Dynamic Pricing in the Airline Industry
Dynamic Pricing in the Airline Industry
R. Preston McAfee and Vera te Velde California Institute of Technology
Abstract: Dynamic price discrimination adjusts prices based on the option value of future sales, which varies with time and units available. This paper surveys the theoretical literature on dynamic price discrimination, and confronts the theories with new data from airline pricing behavior.
Correspondence to: R. Preston McAfee, 100 Baxter Hall, California Institute of Technology, Pasadena, CA 91125, preston@mcafee.cc.
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Computerized reservation systems were developed in the 1950s to keep track of airline seat booking and fare information. Initially these were internal systems, but were soon made available to travel agents. Deregulation of airline pricing in 1978 permitted much more extensive use of the systems for economic activity, especially pricing. The initial development of dynamically adjusted pricing is often credited to American Airlines’ Robert Crandall, as a response to the rise of discount airline People’s Express in the early 1980s. The complexity and opaqueness of airline pricing has grown over time. As a result, the “yield management” systems employed by airlines for pricing have become one of the most arcane and complex information systems on the planet, and one with a very large economic component. Airline pricing represents a great challenge for modern economic analysis because it is so distant from the “law of one price” level of analysis. This paper surveys the theoretical literature, which is mostly found in operations research journals, develops some new theory, assesses the holes in our knowledge, and describes some results from a new database of airline prices. Dynamic pricing, which is also known as yield management or revenue management, is a set of pricing strategies aimed at increasing profits. The techniques are most useful when two product characteristics co-exist. First, the product expires at a point in time,
R. Preston McAfee and Vera te Velde California Institute of Technology
Abstract: Dynamic price discrimination adjusts prices based on the option value of future sales, which varies with time and units available. This paper surveys the theoretical literature on dynamic price discrimination, and confronts the theories with new data from airline pricing behavior.
Correspondence to: R. Preston McAfee, 100 Baxter Hall, California Institute of Technology, Pasadena, CA 91125, preston@mcafee.cc.
i
Computerized reservation systems were developed in the 1950s to keep track of airline seat booking and fare information. Initially these were internal systems, but were soon made available to travel agents. Deregulation of airline pricing in 1978 permitted much more extensive use of the systems for economic activity, especially pricing. The initial development of dynamically adjusted pricing is often credited to American Airlines’ Robert Crandall, as a response to the rise of discount airline People’s Express in the early 1980s. The complexity and opaqueness of airline pricing has grown over time. As a result, the “yield management” systems employed by airlines for pricing have become one of the most arcane and complex information systems on the planet, and one with a very large economic component. Airline pricing represents a great challenge for modern economic analysis because it is so distant from the “law of one price” level of analysis. This paper surveys the theoretical literature, which is mostly found in operations research journals, develops some new theory, assesses the holes in our knowledge, and describes some results from a new database of airline prices. Dynamic pricing, which is also known as yield management or revenue management, is a set of pricing strategies aimed at increasing profits. The techniques are most useful when two product characteristics co-exist. First, the product expires at a point in time,