Crain’s Chicago Business: United gets smarter at the ticket pricing game
December 13, 2014-
By Meribah Knight
Years after the rocky merger of United and Continental airlines, United’s bottom line finally is taking off—thanks in large part to getting smarter about how much the airline charges for seats.
It’s not as simple as just raising ticket prices. Using big data, statistical models and a touch of human intervention, airlines rely on what they call revenue management to boost their low margins by selling seats for the right price at the right time to the right customer.
It’s a delicate process that places an educated bet on consumer demand. George Hamlin, president of Fairfax, Va.-based Hamlin Transportation Consulting, compares it to eating a poisonous blowfish, a delicacy in Japan. “Eat the wrong part and you die. But the rest of it is highly prized.”
“There are lots of facets to revenue management, and understanding that and doing it well gives you an edge in a very low-margin business,” says Gordon Bethune, former CEO of Continental Airlines.
After analysts accused the company of botching the process in late 2013 and early 2014, United got a better handle on it in the last two quarters. The shift has helped the Chicago-based airline increase its per-passenger revenue by 4 percent in the third quarter over last year, making a record $1.1 billion in profit. But with so many moving parts to the equation—pricing, inventory, scheduling, passenger demographics—one miscalculation can lead to big losses.
Click to see how United’s economy class seats are laid out
In late 2013 and early 2014, for instance, United Continental Holdings had too many early bookings and didn’t sell enough higher-priced seats closer to the date of the flights, costing the airlines hundreds of millions of dollars in revenue. “They basically sold too many seats at a discount,” says Helane Becker, a senior analyst at Cowen.
United disputes that analysis, saying the decision to sell more seats at a lower price was a calculated move to let the fewest seats go empty as lucrative business travelers moved away from the airline because of its poor on-time performance. “With fewer of those customers booking United, we took the right revenue management step, which was to sell more discounted seats,” says Rahsaan Johnson, a spokesman for the airline.
The practice of revenue management emerged after the Airline Deregulation Act in 1978, as low-cost domestic carriers sprung up and larger legacy airlines needed to compete. The key to matching rock-bottom fares was “to be able to do it on a portion of your inventory,” says Robert Mann, a former American Airlines executive who now runs aviation consultancy R.W. Mann, based in Port Washington, N.Y. Predicting ticket sales and allotting a certain number of tickets to be sold at a lower cost than others became the industry standard. “You had to be able to, in effect, divide capacity into a group of buckets, each with an allocated inventory and each priced differently,” Mann says.
That is the science, but experts say the art comes down to making the right game-time decision as the market fluctuates. “Making sure you react appropriately but not overreact is really the balance you need to create,” says Darren Rickey, a vice president at Sabre Airline Solutions, a Southlake, Texas-based provider of revenue management software for airlines such as JetBlue, Virgin America and Etihad Airways.
United has recalibrated chiefly by increasing the number of seats available for late-booking North American business travelers and broadening the spectrum of price points for those seats. United also lowered its first-class fares for North American travel, giving customers an incentive to take the price leap rather than angle for a free or discounted upgrade. The gamble has paid off: United has had a 50 percent increase in first-class sales, and first-class seat revenue is up 20 percent in the third quarter versus last year, Johnson says. The recent initiatives “were the two biggest drivers in revenue management,” he says.
What’s more, United is not increasing capacity. Even as demand rises and business travelers come back to the airline, “the percentage of seats filled is not significantly different,” Johnson says. “What is different is the mix of customers in those seats.”
But as carriers continue to “unbundle” the costs of air travel, charging for luggage, food and Wi-Fi, the equation for maximum profitability, plane by plane, is only getting more complicated. “If you think about that as a slice of the total revenue pie, that slice is getting bigger and bigger every year,” Sabre’s Rickey says. In the third quarter, United’s ancillary revenue, as it’s called, was up 11 percent per passenger, on track to achieve the company’s 2014 goal of raking in $3 billion in ancillary revenue, up from $2.8 billion last year.
“Revenue management is an extremely powerful tool,” says Benson Yuen, president of Pros Travel, a division of revenue management software provider Pros, based in Houston. “It’s not just a system. It’s an initiative, it’s a discipline.”