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This outlines some of the constraints to application of Revenue Management theory.
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Revenue Management:Theory and Practice
Tom BaconRevenue Optimization
June, 2014
Theory and Practice• Revenue Management is now an established science. The science
of RM includes:– Estimation of price elasticities– Statistical analyses of demand patterns– Regression-based forecasting– Overbooking based on no-shows & cost of over-booking– Mathematical optimization including linear programming
• On the other hand, there are a multitude of constraints to an individual airline’s application of the science– Strategic, Financial, Legal, Technical, Organizational, Competitive
• A revenue management analyst today should understand the science but he must also understand its use – and misuse – in real world challenges his airline faces.
Strategic
• “One size doesn’t fit all”– Legacy, LCC, ULCC– Nat’l, Int’l, Regional– Start-up, Growth,
Mature• Increasing airline
differentiation => increasing customization of RM
0 5 10 15 20 25 30 35 40 450
10
20
30
40
50
60
% Ancillary Revenue
% Connect Traffic
Airline (Size )
Legal/Regulatory
• In the U.S., legal constraints exist:– In both raising and lowering
fares– On pricing in airline partnerships
• Over the past year, the government has shown new interest in regulating ancillary fees and e-merchandising
Science:ForecastsModels
Legal/ Regulatory
Price
Systems/Technical
• Every RM system has data limitations and model assumptions which inhibit optimality
• System providers regularly implement “improvements”– Not appropriate for all users; not fast enough for others
• Pricing interaction with Operations, Marketing, Customer Service, Loyalty calls for integrated systems– In addition to links to third party systems
Inputs Process Outputs
Data limitations Enhancements to be released soon
Links to other airlines systems
Model assumptions Future, not yet identified, enhancements
Reports, metrics, diagnostics
Organization and Culture
• The “ideal” RM organization doesn’t exist– Trade-offs in costs, flexibility,
responsiveness, control– …Within RM– …Between RM & rest of
organization
• “Culture” and capabilities are bigger than just RM– Conflict mgmt, decision-making across the airline– Skills, experience, talent management
Financial
• Financial constraints include:
• Balance Sheet– Cash– Capital/resource
availability• Income statement
– Cost structure– Variable costs of services– Profit margins
• Investor relations/ expectations
0
1
2
3
4
5
6
7
8
9
10
MarginF/A CostVarCost
Fare; or Product Pricing
Competitive• “This industry is always in
the grip of its dumbest competitor.”– R. L. Crandall, 1992
• Competitive issues remain the largest constraint to optimized, rational pricing
Practical Trade-offs
Robust:Choosing an Optimum that won’t change too dramatically tomorrow
Flexibility:Anticipating more change
Risk of New Process Risk of Status Quo
Optimized, Deliberate, well-planned
VS.
“In the long term, we are all
dead”
Airline RM Report Card
• In practice, RM can fall short of “theory” in every dimension
Grade
Fare setting FAncillary pricing FDemand forecasting FOptimization FOverbooking F
Conclusion
• Tom Bacon is an instructor for IATA Revenue Management courses
• In addition, Tom has developed his own revenue management courses designed for all levels in RM (from analyst to executive)– Introduction to RM Theory– Heavy emphasis on Practice
• How airlines actually use RM• Limitations in application of RM theory
• Member of Speaker program at University of Denver Daniels School of Business
