations, but fail to honour them. Similarly, there may be airline passengers who book
seats on specific flights, and then will fail to turn up. For this reason, aircraft may sometimes
take-off with empty seats. For this reason, businesses use overbooking and other review
strategies to minimise costs, whilst mitigating customer impact.
9.5.1 Airline Overbooking
In the airline industry, as in any other, it is very important to exercise control over the
variables which affect revenues. Customarily, the airlines’ flights are loaded with a precise
number of seats that are allocated to each fare or class of service. However, in an effort to
reduce and minimise the cost of spoilage (empty seats), several airlines deliberately overbook
Pricing and Revenue Management 4
their flights. Their effective capacity management systems will also enable them to set an
acceptable overbooking level. Yet, the airlines’ overbookings may increase the risk of denied
boardings; which may be detrimental to the airlines’ image and reputation. Both the denied
boardings and the no-shows will result in significant financial losses to the airlines
concerned.
The costs of the spoiled seats (from an airline’s perishable service) can be calculated by
multiplying the number of empty seats by the average fare. However, the cost of denied
boarding is harder to quantify, as this involves handling dissatisfied customers, who may
easily churn for other carriers. Hence, the yield management systems should be designed to
minimise these contingent issues.
Hence, the overselling of any flight is a process which must be handled very delicately, as
different variables must be taken into account, including; time of departure, route, day of the
week, fare mix, seasonality and historic flown data. The fundamental concept behind
overbooking is to maximise revenue opportunities, by limiting seat spoilage, whilst striving
to reduce any denied boarding.
9.6 Integrating Yield Management
Although, yield managers may usually have access to elaborate systems that could provide
them with insightful data about customers; they would also benefit from effective
communication with their colleagues, from reservations; pricing, sales and check-in
departments, among others.
Reservations and sales staff are the airline’s front-liners. They regularly deal with prospective
customers. For this reason, they are in a good position to provide valuable information to
yield managers. Conversely, yield managers can also exchange useful feedback with them.
For instance, they can inform them on special offers that may be targeted at particular
travellers. Certain flights may be suitable for the price-sensitive, leisure customers.
Pricing and yield management (very often they are the same department) could identify high
load-factor markets. Certain destinations may provide an opportunity to increase fares.
Pricing and Revenue Management 5
Alternatively, pricing managers may need to stimulate demand by decreasing fares in low
load-factor markets.
Based on the relevant information that is provided by yield controllers, sales managers can
design programmes which could create new business opportunities for the airline. They can
do this without causing revenue dilution; that is often created by the displacement of high-
yield traffic. Sales and yield management could possibly direct group bookings toward
certain flights and routes, to increase more traffic.
The yield management department should also collaborate with the passenger services
department, particularly with the check-in staff who will often have to deal with denied
boardings, due to overbooked flights. Moreover, check-in staff may possess essential ‘flown’
information (this is information on no-shows and go-shows) which may be useful to the yield
managers (although they may already possess this information through their revenue
management systems). However, it would be beneficial for the airline; if the departments
communicate on a regular basis, particularly about over-sales levels and denied boardings.
From a financial perspective, the airline will improve its operations if the number of spoiled
seats is reduced and the risk of denied boarding is minimised.
9.7 Customer-Centric Yield Management
Marketing managers use pricing, revenue and yield management systems to identify their
customers’ requirements, and their booking behaviours. In essence, there are two basic types
of passengers business and leisure passengers. They differ in terms of their needs, wants
and expectations. The passengers’ unique requirements will dictate their booking
characteristics, including: when they book their seats; how much they are willing to pay; how
likely they are to no-show; which airline they choose to fly with; where they stay; et cetera.
We have already seen how yield management can be extremely beneficial to an airline when
it is implemented in a correct manner. However, these systems are also intended to improve
the customers’ experience. For the business passengers, a yield management system would
ensure that more seats are available for last minute bookings. Moreover, it would also cater to
the leisure market by offering low fares to advance purchase customers.
Pricing and Revenue Management 6
9.7.1 The Business Passengers’ Requirements
The business passengers will usually purchase their flights very close to the date of their
departure. Therefore, they would expect the airlines to provide available seats at the latest
possible time. These customers may need to fly at very short notice. At times, they may also
have to change their flights, or to cancel their itinerary. Generally, the cost of the ticket will
be less important to these travellers, than the time and date of departure. Therefore, business
customers will usually avail themselves of flexible, high fares which will allow them to book
at the very last minute. These customers are charged the highest fares. Therefore, this
segment will provide the higher yields to the airline. As business passengers are willing to
pay the highest fares, they are extremely profitable to airlines. The pricing, revenue and yield
managers must ensure that these passengers’ expectations are always satisfied.
9.7.2 The Leisure Passengers’ Requirements
The booking patterns of leisure passengers are completely different than those of the business
passengers. Unlike the business passengers, who usually book very close to the departure
date; the leisure passengers may book well in advance. In this case, the time and date of
departure may be considered less important factors to the leisure passengers.
9.8 Revenue Management Mechanisms
Since the business and economy class passengers have different purchasing behaviours,
revenue management systems strive to create a balance between these distinct groups of
customers. This may prove challenging to the airlines’ yield managers. The reason for this
lies in the fact that the demand for discounted fares, will usually occur before there is the
demand for the higher fares. As both passenger groups are competing for the ‘same’ seat, it is
up to the yield controller to decide to whom the seat must be allocated. A fundamental task of
yield management is to find a trade-off among full fare (business) passengers and the various
other discount passengers (Smith, Leimkuhler & Darrow, 1992; Belobaba, 1987). If this
balance is achieved, the airlines will be in a position to satisfy all of their passengers’ needs,
while simultaneously maximising their yield.
