Airline Revenue Management – Decoding the Buydown and Adjusted Fare Concepts
Festivals are synonymous with homecoming and catching-up with long-lost friends, relatives and the flavors of homemade food. Diwali is one such festival which has lots of childhood memories of bursting crackers and lighting diyas.
Like every year, my competition with airlines started as I wanted to find the best possible deal for my Diwali vacation. I had to first search for the airline options which suited my travel plan, but the first round led me to all kinds of confusion and a feeling that the ticket prices are high.
Here are a few observations:
- It was high just before the Diwali day and lower if booked 3 days before Diwali which meant more official leaves.
- It was economical for a long-distance multiple leg than a short distance point to point flight which meant more number of hours spent in travelling.
After shortlisting two airlines, I geared myself up for the last round which was to find travel booking aggregators with the lowest price. The next confusion was to find the right booking day as there are different banks and payment solutions now, providing various offers on different days.
There would be a discount if paid through a specific bank on a Monday, via a particular website; and the same would be different if done on the next day.
So, the confusion was 3-fold:
- First, to pick the right airline suited to my travel plan
- Second, the right website to provide the best deal
- Third, to match it up with a specific payment option to get more discount
But even after finding my best deal, I knew there is a great chance the person sitting next to me would have paid a fraction of my booking price and would have received the best deal.
However, it was not always this and only about 3 decades ago the airline industry had different rules.
History of Airline Revenue Management
Airlines initially operated in a highly regulated industry where all changes to pricing or routes or number of seats on offer had to be approved from the regulatory bodies. In 1970s, the airline industry was deregulated which opened up possibilities for airlines to enter more markets and charge based on the demand.
The airlines have now started focusing on two major segments of business and leisure:
- Business traveler with a willingness to pay higher price and less sensitive to prices
- Leisure traveler with a willingness to buy lower priced tickets, planned well in advance and highly price-sensitive
According to a study, 72% of American travelers constitute of leisure travelers.
The revenue management was all about figuring out the magical number of forecasting the right mix of seats to maximize the revenue.
Understanding Fare Restriction and Fare Class
The segmenting of customer base into just two broader segments does not allow airlines to maximize their revenue and so they started with further segmenting of their compartments, which constitutes of First class, Business class, Economy and Premium economy.
As a customer, when someone tries to purchase a ticket in economy class, the seats under same compartment will have different fare classes which are mainly differentiated in terms of fare restrictions which constitutes of factors like:
- Advance purchase
- Minimum stay (in case of round-trip)
- Refundable amount in case of cancellation
- Cost of modifications in schedule/trip plan
So, the airlines came up with fare classes for an economy class, as explained below:
|Fare class||Advance Purchase||Minimum Stay||Cancellation charges (%)|
This is the same reason a customer searching for a ticket in economy class might find different prices over a period of months/weeks.
Entry of Low Cost Carriers
Market deregulation allowed the entry of Low Cost Carriers (LCC) which had been quickly gaining market share with their lower cost, that they enjoy on the pretext of their younger fleets and workforce with a simplified fare structure and classes. To meet the fares of these LCC, the existing airlines had to simplify their fare structure and, in most cases, reduce the restrictions. This led to improper segmentation and an ineffective demand forecast for various segments.
With the entry of LCC, the existing airlines were not able to maximize the price a customer was willing to pay for a seat. They had to compete with LCC which had less number of fare classes. With less number of restrictions and absence of any real differences within the fare classes, this allowed a user who could have afforded to buy a high-priced fare class ticket to purchase a low-priced fare class ticket. This concept of a customer who can afford a high-fare class yet bought a lower fare class ticket is known as buydown.
Airlines incorporated fare adjustment as a counter measure to negate the effect of buydown which mainly tries to optimize the seat distribution across various fare classes where highly restricted high-priced fare class seats depend on closing of lower-priced fare classes. This is done mainly to reduce the availability of lower-priced seats to compete with markets with Low Cost Carrier competitors. This also allows a higher seat protection to high-priced fare classes for maximizing the overall revenue.
The adjusted fare based on which the classes are closed/opened is the effective price of a ticket which is the difference between the actual fare and reduction due to risk of buydown. The reduction due to risk of buydown is known as price elasticity, which is effectively the change in demand with the change in price.
Challenges and the Way Forward
Dynamic pricing has become a bigger challenge for airlines trying to ensure that even if customers are charged differently, they should not get a feeling of being over-charged. It is giving way to personalized service offerings as airfare cannot be the only parameter to calculate the total value of a passenger; it might also include extra revenue in terms of allocated seats class, priority boarding, meals, etc.
This new game of airline revenue management has spread to hotels, restaurants and other industries too. But the challenges are growing with increase in the volume of data triggered by increasing level of multiple fare classes which try to segment the huge customer base into smaller groups.
Do you think the adjusted fare and dynamic pricing is fair and should be encouraged? Let us know your views at firstname.lastname@example.org.
References: www.tourism-review.com - research-leisure-travel-in-us-prevails-over-business-travel-news RM Methods for Multiple Fare Structure Environments - Matthew R. Kayser Airline revenue management methods for less restricted fare structures- Cléaz-Savoyen, Richard L