The Story of Airline Pricing Strategies

The past 50 years in commercial aviation have seen transformation and growth at unbelievable speed. There have been significant developments in most areas of the industry, including the aircraft and engines themselves, the navigation and communication equipment used to fly them and the routes navigated around the globe.

But long before a flight takes off, passengers need to buy tickets, which means airlines need pricing models and strategies in place. And just like in other corners of the industry, there has been plenty of innovation in this area, too.

The technology we use today simply was not available when airline pricing strategies were first developed, but some of the basic principles still underpin the newer systems used today.

We’ll take you back to the early days of air travel to see how airline pricing strategies were developed, and bring you up to date with the modern-day approach to setting air fares.

How it all started

At the origin of modern-day schedules and ticket distribution, when the first Official Aviation Guide was published in 1929, airfares sat alongside selected routes. Flying from X to Y cost a set fee and seat and cabin classes were some years away. Commercial flying was reserved for the rich at this time.

Up until the 1970s airline pricing was a very controlled affair; airfares in the US were regulated by the CAB (Civil Aeronautics Board), and indeed, airfares were regulated by all Governments around the world and any increases in fares had to be approved at the IATA Tariffs Conference which was held twice a year. But the economic pressures of increased inflation forced a step change. The year 1978 saw the passing of a critical bill which led to deregulation, and by 1983 airlines were increasingly free to set their own prices. And so began the era of yield management, which evolved into price optimization and competitor pricing analysis.

American Airlines and its then President Robert Crandall trailblazed many innovations still in use today, such as the first frequent flier program, route optimization practices and central reservation system adoption. Also pioneered by Crandall was the practice of yield management — the set of price optimization strategies that preceded revenue management.

These strategies include the now controversial practice of overbooking, and other procedures we are all familiar with, such as offering cheaper rates to passengers who book earlier and providing seat reservation at a higher price.

How does airline ticket pricing work?

As a consumer, it seems there is a big variation in the ticket prices available for the same flight, depending on time of day, travel date, date of booking and other factors. Why do flight ticket prices seem to vary so much?

Pricing and availability of fares are determined today by a system of booking classes — not to be confused with travel classes (i.e., economy or business class) — which consist of a series of letters that define the fare level paid.

These have changed and diverged since their introduction, and different airlines use many more booking classes today. But some are generally consistent, including:

• F for full-fare first class
• J for full-fare business class
• Y for full-fare economy

Think of these as the ‘standard’ rate from which other rates are calculated.

The booking classes used for discount levels below full fare vary between airlines. For example, with most Oneworld airlines (including American Airlines and British Airways), a discounted business class fare is represented by D, C, R, and I classes. This differs from the letters used by United Airlines, where business class discounted fares are J, C, D, Z, and P, while R is used for premium economy, and I previously for first class.

To properly optimize a revenue management system, carriers must carefully adjust booking classes and control availability. In this manner, airlines can use mathematics and statistics to optimize their revenue generation systems.

What pricing strategies are used by airlines?

Approach #1 — Static Pricing

An airline creates its fare structure using a limited number of price points based on reservation booking designators (RBD) and then publishes them through ATPCO (Airline Tariff Publishing Company). Each price point is developed for a specific customer segment and demand situation.

The flight schedule, connection times, journey times, sales channel, seat class, time of purchase and more can all play a role in unlocking price advantage, while a more price sensitive passenger will choose the cheapest fare regardless of these elements.

This approach has many limitations. Without the context of competitive insight, analysis of fare distribution, applied knowledge of market conditions and broader criteria, staying profitable is a challenge.

Approach #2 — Dynamic Pricing

Dynamic pricing is a technique of pricing a product according to current market conditions. Airlines have high fixed costs (fuel, airport slots, ground handling) and low variable costs (the cost of carrying one more passenger) so, to drive the most revenue and maximize profits, airlines need to sell the greatest number of seats for the highest possible price.

Airlines can now analyze various criteria e.g passenger behaviour and market demand in real-time to deliver personalized pricing.

Prices can change in real-time based on timely data: Data about customer booking patterns, competitor prices, even weather and popular events can impact booking demand and allow the airline to adjust prices to increase profits.

This is a big step up from the static pricing of the past, however, challenges remain.

• Legacy technology and rule-based software, still prevalent in many airlines, prevent speedy adoption. The technology needs to be able to handle vast amounts of data in real-time, employing sophisticated analytic and Machine Learning capabilities.
• An airline’s ability to price flights is restricted by legacy distribution mechanisms. They can offer a limited number of price points based on reservation booking designators (RBD) and when publishing them through ATPCO, they can update prices only in specific intervals. Consequently, while an airline’s revenue managers may have data informing them that prices should be changed, in reality, prices are not adjusted in real-time. This leads to other problems, like uncertain net revenue as airlines often file different fare products under the same RBD.

Approach #3 — Continuous Pricing

Continuous pricing is the process of dynamically adjusting fares in response to contextual signals. It can also be called total dynamic pricing. IATA calls it Dynamic Offers and it will likely become a new standard for offer construction and pricing. It will address other limitations and build on NDC and One Order standards to create holistic revenue management with improved demand forecast and personalized offers.

In order to implement continuous pricing strategies, airlines need a good understanding of customers’ willingness to pay (WTP), which at present remains mostly a mystery to airlines. It currently works on the assumption that passengers always make rational decisions that can be easily predicted, which is not true. A revenue manager often can’t anticipate or estimate what price suits what customer segment and may not even be able to segment customers correctly. The most accurate way to do that is by employing machine learning solutions and AI algorithms. Which brings us to the next improvement brought in by continuous pricing strategies…

Increased conversion. The more relevant offer a customer receives, the greater the chance they’ll take it. This results not only in more sales, but also in more loyal customers who can 1) personalize their flight experience and 2) get cheaper tickets by stripping the price of extra services.

Though an important area of revenue development, until this point there has been little consideration for ancillary pricing. Ancillary revenues bring the industry around $55 billion a year and have been on the rise for the past ten years, being a huge part of low-cost carriers’ profits. Yet base flight products and ancillary products have been managed in separate processes and through separate IT systems (revenue management and merchandising systems). So, extra baggage, seat selection, meals, internet access, and many more services are priced statically and not accounted for in revenue management implementation. Customers would receive the same price for the same product and the shopping process doesn’t consider contextual customer information. Basically, there’s been no personalization.

Consistent offers bring more partnership opportunities, allowing airlines to incorporate more third-party ancillaries and interlining offerings.

Future pricing trends

How close is the future?

Change comes slowly, but it does come. In 2024, airlines still majorly rely on traditional fare distribution, making forecasts with much room for improvement, ignoring ancillaries, and struggling to update decade-old technology. But if you are ready to grow, look to the pioneers for encouragement.

The first adopter of a new distribution model was Lufthansa. After heavily investing in NDC technology, the company started experimenting with dynamic offers on direct and indirect channels in 2020. Other big airlines like Air France-KLM and Singapore Airlines collaborated with Amadeus and Travelport to work on adoption as well.

These examples indicate that the concept is no longer a theory or a proposition — it will become an alternative or even a norm in the world of commercial aviation.

Originally published at https://www.oag.com.