American Airlines Dynamic Pricing
EXECUTIVE SUMMARY
Revenue management is a proven technique to help service industries maximize revenue. It involves management of inventory and distribution channels and prices to maximize profits over the long run. Simply stating the technique involves selling the right product to the right customer at the right time at the right price. The following are the primary activities involved: demand data collection, demand modeling, demand forecasting, pricing optimization, and system implementation and distribution.
Though individual airlines in the States are not owned by the government, it effectively controlled their performance until the late 1970s by setting a single price for each route and decreeing which of many carriers could operate where, but from the late 1970s on, the government relaxed the rules. American Airlines (AA) was the first to use basic revenue management techniques, offering dynamic pricing in shape of discounted fares to passengers who booked early, incentivizing customers by reserving seats for higher paying customers, and overbooking seats in the knowledge that some passengers would cancel at the last moment and that others would fail to show up.
AA pioneered the revenue management system and reaped the rewards of being one of the first movers in that direction. By using the methods mentioned earlier American Airlines claims to have been able to generate as much as $500 million a year in additional profits from 1980s onward. The methods used and the steps taken highlight the simple use of basic microeconomics principles in that dynamic pricing helps reduce the consumer surplus and deadweight loss and at the same time increases the firm’s profits. Using dynamic pricing (and coupling with yield management) AA decreased demand variability in that the customers understood that the earlier they book the better price they will get.
The questions American Airlines asked itself were: How many seats to make available at each of the listed fares,
Revenue management is a proven technique to help service industries maximize revenue. It involves management of inventory and distribution channels and prices to maximize profits over the long run. Simply stating the technique involves selling the right product to the right customer at the right time at the right price. The following are the primary activities involved: demand data collection, demand modeling, demand forecasting, pricing optimization, and system implementation and distribution.
Though individual airlines in the States are not owned by the government, it effectively controlled their performance until the late 1970s by setting a single price for each route and decreeing which of many carriers could operate where, but from the late 1970s on, the government relaxed the rules. American Airlines (AA) was the first to use basic revenue management techniques, offering dynamic pricing in shape of discounted fares to passengers who booked early, incentivizing customers by reserving seats for higher paying customers, and overbooking seats in the knowledge that some passengers would cancel at the last moment and that others would fail to show up.
AA pioneered the revenue management system and reaped the rewards of being one of the first movers in that direction. By using the methods mentioned earlier American Airlines claims to have been able to generate as much as $500 million a year in additional profits from 1980s onward. The methods used and the steps taken highlight the simple use of basic microeconomics principles in that dynamic pricing helps reduce the consumer surplus and deadweight loss and at the same time increases the firm’s profits. Using dynamic pricing (and coupling with yield management) AA decreased demand variability in that the customers understood that the earlier they book the better price they will get.
The questions American Airlines asked itself were: How many seats to make available at each of the listed fares,