M I T I n t e r n a t i o n a l C e n t e r f o r A i r T r a n s p o r t a t i o n PRICING AND REVENUE MANAGEMENT RESEARCH Airline Competition and Pricing Power Presentations to Industry Advisory Board Meeting November 4, 2005
PRESENTATIONS Pricing and Competition in Top US Markets (Celia Geslin) Fare, Traffic and Revenue Changes 2000 to 2004 Impacts of Airline Fare Simplification (Maital Dar) MIT PODS Research Consortium Simulations of Revenue and Traffic Impacts Adapting Revenue Management Systems (Peter Belobaba) Development of New Forecasting and Optimization Algorithms 2
M I T I n t e r n a t i o n a l C e n t e r f o r A i r T r a n s p o r t a t i o n AIRLINE PRICING AND COMPETITION IN TOP US MARKETS Célia Geslin
Objectives and Approach Preliminary analysis of airline pricing power in US markets: How have air fares changed in domestic markets in the past 5 years? Differences by length of haul? Differences between LCC and non-lcc markets? Empirical analysis of largest domestic markets Top 100 US 2004 Markets from O&D Plus Data Aggregate analysis and overall trends between 2000 and 2004 Analysis by carrier and type of carrier (legacy, LCC) 4
Average Fares in Top 100 US Markets Fares continue to decrease. On average, fares were 19.3% lower in 2004 compared to 2000. Average Fares - Top 100 Markets $150 $140 $130 $120-8.4% -15.6% -14.7% -19.3% $110 $100 2000 2001 2002 2003 2004 5
Total Passengers in Top 100 US Markets Passenger volumes have rebounded to 2000 levels after dropping by over 11%. Total Passengers per day - Top 100 Markets 150,000 145,000 140,000 135,000-8.5% -11.7% -9.5% -8.5% -12.6% -10.4% + 0.4% -0.6% 130,000 125,000 120,000 2000 2001 2002 2003 2004 6
Total Revenues in Top 100 US Markets Huge revenue drop of 25.4% by 2002. Slow recovery since then, but still 19% below 2000. Total Revenues per day - Top 100 Markets Millions $22 $20 $18 $16 $14 $12 $10-16.2% -25.4% -22.8% -19% 2000 2001 2002 2003 2004 7
Carrier Market Share Losses and Gains Market share losses for network carriers, gains for LCCs led by JetBlue Southwest is MS leader in Top 100 Markets, in both 2000 and 2004 % Market Share Change 2000-2004 - Top 100 Markets 7% 6% 5% BIGGEST LOSSES BIGGEST GAINS 4% Market Share 3% 2% 1% 0% -1% -2% -3% -4% US Airways United Airlines Continental Airlines Delta Air Lines Southwest Airlines America West Airlines Spirit Air Lines Jet Blue 8
Market Share by Carrier Group Overall, LCC group MS increased from 26% to 37%, while Legacy group MS dropped from 60% to 53% % Market Share - Top 100 Markets Market Share 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% Legacy LCC Others 2000 2004 9
Fares by Distance Category Average fares have dropped by 36% in long haul markets, while short haul fares actually increased slightly compared with 2000. Average Fare comparison 2000-2004 $300 $250-36.08% $200 $150 $100 + 0.92% - 21.34% 2000 2004 $50 $- Short Haul Medium Haul Long Haul 10
Passengers by Distance Category Passenger traffic in short haul markets dropped 18%, while increasing 10-13% in medium and long haul markets Total Passengers comparison 2000-2004 80,000 70,000 + 9.9% 60,000 50,000 40,000 30,000-17.8% + 13.4% 2000 2004 20,000 10,000 0 Short Haul Medium Haul Long Haul 11
Revenues by Distance Category Total Revenues decreased most in long haul markets despite traffic growth down 27% overall Total Revenue comparison 2000-2004 Millions $12 $10-13.5% $8-27.5% $6 $4 $2 $- - 17% Short Haul Medium Haul Long Haul 2000 2004 12
Markets Grouped by LCC Presence In 2000, 27 of Top 100 US Markets without LCC presence By 2004, only 10 Top 100 US Markets without LCC presence (6 when Hawaii markets excluded) 84 of the Top 100 US Markets with more than 10% LCC MS LCC Market Share Distribution ( 2000-2004) Frequency 90 80 70 60 50 40 30 20 10 0 84 65 27 10 7 6 LCC=0 LCC<10% LCC>10% 2000 2004 13
Average Fares and LCC Presence Average Fare decreased more for markets with a small 2004 LCC market share than the markets with well-established LCC presence. Largest (31%) decrease in fares observed for markets with new entry by LCC between 2000 and 2004. Average Fares Comparison (2000-2004) $250 $200 $150 $100-20.4% -17.8% -31.3% 2000 2004 $50 $- LCC MS < 10% 2004 LCC MS > 10% 2004 LCC New Entry 2000-2004 14
Passenger Traffic and LCC Presence Markets with LCC presence showed traffic growth of 4.51% But in O&D markets with small or no LCC market share, traffic is still 16% below the 2000 level. Total Passengers Comparison (2000-2004) 140,000 120,000 +4.51% 100,000 80,000 60,000 2000 2004 40,000 20,000-16.3% 0 LCC MS > 10% LCC MS < 10% 15
