How Do Airlines Set Their Ticket Prices?

They keep going up and down!
By Melonyce McAfee
Updated Wednesday, Nov. 22, 2006, at 6:03 PM ET

This article found at : http://www.slate.com/id/2154261

Thanksgiving is the busiest holiday of the year for the airline industry. High travel demand means full seats and, presumably, full coffers for the airlines. But how do they decide how much to charge passengers?

The most important variable is competition. Until airline deregulation in the late 1970s, rates for flights were more-or-less determined by distance. Now, ticket prices have almost nothing to do with how far you're traveling and more to do with how many airlines are competing for your business. A short route flown by few carriers may be more expensive than a long route flown by all the major airlines. For example, flights between Portland and Medford, Ore., used to boast extraordinarily high per-mile fares, at least until more airlines began offering that service. The presence of discount carriers, such as JetBlue or Southwest Airlines, can drive prices even lower on a given route.

An airline will adjust its ticket prices on a minute-by-minute basis, depending on what competitors are charging. But how do they know the other guys' prices? Each airline enters its rates into the Airline Tariff Publishing Co. computer system, which in turn supplies information about all the others. Plus, most airlines supply their rates and flight availability to booking systems used by travel agents and online travel sites, called Global Distribution Systems.

There is generally not one set rate for a flight, but a range of prices depending on when you buy your ticket. The airline industry engages in "yield management" to adjust how many tickets it sells and for how much, according to the buyer and the market conditions. United Airlines, for example, uses a computer system called Orion to predict passenger load, how many passengers will pay a higher fare, and the optimal time to change rates. Systems like Orion help carriers guess how many tickets they can sell, say, more than 14 days in advance at the lowest price, and then decide when to raise the price in order to make a greater profit.

The customer matters too. If a route attracts lots of business travelers, the airline may up the price for tickets booked on that route at the last minute because, generally, business travelers book flights closer to the time they travel and are willing to pay more. Likewise, it may reserve a block of last-minute seats to accommodate business travelers so they'll develop loyalty to the airline. Vacation travelers, on the other hand, tend to book flights well in advance and are more willing to endure long layovers or weekend travel restrictions to save money.

Lately, fuel surcharges have been increasing how much customers pay. The weather, last year's rates, taxes, the price of tea in China … pretty much anything can affect air travel prices. Columnist Dave Barry once joked that Rudy the Fare Chicken pecks at a keyboard sprinkled with corn to determine ticket prices. If Rudy is sick, he added, Conrad the Fare Hamster takes over.

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Found at : http://en.wikipedia.org/wiki/Yield_management


Yield Management
Yield management, also known as revenue management, is the process of understanding, anticipating and reacting to consumer behaviour in order to maximize revenue. Firms that engage in yield management usually use computer yield management systems to do so. The Internet has greatly facilitated this process. Other terms to describe this process are revenue optimization and demand mangement.

In relation to Telecoms, a company that is focused on profits rather than sales is said to be undertaking yield management. Airlines, for example, use it. Airlines monitor through the use of specialized software how seats are being reserved and offer discounts when it appears as if seats will otherwise be vacant.

In addition, hotels used to use Revenue Management as a way to know when to sell what. Now demand management is becoming a more favorable way to calculate the rates, rooms and restrictions to sell in order to best maximize the return for the property.

Enterprises that use yield management periodically review transactions for goods or services already supplied and for goods or services to be supplied in the future. They may also review information (including statistics) about events (known future events such as holidays, or unexpected past events such as terrorist attacks), competitive information (including prices), seasonal patterns, and other pertinent factors that affect sales. The models attempt to forecast total demand for all products/services they provide, by market segment and price point. Since total demand normally exceeds what the particular firm can produce in that period, the models attempt to optimize the firm's outputs to maximize revenue.

The optimization attempts to answer the question: "Given our operating constraints, what is the best mix of products and/or services for us to produce and sell in the period, to generate the highest expected revenue?"

Optimization can help the firm adjust prices and to allocate capacity among market segments to maximize expected revenues. This can be done at different levels of detail:

by goods (such as a seat on a flight or a seat at an opera production)
by group of goods (such as the entire opera house or all the seats on a flight)
by market (such as sales from Seattle and Minneapolis for a flight going Seattle-Minneapolis-Boston)
overall (on all the routes an airline flies, or all the seats during an opera production season)
Yield management is particularly suitable when selling perishable products, ie goods that become unsellable at a point in time (for example air tickets just after a flight takes off). Industries that use yield management include airlines, hotels, stadiums and other venues with a fixed number of seats, and advertising. With an advance forecast of demand and pricing flexibility, buyers will self-sort based on their price sensitivity (using more power in off-peak hours or going to the theatre mid-week), their demand sensitivity (must have the higher cost early morning flight or must go to the Saturday night opera) or their time of purchase (usually paying a premium for the luxury of booking late).

In this way, yield management's overall aim is to provide an optimal mix of goods at a variety of price points at different points in time. The system will try to maintain a distribution of purchases over time that is balanced as well as high.

Good yield management maximizes (or at least significantly increases) revenue production for the same number of units, by taking advantage of the forecast of high demand/low demand periods, effectively shifting demand from high demand periods to low demand periods and by charging a premium for late bookings. While yield management systems tend to generate higher revenues, the revenue streams tends to arrive later in the booking horizon as more capacity is held for late sale at premium prices.

Firms faced with lack of pricing power sometimes turn to yield management as a last resort. After a year or two using yield management, many of them are surprised to discover they have actually lowered prices for the majority of their opera seats or hotel rooms or other products. That is, they offer far higher discounts more frequently for off-peak times, while raising prices only marginally for peak times, resulting in higher revenue overall.

By doing this, they have actually increased demand by selectively introducing many more price points, as they learn about and react to the diversity of interests and purchase drivers of their customers.