Indian Aviation: The Ultimate Revenue Management Challenge
Head of Operations
The basic underlying principle of revenue management or “RM” is that airline inventory (i.e. seats available for sale on an aircraft) is a perishable commodity. The moment you close an aircraft door for departure, empty seats in the cabin are worthless and essentially lost revenue which could have been pocketed by an airline. The second and equally important guiding principle is that not all customers have the same purchasing power. This is why airlines focus on various segments of travellers e.g. business and leisure travellers. Business travellers are those who often book closer to the date of departure and are usually willing to pay a higher fare. Leisure travellers, on the other hand, usually plan their trips well in advance and are more often than not on the lookout for deals.
Traditional mantra in RM has been “Never cheaper tomorrow”. The goal of sound RM is to maximize revenue. This is often confused with maximizing loads or maximising prices.
Airlines the world over have dedicated departments with both analysts and data scientists who use extremely sophisticated forecasting and optimization methods to ensure every seat on every flight is sold to the customer who is willing to pay the most for it. The idea is to fly the least number of empty seats by offering differentiated fare products which help stimulate demand. Airlines also try their best to forecast the right mix of business and leisure travellers throughout the year to maximise revenue. E.g. During the holiday season, leisure travellers would be willing to pay a higher fare. Airlines factor these insights into the way their tickets are priced.
The segmentation of the airline customers, goes well beyond the well-defined business and leisure travellers. Depending on their individual business models, airlines have different cabins i.e. first, business, premium economy and economy. Each cabin has different fare classes. Each fare class comes with its own set of restrictions. Some of these restrictions, if not all, revolve around advance purchase i.e. how many days prior to the date of travel is the ticket purchased, minimum stay requirements for round-trip tickets, fees to reschedule the ticket and cost of cancellation.
Revenue managers at airlines take all of the above into consideration and come up with fares for various classes. The different fare buckets offer a certain amount of flexibility to the customer and in doing so, encourage the customer to purchase the next higher fare bracket within the same cabin. This applies to all cabins at all airlines including first and business class cabins.
The advent of low-cost airlines or “LCC’s” disrupted the aviation industry. Southwest, the world’s largest LCC, pioneered this business model. LCC’s place orders for a large number of aircraft directly with the original equipment manufacturers or “OEM’s” and usually enter into complex sale and leaseback transactions for each aircraft upon delivery. This transaction guarantees additional revenue upon delivery and in some cases, LCC’s sign up for shorter than usual lease terms.
This model was replicated the world over, quickly ensuring LCC’s had younger fleets resulting in lower maintenances costs. LCC’s learnt from the challenges faced by legacy full-service airlines and nipped a lot of issues, faced by their predecessors, in the bud. They hired younger employees on simpler contracts. They invested in technology which in turn helped them sell their inventory directly through their own platforms instead of relying on Global Distribution Systems or “GDS’s”. They simplified processes, empowered employees and reduced red tape. Most importantly, LCC’s offered simplified fare brackets and unbundled fares.
Unbundled fares offered by LCC’s have enabled millions, all over the world, to fly. They have also changed customer booking behaviour forever. Surprisingly, passengers who may have the ability to pay over and above an LCC fare, now end up buying the cheapest fare on offer. This phenomenon is also called ‘buydown” and is extremely worrying for airlines across the board. Even in a market like India where LCC’s rule the roost.
In the good old days, selling a seat was pretty much what an airline did to bring in revenue. Today, “ancillary revenue” i.e. non fare revenue, derived from products and services sold beyond the actual ticket sale, amounts to a big chunk of revenue for airlines globally. Many of the ancillary revenue products i.e. meals, checked baggage, seat assignment, etc. were included in the ticket prices prior to the unbundling of airfares. IATA estimates USD$899 billion will be spent on airfares in 2019. Ancillary revenue will account for 12.2% of global airline revenue or USD$23.91 per passenger.
Sir Richard Branon, founder of Virgin Atlantic famously said “If you want to be a millionaire, start with a billion dollars and launch a new airline”. His brainchild Virgin Atlantic, the UK’s second largest full-service airline continues to struggle with profitability, despite having Delta Air Lines, Inc. the world’s most profitable airline as 49% shareholder and transatlantic JV partner.
Closer home, aviation in India is known for its double-digit growth rate, extremely high cost of operations and rock bottom yields. It is also known for some of the lowest airfares on the planet. These factors make the jobs of revenue managers extremely challenging. There are however some facets which make India an extremely unique market for revenue managers to operate in.
The Indian aviation space is dominated by LCC’s. As per Directorate General of Civil Aviation or “DGCA” data, LCC’s accounted for 81.2% of the domestic passenger market in India for the month of January 2020.
