FT/Gapper: Airline seat pricing alienated frequent flyers

John Gapper: Flying into trouble on autopilot
By John Gapper

Financial Times
Published: January 12 2005 20:14

Every so often, a business wheeze that appears to be a foolproof solution to
a difficult problem turns out to be too-clever-by-half and backfires. So it
has proved with one of the airline industry's great innovations of the 1980s
- yield management.

It was a good idea at the time. By offering seats at fixed prices, airlines
risked either having empty seats or selling out when last-minute travellers
might have paid more. Yield management - fare variation using electronic
booking systems - was the answer. They could gain the maximum possible
revenues by charging some passengers more than others.

Yield management reached its height before September 11 2001, when
last-minute business travellers - passengers who needed to travel and were
therefore willing to pay the most - were charged an average of five times
basic economy fares. As competition pushed down fares for the cheaper seats,
airlines relied on "walk-ups" to provide all their profits.

Four years on, the error is obvious. Business travellers have deserted US
legacy carriers such as US Airlines and Delta for low-fare airlines such as
JetBlue and Southwest with simpler fare structures. Led by Delta, the legacy
carriers (which lost $24bn between 2001 and last year) last week threw in
the towel by capping fares for late bookings and journeys without Saturday
night stopovers.

One lesson is that something that seems ingenious and logical to a company
may feel incomprehensible and unfair to its customers. That is especially
true when computers are involved. "As the legacy guys tried to squeeze every
last drop out of revenue, they got more and more complicated and they
eventually confused and alienated a lot of passengers," says Dave Emerson, a
partner at Bain, the management consultants.

A second one is that it helps not to treat your best customers as if they
were your worst ones and vice versa. Business travellers were given lots of
perks such as frequent flier miles and better food, but none of it remotely
made up for the gap in prices. They might have been getting a generous
selection of salted nuts, but the passengers at the back were saving several
hundred dollars.

Anybody in his right mind feels ripped-off if he realises he paid six times
the fare of the person next to him, but the penny took time to drop. For one
thing, nobody concentrated very hard in the late 1990s. Business travellers
usually do not pay for their own tickets and their employers were awash with
cash at the time.

Even those who tried to save money found it hard. Flights tended to be
booked through travel agencies that were loyal to legacy carriers, not
through the internet, and low-fare airlines covered fewer cities in either
the US or Europe. Meanwhile, like the computers used by hedge funds to trade
in financial markets, the airlines' yield management systems tended to spit
out similar prices.

Meanwhile, airlines fenced in business customers who were tempted to escape
to the cheap seats by imposing conditions such as the Saturday night stay.
It would be hard to think of a device better calculated to raise revenues
while making it painfully obvious to businesses that airlines had them
trapped and there was nothing they could do.

Then came the World Trade Center attacks and a slump in airline travel that
cut $20bn a year off US airline revenues. Even when the recovery came, the
business traveller had become more price-sensitive and better-informed,
thanks to the internet. He also had a lot more choice: low-fare carriers had
expanded to 25 per cent of US airline capacity and were operating out of
many more cities.

Airlines such as Southwest, having traditionally served leisure travellers
from secondary airports, now compete head-on with legacy carriers: US
Airways admitted to being shocked when Southwest started flights from its
Philadelphia hub last May. They have also added facilities such as leather
seats and television on the backs of head-rests while still charging much
less than legacy carriers.

The result has been the collapse of the old guard. Thirty nine per cent of
US Airways passengers paid a premium for seats in the first quarter of 1998,
but only 4.6 per cent did so in the same period of 2004, according to its
bankruptcy filings last September. The desertion of business travellers
accounts for most of the 15 per cent drop in revenues per passenger mile
experienced by legacy carriers.

In fairness, it was hard to avoid the trap into which yield management lured
the legacy carriers in the late 1990s. American Airlines made an abortive
effort to reduce the divide between business and leisure fares in 1992 with
its Value Pricing initiative - similar to Delta's new Simplifares - but came
off worst in the subsequent fare war and soon retreated.

Still, the airlines are a sorry example to other industries. Most companies
can identify the 20 per cent of customers who are the most valuable to them,
but what then? Do they work hard to ensure the continuing loyalty of those
customers, or find ways to extract more money from them? The airlines did a
few things in the first category, but their pricing strategy fell squarely
into the second.

Maybe they were fooled by the ingenuity of their yield management systems in
devising arcane fares. But that is a lame excuse. An algorithm may have
decided it would work nicely to give leisure passengers cheap rides and to
sting the business travellers who were single-handedly keeping the
enterprise aloft. Common sense, however, would have produced a different
answer.


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