Yield Management in Commercial Aviation - Coursework Example

Commercial Aviation Management Functions: Yield Management Insert s Insert of 10th March Outline I. Introduction a. Definition of Yield Management II. Advantages of using yield management III. Use of yield management to gain competitive advantages IV. The future of yield management V. Commercial Aviation Management Functions: Yield Management The airline industry is a very volatile field of business because of the high level of competition. In order to deal with competition, airlines came up with the concept of yield management principally to maximize revenue per flight. This aim of this paper is to critically examine how airlines utilize yield management as a tool to maximize their revenue. Yield management, also known as revenue management, is a profit maximization approach that seeks to maximize revenue by using price discrimination (Bazargan, 2010). The term, Perishable-Asset Revenue Management (PARM) seems more concise, but it is too loaded for meaningful use (Yu, 1998). This approach to pricing management came about as a response to the liberalization of air transport that led to high competition among service providers. Aviation companies realized that they could increase their revenues by selling the same seats in an airplane to customers based on what they were willing to pay, “as opposed to using unit cost as the only factor in pricing” (Shy, 2008, p.23). Yield management started as an analysis of variable demand but it grew to an advanced stage of complexity where it now seeks to determine how customers respond to pricing (Hayes & Miller, 2010). Advantages of using yield management Yield management brings about a number of related benefits to commercial aviation. First, it increases revenue without increasing the cost of providing services (Quain & LeBruto, 2010). The revenue comes from selling units produced but not consumed under the unit based pricing model. The second advantage of yield management is that it brings about increases in profits, and not just gross sales (OFallon & Rutherford, 2010). In fact, the overall increase in gross sales in usually marginal compared to the percentage increase in profits. Without it, the seats sold under yield management would bring in zero revenue. The third advantage of using yield management is that it makes it possible for commercial aviation to “maximize revenue from available capacity” (Rouse et al., 2010, p.57). Commercial airlines sell seats that they would have flown unoccupied at low cost hence they get extra revenue. Finally, it assures revenue despite cancellations when one of the conditions for low fare tickets includes a non-refund policy (Button, 2010). Under most unit-based costing systems, refund policies lead to loss of revenue if buyers request for a refund. Use of Yield Management to Gain Competitive Advantage Yield management in commercial aviation has two objectives. These are, “to get the best average fare (‘yield’) possible”, and secondly, “to fill a high percentage of the seats” (Forsyth, 2005, p.98). These two objectives sometimes clash. Airlines historically used yield management to develop and maintain competitive advantage. It provides them with the best way to maximize revenue because the fixed costs required to provide air transport service are large and inelastic. (Froeb & McCann, 2009). For yield management to work, the pricing of the product must be flexible (Peppers & Rogers, 2004). It allows airlines to take advantage of seasonal traffic more effectively, especially if they have the capacity to determine the demand patterns (Young, 2009). There is a need to have an optimized mix of long haul versus point-to-point flights because point-to-point flights tend to be more profitable using yield management hence an airline may turn away long haul fliers for short-term profits at the expense of long-term business survival (Shaw, 2004). Yield management as a tool for getting competitive advantage began when People Express offered low fare, no amenities tickets to passengers. American Airlines introduced yield management in the face of easing regulation that put it at a disadvantage when compared to budget flyers. American instituted a program where the objective was to “keep high paying traffic at its current level while selling the otherwise empty seats at a discount” (Ben-Yosef, 2005, p.213) American Airlines and United Airlines responded to the move by People Express by providing certain seats in their planes at the same prices People Express offered while still maintaining their proportion of high paying customers. This strategy eventually led to the bankruptcy of People Express (Kimes, 2000). American airlines took the lead in developing yield management because it had the capacity to study the demand patterns and the loading factor of its fleet, whereupon it found that it could use both the supply and demand elements of their business to optimize bookings (Johnson et al., 2006). As of 2010, American Airlines business travelers accounted for 15-20% of their flight capacity (McGuigan et al., 2010). These travelers continue to demand responsive travel arrangements that can change at any time, hence their willingness to pay higher fares. The rest of the traffic comes from vacation travelers looking for bargain prices but can afford to book their flights many months in advance (McGuigan et al., 2010). In order to maintain their competitive advantage, American Airlines keeps refining their yield