Why airlines adopt approaches to improve yield and revenue

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Nov. 20 2020, Updated 4:42 p.m. ET

Applying the revenue management system

As mentioned earlier, Alaska Airlines (ALK) has the lowest yield of $0.148 among all its peers. Its peers include Delta (DAL) at $0.1689, United (UAL) at $0.1614, American (AAL) at $0.1622, and Southwest (LUV) at $0.1602. In this part of the series, we’ll discuss the approaches that airlines adopt to effectively manage their revenue.

Revenue management is essential for the airline industry. The industry needs to maximize revenue by selling the most aircraft seats possible to customers at the best price. Revenue management can be applied to any industry. It uses the following business characteristics. It can be applied to airlines, hotels, car rental agencies, healthcare, etc.

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  • The market can be segmented with differing price elasticity for each segment
  • Capacity is relatively fixed and can’t be altered in the short run
  • The commodity is available for sale for a limited time—for example, when a product is perishable by nature
  • The cost of selling additional units of capacity is less
  • Advance booking and cancellations are present

Challenges in revenue management

Forecasting demand is the biggest challenge in revenue management. It’s necessary to determine the level of overbooking that’s required. It also determines discount allocation.

  • Overbooking – Booking tickets in advance is allowed. There’s a greater risk of cancellations or “no-shows.” As a result, airlines overbook by selling more tickets than the aircraft capacity. Based on past trends, airlines have to forecast no-show rates to determine the appropriate level of overbooking.
  • Discount allocation – Another challenge in selling airline tickets is determining the number seats to allocate for discounted fares versus full fares. This impacts the overall yield. It involves calculating the opportunity cost of selling a discounted ticket instead of a full fare ticket. The seats are allocated accordingly at the right prices.

How can airlines maximize their revenue?

Revenue can be maximized either by increasing the unit price or by improving the aircraft capacity utilization—load factor. Airlines use the following approaches to improve yield and revenue:

  • Market segment pricing – In the airline industry, the market can be segmented as business travelers and leisure travelers. The business travelers segment isn’t as sensitive to price—compared to leisure travelers. Leisure travelers are attracted to discounts. As a result, airline yields vary according to the segment that they cater to.
  • Peak and off-peak season pricing – Airlines increase prices during periods of high demand—peak periods. They offer discounts to attract passengers during the slower season.
  • Increasing load factor – Depending on demand, airlines will need to offer competitive fares to increase the load factor. This will improve revenue. The marginal cost of adding an extra passenger is limited to the passenger’s meals, commission, and processing charges.

Visit the Market Realist Airlines sector page to learn more about the airline industry.

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