An Introduction to Yield Management

1. YIELD MANAGEMENT
An Introduction To Airline Economics
(Revised Version November 21, 2016)

2. 2
Airline Economics
Why does it seem that almost every
passenger pays a different fare on the
same plane on the same flight?

3. 3
Examples
• Price of an Economy Class Return Ticket from
Amsterdam to Madrid with the same airline:
Booked more than one month before departure:
• Depart Monday, return Friday: € 186.00
• Depart Monday, return Sunday: € 167.00
Booked less than one week before departure:
• Depart Monday, return Friday: € 307.00
• Depart Monday, return Sunday: € 263.00

4. 4
What does strike you?
• It is more expensive to return on a Friday, than in
the weekend
• Tickets are more expensive when booked closer to
the departure date
• Why is that?
• The answer is in the specific nature of airline
economics
• So let’s explore some basics of airline economics!

5. 5
First, some related questions:
• Why are flowers around Valentine’s Day
more expensive than on other days?
• Why is fish at the closing time of the market
less expensive?
• Why do you pay less for a theatre ticket 10
minutes before the opening of the show?

6. 6
Answers:
• After Valentine’s Day the demand for flowers drops
dramatically
• After closing the market, it is difficult and expensive
to keep fish fresh
• After the start of the show, the value of an unsold
seat is lost forever
These answers apply to all perishable goods and all
services: after a certain time there is no longer an
opportunity for making a revenue

7. 7
Goods and Services: Differences?
• Goods can be produced and stored;
• Production capacity is flexible: it can be matched
with demand, when demand is low;
• If you do not sell it today, you can sell it tomorrow;
• Services cannot be stored;
• If you do not sell it today, it is lost forever;
• Production capacity is inflexible: you cannot cut a
plane in two when demand is low;

8. 8
Yield Management
• It is a technique to optimize revenues
resulting from sales of perishable products
and services
• Sell the right product/service to the right
customer for the right price at the right
moment, via the right distribution channel

9. 9
Yield Management
• It consists of three components:
1. Pricing policy
2. Inventory Management
3. Selling policy

10. 10
Yield Management
• What can sellers of services and perishable goods
do to optimize their sales?
• They cannot influence the supply
• So that leaves them only one option:
INFLUENCE DEMAND
• How: Price discrimination
• Same service/good offered at a different price to a
different group of clients, because:
• Different types of clients react different to changes
in price (Price elasticity)

11. 11
Price Discrimination
• Different market segments react different to
changes in price for the same service
• Early Bird Coupons for a dinner:
– Come before 18.00 and receive a discount
– Come on Monday and receive a discount
– Etc.
• So there is always a condition which is acceptable to
a certain market segment and not to another
segment

12. 12
Example Price Discrimiation
When you are married for 30 years, you are
hungry and want a good meal!
You don’t mind if it is as early as 17.00 hrs,
because you get a discount!
On your first date, you want a romantic
dinner with moonlight, late at night

13. 13
Yield Management
• When capacity is fixed
• When heterogeneous demand can be segmented
on price sensitivity
• When market segments an be fenced from each
other
• When supply is perishable
• When it can be sold in advance
• When demand is fluctuating in time and by
market segment
• When marginal sales costs are low
• When fixed costs are high

14. 14
Airline Economics
Three main characteristics:
1. Flights are a service
2. Special structure of airline costs
3. Clients: Must and lust travelers

15. 15
Airline Economics 1
• Flights are a service!
– Service is intangible
– Service is perishable
– Service is produced and consumed simultaneously
• This means that the value of an unsold seat is lost
forever, no opportunity to make a profit with that
particular seat

16. 16
Airline Economics 2
• Special Cost Structure (simplified) of an Airline:
(Source: Financial Times)
– Variable costs (fuel, crew, maintenance) 57%
– Fixed costs (depreciation, interest, overhead) 33%
– Passenger costs (distribution, agents) 10%
• A plane costs money, also when they are not flying
• This means a need for a high cash-flow
• When it flies with empty seats, these seats represent a loss
• So you need to sell seats, at almost any cost!

