Biz Fares Reflect Value Of Last-Minute Bookings
<B> Biz Fares Reflect Value Of Last-Minute Bookings</B>
By Brad Boggess
When people find out that my job is helping airlines determine how much to charge for each seat, they invariably say, "So you're the one to blame for these high prices." Then they glare at me with that how-can-you-live-with-yourself look. It's always the same. No explanation is likely to ease their outrage. Lucky for me, lynching is no longer politically correct.
How come most business travelers and corporate travel managers think they are being gouged by the airlines when they buy a ticket? Sure, last-minute purchasers may pay up to five times as much for a seat as other travelers, but they also get more in return. What? You say they don't get more in return? You say a seat is a seat? Well, maybe that's what is wrong. Perhaps the feelings of resentment over price come from a misunderstanding about what is actually being purchased. Let me explain.
The idea of mutual gain from voluntary exchange is a fundamental principle of economic theory. This principle tells us that unless there is deception or misunderstanding of the facts, a voluntary exchange between two parties must make both parties better off. Even though no additional goods or services are produced by the act of trading, the general welfare of society is increased because each individual acquires goods or services that are more suited to his or her needs and tastes.
This is also true when a traveler voluntarily exchanges money for the use of an airplane seat. Both parties benefit. The traveler is able to pursue business deals, visit with relatives or relax on a tropical island. The airline avoids holding an empty seat and is better prepared to meet its financial obligations with suppliers, employees and shareholders. The welfare of society is increased because each party gets what they want. If the price is too steep or if the airline is unreliable, the parties will not agree on a mutually beneficial arrangement and no trade will take place.
The thing that's unfortunate is that aggressive fare competition between air carriers has led the traveling public to view airplane seats as a commodity, differentiated only by price and restrictions of price. This perception makes us resent the fact that we may have paid more for a seat than the person sitting beside us. But airline seats are no commodity. They are distinct products and the price of each seat is actually an expression of value. A seat's value rests in its availability for purchase, in the reach, convenience and timeliness of the flight schedule, in the airline's safety record, product image and in-flight service, and ultimately in its usefulness to the purchaser. A business traveler who urgently needs to reach a client site today will place far more value on a seat than will a college student looking for an inexpensive trip to Las Vegas. The price that a traveler is willing to pay is therefore based on his or her particular circumstances, perceptions and estimation of value at that time and place.
Airlines, with their multitude of fares and travel restrictions, are simply trying to match the price of a seat with its corresponding value to the customer. This strategy of differential pricing is vital to the success of an airline, but it does lead to debate. Some people believe that selling the same seat at different prices is unethical and discriminatory. Others think it's more personal and vindictive. Nevertheless, the thing we must realize is that the value of an airplane seat is different for each traveler, in each situation. Additionally, the value of an airplane seat purchased weeks in advance is not the same as an airplane seat bought at the last minute when inventory is limited and demand is high.
Airplane seats have a high time utility and inventories are completely perishable. If a seat on today's flight goes out empty, it is wasted--forever. It cannot be restocked, reshelved or saved for future demand. This characteristic of the service industry puts airlines at tremendous financial risk. Inventory must be carefully managed. If an airline holds back too many seats for time-sensitive business travelers, it loses the chance to sell them to price-sensitive leisure passengers who book well in advance. If the last-minute business doesn't come in as expected, the flight departs with empty seats that will never be sold. By paying higher rates to have these seats, the last-minute traveler is assuming part of the risk in saving them.
One way airlines minimize the financial risk associated with empty seats is through what is called revenue management. Revenue management is the art and science of controlling inventory with the single goal of maximizing revenue. Revenue management systems employ high-speed computers to analyze vast amounts of historical data. Then, sophisticated mathematical models are used to predict consumer demand and optimize product availability. This allows the airlines to more accurately forecast the number of seats required for last-minute business travelers. Remaining seats then may be sold in advance, at a discount, to help cover fixed costs and reduce the amount of "risk-sharing" revenue needed from business passengers.
Revenue management captures more money from existing operations and airlines typically see a 4 to 12 percent increase in revenue after they start using its techniques. Because the margins in the airline industry are so thin, this 4 to 12 percent revenue growth can translate into a 40 to 50 percent increase in bottom-line profits. Not only is this good news for the airlines, but it also benefits business travelers to have an airline industry that is healthy and strong.
Business travelers' schedules are in constant flux, yet they require inventory to be available where they want it and when they want it. A healthy, robust airline is able to provide more flights, to more destinations, with more reliability than a weak, anemic airline. A viable airline industry keeps the wheels of business turning.
When you buy a seat, you also are buying the opportunities, experiences, risks and benefits that go along with it. Those are the characteristics that make one seat's value different from another. By paying for the real value of your seat, you are able to pursue business deals, visit with relatives, or relax on the beach whenever and wherever you choose. The airline is able to grow and meet your needs in the future.
Brad Boggess is vice president of revenue management for Open Skies Inc., a Salt Lake City-based airline technology firm that provides small to medium-sized airlines with revenue management and inventory control tools.