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Don’t Fly by the Seat of Your Pants: Lessons from Airline Pricing Strategies
Airline carriers have primarily functioned on hub-and-spoke networks since industry-wide deregulation in 1978. The approach vastly improved airlines’ efficiency by decreasing the number of flights operated and increasing capacity on those flights. The result was carrier dominated airport hubs, such as Chicago’s O’Hare International Airport for United Airlines and Dallas/Fort Worth International Airport for American Airlines. Since purchase decisions for leisure travelers are largely on price, there is high price elasticity of demand, and fierce price competition.
In this competitive, hub-and-spoke-driven environment, airlines must compete with the lowest fares on every route. Generally, customers prefer to fly direct, and therefore, the same connecting route is typically sold at a lower price, which can lead to a strange consequence: airlines often charge less for a multi-legged flight than they do for the first leg of the same route sold as a direct flight. For example, flying from Los Angeles International Airport direct to Chicago’s O’Hare costs $558, but a ticket from Los Angeles to Montreal with a layover in Chicago on the exact same flight is $365[i]. This allows for “hidden city” ticketing, where customers intentionally purchase a ticket with a connection to their desired destination city, but do not use the second leg of their ticket.
This seemingly counter-intuitive pricing is actually quite profitable for airlines, so when a new website emerges that exposes pricing “inefficiency,” and links travelers to travel booking websites to purchase tickets based on that pricing strategy, it can pose a problem. This pricing conundrum poses the following questions for airline executives, “How real are these price pressures?” and “What does this indicate for the future of our go-to-market strategy?”
Our engagements across a wide variety of B2B industries have identified two common causes that are manifesting in the airline industry: underlying market pressures and poor customer chain management.
There are new entrants, but in this case, quite different than a classic, “new player, lower prices” situation. A new website, “Skiplagged,” exposes airline pricing “inefficiencies” by linking customers directly to travel booking websites, such as Expedia and Kayak to purchase “hidden city” tickets. While not immediately worrisome, it sends signals about the future of transparency in pricing and its impact on pricing strategy. Technology has allowed for effective price discrimination on multiple purchase factors (e.g., time of day and remaining supply on flight), as well as multiple purchase options (e.g., first class, business class, and coach). While technology has shown itself as a catalyst for advanced pricing strategies, that sword may show its double-edge soon.
Poor customer chain management
Successful customer chain management requires understanding and rewarding value-added activities that each customer chain player brings. Already, a major airline carrier and booking website have come into conflict due to the website allowing linking from the “hidden city” enabling site. However, not only is “hidden city” ticketing difficult for an end-customer to do successfully (due to baggage issues, potential redirects, need to book one way tickets, and policy issues), but it is also a small percentage of total flights. Putting relationships under pressure for small issues makes customer chain partnerships and alignments even more challenging. Customer chain players, including the airlines and the booking sites, should instead focus on reinforcing their strong position in the omni-channel experience, and staying vigilant in providing value-added service at each point along the customer chain.
The warning signs of pricing problems are present. New paths to lower prices are beginning to gain attention, and there are too many channel partners offering the same price for an undifferentiated product. When faced with market pressures, the first step is to evaluate the underlying cause of concern. Once the root of the problem is identified, active customer chain management that applies solutions and aligns company policies and procedures, channel design, and performance will get your wheels off the ground and ensure a smooth flight towards growth and profitability.[ii]
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For more on this topic, download Blue Canyon’s white paper, Understanding and Overcoming Pricing Conundrums.
[i] Fares as of 03/16/15 for flights on 04/03/15. All flights one way. Prices from Priceline.com.
[ii] Valentine Pope and Karr, Understanding and Overcoming Pricing Conundrums, Blue Canyon Partners, Inc., ©2015