Conclusions: Top 100 Markets Overall trends in largest US markets 2000-2004 Traffic has rebounded to peak 2000 levels But average fares have dropped 19%, with a corresponding total revenue decrease Major differences identified: By carrier type Legacy carriers have lost 5% market share and over 9% revenue share Long-haul market fares have dropped the most, with greatest traffic growth. On the other hand, short-haul traffic is down, and average fares stable. Substantially lower total revenues in all distance categories. Markets with LCC new entry saw the greatest drop in average fares between 2000 and 2004 16
Future Research Expand the sample to 500 or 1000 Top US Markets Identify relevant factors in the evolution of pricing and competition in airline markets: Length of haul Low-fare carrier competition Hub vs. non-hub markets Broader questions include: How has willingness to pay (price elasticity) changed? Are people less willing to pay for air travel? How has airline pricing power been reduced? How can we quantify this effect? 17
M I T I n t e r n a t i o n a l C e n t e r f o r A i r T r a n s p o r t a t i o n IMPACTS OF AIRLINE FARE SIMPLIFION Maital Dar
PODS RM Research Consortium Airline revenue management research at MIT funded in large part by PODS Research Consortium Focus on forecasting and optimization models for seat inventory control (seat allocation) Findings used to help guide each airline s RM system development Most member airlines have renewed; new member added in 2005 Continental Airlines Scandinavian Airlines System Delta Air Lines Air New Zealand Lufthansa German Airlines Northwest Airlines KLM/Air France LAN Airlines (new) 19
Tumbling Airline Revenues Fares have been decreasing The lower fares are due in part to LFA competition, but not exclusively RM system shortcomings are also involved Passenger choice process has changed, but RM systems have not Airline customers have learned how to get cheaper fares, but existing revenue management systems in use largely don t take this new reality into account Traditional RM systems all based on: Identifiable and independent demand for different fare products with restrictions associated with lower fares 20
BOS-SEA Traditional Fare Structure American Airlines, October 2001 Roundtrip Cls Advance Minimum Change Comment Fare ($) Purchase Stay Fee? 458 N 21 days Sat. Night Yes Tue/Wed/Sat 707 M 21 days Sat. Night Yes Tue/Wed 760 M 21 days Sat. Night Yes Thu-Mon 927 H 14 days Sat. Night Yes Tue/Wed 1001 H 14 days Sat. Night Yes Thu-Mon 2083 B 3 days none No 2 X OW Fare 2262 Y none none No 2 X OW Fare 2783 F none none No First Class 21
Simulation of Leg-Based RM Benefits Differentiated Fare Structure Revenue Gain W hen Both Airlines Im plem ent EM SRb AL 1 AL 2 16.00% 14.74% 14.00% 12.00% 10.62% 10.00% 8.63% 8.00% 6.00% 5.72% 4.00% 3.85% 2.00% 2.18% 0.00% EMSRb ALF=78% EMSRb ALF=84% EMSRb ALF=89% 22
Fare Simplification: Less Restricted and Lower Fares Recent trend toward simplified fares compressed fare structures with fewer restrictions Initiated by low-fare airlines in many parts of the world Early in 2005, implemented in all US domestic markets by Delta, matched selectively by legacy competitors Simplified fare structures characterized by: Little or no minimum stay restrictions, but advance purchase and non-refundable/change fees Lower fare ratios from highest to lowest published fares, typically no higher than 5:1 in affected US domestic markets 23
Example: BOS-ATL Simplified Fares Delta Air Lines, September 2005 One Way Bkg Advance Minimum Change Comment Fare ($) Cls Purchase Stay Fee? $124 T 21 days 0 $50 Non-refundable $139 U 14 days 0 $50 Non-refundable $199 L 7 days 0 $50 Non-refundable $224 K 3 days 0 $50 Non-refundable $259 Q 0 0 $50 Non-refundable $444 B 3 days 0 $50 Non-refundable $494 Y 0 0 No Full Fare $294 A 0 0 No First Class $594 F 0 0 No First Class 24
LEG RM SIMULATIONS: Impacts of Fare Restriction Removal 2 carriers, single market, both use EMSRb leg RM controls 6 fare classes, 3.5:1 fare ratio: Class 1 2 3 4 5 6 Fare 425.00 310.00 200.00 175.00 150.00 125.00 BASE CASE: Restricted and Differentiated Fares Fare Class AP MIN Sat Night Chg Fee Non- Refund 1 0 0 0 0 2 3 0 1 0 3 7 1 0 0 4 10 1 1 0 5 14 1 1 1 6 21 1 1 1 25
Revenue Impact of Each Simplification 65,000 60,000 55,000-0.5% -16.8% 50,000-29.6% 45,000 40,000 35,000-45% 30,000 Fully Restricted Remove AP Remove Sat Night Min Stay Remove All Restr, Keep AP Remove All Restr and AP 26
Loads by Fare Class 100 90 81.6 87.8 79.8 82.7 88.1 80 70 60 50 40 FC 6 30 FC 5 20 FC 4 10 0 Fully Restricted Remove AP Remove Sat Night Min Stay Remove All Restr, Keep AP Remove All Restr and AP FC 3 FC 2 FC 1 27
