Driving Airline Profitability Better with Dynamic Pricing
Several management consulting firms have noted, for years, that a mere 1% improvement in the realized price typically translates into a profit margin of up to 10%-12%. This impact measures significantly greater than any other profit lever such as variable costs, fixed costs, or sales volumes. Pricing is the single most important lever available to improve profit margins in general, and the airline cargo business is no exception to this.
The Airline Industry is currently abuzz with the term Dynamic Pricing. The simplest definition of dynamic pricing is the “change in prices over time.” This phenomenon draws a lot of attention because it brings leverage to the industry for driving profitability. However, effective implementation of the dynamic pricing models remains a top challenge before the industry.
Under the traditional pricing model, the industry saw incremental increase in the prices at certain discrete points in time, such as before departure or when a certain amount of capacity was sold. The other popular methodology was bid pricing, which was based on the type and amount of remaining demand and remaining capacity.
While these traditional approaches still remain valid in terms of providing changing prices over time, they do not truly recommend dynamic pricing.
Airline Cargo Industry Today and Ahead
Many airlines have three distinct ways of doing business today – contract rate, spot rate, and published rate.
Contract rate is about providing a certain amount of space at agreed prices for future use. This has two different flavors. The first one is generally called as allotment business where customers get allocated/protected space at a certain rate but there is no penalty in case they don’t use their allocations.
The second one is known as negotiated contract rate where the rate is protected but accepting a booking is subject to available space as well as hurdle price which is a function of anticipated demand versus capacity.
The third one is Spot rate which is for a specific request. The customer may have a contract rate but may choose to ask for a special rate due to certain specific nature of the booking – size of shipment, type of commodity, or other airlines offering a better rate.
The industry is slowly moving away from the last two distinct ways of doing business and combining them into one called dynamic pricing. The inertia is quite high, but it is slowly making its way.
Dynamic pricing – Understanding It Better
The true understanding of dynamic pricing comes with answering a set of questions. Here we go. What variables influence the change in price over time (Price Influencers)? Do we have data available for these variables (Data Driven Prices)? How can we use the available data to influence prices (Sophisticated Mathematical Models)? And, finally how can we have a streamlined process that incorporates the above (Efficient Quoting Process).
Under dynamic pricing, each booking request is evaluated considering all the price influencers at that point in time.
Identification of Price Influencers
There are several variables that impact the price to offer. Here are a few to mention: capacity, nature of demand – for what product/service, the quantity booked, how many days in advance booked, certainty of show up, etc.
The other influencers include customer characteristics such as willingness to pay, how much business the customer gives, type of contracts the customer has, etc., and competitive data – what other airlines serve the market, the prices customers paid them, their share of the market and customer.
Data driven prices (Dynamic)
Some of the data for the price influencers comes from an airline’s own air waybill and others may route through third party sources. Other data such as bid prices and willingness to pay must be derived or computed using certain models. There is quite a bit of work that needs to be done to clean the data including removing outliers and accounting for missing data.
Sophisticated Models to Optimize Prices
Rates such as contract and tariff may still exist but price to be offered for a given booking is based on maximizing profit potential – considering all available rates along with willingness to pay and hurdle rate at that time. This requires advanced mathematical optimization models to process the data and recommend optimal prices that maximize profitability.
Efficient Quoting Process
Given the B2B model of the air cargo business and the importance of relationships, any dynamic pricing solution implemented should have the flexibility to allow for human intervention within a specified range of price band.
Effective business rules need to be in place to handle exceptions as well as provide governance control. An important technical aspect is to ensure that the process flow supports the interactions with the users between booking request and confirmation/non-acceptance of booking during the offer.
Summing Up
Dynamic pricing in the airline cargo business is still not very mature. Several airlines have been mulling through these ideas, while some have been experimenting with this concept and only a very few thought leaders have actually taken the steps to implement it.
Major challenges include cultural shift from both forwarders and airlines, sales people mindset, and data availability. We have actually partnered with some airline thought leaders in making the Dynamic Pricing dream a reality.