The Financial Effects of Yield Management on the Airline Industry - Research Paper Example

The Financial Effects of Yield Management on the Airline Industry 13th, March Yield management, also referred to as revenue management, is a system that various companies employ in order to maximize their profits. This involves a company researching on the behavior of its consumers, and then works at ensuring that appropriate services are offered to consumers, in a way that complements its consumer behavior (Huefner, 2011). In order for a company to have an effective yield management, it must be able to predict its future financial status. This is through focusing on its past financial status, as well as its present financial status (Atrill & McLaney, 2007). This way, the business transactions between consumers and the company are monitored in order to help in the company’s revenue management. The company in question also needs to base on other external information including information about prices of the company’s competitors in the market, the season in the market, as well as the consumers buying patterns. Basically, yield or revenue management involves decision-making, as the company attempts to figure out and make decisions regarding the kind of services to be sold, at what time to sell them, and at what price to sell them at, which would ensure that the company rips maximum profits (Coombs, Hobbs & Jenkins, 2005). Yield management is therefore, an integral part of management accounting, as it involves financial control in a company, as well has financial consequences on a company. The decisions made in the process of revenue or yield management in a company are instrumental in helping a company settle for specific prices for its services, which will be in alignment with the demand in the market. This is with regard to ensuring that consumer needs are met, while at the same time ensuring maximization of profits for the company (Sani, 2011). There are various aspects in the company and in the external environment, which help the company make viable decisions in the process of yield management, especially with regard to the determination of prices for the services offered by the company. Such aspects include the type of services offered by the company. Depending on the nature and quality of the services a company offers, the management are in a position to make decisions, regarding the price they will fix for each type of service. In addition, the market type is also of essence in helping a company make decisions concerning service pricing. If the market is dominated by middle income-earners, it is more likely that a company will make service-pricing decisions based on the income or the economic status of the consumers in the market, as this calls for the consideration of the consumers’ purchasing power. However, in revenue management, a company aims at making the most profits, therefore, if the consumers have low purchasing power, the company might compromise on the quality of services it offers, so that this is in proportion to the amount of money consumers are willing to spend (Maher, Clyde & Weil, 2007). These among other aspects are important in helping a company in decision-making, with regard to pricing in the process of revenue management. There are specific companies that widely employ the process of yield management. These include hotel and hospitality companies, the airline industry, and car hire, among others. According to Huefner (2011), yield management began with the airline industry before being adopted by other industries. The process of yield management is most effective when companies employ yield management systems that are computerized. Today, the internet presence has greatly contributed to making yield management successful. The airline industry effectively uses yield management, since most airlines can record and monitor interactions with their customers. These have special computerized systems or software, which help in the monitoring of seat reservations. When there are many vacant seats, the company might decide to lower the fare prices in order to entice more passengers into using the airline. This price reduction is advantageous to customers, but also advantageous to the airline. When an airline makes a decision to offer discounts to passengers at a period when travels are low, the airline company will benefit more. This is considering the fact that if discounts are not offered; passengers might opt for other airlines with discounts, thus making a specific airline lose out (Huefner, 2011). According to Voneche (2005), the American Airlines were the first to practice automated reservations in the 1960’s. They later introduced a software called SABRE (Semi-Automated Business Research Environment), which still dealt with automatic reservations. The size of American Airlines prompted it to automate nearly all its operations, as manual operations would be slow, since the decision-making process in yield management was also too large and too sophisticated to be performed manually (Eldad, 2005). This system of yield management has been applied by other industries, including the passenger railroads. Nonetheless, the management of American Airlines agrees that automated yield management has been beneficial to the company, generating close to $500 million each year (Voneche 2005). Generally, revenue management is most suitable if applied to companies, which sell goods and services, which are perishable. In the case of the airline industry, this financial managerial aspect is best fit for this industry. According to Rouse, Maguire & Harrison (2011), this is because the airline industry mainly uses tickets for passenger bookings, and these tickets usually expire after a specific period. The tickets are also not sellable, once a flight materializes. The airline industry has to forecast the demand of its services in future, and from there, they can set their preferred prices. The United Air Lines (UAL) increased its total airline capacity when its financial analysts forecast an increase in demand for seats (Maher, Clyde & Weil, 2007). This came with a change in pricing too. Therefore, the airline industry highly employs price flexibility in its operations, as no price is fixed (Cho, Fan & Zhou, 2007). Therefore, the consumers are able to exhibit their power of choice when using the airlines to use. For instance, some consumers might decide to travel during the off-peak period, because in this period, most airlines have always made the decision of price reduction, considering the low demand of consumers. However, during the high-peak season, most airlines reach a decision of raising the prices of their tickets. In doing this, the company has strategically arrived at that decision in order to compensate for the low returns during the off-peak period. Therefore, in trying to maximize profits, airline companies have to strategize, and make important decisions that will ensure high profits (Cho, Fan & Zhou, 2007). Different airlines engage in various strategies of yield management to ensure maximum profits. Apart from the aspect of price flexibility, airlines also engage in overbooking (Lanquepin-Chesnais, 2012). In overbooking, an airline sells more seats than those available in order to ensure that the excess numbers given out occupies the seats for passengers who do not turn up. Therefore, this offsets cancellations, as well as no-shows. However, overbooking comes with many challenges, and therefore, an airline company needs to make the most appropriate decisions as far as overbooking is concerned, in order to avoid inconveniences on the side of the passengers (Voneche 2005). Since yield management is highly employed in the airline industry, there must be different ways in which it influences the operations in the different companies, as well as their profit margins. Overall, revenue or yield management in a company leads to a mix of services, which are differentiated in terms of pricing, depending on the period these are offered to consumers. Therefore, yield managers must have high analytical and decision-making skills, since the process of yield management is quite sophisticated and bases on various decisions made in the company (Coombs, Hobbs & Jenkins, 2005). Nonetheless, for yield management to be considered effective in a company, this process must result in increased revenue for the company, as this is the main objective of the process (Chen & Farias, 2012). The management in charge of yield management is therefore, responsible for the outcomes of the process. If this process in a company leads to increased returns, the yield managers can be regarded as good decision-makers and skilled financial analysts. On the other hand, if this process fails the company, the involved yield managers will be considered not up to task, poor decision-makers, and lacking analytical skills to appropriately conduct yield management in the company (Huefner, 2011). For airline companies, yield management is a strategy, which gives the company their power in pricing. This is why some other companies resort to yield management in order to take control of their pricing. The aspect of flexible product pricing in yield management for airline industries, generally result in increased profits, if managers who are good decision-makers oversee the process. Nonetheless, yield management has realized various positive effects in the airline industry, with regard to the financial status of various airline companies. Specifically, the United States airline is an example of an airline that has benefitted from the effective revenue management it employs in its operations (Chen & Farias, 2012). Since the revenue management professionals in this company are well qualified and experienced, these have ensured that the process of revenue management is exercised with the needed expertise, including effective decision-making. Before the adoption of revenue management by this airline company, there were approximately $13 billion losses incurred by this company in four consecutive years. However, in the first year of adopting the revenue management process, this company registered a profit of $2.5 billion. This therefore, emphasizes the importance of good analysis and decision-making in the revenue management process (Chen & Farias, 2012). According to Cho, Fan & Zhou (2007) revenue or yield management has led to better financial health for most airline companies. This has in turn contributed to the high competition witnessed in the airline industry. Most airline companies today therefore, are better placed financially. Since most of the airlines are financially healthy, they compete among themselves, which is fair. However, the new, smaller airlines that come into market are mostly affected negatively by this competition, forcing some of them out of the market. This is the case, especially when these new airlines aim at creating new secondary markets, with newer flight destinations. When the new airlines with new routes fall out of the competition, the major airlines then introduce the new routes, but at an increased price. Therefore, revenue management has increased the profits of major airlines, making them more financially independent, and able to beat competition from new entrants in the market. According to Gupta (2011), airline companies should be more concerned with researching the choices of their customers, then incorporating them in the price decision-making of their yield management process. Additionally, the professionals in revenue management working in airline companies ought to use their expertise in these companies beyond the basic management decisions involved with revenues. Instead, these should also develop ways through which the revenue management in airline can be extended to the customers. The revenue management professionals in the airline industry must also be the epitome of decision-making in their companies, as their area of specialization requires individuals with commendable decision-making skills. Nonetheless, most airlines hire qualified revenue management professionals, with proven decision-making skills. Today, these professionals working in the airline industry are able to integrate their customers’ behavior into the company revenue management process, after which important revenue management decisions are made (Sani, 2011). The process of revenue management has been effective in the airline industry; however, there are considerable challenges that have been witnessed in this process. The major challenge for some airlines is the lack of sophisticated systems. For effective revenue management, airline companies need to have smart systems, which will make the process of decision-making in revenue management easier. This is with regard to the aspect of price optimization in the airline industry. Most systems in airline companies have been restricted to particular spheres and not all areas that affect the airline. If the systems could be extended to cover various areas in the airline industry, and integrate them in the current system, then the airline industry can experience operations that are more effective (Sani, 2011). Some yield managers in the airline industry overlook the tenets of the process of revenue management. While this process includes price setting depending on the demand of the service and the season, some managers would go ahead and reduce their prices even in the high-peak periods, in order to attract more customers. This however, cannot work in their favor, since the company will experience losses. Price increase during the peak period in the airline industry in the process of revenue management is meant to compensate for the low profits made in the low-peak period. On the other hand, the discounted prices during the low peak period are meant to attract more customers. Therefore, yield managers are required to make their decisions on pricing, based on the facts of revenue management process, and not their own biased opinions of the process. Therefore, a good yield manager should evaluate their decisions, and find out whether these are based on facts or on personal instincts and convictions (McAfee & Velde, n.d). An effective yield manager knows their responsibilities, and executes them in the most appropriate manner. The different tools used by the yield manager in the airline industry are important in the revenue management process, and therefore, the yield manager should understand the value of those tools, including the various reports from different systems, involved in the process. Therefore, a yield manager should ensure that revenue management process in the company is effective, by utilizing the collected reports in the decision-making in the process. More time should however, be spent on data analysis, as opposed to data compilation. In this case, the yield manager sets priorities for the company. By spending more time on data analysis, they are likely to come up with new trends in the market or company, which are useful for strategizing and decision-making in the process of revenue management (Voneche, 2005). Despite the challenges faced by most airlines in the restrictive nature of their revenue management systems, these can still be upgraded if the companies look for more resources to invest in the diversification of their revenue management systems. It is important that revenue management in the airline industry involves other disciplines, and not be limited to specific areas only. This will ensure that the process is more successful. Currently, revenue management in the airline industry has been limited to the aspect of pricing. However, this process should be extended to involve other departments such as marketing, sales, and company operations in order to be effective. When this is done, the revenue management professionals in the airline industry will be able to make more informed decisions in the revenue management process, as the professional interaction with other professionals in different departments add to their knowledge about finance and decision-making. This will lead to better strategies and successful campaigns in the industry (Huefner, 2011). According to Voneche (2005), it is important that airline companies consider and address the issues the yield managers face during the decision-making process in the course of their practice of revenue management. First, it is hard to measure the performance of yield management in the airline industry. Secondly, the price flexibility issue in yield management sometimes alienates customers, as most feel that the prices are discriminatory. This therefore, makes an airline lose customers to its competitors in cases where competition