Revenues by Fare Class 70,000 60,000 50,000 40,000 30,000 FC 6 20,000 FC 5 10,000 FC 4 FC 3 0 Fully Restricted Remove AP Remove Sat Night Min Stay Remove All Restr, Keep AP Remove All Restr and AP FC 2 FC 1 28
Effectiveness of Traditional Leg RM Percentage improvement over No RM Controls 65,000 60,000 8.2% 9.9% EMSRb 55,000 50,000 11.8% FCFS 45,000 6.7% 40,000 35,000 0.1% 30,000 Fully Restricted Remove AP Remove Sat Night Min Stay Remove All Restr, Keep AP Remove All Restr and AP 29
Summary Impacts of Fare Simplification Simplified fares have contributed to large revenue losses for US airlines PODS simulated revenue losses in line with 15% impacts quoted by airlines Fare class mix is also affected Simplified fare structures have changed the types of products passengers buy The fundamental assumptions of RM systems: Are no longer appropriate under changing conditions May even be hurting airline revenues 30
M I T I n t e r n a t i o n a l C e n t e r f o r A i r T r a n s p o r t a t i o n ADAPTING RM SYSTEMS AND MODELS Peter Belobaba
Existing Airline RM Systems Need to be Modified for Changing Fare Structures RM systems were developed for restricted fares Assumed independent fare class demands, because restrictions kept full-fare passengers from buying lower fares Without modification, these RM systems will not maximize revenues in less restricted fare structures Unless demand forecasts are adjusted to reflect potential sell-up, high-fare demand will be consistently under-forecast Optimizer then under-protects, allowing more spiral down RM system limitations are affecting airline revenues Existing systems, left unadjusted, generate high load factors but do not increase yields 32
Models for Undifferentiated Fares Need to forecast demand by willingness to pay (WTP) higher fares with same restrictions (i.e., sell-up) Q-forecasting approach requires estimates of passenger WTP by time to departure for each flight Approach is to forecast maximum demand potential at lowest (Q) fare, and convert into partitioned forecasts for each fare class Then, modified WTP forecasts can be fed as demand inputs to RM optimizers: Standard EMSRb for Leg-based RM Dynamic Programming methods Network optimization methods for O+D Controls 33
Example of Expected WTP Behavior Typical values exhibit an S-shape reflecting the changing business/leisure mix across time frames 4.5 4 3.5 3 FRAT5 2.5 2 1.5 1 0.5 FRAT5 A FRAT5 C FRAT5 E 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Time Frame 34
Hybrid Forecasting For Simplified Fare Structures Separate forecasts for price and product oriented demand A passenger is counted as price-oriented if the next lower class from the one booked is closed A passenger is counted as product-oriented if the next lower class from the one booked was open. Combine standard RM forecasts and WTP forecasts For product-oriented demand, bookings are treated as a historical data for the given class, and standard time series forecasting applied. For price-oriented demand, forecasts by WTP based on expected sellup behavior Combined forecasts fed into optimizers 35
Impacts of Hybrid Forecasting Airline 1 Hybrid Forecasting and EMSRb Airline 2 Standard Pick-up Forecasting and EMSRb Airline 1 revenues increase by 1.36%, with greater protection for higher classes and fewer seats sold in classes 5 and 6, leading to lower Load Factor Bookings 100 90 80 70 60 50 40 30 20 10 0 FC 1 FC 2 FC 3 FC 4 FC 5 FC 6 Product-oriented AP Price-oriented RM Price-oriented 36
New Forecasting and Optimization for Simplified Fare Structures Combining Hybrid Forecasting and Dynamic Programming (DP) for optimization of seat inventory further improves revenues. 54000 53000 52000 51000 50000 49000 Revenues of Airline 1 +4.1% +2.6% Trad RM DP DP-HF RM of Airline 1 37
Impact on Fare Class Mix: DP w/hf Fare Mix of Airline 1 Fare Mix of Airline 1 LF = 80.4 LF = 77.4 120 120 100 100 80 80 60 60 40 40 20 20 0 1 2 3 4 5 6 0 1 2 3 4 5 6 Traditional RM DP w/ Hybrid Forecasts DP with hybrid forecasting increases revenues by capturing more high yield passengers in middle and upper classes. 38
Conclusions: RM Systems in Simplified Fare Structures Relaxed fare restrictions increase the importance of effective RM controls to airline revenues But, traditional RM methods do not maximize revenues Modifications required to better forecast consumer choice New approaches to hybrid forecasting of price- vs. product-oriented demand show good potential Incremental revenue gains over traditional RM methods Need to estimate passenger WTP, affected by competitor s RM method and seat availability Focus of current research is how to actually ESTIMATE these values, required to generate the modified forecasts 39