Pricing and Revenue Management 7
If the airlines quote a low-yield price for their seats, they will sell them well in advance of
their flight departure dates. In this case, it would be likely that most of the customer bookings
will be mostly from leisure passengers. Therefore, there won’t be seats available for sale
when business passengers contact the airline, at a later stage. This issue may lead the business
persons to travel with one of the airlines’ competitors (assuming that a seat is available with
them). If the business travellers are consistently refused last-minute bookings with any
airlines, they will stop trying to fly with them.
The airlines’ yield management systems control when capacity is made available for sale.
These data-driven systems will usually involve the blocking of seats to high-yield passengers.
This capacity will be released prior to the departure date. Higher prices will be charged to
passengers as the departure date approaches. It is very likely that these seats will be
purchased by the business travellers who will usually book late, at very high prices
(Swarbrooke, & Horner, 2001).
Whilst the former approach ensures that the airlines’ flights are filled with low yield
passengers. The latter approach offers greater opportunities to sell more seats at high yield
fares. At the same time, it is equally possible that high yield seats could remain unsold. This
could result in a loss of revenue.
In sum, elaborate revenue management systems are capable of providing a high degree of
accuracy, as they are based on previous booking patterns (Chase, 2007). Therefore, yield
controllers are increasingly relying on advanced digital technologies to price their seats to
different consumer segments.
9.9 The Essential Criteria for Successful Yield Management
9.9.1 Personnel
A successful yield management programme requires dedicated and competent employees that
are experts on their airline’s route network, competitors’ destinations, schedules, prices, as
well as on consumer demand (Smith et al., 1992; Belobaba, 1987).
9.9.2 Data-driven Systems
Pricing and Revenue Management 8
The yield controllers necessitate up-to-date information on their external marketing
environment and on their companies’ capabilities, resources and competences. Moreover, the
management of data and analytics will support them in their strategic decision making and
day-to-day operations. Very often, revenue management systems will provide them with
detailed information on past transactions, which will clearly indicate the number of (un)sold
seats (and waitlisted passengers, et cetera) for specific flights, during the day, week or other
periods. They may also anticipate the booking patterns into the future. These systems usually
indicate when and where there is demand for certain destinations. They could specify which
flights may be sold quicker than others; as they reveal how many bookings have been
received, to date. They may be used to analyse booking patterns, by comparing data with
previous periods. They could also report past punctuality records, no-shows, go-shows and
denied-boarding, among other metrics.
The pricing, revenue and yield management systems would typically consist of the following
elements:
i. The Yield Management System: This involves drawing information from the airline’s
reservation system This data could be used to extract reports on advance bookings;
ii. Historic Bookings: This is information on the airline’s full booking history for the
past months or years. It could include forecasts that are based on past records;
iii. Flown Data: This is relevant information on past flights, including; no-shows and go-
shows;
iv. The Reservation System: An airline’s reservation system will usually hold inventory
flights into the future as well as booking records of past itineraries. The reservation
systems are used by yield controllers to load the schedule with specific seat
allocations for a full season, and to make changes to the airline’s inventory on a day-
to-day basis;
v. Culture: The organisations’ different departments must support the yield managers.
An organisational culture which fosters a collaborative environment among members
of staff would improve the objectives of yield management. For example, the yield
managers could hold relevant data which could assist the check-in staff in dealing
Pricing and Revenue Management 9
with displaced passengers, particularly during the high season when there are more
travellers. The members of staff should recognise the importance of having a total
quality management mantra. Effective engagement across departments would help the
airline to improve the customers’ overall experience with the airline.
9.10 Questions
Yield management can be defined as: ‘the process which matches demand and supply,
to earn the maximum revenue on each and every flight’. How is this match actually
achieved?
What is the reason for the widespread practice of overbooking within the airline
industry?
Define (i) the cost of a spoiled seat and (ii) the cost of denied boarding.
Business passengers and leisure passenger have different booking characteristics.
Briefly outline the booking pattern of both passenger groups.
9.11 Summary
Yield management can be defined as the process that is used to match demand and supply; to
earn the maximum revenue on each and every flight. Its underlying objective is to optimise
the passenger mix on each departure. In the airline industry, the technical definition of the
term ‘yield’ is revenue per revenue passenger kilometre. This can be calculated from the net
fare (after discounts and commissions) divided by the number of kilometres flown. It can also
be defined as the yielded amount.
Yield management increases the possibility of seats being available for high yield, late
booking passengers. It also involves the allocation of seats to lower discount fares. This has
the effect of both stimulating demand and filling excess capacity, without decreasing
Pricing and Revenue Management 10
revenues by any significant amount. Revenue management systems could reduce
unanticipated denied boardings, while at the same time, increasing load factors. This can be
achieved by managing differential pricing or overbooking practices. An effective
overbooking management could reduce seat spoilage.
Yield management systems can make a substantial difference to an airline’s profits.
Therefore, it is imperative that the entire airline is committed and dedicated to it, including
the reservations, pricing, sales and check-in employees, among others. Some of the essential
criteria for successful yield management include; the airlines’ (or hotels’) personnel and data
driven systems.
Pricing and Revenue Management 11
... However, the choice of hotel attributes is relevant, and the evidence of their impact on rates differs from study to study according to the particular nature of the case under analysis. For this reason, there is no shared basis for approaching this issue (Chen & Rothschild, 2010), and hotel room pricing can be studied from both demand-side and supply-side perspectives (Camilleri, 2018b;Chen & Rothschild, 2010). ...
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