management practices to optimize on the two types of traffic. The Future of Yield Management The business world is very dynamic. The commercial aviation industry has to keep on figuring out how to survive in the rapidly changing global business environment. One of the overarching changes in the business world is that businesses go through very rapid growth cycles, where the sources of competitive advantage diminish quickly. Based on this view, the practice of yield management will reduce as a source of competitive advantage an airline has in a market because all players have developed robust yield management systems to maximize returns. The main factor that will take over will be the brand strength of each commercial aviation service. Brands will play an increasingly important role and not just pricing because price “is not always the deciding influence” (Sfodera, 2006). Secondly, there is a trend towards simplification of yield management techniques by avoiding product differentiation and using booking time as the means of discriminating between the passengers who to enjoy lower fares, and their higher paying counterparts (Cento, 2008) The third trend in yield management is that the techniques used will increase in sophistication because of the growing availability of technological options for data collection and analysis (Wensveen, 2007). In the last ten years, data processing speeds and analytical techniques have improved and become more sophisticated because of the global IT revolution. Yield management will have a greater place as a source of information such as the popularity of the routes and the efficiency of the timing. In addition, it will be a resource of greater significance in the development of the marketing strategies for airline competition (Kaps, 2000). This is important because of the increasing use of dynamic pricing in airlines (Wittmer et al., 2011). Airlines using dynamic pricing either choose a “matching strategy” to ensure their service compete well on price, while others prefer a “skimming strategy” to get the highest paying clients in every market segment (Wittmer et al., 2011, p.152). The above notwithstanding, there is a greater realization that yield management is not a comprehensive solution to pricing. This came about after the events of September 2001. In response to dwindling passenger numbers, airlines continually increased their fares, and hence more people chose to buy low fare tickets to the extent that no one was paying the full fare (Pilarski, 2007). Business travelers, who traditionally bought the full fare tickets, found other ways of travelling or how to avoid flying all together to avoid the high airline fees. This led to a reduction in airline revenues, many of them made losses, some filed for bankruptcy while others merged to hedge their positions. In this case, using yield management led to losses. Another force affecting yield management is convergence of business models. The commercial aviation industry is a relatively young industry barely seventy years old (Iliescu, 2008). After years of operations, airlines are now moving towards similar business models based on the best practices documented over time for that industry. Commercial aviation business models usually revolve around the hub and spoke model, and the hub model depending on whether an airline is an international and long haul carrier, or a point-to-point carrier. Convergence of these business models will have a significant effect on how the practice of revenue management moves on from this point (Goedeking, 2010). The industry is working towards greater efficiency hence the drive towards convergence. It is still unclear whether the traditional business models will remain as they are or whether new ones will emerge (Bieger & Agosti, 2005). This outcome will have a significant effect in the practice of yield management. The development of alliances among commercial airlines is another trend that will be significant for yield management. The reason for these alliances is airlines seeking to reduce the cost and impact of entering new markets (Pavlovich, 2005). Market entry is a very risky process. Therefore, instead of incurring the expenses of market entry, airlines find it easier to work with other airlines with a presence in their area of interest. One serves as a feeder to the other in order to optimize their returns. This trend means that there is a certain degree of agreement required on the type of yield management strategies to adopt. Finally, globalization is likely to have a significant impact on yield management because there are an ever-increasing number of international travelers globally (Phillips, 2006). This trend is complicating market segmentation because business travelers no longer need to travel as often because of the technological options available to deal with distance. There is however more travelers on touristic or academic and research tours. With lower airfares because of competition, many people can afford to fly. It means that the methods traditionally used in yield management will need to adapt slowly with the changing traveler profile. Reference List Bazargan, M., 2010. Airline Operations and Scheduling. 2nd ed. Hampshire: Ashgate publishing. Ben-Yosef, E., 2005. The Evolution of the US Airline Industry: Theory, Strategy and Policy. Heidelberg: Springer. Bieger, T. & Agosti, S., 2005. Business Models in the Airline Sector: Evolution and Perspectives. 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