yield management in aviation

8/13/2019 Yield Management in Aviation

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YMANAGEMENTIELD


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Abstract

Yield management is a term for a set of strategies that enable capacity-constrained service

industries to realize optimum revenue from operations. The core concept of yield management

is to provide the right service to the right customer at the right time for the right price. That

concept involves careful definition of service, customer, time, and price. The service can be

defined according to the dimensions of the service, how and when it is delivered, and how,

when, and whether it is reserved.


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YIELD MANAGEMENT| Transport PolicySHAHID NASEM | IUBH, Bad Honnef

T a b l e o f C o n t e n t s

Yield Management Introduction........................................................................................................... 1

The History of Yield Management ........................................................................................................ 2

Yield Management Preconditions ........................................................................................................ 3

Product is Perishable ...................................................................................................................... 3

Can be Sold in Advance .................................................................................................................. 3

Capacity is Limited ......................................................................................................................... 3

Market can be Segmented............................................................................................................. 3

Variable Costs are Low................................................................................................................... 3

Demand Varies............................................................................................................................... 3

Overview Of Revenue Management System ....................................................................................... 4

Steps of Yield Management ........................................................................................................... 4

Data Collection ..................................................................................................................... 4

Segmentation ...................................................................................................................... 4

Forecasting and Estimation ................................................................................................... 4

Optimization ........................................................................................................................ 5

Dynamic Re-Evaluation ......................................................................................................... 5

How Does It Works?............................................................................................................................... 6

Market Segment Pricing ................................................................................................................. 6

Airline Industry Segmentation ............................................................................................... 6

Segmentation In Other Industries .......................................................................................... 7

Peak/Off-Peak Pricing .................................................................................................................... 7

Price Discrimination ....................................................................................................................... 8

Forecasting Demand ...................................................................................................................... 9

Inventory Allocation Basics .......................................................................................................... 10

Yield Management Benefits................................................................................................................. 11

Customer Expectations ................................................................................................................ 11


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Competitive Pricing ...................................................................................................................... 11

Market Segments ......................................................................................................................... 11

Company Divisions: ...................................................................................................................... 12

Yield Management Application Areas ................................................................................................ 13

Success Stories..................................................................................................................................... 14

Conclusion ........................................................................................................................................... 15

References ........................................................................................................................................... 16

T a b l e o f F i g u r e s a n d C h a r t s

Table 1: Airline Industry Segmentation ............................................................................................. 6

Table 2: Segmentation in Other Industries ....................................................................................... 7

Table 3: Peak/Off-Peak Pricing ........................................................................................................... 7

Figure 1: Price Discrimination ............................................................................................................. 8



Table 4: Inventory Allocation Basics ................................................................................................ 10


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Y I E L D M A N A G E M E N T I N T R O D U C T I O N

ield management is an approach used by many corporations (mostly airlines) to maximize

the profit in contrast to other profit raising techniques. Yield management is not about just

increasing or updating pricing. Companies applying yield management is vary from company but

they have to fulfil four conditions that we will discuss in next chapters.

Yield management is a science of maximizing profits by considering different steps like:

Market demand Forecasting Mathematical optimization of pricing and inventory

Yield Management is the process of understanding, anticipating and influencing consumer

behavior in order to maximize yield or profits from a fixed, perishable resource.

Another way of describing Yield Management is:

Selling the right product to the right customer at the right time at the right price.

In Yield Management we emphasis on setting the best price for our products to gain more

profit. Like in airline industry tickets for the same flight are sold on different prices subjected to

time until departure and remaining unsold seats.

Y


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T H E H I S T O R Y O F Y I E L D M A N A G E M E N T

The concept of Yield Management initiated by airline companies in the United States of America.

American Airline is the first airline to adopt this strategy. After 1978 congress passed the act of

Airline Deregulation. That was a huge shock for airline industry in the US. Everything was

completely changed because now airlines are free to choose their fares and domestic routes.

After that many new airlines jumped into the market and PeoleExpress, a small company with

very low fares, 50% to 70% lower as compared to bigger airlines. It was a big distress for major

airline because they cant compete with these low fares. They had to cover their huge

expenditures and they cant choose low fares to compete. That was a very crucial time. If they

decided to lower the fares it is going to lead them towards bankruptcy and if they go with higher

fares they are going to lose their passengers.

It appeared that there was no option to overcome this issue and American Airline is going to be

bankrupt in new deregulated environment. But Robert Crandall, former CEO of American Airlines

announced its Ultimate Super Saver Fares, just like PeoleExpress and in some cases even lower

with few conditions. American Airlines segmented the market with two classes and this is

considered to be the start of yield management.

With the passage of time many airlines and after many other industries like Hotels, Operas,

Restaurants, Car Rental companies start applying this approach to maximize profits.


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Y I E L D M A N A G E M E N T P R E C O N D I T I O N S

There are some preconditions for applying yield management system in any industry. Without

having these conditions it is not possible to apply yield management system.

1. Product is perishableThe product should be unpreserved able like you cant sale a seat after the departure of flight or

if a room is free for a day its not possible to get its rent on other day. But on other products like

cars, if you cant sale them in this week you can in upcoming weeks or even after a month.

2. Can be sold in advanceThe second condition is that you can sale your product in advance, like you can sale or book airline

tickets even months before flight or you can book a room months before arriving.

3. Capacity is limited (Hotel Rooms)Capacity should be limited, like in a plane you can carry only a limited number of passenger

depending on aircraft size, same you have limited number of room available in a hotel and limited

number of seats in opera or theatre. If you have unlimited capacity then it is not possible to apply

yield management.

4. Market can be segmented (Business Class and Economy Class)While applying Yield management you should be able to segment your product into different

categories, like in hotels you can book a luxury suit, may be a normal single or double room. Or in

airline you can book ticket with different classes economy, business or leisure.

5. Variable costs are low (Cost per Passenger)Flexible cost as per passenger because you are selling seats with different prices.

6. Demand varies (demand for train/air tickets travel is higher on seasonal holidays)Demand varies with different reasons and causes, like on seasonal holidays demand for air

tickets and hotel rooms is higher than usual days.


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O V E R V I E W O F R E V E N U E M A N A G E M E N T

S Y S T E M

Steps of Yield Management

1. Data Collection:2. Segmentation3. Forecasting and estimation:4. Optimization:5. Dynamic Re-evaluation

Now lets have a glance on thestructure of a yield management system, and how it works. Yield

management system calculates and updates the booking limits within a reservation system. The

yield management system goes through fowling steps:

1) Data Collection:Companies using yield management have to keep their historical data of customer conduct, fares,

demand and other factors for better forecasting and estimation. This is the groundwork of all yield

management systems. The more precisely we collect data the better forecast we can make.

2) SegmentationAfter gathering the relevant data, market segmentation is the key to market-based pricing and

revenue maximization. Successful application of yield management depends on your customer

segmentation on behalf of their responses on certain product prices based on time and place.

3) Forecasting and estimationWithin this phase we have to evaluate the factors of our model, and after that we have to make

forecast using these factors or parameters. Sometimes companies not only forecast demand, but


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no-shows, or cancellations too. We cannot optimize the controls without considering all the

factors involved.

4) OptimizationDuring the forecasting process we recommend that what customer are like to do and in

optimization we suggest how a firm should react to that. Optimization is about assessing multiple

options how to sell your product and whom to sell. We have to find the optimal set of controls

which we are going to use.

5) Dynamic Re-evaluationYield management needs that the organization must continuously re-evaluate their prices,

products and procedures to enhance yield. In the active market an effective yield management

system regularly re-evaluate the factors to move with the current market situation.


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H O W D O E S I T W O R K S ?

For the better understanding of yield management system process now we will look at examples

of following steps:

Market Segment Pricing Peak/Off-Peak Pricing Price discrimination Forecasting Demand Inventory Allocation Basics

Market Segment Pricing:

Airline Industry Segmentation

Characteristics Business Travel Leisure Travel

Advance Booking Booking close to departure. Booked well in advance of departure.

Stay at

DestinationRarely Include a weekend. Usually includes a weekend.

In airline industry usually we have two types of customers, one business travelers and second

leisure travelers. Business travelers usually book their tickets only few days before flight or

sometimes even few hours before departure. So they are willing to pay higher prices to meet their

demand. But on the other hand leisure travelers usually travel in vacations so they book their

tickets even months before, they are not bound of time and days so they get benefit of it and get

the higher discount based on how much advance they book the ticket.


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Segmentation in Other Industries

Industry Method of Market Segmentation

Freight Transportation Vary rates by commodity being shipped.

Health Care Time sensitive care vs. postpone able care.

Broadcasting Guaranteed spots vs. rotatable spots.

Utilities Urgent, non-discretionary service vs. non-urgent, interruptible

service.

Peak/Off-Peak Pricing:

In yield management we offer different prices on the basis of peak and off peak timings, prices

rises when the demand is higher and reduces during the period of slack demand. Like on

seasonal holidays prices of airline tickets and hotel rents are higher than usual days.

Industry Type of Discount

Air Travel Night Coach fares.

Car Rental/Hotel Weekend discounts in major cities (not resorts).

Telephone Companies Reduced long distance rates on nights and weekends.

Theaters Discounted Matinees.

Golf Discounted off peak tee times.


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Price Discrimination:

Yield management may involve price discrimination, but it does not have to. There are few graphs

to explain how price discrimination works. To keep the things simple and better understanding of

the model we take the unit cost same for all quantities.