LCC’s rely on ancillary revenue to often compensate for the rock bottom fares offered to stimulate demand.
Back in 2007 the top 10 airlines in the world, as rated by total ancillary revenue, generated US$2.1 billion. Fast forward to 2018 and the top 10 revenue tally has leapt more than 16 times. In Asia and South Pacific, AirAsia continues to lead the way with 29% of its revenue coming from ancillary sales. This equates to ancillary revenue earned per passenger of US$34.38.
A big chunk of Air Asia’s ancillary revenue comes from checked baggage fees. Sadly, in India LCC’s are burdened by regulation which forces them offer a 15 kg free checked baggage allowance to all passengers except ones who choose to purchase a hang bag only fare.
The DGCA, also mandates airlines in India, including LCC’s, to offer free water to passengers onboard. While offering free water has been argued by some to be a natural right of every passenger, others have argued that there is no harm in water being dispensed on the basis of payment. As such, apart from the obvious cost of procuring and ferrying bottled water, this too is a loss of ancillary revenue for airlines.
Airlines in India are expected to provide free special assistance i.e. wheelchairs for differently abled passengers on all domestic flights in India. Air Asia, in most jurisdictions, charges for this service. They offer a discounted price when the wheelchair is booked in advance compared to a last-minute booking made at the airport counter.
In a market know for rock bottom airfares, these extras which would ideally have brought in additional revenue for LCC’s turn into a cost. Especially because revenue managers have no way of including these into the already deeply discounted airfares on offer.
Last minute discounting
Airlines the world over make adjustments to fares to reduce the effect of buy down. Markets like India where LCC’s rule the roost are a classic example where full-service carriers or “FSC’s” and to some extent LCC’s, restrict sale of lower priced fare classes to reduce availability of cheaper seats. This is done to ensure the higher priced seat classes are sold close to the date of departure ensuring higher revenue per seat.
Due to overcapacity in India, airlines often offer deep discounts barely a few days before departure to get rid of unsold inventory. This rather disturbing practice, not only has the potential to alter passenger booking behaviour but also throws all conventional revenue management logic out the window.
Unfortunately, in an extremely price sensitive market like India, all it takes is for one airline to drop fares and the others don’t have an option but to follow suit. This is done primarily because the leisure traveller which dominates the travel base in India chooses a lower fare over anything else. Airlines also often do this (drop fares) to generate much needed cash flow to support operations.
Irrespective of the reason this is done, revenue managers are left with no choice but to discount their inventory or end up flying with empty seats.
Online Travel Agents or “OTA’s”:
OTA’s today are indispensable to the aviation industry. India has its share of home grown OTA’s which dominate the space. Revenue managers have to entice customers to book directly with the airline without discouraging OTA’s, who in fact bring in a sizable amount of revenue. The OTA’s are in actual fact competing with the airlines for the same customer even though OTA’s are just an intermediary and not the service provider. OTA’s are also an expensive distribution channel as they charge a commission for every seat they sell.
Vistara, a joint venture between Tata and Singapore Airlines, very smartly uses its frequent flier programme to reward customer who book directly. Customers can also modify or cancel tickets booked directly with the airline, within 24 hours of booking at no extra cost as long as your travel is at least 7 days in the future.
Larger OTA’s often buy airline inventory in bulk and sell seats at prices they deem fit. Bulk selling of inventory to OTA’s guarantees revenue for the airline but leaves the airline at a marked disadvantage as the OTA can sell the inventory on its own terms and potentially reap benefits by selling seats as part of a holiday package or selling them last minute for a higher price.
Also, airlines customize their search and booking engines to ensure customers are offered the complete plethora of ancillary services at the time of booking. The User Interface or “UI” is built to showcase the airline’s product offering and is usually geared towards maximizing ancillary revenue. OTA’s by nature sell inventory from multiple airlines and this makes it extremely difficult for them to display, highlight and promote extras offered by each airline as prominently as the airline can. The airlines have no choice then but to reach out to customers later via email, etc. encouraging them to purchase extras which could ideally have been sold in the moment during the booking process.
Despite the copious amounts of data airlines have access to and the wide variety of data mining / revenue management solutions which allegedly help encourage the passenger to spend more, the industry is lacking qualified revenue managers who will use all these data points to understand patterns of local demand and supply.
India is a unique aviation market which is on a growth trajectory like no other. As the industry grows, it will require talented professionals who are passionate about, not just the industry but also about making a difference. The challenge to find and retain such trained personnel is real.
Revenue managers are faced with these challenges’ day in and day out. Each and every decision has a direct impact on route and overall profitability.
Airline revenue management is both a science and an art. It is one of the most fascinating and challenging aspects of running an airline. Operating in a market like India, adds a whole new dimension to it.