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Airline business transformation: From revenue management to retailing

Airline Leader

The function of revenue management has been a game changer within the global airline industry for more than four decades, allowing carriers to offset some of the negative factors associated with a perishable product, fixed capacity, high fixed costs and low variable costs. - By Nawal Taneja

Summary
  • Revenue management has been a game changer for the airline industry, allowing carriers to optimize their revenues by understanding consumer behavior and analytics.
  • Airlines are now integrating ancillaries and loyalty functions into the revenue optimization process, aiming to improve both revenue and customer experience.
  • Forward-thinking airlines are focusing on areas such as ancillary sales, granular customer segmentation, consumer decision choice models, and customer loyalty.
  • Challenges include aligning business and brand strategies, integrating functions within commercial planning, and having the technical capability to optimize revenue on an enterprise level.
  • The analysis, optimization, execution, evaluation, and feedback processes are crucial for revenue optimization.
  • Airlines can learn from successful retailers and global businesses in terms of customer behavior understanding, building relationships, and offering the right product at the right time through the right channel and price.

In the early 1970s, one of the earliest adopters of revenue management, British Airways (then BOAC), began to experiment with capacity-controlled discounted fares based on early bookings, otherwise known as segmental demand. This was soon followed by American Airlines' 1977 experiment with Super Saver fares, implemented again on a capacity-controlled basis. Since then, airlines have been using advanced knowledge of analytics and consumer behaviour to optimise their revenues, a practice which before long has been adopted by many other businesses in other sectors, notably hotels, car rental companies and entertainment companies such as Disney World. However, some of these retailers have capitalised further on this practice and benefited even more than airlines. By spending more time understanding the lifestyles and behaviour of their targeted customers, these retailers have not only mastered how to price inventory more effectively, but also how to promote the product in a way that catches the attention of carefully segmented and targeted customers, motivating them to make a purchase, and to pay attention to the omni-channel experience.

From revenue management to customer-centric retailing

Until recently, airline revenue managers focused on two basic parameters: inventory and price, shown in the diagram on this page by the two circles and their intersection. In this function, they used sophisticated techniques to optimise trip revenue, taking into consideration factors such as booking patterns, load factors and the nature of the itinerary (local segment, or a connection, including details such as whether the connection is inter-line, intra-line, or with an alliance partner). Sophisticated carriers went further and analysed not just the inventory within different buckets, but also the makeup within each bucket. For example, company A in the corporate bucket might get a 10 percent discount while company B in the same bucket might get a 15 percent discount. Similarly, the pace setters looked at whether it was an alliance partner, equity partner, or a joint venture partner requesting a seat before authorisation was provided.

Now airlines have begun to integrate two more functions in the optimisation process, Ancillaries and Loyalty. Optimisation now encompasses the intersection of all four circles, a more complex task, but one that promises to provide a significant improvement in not just revenue, but also customer experience, assuming that the airline has the technical capability, the right systems, and an organisational structure to achieve this level of optimisation at the enterprise level.

Consider ancillaries, for example. In the past three or four years, the revenue management evolution has gained noteworthy momentum, due primarily to the increasing interest of airlines in merchandising and retailing based on the availability of technology, and dramatic changes in new distribution capabilities. Similarly, interest in maintaining the loyalty of current customers, and accessing and gaining the loyalty of new customers, has increased, not to mention the ability to reward the right relationships.

Forward thinking airlines believe they have incredible amounts of data that can be leveraged to understand and respond to the constantly changing dynamics of the marketplace as well as access to advanced technology and analytics to offer value-adding propositions and to monitor, interpret and evaluate performance. But, do they have the right systems to provide a single, transparent 360-degree view of the product to a customer? Do they have the systems, skills and processes to create a unique solution for each customer along the lines of what Amazon and Netflix have done?

Forward thinking airlines believe they have incredible amounts of data that can be leveraged to understand and respond to the constantly changing dynamics of the marketplace.

To their credit, these ambitious airlines have begun to focus on areas where there are opportunities for substantial improvement. These areas include:

(1) The sale of ancillary products and services within the various inventory buckets, including opportunities to up-sell and cross-sell;

(2) Granular customer demand segmentation based, at least, on customer personas rather than traditional segmentations based on purpose of trip;

(3) Demand for these personas based on specific buying behaviour that, in turn, is based on numerous parameters, and in as close to real time as possible, rather than just price, network and schedules;

(4) Use of consumer decision choice models rather than forecasts of market share based only on price and schedule (number of stops, total elapsed time), but including factors such as affinity to the brand and fare rules;

(5) Deployment of rule-based analytics to transactional data (i.e. if this, then this etc);

(6) Event-driven market and competitor conditions and dynamics;

(7) Customer loyalty based on customer centricity and customer experience, as well as customer relationships;

(8) Current and predicted lifetime value of customers; and

(9) Implementation of key revenue performance metrics, based, for example, on (a) wallet share within a given bucket and not just seats sold, (b) customer acquisition and retention costs for various buckets, and (c) the costs to and benefits for other divisions within an airline.

Despite a desire to take the revenue optimisation process to the next level, even the ambitious airlines face monumental challenges. The first one relates to the need to align business strategies and brand strategies. Just within commercial planning, are these four functions integrated? Is there a conflict between branded fares developed by marketing and ancillary products and services being sold by revenue managers? The integration relates not just to the sub-functions within each of Seat Inventory, Price, Ancillaries and Loyalty, but across all four functions. Would inventory control open up a bucket if the passenger asking for a seat had negative experiences during the past three trips? Would inventory control even have this information without human intervention? Would sales be able to get a bucket opened up for a special customer that falls in the category of being an "influencer"? It is integration within commercial planning that will transform an airline's business strategy into brand strategy and, in turn, lead to a customer strategy.

Also, there is the challenge of the technical capability related to the enabling processes and supporting systems to optimise revenue on an enterprise basis rather than within the four individual functions. The steps in the enabling processes are to analyse, optimise, execute, evaluate and provide feedback.

The analysis starts with questions such as who are the targeted customers, what they buy, what are their propensities to buy, what channels do they prefer, and how does the analyst maximise wallet share. The next process, optimisation, is much more complicated. Revenue managers do not know how much people will spend on ancillaries when they are making a reservation months ahead of the travel date. The analyst cannot optimise something they cannot forecast. This leads to the execution process and the use of predictive analytics. Again, the forward thinking airlines have already begun to experiment and build a database. Who purchased what ancillary product or service at what price and at what time in the travel cycle - day of reservation, day of flight, prior to check-in, or during the flight? In a particular bucket, who purchased X and also purchased Y? They are experimenting with prices, up-selling, cross-selling and using market intelligence. A person making a day trip is not likely to be interested in a lower price for checked bags. A person on a long-haul flight that is almost full might be interested in a seat with extra legroom. A person with an exceptionally long layover might be interested in a lounge pass for part of the day, but not the whole day. The evaluation process, a difficult task within a service sector to begin with, involves not just an analysis of how each functional silo is doing but how commercial planning - the combination of all four functions - is performing. Even within a functional silo, evaluation is required in real time, for instance, on how a certain promotion is doing. Is it cannibalising a premium product? Feedback is needed in real time, not two months after the promotion. This is where metrics and key performance indicators enter the evaluation process.

Should every airline undertake this extremely sophisticated revenue optimisation process? A global, full service airline, of course, is clearly a candidate. An ultra low-cost airline, on the other hand, could use a far less sophisticated optimisation framework, depending on the vision of the leadership with respect to the current and future customer base and the complexity of the operations required to meet the expectations of the customer base. Even low-cost airlines need to do some level of segmentation to move from mass marketing to segment marketing to target marketing. Those low-cost airlines that provide service in intercontinental markets (Air Asia X, Jetstar and Norwegian Air Shuttle, for example) need to go much further to identify and interact with customers to optimise revenue by up-selling and cross-selling. And for the large global, full service airlines, especially those who aspire to become successful retailers, optimisation of revenue at the enterprise level will increase margins that are incredible for airlines, but normal for high-end retailers. However, the process requires much more information on customer behaviour, with a focus on customer insights, not just customer friendliness, and the long-term value of building and maintaining a brand, and not a desire to build for scale.

If an airline wants to become a high-margin retailer, as appears to be the case with numerous large global carriers, then it needs to circle back to the practices of successful retailers: ease of use regardless of channel, consistent brand experience at every touch point, customer and data-centric personalisation - at least based on enriched customer profiles of the targeted segments - and optimisation at an enterprise level (not within a silo). Retailers learned from airlines the capability of sophisticated revenue management. But they took the practice to new heights by understanding customer behaviour and building genuine relationships with different customers at different levels by offering the right product to the right customer at the right time through the right channel and at the right price. Airlines can now learn from successful global businesses: Amazon, Disney and Google in North America; ALDI, Carrefour and IKEA in Europe; HSBC, Raffles Singapore and Samsung in Asia; and Corona, Falabella and Skol in Latin America.