Commercial Aviation Management Functions - Essay Example

?Commercial Aviation Management Functions Introduction When deregulation of the US and EU airline industries began in the 70’s and 90’s respectively,competition increased with many airlines jumping into the fray and started to offer customized services to improve performance and revenue for which they started to use yield management systems for inventory control (Rose, 2012; Knorr and Zigova, 2004). As the airline industry is characterized by high investments and fixed costs and considered to be a low frill economics (Homa, 2012), effective strategies for managing supply-demand determines the profits to a large extent as well as the competitive advantage (Knorr and Zigova, 2004). This paper studies the different commercial aviation management functions to understand the issues and the unique solutions applied to solve the problems in an attempt to maximize profits in spite of the fixed inventory and high costs of investments. Overview of airlines management functions Airlines like any other business have a load of functions to manage for a competitive advantage in the industry. Essential functions are marketing, sales, etc. but the most recent emphasis on enhanced marketing tools and techniques characterizes the airlines industry. The use of a yield or revenue management tool to integrate the different functions of the business is an effective tool to realize the profit maximization in the industry. A marketing mix is of crucial importance for the airlines industry and involves activities like product planning, pricing, branding, packaging, promotion, advertising, selling, distribution, physical handling and service. The 4Ps of marketing mix: product, pricing, place and promotion take into consideration all the activities mentioned and are at the heart of the yield or revenue management strategies (Knorr and Zigova, 2004; McGuire and Pinchuk, 2009). What is yield or revenue management (YM or RM)?- Objectives  The main objectives of the yield management system is to effectively manage passenger demand, cancellations and other estimates of passenger behaviour by using non-linear, stochastic and mixed-integer mathematical models or programs to maximize revenue per each unit of capacity (Smith et al, 1992; Dr. Britton, 2009). YM also involves the tactical control of seat inventory through protection of seats for later-booking by high-fare customers by a proper balance of the load factor and yield (Fundamentals of pricing and revenue management, 2012). YM aims to maximize profits by controlling the load factor of the perishable seat inventory and selling the correct number of seats at discriminated prices based on demand and pricing elasticity. YM can be considered to the activity of selling the right product to the right customer at the right place and at the right time for optimum price through the best available channel (Rose, 2012). Further, YM involves management of the inventory, distribution channels and prices to yield profitability in the long run (Kleywegt, 2008). Implementing YM is seen to increase 3-9 percent of airlines revenue by combining different models for discrete choice analysis, forecasting, and large-scale optimization (Rose, 2012). However, there have been changes in the approaches to YM over the years based on the changes in airline business environment (Smith, 2002). Airline planning and marketing: Supply and demand  Airlines usually compete for customers, horizontally and vertically (Netessine and Shumsky, 2004). The inventory is perishable and the demand is time-variable and a trade-off between price (yield) and volume (load factor) becomes essential in this industry. Load factor is the percentage of capacity sold and demand for this perishable inventory changes by the time of day, day of week and season (Dr. Britton, 2009). Seat inventory control under horizontal competition (airlines competing for customers on a single flight leg) and vertical competition (airlines flying different flights on a multi leg itinerary) is usually achieved by a pure strategy Nash equilibrium being established which involves the game of substitution where increase in inventory by one airlines results in decrease in inventory of the competitors (Netessine and Shumsky, 2004). The supply side of the airlines industry is characterized by low marginal costs, capacity constraints, competitive markets and network effects while the demand side is characteristic of heterogeneous customers with product and price sensitivity and purchase behaviour, and also demand variability based on individual uncertainty and aggregate variability (Ryzin, 2012). And the airlines industry needs to maximize revenue by effectively utilizing the fixed seat capacity to cater to the uncertain or high demand. It is also seen that demand is price-sensitive requiring use of different control theories like intensity control theory, closed-form and upper-bound solution, semi-Markov decision process, Poisson process, etc. Dynamic programming solution (rationing capacity with price classes) along with dynamic pricing (and other solutions are normally used to control the profit optimization challenges of the airlines industry considering the changing supply-demand characteristic (McAfee and Velde, 2012). Importance of revenue management (RM) in airlines- airline pricing  The strategy to optimize revenue on every flight by fine tuning the supply-demand curve is crucial to every airline as it is based on knowledge of customer requirement that however are changing and vary as wide as the customer himself. And this idea of dynamic pricing to cater to the changing customer