Dynamic Pricing Made Simple - Part 2
Dynamic Pricing Made Simple - Part 2
Boosting your airline’s pricing power may be easier than you think
Last Tuesday we looked at how airlines approach dynamic pricing and the key ingredients for success. Dynamic pricing aims to allow airlines to offer a much wider range of prices in a way that is more customised to a shopper’s individual circumstances than was possible traditionally. Today we will be exploring the techniques which airlines like British Airways, Etihad and Lufthansa use to implement dynamic pricing in practice.
I think that many airlines will be pleasantly surprised by how easily dynamic pricing can be implemented with the standard fares technology from ATPCO that they already use.
Quantum pricing
Traditionally airlines offer a range of fares a bit like those in the table below:
One way of achieving dynamic pricing is to drastically increase the range of the available fares, an approach which Etihad, the airline of Abu Dhabi, call “quantum pricing”. Under the quantum approach, a shopper’s unique attributes are catered for much more precisely, a bit like in the table below.
In the first table, B class is either open or not, and if it is closed a passenger has to pay £25 more (£150 - £125). However in the second table, assuming that B class (not shown) is still £125, the passenger may pay between £10 (£135 - £125) and £35 (£160 - £125) more.
Notice how an airline moving from the first to the second table has much more power to collect extra revenue from a passenger or offer smaller discounts than were possible before. In the example shown they can increase or reduce the price even if only Y class is available, depending on whether or not the passenger would like a ticket to be refundable, or how far in advance a passenger is making a booking.
Etihad could even apply quantum pricing to dramatically increase the scope of available prices in return for different value added services like on-board meals or excess baggage.
The quantum pricing approach is technically well suited to the existing technology and travel agents can easily book tickets issued under these fares with their own systems. But it is complex to set up and manage, and may be hard to communicate. It reduces but does not eliminate revenue spillage (see article) and the complexities of management and distribution may lead to some Etihad seats going unsold (or spoiled, as we say in the trade)
Continuous pricing
The good folks at German flag carrier Lufthansa kindly made this interesting diagram (see the original here) about their approach to dynamic pricing, which they call continuous pricing. The meanings of the axes and labels are as follows:
Price = the price offered to a shopper
Bid price = the price a revenue management computer wants to achieve
RBD = Revenue Booking Designator, or fare class
Y, B, M, U, H = individual RBD names
The charts show that under a continuous pricing model any intermediate fare can be offered. For example, when B class closes the price does not immediately jump to the full Y level, but rather to a level that is lower than Y but greater than B.
The technology that Lufthansa uses to achieve this is proprietary, no doubt developed at great expense, and I have not seen it in person. I suspect that it relies on the system taking a weighted average of the fare difference between two classes based on the number of seats left unsold. Airlines trying such an approach will have thorny revenue accounting issues to address - that’s best left for another article.
Continuous pricing may achieve revenue management perfection in principle, but because it requires the use of Lufthansa’s own distribution channels to achieve the best price, some passengers may not see it leading to some Lufthansa seats going spoiled.
Dual fare class validation
Since the 1990s airlines in the United States found that many passengers desired to travel in first class but their employers would only pay for economy class tickets. Their solution was to offer a fare that was sold in an economy fare class but in fact led to the passenger sitting in the plush part of the plane. This approach, booking in one higher fare class subject to the availability of another lower fare class, is now known as dual fare class validation.
Due to technical limitations in the way that airline tickets are sold, there are only a certain number of fare classes that an airline can make available. This is exactly 26, the number of letters A to Z in the Latin alphabet. Since one letter can only be assigned to one cabin (first, business, premium economy or economy), airlines like London-based British Airways who offer all four cabins have to make some difficult choices about just how many fare classes should serve each type of seat.
Dual fare class validation is perfect for achieving this in practice because a lower cabin with many fare classes can be used to serve a higher cabin with few fare classes, like in the table below, where W/B means book in W class as long as B class is also available:
In this example, the airline that would normally only have had two premium economy fares now has eight. While in this table I have shown a £100 upgrade fee to W class and a £50 upgrade fee to T class, in practice the airline can change this depending on their unique market requirements. Applying quantum pricing to these tables is also possible.
At British Airways they typically use dual fare class validation to ticket World Traveller Plus (premium economy) passengers based on World Traveller (economy) fares and First passengers based on Club World (business) fares. This can make a lot of sense economically because on flights where First is in low demand but Club World is not, BA can offer First seats at a small premium rather than overbooking Club World and upgrading at the airport. When First is in high demand, such dual RBD fares can simply be switched off for the flight in question and full first class fares charged.
It would also be possible for BA or any airline to use triple fare class validation to offer upgrade deals when three classes are available – the third might be a G class group category or a class normally used for frequent flyer mileage redemptions.
Fare by rule
ATPCO’s categories* 25 and 35, also known as fare by rule, are tremendously powerful dynamic pricing tools. They give airlines the full flexibility to implement quantum pricing, continuous pricing and dual fare class validation on a personalised basis. So different customers receive different prices that can be customised to their specific needs.
For example, airlines operating from Heathrow to New York like British Airways, Virgin Atlantic and American Airlines all offer special deals to their corporate financial services customers who buy hundreds or thousands of business class seats a year. Some customers may have low fares that book into high fare classes but which are non-refundable. Other customers may have low fares booking into low classes but which are fully refundable. I suspect that in many cases they use fare by rule to achieve this.
With fare by rule the possibilities for dynamic pricing are endless. Is your airline ready? Let me know!
* see Travel Industry Basics blog here for an excellent summary of ATPCO categories