The travel industry is one of high fixed-costs, low marginal-costs and price transparency – making it fertile ground for price wars. The thinking is that it's better to fill up all seats - at a low price - than not at all. During a recession, the situation becomes more desperate, as airlines large and small slash prices in an attempt to stimulate demand or gain market share.
The most recent recession was an exceptional one for the travel industry. For almost a decade, online travel agencies have been the engine of "instant price transparency," allowing customers and airlines to quickly and easily see every competing hotel and price for any stay night. The recession, however, hit as mobile devices were ushering in a new era of hyper-transparency. For the first time, the lowest prices could quickly find customers via social media channels and instant messaging to mobile devices. Customers can now receive instant alerts when prices change or go below a certain level. As such, it has never been easier to start a travel industry price war, and it's never been harder to recover from one.
In 2009, with very few sold-out flights, traditional revenue management systems were adding very little value. When demand dropped so low, there were very few opportunities to close out lower rates and charge more for the remaining rooms. Revenue management systems have evolved around managing and allocating inventory to an existing set of prices, not managing the prices themselves. When airlines are expected to have empty seats, revenue management systems keep the lowest rates open for sale right up to a flight departure. If the lowest rate is driven even lower to match a competitor, a traditional revenue management system may recommend keeping the lower rates for sale indefinitely, especially during times of low demand.
When the dust settled in 2010, one thing was evident: the revenue management systems that evolved pre-Internet and before hyper-transparency were not delivering the one vital piece of information – an optimal price recommendation. Having managed through the recession with tools designed to be effective only during high demand, airlines looked to revenue management software providers for a different approach.
Making a price recommendation is all about understanding the underlying elasticity or inelasticity of demand. How much money is a customer willing to pay for a flight, and what is that elasticity relative to competitors' prices? If a competitor's rate for a return flight is £160, could a rate of £180 sell out? Or should prices drop to £120 to increase the likelihood of a sell out?
Price optimisation, which represents the future of revenue management, applies advanced price-elasticity estimation techniques combined with real-time competitor price data. Elasticity algorithms are applied to an airline's historical demand along with data for historical pricing. Combined with bookings on-hand and a forecast of demand yet-to-come, pricing and revenue management systems can now make real-time daily price recommendations that maximises revenue.
For the first time, a pricing and revenue management system can recommend not to engage in the battle. This new competitive posture is a huge advantage for airlines of all sizes in the world of hyper-transparency in pricing. Certainly there will always be price wars, but with wide adoption, price optimisation can help avoid deep and prolonged price wars that cut across seasons and markets, destroying future revenue as prices take months or years to recover.