1 Revenue Management System In Airline Industry Submitted to xxxxxxx Submitted by xxxxxxxxx A Dissertation report submitted in partial fulfillment of requirements for MBA (Aviation Management) April 2009 2 Chapter-1 Introduction Revenue Management was invented by U.S. airlines in the 1980’s in response to a newly deregulated industry and to the increased competition that was created. Since then, it has been adopted by a variety of industries, and the list is constantly growing. But the basic concepts have been around for quite a long time It was developed by the airlines to improve revenue performance in the face of increasing competition. It was obvious to the airlines that passengers could be divided into two broad categories, based on their travel behavior and their sensitivity to prices. There business and leisure travelers. Business passengers tended to make their travel arrangements close to their departure date and stay at their destination for only a short time. There was usually little flexibility in their plans, and they were willing to pay higher prices for tickets. Leisure travelers, on the other hand, booked their flights well in advance of their travel date. They stayed longer at their destinations and had much more flexibility in their plans. They would often decide not to travel rather than pay high fares, and flights often departed with empty seats. The challenge to the innovators of revenue management was to devise a plan that would make the empty seats at the lower fare while preventing passengers who were willing to pay the higher fare from buying low-fare seats. Since low-fare passengers typically book in before higher fare customers, the revenue management system must forecast how many business passengers will want to book on a flight. Then it must set aside or protect these seats so that they will be available when the business passengers request them. 3 Objective of Dissertation This research project examines the concept of Revenue Management in the airline industry. The objective of this dissertation is to understand the current and future trends in revenue management. Also exploring new revenue management challenges and strategies Revenue Management (RM) Background In the early 1970s, some airlines began offering restricted discount fare products that mixed discount and higher fare passengers in the same aircraft compartments. For example, BOAC (now British Airways) offered earlybird bookings that charged lower fares to passengers who booked at least twenty- one days in advance of flight departure. This innovation offered the airline the potential of gaining revenue from seats that would otherwise fly empty; however, it presented them with the problem of determining the number of seats that should be protected for late booking, full fare passengers. If too few seats were protected, the airline would spill full fare passengers; if too many were protected, flights would depart with empty seats. No simple rule, like protecting a fixed percentage of capacity, could be applied across all flights because passenger booking behavior varied widely with relative fares, itineraries, season, day of week, time of day, and other factors. It was evident that effective control of discount seats would require detailed tracking of booking histories, expansion of information system capabilities, and careful research and development of seat inventory control rules. LITTLEWOOD (1972) of BOAC proposed that discount fare bookings should be accepted as long as their revenue value exceeded the expected revenue of future full fare bookings. This simple, two fare, seat inventory control rule (henceforth, Littlewood’s rule) marked the beginning of what came to be called yield management and, later, revenue management. In North America, the beginning of intensive development of revenue management techniques dates from the launch of American Airlines’ Super Saver fares in April of 1977, shortly before the deregulation of U.S. domestic and international airlines. Over the last twenty years, development of revenue management systems has progressed from simple single 4 leg control, through segment control, and finally to origin– destination control. Each of these advances has required investment in more sophisticated information systems, but the return on these investments has been excellent. In 1999, most of the world’s major air carriers and many smaller airlines have some level of revenue management capability. Other small airlines and international airlines in newly deregulated markets are beginning the development process. The success of airline revenue management was widely reported, and this stimulated development of revenue management systems for other transportation sectors and in other areas of the service sector. Meaning Revenue Management is the process of analysing and forecasting consumer demand in order to optimize inventory and pricing levels to maximize profitability. Fig 1 Process of RM In other words, to constantly analyse and forecast the remaining demand for a certain future product or event and subsequently adjusting the pricing levels in order to sell the right product at the right price to the right customer at the right time to maximize profitability. It is important to note that Revenue Management addresses the revenue side of the equitation, not the cost side. There exists an inverse proportionality between Load Factor (Units Sold) and Average Yield (Unit Revenue) and Revenue Management will thus find the optimum balance between these factors in order to maximise Revenue or Income. 5 Profit = Operating Revenue – Operating expense = RPK X Yield - ASK X Unit cost or = ASK {Unit revenue – Unit Cost} or = ASK {Average load factor X Yield – Unit Cost} Units Sold/ Unit Cost Load Factor Average Revenue Yield/ Manageme nt Unit Revenue Fig.2 Relating terms of RM The following examples explain RM: . The ability to optimally match supply to demand at the best price points . The ability to proactively affect this price point. Getting the most revenue possible from your assets - particularly if they are perishable. If it is not sold today you loose the ability to attain that opportunity revenue. The effort to gather all possible data to try and reach this market knowledge so you can be proactive with your product or purchase and not be reactive to the market. It is your product or your money, why be reactive rather than proactive with the market? . The ability to use this information to target different market segments through their unique discreet distribution channels, and therefore divide the market into segments you can target and reach at the right time, the right price and the right product without diluting your main market base. The ability to fulfill the idea in the "quotes" section from "The Art of War" 6 . A proven way to increase revenues from your existing market share without battling to take market share from competitors. This can be far more cost effective than fighting to increase revenues and profits from gaining market share from your competitors. A multimillion dollar a year industry embraced by the largest travel, energy and broadcasting companies. American Airlines has stated that Revenue Management increases its revenues by about 5% per year, which many years has been the difference in profits or losses. The Wall Street Journal has called RM the most powerful new business tool of the next century. Problem and Challenges The objective in revenue management is to maximize profits; however, airline short-term costs are largely fixed, and variable costs per passenger are small; thus, in most situations, it is sufficient to seek booking policies that maximize revenues. Also, although there is lower risk in accepting a current booking request than in waiting for later possible bookings, booking decisions are repeated millions of times per year; therefore, a risk- neutral approach is justified. Consider the arrival of a booking request that requires seats in an itinerary—one or more flights departing and arriving at specified times, within a specific booking class, at a given fare. The fundamental revenue management decision is whether or not to accept or reject this booking. A large computer reservations systems must handle five thousand such transactions per second at peak times, thus the decision must be reached within milliseconds of the request’s arrival. Not surprisingly, no current revenue management system attempts full assessment of each booking request in real time. Instead, precomputed aggregate control limits are set that will close the system for further bookings of specific types while leaving it open for others. The reservations system can quickly determine the open or closed status of a booking category and report back to an agent or customer without actually evaluating the request. The accept–reject decision can be restated as a question of valuation: What is the expected displacement cost of closing the incremental seats in the requested itinerary? To maximize expected revenues, the request should be satisfied only if the fare value of the requested itinerary 7 equals or exceeds the expected displacement cost. The apparent simplicity of this valuation problem is deceptive—a complete assessment must allow for all possible future realizations of the reservations process that could be influenced by the availability of any of the seats on any of the legs in the booking. Fully traced, this influence propagates across the entire airline network because a booking can displace potential bookings that will have subsequent impacts of their own. This influence also propagates forward in time because many affected itineraries will terminate later than the booking being considered. Also, a booking will normally have a return component at a later date with its own set of concurrent and downstream effects. Many other factors increase the complexity of the evaluation process. Table I lists some of them. As can be seen in Table I, the practical complexities of revenue management are daunting—we do not have space here to discuss all of them.