Fig. 1

Fig. 1shows the pricing without any discrimination. The higher the quantity the lower the price

accordingly. But after a certain quantity company put more efforts on higher quantity but the

profit remains same. And before a certain quantity customer need to pay more price because

they are buying less quantity.

Fig. 2


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Fig. 2 shows price discriminations for some certain level. It is very basic model of price

discrimination. Deadweight loss is lower than previous model and customer surplus is also divided

into two part enhancing the better product pricing.

Fig. 3

Fig. 3describing an enhanced model of price discrimination. Profit margin is higher than before

and you can offer even better prices to you customers. Deadweight loss is minimal and customersurplus is divided into many parts. For a certain model this the best pricing you can get with yield

management.

Forecasting Demand:

Estimation and forecasting methods are dynamic components of both the price based and the

quantity based yield management systems.

Quantity based yield management we collect data from past and use time series methods to

forecast demand in future. In addition to demand, booking forecasting is also essential.

Cancellation and no show odds are also essential to calculate.

Price based yield management we predict the demand as a function of a variable, such as price or

promotion. These involve building forecasts such as market response or customer behavior at

certain price points. By relating these predictions a yield management System can then quantify

these benefits and develop price optimization strategies to maximize revenue.


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Inventory Allocation Basics:

Allocate inventory among price levels/market segments to maximize total expected revenue or

profits in the face of uncertain levels of demand.

Potential Customer Customer A Customer B Customer C Customer D

Price $100 $60 $80 $70

Probability 70% 100% 100% 100%

Expected Revenue for the unit $70 $60 $80 $70

10 Times $700 $600 $800 $700

Decision - Reject Accept Indifferent

We should never sell a unit of capacity for less than we expect to receive for it from another

customer, but if we can get more for it, the extra revenue goes right to the bottom line.


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Y I E L D M A N A G E M E N T B E N E F I T S

The benefits of yield management involves better capability to forecast customer requirements,

better pricing tactics, growth of markets and stronger association between the company divisions.

Customer Expectations:

Yield management provides better understanding of customersexpectations about product. The

research involved with yield management gives companies insight into the specific wants and

needs of their customers, and enables the company to shape the product and its presentation

more effectively. For instance, a hotel chain working on revenue management might discover that

their customers are typically business travelers who need easy access to the Internet. As a result,

the hotel chain might incorporate a policy providing free wireless internet in all hotel rooms.

Competitive Pricing:

Yield management support the company to build a competitive pricing approach that will provide

the company an advantage over its rivals. Yield management is so pervasive within certain

industries that companies failing to implement yield management strategies are unable to

continue competing effectively within the marketplace. For example, an airline might complete

research that shows customers who would otherwise be willing to fly are struggling with high

prices and extra fees. As a result, the airline can boost its competitive advantage by lowering

prices on certain flights or even by eliminating the baggage fees.

Market Segments:

Yield management seeks to show the company the full extent of its market segment and to

introduce the company to new market segments that are available. Companies that usually focus

on a certain market segment might need to expand their focus to continue growing in the

industry. For instance, a hotel chain that focuses primarily of business travelers might realize that

many of its chain locations are in destinations that have become popular family vacation spots.

As a result, the hotel chain can begin advertising to family travelers and making any necessary

adjustments in the chain locations, such as larger breakfast offering or play areas for children, to

encourage business from this market segment.


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Company Divisions:

Yield management creates a strong awareness between the activities of different company

divisions, and particularly the activities of those working on sales and marketing, and those on the

front line of service. Sales and marketing representatives must develop programs to reach out to

customers, but it is the service representatives on the frontline who are responsible for carrying

out many of these programs. Revenue management provides companies with the opportunity to

coordinate their divisions more closely and thus create the most effective programs possible.


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Y I E L D M A N A G E M E N T A P P L I C A T I O N A R E A S

Airlines Hotels Car rental Tour operators Cruise ships / Ferries Healthcare Amusement parks, golf courses. Theatres, Opera. Energy companies Advertising & TV


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S U C C E S S S T O R I E S

American Airlines increased annual revenue with $500 million through yield management Delta Airlines increased annual revenue with $300 million through yield management Marriott hotels increased annual revenue with $100 million through yield management National Car Rental was saved from liquidation with yield management Canadian Broadcasting Corporation increased yield $1 million per week


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C O N C L U S I O N

Yield management is a process that can significantly increase revenues of capacity-constrained

firms through better inventory management and pricing. By using yield management concepts,

these firms can protect premium inventory for sale at higher prices, stimulate market growth

by offering discounts and minimize wastage of perishable inventory.


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R e f e r e n c e s :

Revenue Management by Kristie Lorette

IATA Yield Management Program

Impact of Yield Management by Orreia Nunes Da Silva

Airline Revenue Management in a Changing Business Environment by Richard Klophaus

Implementing Revenue Management by Sevin Gken

Demand and Revenue Management by Anton J. Kleywegt

The End

yield management in aviation

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