Information Technology Reference
In-Depth Information
2 Revenue Management at Low Cost Carriers
In this section we first introduce the basic concepts of revenue management and
outline the logic which is the conceptual basis of RM systems in FSC. Then we
analyze and describe the different situation a LCC faces. This exposition is to
settle ground for the models given in Section 3.
Revenue Management (RM) addresses the situation where a fixed amount
of perishable goods or services has to be sold to different customers willing to
pay different prices. Thus it addresses pricing as well as capacity planning. RM
is essential in situations where the fixed cost related to the provision of the
perishable goods or service far outweighs the variable costs. RM is critically
important in the airline industry. Here the schedule offers a fixed capacity of
seats on a flight. Airplane seats are perishable goods since as soon as a flight has
left the gate unsold seats on board are worth nothing.
The approach taken by a FSC is to divide the seat capacity on an aircraft
into different products, so called
fare classes
, based on different classes of service
like first class, business and economy with different degrees of flexibility like
minimum stay, advanced booking etc. The different products are offered and sold
at different prices at the same time. Then, RM is to manage the relationship
between price, demand, capacity and customer behavior in a way that maximizes
revenues.
Due to its business model, consumer segmentation using fare classes related
to different service levels or restrictions makes no sense for LCC. All booking
requests refer to the same product and each request is dealt with uniquely and
offered a price which is economically appropriate at the time of request. Requests
are treated by a first-come first-served process with passengers getting cheaper
fares by booking earlier and the airline controlling revenue by increasing price,
i.e., sequentially closing low price fare classes. Note that there are ad-hoc offers
if demand does not meet expectation and special offers like blind booking which
are to attract revenue for otherwise unused seats. Also, ancillary revenue from
non-ticket sources has become an important revenue component which we do
not consider in this study. Note that overbooking is also neglected in our study,
here strategies of simply enlarging aircraft capacity are applied.
In the LCC business environment where classes have no differentiation other
than price the knowledge of price sensitivity has become even more crucial.
Generally, a market-response-function is used to express the connection between
price and demand. And such a function has to be estimated separately for every
single flight by analyzing historical data for so called reference flights. Those
are flights with the same relation on similar days of the week, comparable flight
times and same seasonality etc.
Now customer behavior, i.e price sensitivity, changes over the booking pe-
riod. Therefore, several forecasts of market response are estimated for different
time intervals before the day of departure with intervals getting smaller when
approaching the day of departure. Figure 1 shows an example of two market-
response-functions created by the forecasting component.
