Airfare Arbitrage
A choice between point-of-sale and point-of-origin logic leads to a product pricing dilemma
To save money on air fare it is sometimes possible to call an agent in another country and pay for your ticket in a foreign currency. The savings can be substantial, perhaps £500 to £1,000 in premium economy or business class, and far outweigh any credit card’s foreign exchange fees. It is just like arbitrage in finance.
This is because some airlines, including some big carriers like BA, determine inventory availability based on where a ticket is bought and not where a passenger is travelling to and from. This article explores how an airline should apply this logic and whether anything changes when seats are bundled with other travel products through an Offer Management System (OMS).
Point-of-sale logic – what’s going on?
When an airline offers a seat under traditional revenue management, the optimisation system decides which price to charge on the basis of how likely a seat is to sell at each fare. In this example the airline will charge £200, not £100 or £250:
Seat is 95% likely to sell at £100 – expected revenue = £95
Seat is 90% likely to sell at £200 – expected revenue = £180
Seat is 50% likely to sell at £250 – expected revenue = £125.
But airlines often experience quite different demand at one end of the route from another. Consider Dubai for example, where the weekend is Friday and Saturday. Lots of Dubai residents want to travel out of Dubai on Thursday night or Friday morning, but tourists want to leave Dubai on Sunday to be home on Monday. Demand for the Friday morning flight is high for passengers originating in Dubai but low for passengers turning around in Dubai.
So if an airline sets inventory availability according to where the ticket is sold, influenced by local demand, we might see the following:
Friday 0800 DXB CDG 1300 J9 C9 D4 R0 I0 at point-of-sale Dubai
Friday 0800 DXB CDG 1300 J9 C9 D9 R9 I9 at point-of-sale Paris
Because nobody in Paris wants to end their holiday at 8am on a Friday, the airline’s revenue management tool is prepared to accept any sale. But meanwhile in Dubai everyone wants to leave at the same time, so the expected demand is higher and the airline expects to achieve the most revenue by accepting a D class fare at the least.
This means that a savvy passenger in Dubai can pick up the phone, call an agent in France, and buy her flight while only paying the I class fare.
Under another pricing model, known in the trade as origin-destination or O&D, an airline will charge the same price to everybody, regardless of where they buy their ticket. In that case we would probably see something like:
Friday 0800 DXB CDG 1300 J9 C9 D5 R1 I0 at every point-of-sale
Here there is a bit of a compromise – low demand for passengers returning to Paris means that an extra D and R class seat are available. But reflecting the fact that most passengers will be travelling out of Dubai and the flight will be constrained, this effect is small. Our savvy passenger is no longer able to save money by calling Paris.
Advantages of POS vs. O&D logic
O&D logic has some clear advantages:
1. Everyone pays the same price – no “arbitrage” opportunities
2. Easy to manage – one flight is one price, whether outbound, return or connecting
But there are some advantages to the point-of-sale based approach too.
1. Many passengers are not savvy and even though they can save a lot of money by picking up the phone and calling overseas, they do not – the airline makes more money from the high-demand market
2. Offering seats cheaply in markets where demand is low might help the airline pick up one or two sales that would otherwise go to competitors (boosting market share) or achieve one or two upgrades to a higher cabin (getting people hooked and ready to pay more next time) – the airline makes more money from the low demand market
3. If an airline wants to support sales in a specific market without diluting other sales channels they can do so, perhaps to promote a new frequency, connection or route.
OMS does not make the choice go away
Much of the discussion when it comes to dynamic pricing of travel packages, often through IATA’s New Distribution Capability (NDC), speaks about offering a specific price to a specific customer. At first glance this framework seems well suited to the O&D pricing model. People buying the bundled hotels, meeting rooms and rental cars in Paris will certainly be originating in Dubai.
But the issue does not disappear. An airline might still want to offer Friday morning flights from Dubai to Paris more cheaply in the Paris market for all the reasons I listed. If this is the case our savvy passenger might still save money by buying flights and hotels separately, causing the airline to lose sales commission on the other travel products.
For airlines who currently use point-of-sale logic, they will need to think carefully about whether to keep it in the OMS world.
Postscript – BA’s interesting shorthaul safeguards
One interesting safeguard I noticed that BA use is booking all their longhaul First and Club World bookings into J class, the highest Club Europe inventory category, on shorthaul. This means that they can safely revenue manage their shorthaul routes without risking a passenger calling America to book their flight from London to Barcelona.