17. 17
Airline Economics 3
• Two main types of travelers:
– MUST Travelers: They have to travel (business,
urgent family matters etc.)
– They are PRICE UNSENSITIVE and TIME SENSITIVE
– LUST Travelers: They want to fly
(holiday)
– They are PRICE SENSITIVE and TIME UNSENSITIVE

18. 18
Yield Management
• Adjusting demand to supply, since we cannot
match supply to demand!
• Using price discrimination to move consumer
demand
• Pricing by demand, rather than pricing by
costs
• Application by price management and
capacity planning

19. 19
Price Management
• So there are two types of travellers:
– ‘Must’ travelers: Not price sensitive
– ‘Lust’ travelers: Very price sensitive
• Both groups can easily be identified (by
booking and travel behavior)
• Marginal cost of flying an additional
passenger is low
• Opportunity costs are high: an empty seat
means revenue that is lost forever

20. 20
Yield Management
• Use historical data to forecast the sales pattern of seats for a certain
date on a certain flight;
• If bookings are below projection, than raise the number of seats to
be sold at lower fares;
• If bookings are running ahead of projection, than reduce the number
of seats offered at lower fares.
• Avoid selling cheap seats to high paying customers
(Fence Lust and Must Travelers by conditions)
• Overbook: there are always last-minute cancellations and also there
are no-shows, so you can do this rather safely!
• Compensate ‘Overbooked passengers’. This is cheaper than flying
with an empty seat
• Without overbooking, American Airlines estimate that 15% of seats
would be spoiled on sold-out flights!
• Aim: to get the load factor as close as possible to 100%
(Load Factor: Seats Sold / Seats Available)

21. 21
Yield Management
• Yield Management is price discrimination
Only possible when you can ‘fence’ the different
segments (’must’ and ‘lust’) from each other

22. 22
Fencing between Segments
• Physical Fencing:
– Classes of Service: First <-> Business <-> Economy
• Non-physical:
• Conditions:
– Cancellation Fees
– Minimum Stay
– Advance Purchase Requirements,
– Categories (seniors, students, ..)

23. 23
Is Yield Management easy?
Yes, for some people ……………..

24. 24
No, it is not so easy!
• The principles look easy enough!
• However, in reality it takes very sophisticated
software to execute Yield Management
• Imagine: 1000’s of flights on hundreds of
days must be managed at the same time!
• Top secret!

25. 25
Without Yield Management
• Prices would likely go up:
– Average prices would prohibit lower end of
market to travel;
– This loss of revenue would increase price
– Result would be more lost revenue
– This would increase price another time
– Etc....

26. 26
Problems with Yield Management
• Book too many discounted fares, resulting in early sell out of
higher priced sales ;
• To reserve too many higher priced seats, resulting in unsold
seats;
• Overbooking pays off: Denied boarding compensation is less
than the revenue of a full fare seat;
• Stressed inventory to be sold through Priceline.com, Click ‘n
Go etc.
• Caution: Customers often do not understand the system and
think that they are cheated (airlines often advertise the
lowest possible fare!)

27. 27
Customers reactions towards Yield
Management
Customers can experience Yield Management
as unfair and as a result consider the
company as dishonest. However:
• Considered more fair when familiar with the
concept of Yield Management
• Accepted as fairer when presented as
‘Discount’ instead as ‘Surcharge’
• Clear explanation of Rules should be given

28. 28
Yield Management
• Is Yield Management ethical?
– Yes, it is, in the end it lowers prices
• Are those cheap flights really available?
– Yes, but on a limited scale!
• Does the public understand it?
– No, but do they have to?

29. 29
Alternatives for Yield Management
• Fluid Pricing / Dynamic Pricing
– Prices established on a daily/hourly basis
• Reverse Auction
– Role of buyer and seller are reversed
– Price changes (up or down) in a dynamic way in relation
to a certain point in time.
– Customer can decide for himself if the shown price is
acceptable to him.
– Waiting too long can result in either’ sold out’ or ‘too
expensive’

30. What do you know?
Some questions
about
Yield Management

31. 31
Client Types:
Time & Price Sensitivity
High
Time
Low
Low Price High
Business Traveler:
100% Must
Leisure Traveler:
Flexible. 100% Lust
Business Traveler,
interested in saving
money, but time stays
important
Insensitive to Price and
Time.
Indifferent

32. 32
Target Groups for Yield Management
• Which groups are the main targetgroups
when using Yield Management?
• How do you fence them from other traveler
groups?

33. 33
Client Types: Targeted Segments for
Yield Management
High
Time
Low
Low Price High
Leisure Traveler:
Flexible. 100% Lust
Business Traveler,
interested in saving
money, but time stays
important

34. 34
Applications outside the airlines
• Could a tourist attraction benefit from the principle
of Yield Management?
• If yes, how and what could they implement?