Airline Industry: Pricing Structure and Strategies

Topics: Price discrimination, Pricing, Yield management Pages: 9 (2098 words) Published: October 11, 2014

Airline Industry: Pricing Structure and Strategies

ABSTRACT
The profitability of an airline industry depends on filling seats, and on the company’s ability successfully to anticipate the cost and price structures of their competitors. However, many airline carriers have a hard time accomplishing this because the average airline passenger just needs to travel from one destination to another in the most convenient and shortest amount of time at a reasonable price. Therefore, customers in this market are not as loyal to one specific airline (brand) in the industries. The reason for this is that airline carriers provide the same services at similar prices. In addition, the passenger will only incur high switching costs if they choose to take another mode of less desirable transportation. Airline carriers have overcome these problems by using the strategy of “Price discrimination.” That is a strategy that allows them adequately to segment their potential passengers, and to offer different pricing structures that match passengers’ sensitivity to price and value differences in cost to serve, and their different competitive positions (Stern, 1989). While it also allows passengers to maximize their “expected utility” when flying with the airline carrier that meets their needs.

The 1978 deregulation of the airline industry has resulted in airline carriers being unable to make a profit by filling seats, and successfully to anticipate the cost and price structures of their competitors (Bailey, David, Graham, Kaplan 1985). According to statistic, the airline industries’ profits declined in 2001 through 2003 by $23.2 billion (Smith Jr. & Cox). During this time the average airline passenger just needed to travel from one destination to another in the most convenient and shortest amount of time at a reasonable price. However, because all airline carriers provide the same services at similar prices, the passengers in this market are not as loyal to one specific airline (brand). For, example, any passengers not able to purchase a flight plan that they value, will not necessary buy the next best plan offered. Instead, these price-sensitive passengers will gravitate toward a lower-cost competitor airline (Smith Jr. & Cox). This is especially true in this particular industry because a passenger will only incur high switching costs if they chose to take another mode of less desirable transportation. Therefore, many airline carriers had a hard time making a profit or breaking even (Brady, & Cunningham, 2001).

In addition, this same deregulation of the industry provided new companies the opportunity to enter an already competitive market (Bailey, David, Graham, Kaplan. 1985). This stressed the market because pricing strategies that airlines used in the past did not adequately different between price sensitive passengers and price insensitive in this market (Sterns, 1989). Therefore, many airline carriers could not “capitalize on opportunities that [would] influence customer and [their] competitor responses (Stern, 1989). Because of this lost of profit, many airline carriers were force to file bankruptcy (Brady, & Cunningham, 2001). Therefore, as a reaction to these, external pressures many of the remaining companies (American, United, Continental, Northwest, US Air, and Delta) developed complex pricing strategies that would help them to outmaneuver their rivals (Smith Jr. & Cox). Different pricing structures were developed that allow them to match passengers’ sensitivity to price and value differences in cost to serve, and their different competitive positions (Stern, 1989). In addition, sense airline carriers offer a product that is homogenous; to be successful they had to offer a product that potential passengers would view as different from their competitors’ product (Westermann, 2005). One strategy that airline carriers’ use is “differentiated pricing, which is a form of “price...

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