Want to keep learning?

This content is taken from the École Nationale de l'Aviation Civile's online course, An Introduction to Pricing Strategy and Revenue Management. Join the course to learn more.

Skip to 0 minutes and 16 seconds Hi Bill. Hi Christophe. From the start you’ve been involved in the evolution of revenue management How has it all started? Well when I was first in the industry, which was in the sixties,

Skip to 0 minutes and 29 seconds one of the major airplanes, a typical one was the 707 which was about a hundred and eighty seats. It went just under a thousand kilometers an hour and it had a range of about five thousand kilometers. I brought some pictures for you. Here is the old airplane. And the reservation system in those days was not a computer, but business machines. There were people on telephones and maybe a punch card machines. And before that, they had a big wooden drum with file cards in slots. Each flight had a file card and they would, when someone would call up, grave his name on a card and put it back in the drum.

Skip to 1 minute and 6 seconds So each day of the week of the month was down in the drum and each flight was around the drum. And that was the reservation system before revenue management came in. But, in those days, all the travelers were business travelers. It was quite high priced. And leisure travelers and poor people travelled in buses and trains. So it was all very fancy people and quite high priced in its time. Now today it turns out. A very typical airplane would be the 737-800 or the A321 which has about a hundred and eighty seats and goes just under a thousand kilometers an hour and has a range of about five thousand kilometers.

Skip to 1 minute and 41 seconds So the airplane hasn’t changed very much in this performance at least but the whole reservation system and booking is a whole lot different because it’s all on the computers and very controlled. The airplanes are no longer just full of business passengers. They’re mostly 75-80% leisure travelers.

Skip to 2 minutes and 0 seconds So Bill what is revenue management? Revenue management is really three different ideas.

Skip to 2 minutes and 8 seconds I brought a slide for that as well. The first idea is to separate out the business travelers from the leisure travelers and charge them different fares. You have some way of separating them out. The second ideas to limit the number of tickets you sell in leisure class so there’s plenty of room for the high paying business travelers And the third idea is to make sure the discounts are deep enough that you fill a whole airplane with people because that gives you the most revenue. So that’s three ideas, right? That’s three ideas and each one we came across by making a really stupid mistake. A mistake? Yes. Can you tell us what sort of mistake leads to these ideas?

Skip to 2 minutes and 47 seconds Well the first mistake has to do with the 747, which was way too big when it first came out. It was twice the size of the 707, the normal airplane of its day. And the reason they put a big airplane where a little airplane used to be is they had a demand model that said that the airlines market share was bigger if it had more seats in the market. Now it turns out that it was a stupid mistake. What really happens was if the airline had a lot bigger market share, it put more seats in the market to carry the passengers. The causality went the other way. So when they put the 747 in, it was empty.

Skip to 3 minutes and 23 seconds They had nobody on the seats. That was the first mistake.

Skip to 3 minutes and 28 seconds How is it related to revenue management? Well they had to do something about it. So Boeing went around with this idea they called surplus seat sales. And the idea was to find a bunch of customers that you weren’t serving, they had nothing to do with the business travelers, and offer them special discounts and then fill the empty seats with those discount customers. So what really happened is that they started offering low prices to students, to the military, to people in the ministry, to old folks and to left-handed green eyed dwarfs. I brought a picture. Yes, I see the troll over there. So that sounds good? Well it was good but it leads to the next big mistake. Which was what?

Skip to 4 minutes and 19 seconds The discount people bought their tickets early and they bought the whole airplane out in there wasn’t any space left for the high fare customers. So that was very quickly fixed. But it was fixed by a clever idea now by a bunch of fancy computer people. And what was this idea.

Skip to 4 minutes and 34 seconds Well in the international flights they had three cabins: a first class business class and what they call the tourist class. And for

Skip to 4 minutes and 42 seconds the domestic flights they only had two cabins: a business and a tourist class cabin, what they call a full fare cabin. So they had a computer ready to accept three cabins. So they imagined they would divide the seats that are called tourist class seats in the back of the airplane into a high fare group of seats and a discount group of seats and only sell seats in the discount in their group.

Skip to 5 minutes and 9 seconds And there’s little cabin so they ended up with three cabins again: a first class, a full fare, and a discount cabin. And the big idea was instead of having them fixed as twelve seats in first class and a hundred and sixty in discount or in coach, they change the size of the full fare cabin depending on the demand every day for every flight. And that was the beginning of the revenue management idea and by 1975 that idea was working and we had the seats divided in three cabins first class what looks like Business class became full fare and then what we call K classes is a discount class. I know that one.