is high (McAfee & Velde, n.d). Finally, employees concerned with revenue management might feel that they have less power of decision-making in cases where the yield management is automated, and decisions are made by the system. However, Lieberman (1993) considers this as a myth, as he argues that the tools of revenue management might perform some of the tasks that were previously performed by employees, however, these do not take over the responsibilities of the employee, neither do they take over the power of employees to make decisions in the revenue management process. Nonetheless, a proactive management in the airline industry will aim at addressing the concerns raised by employees in their course of revenue management, in order to achieve success in the whole process. Another issue with revenue management as Da Silva (2012) notes is that the customers in the airline industry understand that the yield pricing strategy in airline companies is not meant to favor the passenger, but to ensure that the airline makes most profits from their passengers. This makes passengers believe that the airline is not after strengthening its relationship with customers. This therefore, leaves yield managers in a dilemma when making important decisions in the airline’s revenue management (Cento, 2008). However, Da Silva argues that despite this knowledge, most passengers have remained loyal to their airlines (2005). This issue therefore, affects the decision making of yield managers. In addition, most customers consider the aspect of price flexibility unfair, since others pay highly, while others will pay a lower amount, depending on the season (Cento, 2008). However, most passengers determine their loyalty to an airline based on other factors, apart from pricing of the airline. Conclusively, yield management is an important practice in the airline industry, considering this is also a service industry. Yield management also is an integral part of management accounting, as it deals with important issues of finance control and planning in the company. Generally, if yield management is performed well by expert professionals in the airline industry, it leads to positive results in a company. Since the main objective of yield management is profit maximization, this process leads to the financial productivity of an airline company, as proved by the various airlines in the discussion. However, for the effectiveness of this process to be realized, the professionals executing it should have good accounting and decision-making skills, including analytical skills. This is because, the minor processes involved in revenue management, such as pricing, requires the prediction of future financial health of the company, analyzing the past financial status of the company, and making concrete decisions about the pricing of the services involved. Nonetheless, yield management is beneficial to service industries, but can also be applied to manufacturing industries in form of inventory management. References Atrill, P. & McLaney, E. (2007). Management Accounting for Decision Makers. New York: Trans-Atlantic Publications, Inc. Cento, A. (2008). The Airline Industry: Challenges in the 21st Century. New Jersey: Springer. Chen, Y. & Farias, V. (2012). What’s on the Table: Revenue Management and the Welfare Gap in the US Airline Industry. Retrieved from http://web.mit.edu/~vivekf/www/papers/Welfare.pdf Cho, M., Fan, M. & Zhou, Y. (2007). An Empirical Study of Revenue Management Practices in the Airline Industry. Retrieved from http://faculty.washington.edu/yongpin/RM_Nov_15_07.pdf Coombs, H., Hobbs, D. & Jenkins, E. (2005). Management Accounting: Principles and Applications. New York: SAGE. Da Silva, K. (2012). The Impact of Yield Management in the Airline Industry on Customers’ Feelings of Price Fairness. E-zine 53: 1-6. Retrieved from http://aerlinesmagazine.files.wordpress.com/2012/08/53_correia_nunes_da_silva-the_impact_of_yield_management_in_the_airline_industry_on_customers_.pdf Eldad, B. (2005). The Evolution of the US Airline Industry: Theory, Strategy and Policy. New Jersey: Springer. Gupta, R. (2011). Working on optimal revenue management strategy for 2012. Eye for Travel. Retrieved from http://www.eyefortravel.com/revenue-and-data-management/working-optimal-revenue-management-strategy-2012 Huefner, R. (2011). Revenue Management: A Path to Increased Profits. Retrieved from http://www.businessexpertpress.com/books/revenue-management-path-increased-profits Lanquepin-Chesnais, G. (2012). Revenue Management in the Airline Industry: Problems and Solutions. Retrieved from http://brage.bibsys.no/hsm/bitstream/URN:NBN:no-bibsys_brage_36960/1/Trial_Lecture_Lanquepin.pdf Lieberman, W. (1993). Debunking the Myths of Yield Management. Retrieved from http://veritecsolutions.com/Documents/ym_myths.pdf Maher, M., Clyde, S. & Weil, R. (2007). Managerial Accounting: Intro to Concepts Methods Uses 10e. New York: Cengage Learning. McAfee, P. & Velde, V. (n.d). Dynamic Pricing in the Airline Industry. Retrieved from http://vita.mcafee.cc/PDF/DynamicPriceDiscrimination.pdf Rouse, P., Maguire, WW. & Harrison, J. (2011). Revenue Management for Service Organizations. Retrieved from http://www.businessexpertpress.com/books/revenue-management-service-organizations Sani, A. (2011). Strategic Management Accounting: Implementation and Control. World Academy of Science, Engineering and Technology 59: 57-62. Voneche, F. (2005). Yield Management in the Airline Industry. Retrieved from http://www.ieor.berkeley.edu/~ieor166/Yield%20Management%20in%20airlines.pdf Read More