requirements also utilizes database technology (as in the case of Delta Air Lines) (Shulman, 1997) as it enables key YM or RM components: product design, pricing and capacity allocation (Ryzin, 2012). Also, the relatively fixed seat capacity, high fixed costs and combination of elastic and inelastic market segmentations along with more complex airline environments where there is oligopoly in market behaviour with multi-period market strategies necessitate the complex pricing strategies of YM. Further, YM also integrates the multi-channel planning system for bid pricing (Smith, 2002). Key elements or inventory controls of RM in airlines: pricing strategies  Key elements of RM include differential pricing, fare simplification, demand forecasting, overbooking, resupply, cancellation, discounting, holding costs, network optimization, flight leg optimization, market segmentation, etc. while consumers benefit from differential pricing, carriers too benefit as it allows for increasing revenues without effecting operating costs. Also, the price-demand curve allows for market segmentation into business and leisure travellers who can be targeted with a range of product fare options to optimize revenue (Fundamentals of pricing and revenue management, 2012). Overbooking allows carriers to set higher reservation levels than seat capacity and allows customers to cancel reservations with no penalties including no-shows. Further, discount seat allocation enables differing fares as per class code and nesting and fare simplification allows for more flexibility and optimization (Smith et al, 1992). It can also be seen that demand forecasting is key component of planning which impacts overbooking based on predictions of cancellations, no-shows and ultimate demand. Decision systems that integrate the different components of airline planning including network optimization, flight leg optimization, etc. are being developed by increasingly considering the combination of the different key controls or elements of YM (McGill and Ryzin, 1999). American Airlines, the first airlines to implement YM allocated limited seats (a perishable commodity) among differentiated customers while implementing a strategy that has price discrimination, fences in terms of stay, etc., service classes, inventory and available control systems and powerful distribution system as the interdependent elements of YM (Knorr and Zigova, 2004, pp 7,8). Impact of YM on competitive positioning  The different controls or elements of YM are increasingly enabling the integration of the various airlines to form alliances that utilize transfer pricing mechanisms among others to develop networks or groups with specific characteristic behaviour (Wright et al, 2009). Also, every airline carrier that implemented YM has seen an increase in revenue (Rose, 2012). American Airlines increased its revenue by $500 million and Delta Air Lines increased revenue by $300 million by implementing similar YM strategies to gain competitive advantage (Shulman, 1997; Kleywegt, 2008). With increased customer and revenue turnover, airlines are now turning to utilizing customer relationship management (CRM) to efficiently manage their customer relations to gain a competitive advantage (Boland et al, 2002). There is a significant increase in revenue for the ‘first mover’ airlines that implement YM with a competitive advantage and scheduling strengths (Belobaba and Wilson, 1997). Evolution of yield management (YM)  The airline industry has evolved over the years to address the challenges in revenue and profit optimization as it caters to the limited and perishable inventory in terms of aircraft and seat capacities. Earlier (prior to 1970’s) YM systems focused solely on revenue optimization systems while later YM systems (after deregulation in 1970 and 1990) focused on technological advancements. However, the current market of airline YM systems is seeing a shift in approach to develop new solutions and models to address the YM problems of effective marketing mix and price optimization while the future looks to developing new models of optimization based on the needs of the emerging carriers. Fleet assignment model (FAM) is also being increasingly integrated with YM in the attempt to address future trends of emerging carriers (Smith, 2002). Figure 1 represents the evolution of YM over the decades. Figure 1: YM evolution. Source: (Smith, 2002). Conclusion Yield management or revenue management systems are increasingly being used in the airline industry where inventory management and revenue optimization are crucial for profitability, competitive advantage and sustainability in the long run. YM systems are seen to yield 3-9 percent profits for airlines. Key elements or controls of YM are demand forecasting, overbooking, differential pricing, fare simplification, network optimization, flight leg optimization, cancellations, no-shows, etc. that are used as the determining components of the different models and theories of YM for achieving profit optimization and also gain a competitive advantage. Future trends in YM implementation are considering airline alliances and technological advancements to address the changing and dynamic needs of the industry. References Belobaba, P.P and Wilson, L.J. 1997. Impacts of yield management in competitive airline markets. Journal of Air Transport Management. Vol. 3, Issue 96. DOI: 10.1016/S0969-6997(97)82787-1. Boland, D, Morrison, D and O’Neill, S. 2002. The future of CRM in the airline industry: A new paradigm for customer management. IBM Institute for Business Value. Dr. Britton, 2009. 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