Skip to 5 minutes and 50 seconds You’re in it all the time, we call it the back of the bus. And so that sounds very good and then they manage the system and after that, everything went Ok with this? At that point you are in a position that look resembles modern revenue management. Because they put it on the computer originally they would making these estimates by hand of how much to protect for full fare and then they put it on a computer and the math geeks got hold of it and they started optimizing the right size of the cabin against the uncertainty of the forecast for the full fare demand.

Skip to 6 minutes and 26 seconds And there were lots of studies about that and a lot of discussions of what the real problem was and they made a few little technical errors on the way there were lots of conferences to try straight nose out. What was these little detail? The silliest of them was, it turns out if you happen to sell all the full fare seats. If it’s a separate cabine, it is not allowed to reach into the discount seats and use any available up empty seats for full fare. So they change the cabin’s instead of being separate to nesting for the high fare cabin in the low fare cabin.

Skip to 7 minutes and 2 seconds So they protected seats for high fare but high fare could reach down into the low fares seats if it needed to. That’s the kind of thing they came across but then we’re pretty much at what you might think of as revenue management but there was still one big mistake left to make. Which is the third mistake, right ? This is the third mistake and I happen of been right in the middle of this one so I can tell you the inside story that I haven’t found any place else. Because you will there! I was in American Airlines at the time. And in the 1980’s there was a start-up airline in New York City called People Express.

Skip to 7 minutes and 33 seconds And People Express was a rough airline we crowded seats and you had to carry a baggage on and the fare is a very very very low. And they were connecting a lot of passengers across New York City. And those connecting passengers, American finally figured out and we figured out that were coming off of our flights that were connecting over our hubs. And so we didn’t want the People Express to take our customers. So we decided to teach them a lesson and play mean, and we learned a lot from the lesson. This all happened because American was both one of the hardest playing airlines in competition and one of the most disciplined airlines in reviewing how it was doing.

Skip to 8 minutes and 13 seconds So what happened, yes. What happened was American match the very low discounts of People Express. Expecting to lose money at those high discounted low fares but hoping to push People Express out of business. And because American was the preferred airline. What happened was everybody who wanted a cheap flight went on American whatever they could get the seats. And because of revenue management they were still protecting the high fare space but they sold out all of the empty space every day of the week on Wednesday they were full, on Sunday they were full and People Express all of a sudden only got the leftovers that didn’t make it onto American airline.

Skip to 8 minutes and 55 seconds So they had a terrible peeking problem People Express because they were full all weekend when everybody wanted to travel in empty in the middle of the week when everybody was on American Airlines. And they went out of business. Which was the goal Well it wasn’t happy answer for American because Continental took over the People Express operation in Newark and they’re much better competitor. So in the end they didn’t get rewarded but.

Skip to 9 minutes and 19 seconds They did look into how they did financially how much money they lost trying to do it and that’s was how they discovered the third mistake So when they went to study how much money they’d lost trying to put People Express out of business it turned out they made money by playing these dirty tricks. So from then on, the new paradigm for revenue management was to drop the discount fares enough just enough to fill all the empty seats and so instead of having an annual load factor of 65%, it was 85% is now the standard and they fill all the seats almost all the time which is why the airplanes are always full whenever you get on.

Skip to 9 minutes and 54 seconds I’m very happy you’re doing this. It’s a good thing we are doing I’m happy to be part of it. Thank you. Thank you very much, Bill. Polite applause.

Business talk: Revenue Management in the airline industry

Airlines have been practicing Revenue Management for decades now and are among the early developers of some of the most sophisticated techniques used by other industries today.

But how did it all get started? How have these techniques been implemented?

Can you identify the 3 “big mistakes” that have forced airlines to invent revenue management as we know it today?

Join the discussion

In response to the question above, share your interpretation of Bill Swan’s explanations.

William “Bill” Swan is Chief Economist for Seabury-Airline Planning Group.

Previously and for many years, he was Chief Economist for Boeing Commercial Airplanes. He has worked for United and American Airlines in operations research and strategic planning. He holds a PhD in Transport Systems from MIT. He has been a researcher, an economist and an expert in air transport for many years. He has been one of the early revenue management developers and has followed the evolution of revenue management in air transport since the 70s.

Share this video:

This video is from the free online course:

Manage Your Prices: an Introduction to Pricing Strategy and Revenue Management

École Nationale de l'Aviation Civile

Get a taste of this course

Find out what this course is like by previewing some of the course steps before you join: