Dynamic Pricing Made Simple - Part 1

Boosting your airline’s pricing power may be easier than you think

The airline revenue supply chain is awash with technology promising to help grow revenue. The marketing seems to suggest that dynamic pricing will magically materialise if only the airline buys the right technology.

Sadly, airlines buying such technology will most likely be disappointed, for dynamic pricing requires a mindset that needs to be nurtured not bought. Much technology is also unnecessary, because dynamic pricing can be achieved using standard fares technology from ATPCO that almost every airline has used since the 1960s.

This is the first of two articles explaining how to achieve dynamic pricing in practice. Today we will be looking at what dynamic pricing is, the mindset required for success, and the underlying infrastructure.

On Thursday we will outline three practical methods:

1. “Quantum pricing” – a term coined by Etihad, the airline of Abu Dhabi

2. “Dual RBD validation” – used extensively by British Airways among others

3. “Fare by rule” – the most obscure but perhaps also the most powerful.

Many airlines will be surprised by how many of these they already use.

What is dynamic pricing?

Systems vendors like to explain that revenue management sells the right seat to the right passenger at the right time, all together at the right price. A computer decides which fare to sell from a pre-determined range based on how likely it is that the seat in question could be sold at a higher fare in the future. Fundamentally revenue management is an English-style auction – the highest bidder attending wins the seat.

The airline uses two things to evaluate whether the current “bid price” is the best that they can do – how well similar seats on similar flights performed in the past and what the analyst managing the flight thinks can be achieved based on what they see happening in the world today.

But this approach has two significant disadvantages:

1. The money received by the airline is not necessarily what the airline’s computers thought it would be, as sometimes discounts are given at the end of the year to large corporate customers or agents who achieve certain sales targets

2. The fares are chosen from a pre-determined list that does not always match what the computer would like to charge – for example, when the computer wants to charge $110 it might be forced to choose between $120 (with a risk of spoiling the seat) or $100 (spilling $10).

Dynamic pricing aims to solve these two problems by allowing the airline to offer a much wide range of prices. The industry is currently divided as to how this should work in practice. Etihad, the airline of Abu Dhabi, offers a “many fares” model which they call “quantum pricing”, while German flag carrier Lufthansa tries to offer “any fare”, which they call “continuous pricing”.

Etihad’s approach works well with the technology which airlines use to get their seats to travel agents but comes with high costs for planning, management and analysis, as well as only approaching, not meeting, the true optimum. Lufthansa’s approach achieves revenue management perfection but at the risk of losing market share as agents are forced to use Lufthansa’s systems rather than their own.

The dynamic pricing mindset required for success

Airline revenue teams need three things in their mindset to be successful at dynamic pricing: agility, the ability to recontextualise problems and a focus on individual customers rather than their airline’s general policies and strategies.

Agility is all about trial and improvement. Airlines who enable their team to try something new, see if it works and either continue or discard it without layers of management approval will be well-placed to learn about how dynamic pricing works in their markets. A strong culture of mentoring, little hierarchy and results-based compensation all help a great deal.

Dynamic pricing is all about working on the fares rather than the process of deciding how many seats to offer at each price point. But in the past 20 years many airlines have focused almost exclusively on the latter. Airlines seeking success in dynamic pricing will need to be able to answer questions like should I charge $10 or $11, how often should I have a sale and how much will people pay for premium economy over economy (see article 1 and article 2).

Airline revenue analysts typically focus on a flight or a market, rather than individual passengers. Whether Anna or Bob buys a seat they neither know nor care, as long as the correct fare is paid. But in the dynamic pricing environment it will often be appropriate to offer one fare to Anna and another to Bob, so analysts will need to have a good understanding of their typical passenger profiles, how they each shop for travel and what forms of rich content (like pictures of the seat or the in-flight meals) will inspire them to make a purchase.

The infrastructure supporting dynamic pricing

ATPCO, formerly known as Airline Tariff Publishing Company, have a large number of optional rules called categories that an airline can associate with each of it’s fares. Travel Industry Basics blog has an excellent summary here. Together these rules offer an extremely large range of possibilities for what an airline can offer it’s customers.

When a fare with a particular set of rules is created it is given a unique code (called a “Fare Basis Code”) and assigned to a given category of seat inventory (called a “Revenue Booking Designator” or RBD). Next time we will see how to use these to achieve dynamic pricing in practice.