American Airlines Dynamic Pricing

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Revenue management is a proven technique to help service industries maximize revenue. It involves management of inventory and distribution channels and prices to maximize profits over the long run. Simply stating the technique involves selling the right product to the right customer at the right time at the right price. The following are the primary activities involved: demand data collection, demand modeling, demand forecasting, pricing optimization, and system implementation and distribution. Though individual airlines in the States are not owned by the government, it effectively controlled their performance until the late 1970s by setting a single price for each route and decreeing which of many carriers could operate where, but from the late 1970s on, the government relaxed the rules. American Airlines (AA) was the first to use basic revenue management techniques, offering dynamic pricing in shape of discounted fares to passengers who booked early, incentivizing customers by reserving seats for higher paying customers, and overbooking seats in the knowledge that some passengers would cancel at the last moment and that others would fail to show up. AA pioneered the revenue management system and reaped the rewards of being one of the first movers in that direction. By using the methods mentioned earlier American Airlines claims to have been able to generate as much as $500 million a year in additional profits from 1980s onward. The methods used and the steps taken highlight the simple use of basic microeconomics principles in that dynamic pricing helps reduce the consumer surplus and deadweight loss and at the same time increases the firm’s profits. Using dynamic pricing (and coupling with yield management) AA decreased demand variability in that the customers understood that the earlier they book the better price they will get. The questions American Airlines asked itself were: How many seats to make available at each of the listed fares, depending on time of year, time of week, remaining seats available, remaining time until departure, what contracts and prices to provide to corporations, how many seats to make available to consolidators and travel agents (if at all), and at what prices, how much capacity to make available to cargo shippers and freight forwarders, and at what prices. The same techniques can (and have been) applied in many other sectors like hotel industry, Ocean cargo industry, car rental industry, restaurant industry, manufacturing industry, retail industry and many others where the goods are perishable and opportunity costs exist including even golf courses and entertainment industry (ticket pricing, advertisement slots etc). Analysis

1. What are AA’s major strategic & tactical Decisions American Airlines (AA) faces intense competitive threat as airline deregulation had opened the market to new entrants; the deregulation has also allowed airlines to change their fares and route structure at will. AA executives have to make major strategic and tactical decision to thwart these competitive threats and maintain AA leadership as airline of choice. * Cost Containment – AA has to keep it cost in control, acquire new fuel efficient aircraft, maintain its labor and pilots productivity and reduce its aircraft maintenance costs. * Route Structure – The evolution of hub-and-spoke model of airlines operation required AA executives to decide on optimal routes, aircraft size, fares and terminal allocation. * Marketing - AA executives have to find out the optimal way of using AMR’s SABRE reservation system and leverage bit to seek competitive advantage. SABRE system as Quantitative Decision Support System

AMR’s SABRE ticket distribution system has information regarding 35% of all airlines reservation in United States wealth of ticketing and routing data that can be leveraged by AA to understand where it stands with respect to the competition. AA can utilize data mining on...
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