Journal of Revenue and Pricing Management

Volume 4 Number 4

(Realtime) dynamic pricing in an integrated

revenue management and pricing
environment: An approach to handling
undifferentiated fare structures in
low-fare markets
Dieter Westermann
Received (in revised form): 28th September, 2005
Lufthansa Systems Berlin GmbH, Fritschestrae 2728, 10585 Berlin, Germany
E-mail: dieter.westermann@lhsystems.com

Dieter Westermann has been an employee

of Lufthansa Systems Berlin since July
2004. He holds the position of General
Manager Strategic Projects in the Division
of Revenue Management. Dieter has
extensive experience in revenue management business processes and systems as
well as in the area of pricing, reservations
and distribution. During his 15 years in
airline revenue management, he has
worked for carriers such as Lufthansa and
Swissair. During his last assignment at
Swiss International Air Lines as Vice
President Business Solutions, he was
responsible for the systems environment
for revenue management, pricing, reservations and inventory, and CRS distribution.
An important step during that time was the
successful implementation of an origin
and destination revenue management
system.

ABSTRACT
KEYWORDS: traditional pricing, dynamic
pricing, undierentiated fare structures,
realtime distribution, willingness to pay,
passenger segmentation

This paper compares the traditional pricing procedure of network carriers using fare products
dened by rules and restriction with the concept
of dynamically adjusting prices based on current
market conditions. It describes why traditional
revenue management procedures and algorithms
fail in a fenceless environment typical of low-fare
carriers. The paper attempts to explain how a
dynamic pricing concept based on willingness to
pay could form the basis of a long-term revenue
management solution for various types of airlines, from low-fare carriers to network carriers.
The concept requires signicantly more integrated business processes between pricing and
revenue management and therefore demands a
new and future-oriented approach to revenue
optimisation.
GLOSSARY
O&D
Origin and destination: part of a
passenger itinerary. Rather than
splitting the itinerary into pieces
dened by the physical stops of an
aircraft (leg) or by ight number
dened by the schedule of the
airline (seg-ment), it considers the
single passengers boarding and
landing airport.

Journal of Revenue and Pricing

Management, Vol. 4, No. 4, 2006,
pp. 389405
# Palgrave Macmillan Ltd,
14766930/06 $30.00

Page 389

(Realtime) dynamic pricing

GDS

Global distribution system:

computerised
distribution
systems providing independent
availability, schedule, and
booking functionality for the
travel industry such as airlines,
hotels and others.
ATO/CTO Airport and city travel oces:
sales oces at an airport or in
a city, which oer and sell
mainly the own airlines
product.
AVS/AVN Message to communicate seat
availability between the inventory holding system of an
airline and the distribution
systems. The status is communicated either in numeric form
or by specic codes dening
the current status.

the airline with various levels of discounted

fares that were dened by a set of rules and
restrictions around the fare levels. The
lower the fare level, the more restrictive
the set of rules and restrictions.
The reasoning behind this is based on the
theory of market segmentation. As shown
in Figure 1, there are two reasons why
charging only a single price may result in
lower revenues. First, passenger segments
willing to pay higher prices will just pay
the price published. At the same time, passengers considering the price too high will
not purchase the product. By oering different products at dierent prices, the
market is being segmented. Higher prices
can be maintained by oering better but
more expensive products. At the same
time, less expensive products are being
oered to the consumers who are not willing to accept the higher prices.

BACKGROUND
Segmentation of demand
Airlines recognised decades ago that if they
could structure a pricing model that would
force the few elite travellers to pay the premium fares (and incidentally generate the
majority of the airlines revenue), the
remaining customer segments that were
more price sensitive could be attracted to

Airline product
A problem with the classical airline product is that it is a homogenous product as
long as the passenger books a specic cabin
for transportation. Therefore, the airlines
had to create a methodology which, from
the customer perspective, would associate a
set of product descriptions that would
create heterogeneous products within the

Figure 1: Market segmentation by oering multiple products at dierent prices

Passenger
Demand

Lost passengers
and hence lost
revenue

D6

Multiple price points allow products to

be offered to multiple customer
segments. More revenue is extracted
from the market.

D5
D4
D3
D2
D1

D1

F1

Page 390

Fare

F6

F5 F 4 F 3

F2

F1

Fare

Westermann

same cabin. The airline solution was to

dene the airline product as more than just
a seat on an aircraft. The airline product
was dened as the fare level and the set of
rules and restrictions around that fare level.
In this business concept, the various seats
in an aircraft compartment can be dened
as dierent products depending on the
rules and restrictions that apply to the fare
purchased by the passenger. Typical rules
and restrictions around a fare are indicated
in Table 1.
The primary objective of this type of
customer segmentation was to establish
robust boundaries (the set of rules and
restrictions around each fare level) that
eectively prevented the higher fare
paying passengers from buying-down into
the lower fare levels. The better the set of
restrictions were dened, the more precisely the airline could segment the customer marketplace.
Traditional airline revenue management
Customer segmentation based on the rules
and restrictions around the fare levels
meant that the airlines would be able to
track passenger booking behaviour at these
fare levels (booking classes), and this would
be the basis for generating forecasts of
future passenger demand. Passengers
unable to purchase the product (booking
class) desired, did not automatically buy-up

into another product. While there is denitely some buy-up behaviour, for the
most part the customers changed the dates
or time of travel or were lost to a competitor airline. Even more importantly, owing
to the nature of the restriction set around
the fares, a customer segment is excluded
from being able to purchase an available
lower fare booking class product. Segmenting the passengers in this way allowed
the airlines to consider the demand for
each booking class as independent passenger demand.
The combination of passenger demand
forecasting and multiple fare levels inevitably led to the use of sophisticated algorithms to determine the optimal mix of
passengers at each of the fare levels on
board an aircraft, to maximise the total
revenue for the airline. Airline revenue
management was the end result.
Low-fare carriers
Over the last few years, there has been a
dramatic rise in the number and scale of
low-fare carriers. Low-fare carriers have,
to some extent, avoided complicated business processes. They started from scratch
and are primarily focused on keeping costs
low (in comparison with the traditional
airlines) to allow low fares to be oered in
the market which signicantly undercut
the established airlines, and yet still allow

Table 1: Example of fare levels by booking class and rules and restrictions
Booking class

Fare

Refund

Rebook

Min stay*

Adv. purchase

Y
C
D
R
M
Q
W

499
299
259
199
149
119
99

No
No
No
No
No
No

Fee 50

No
No
No

Yes
Yes
Yes
Yes

7 days
14 days
21 days

*Can only be enforced in the case fares are not really oered as one-way fares.

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(Realtime) dynamic pricing

the low-fare carrier to be protable.

Owing to their focus on costs and the fact
that some of them reduced their service to
very basic levels, terms such as low-cost
carriers (LCC) or no-frills carriers are commonly used. One part of their strategy is
to reduce their network to simple point-topoint trac in domestic markets. Until
today, the majority of LCC have ignored
or have not specically attempted to
exploit connecting trac and the complicated and therefore more costly intercontinental markets.
The LCC introduced a pricing model
that segments the market primarily by
charging dierent prices at dierent times
before departure. Within the family of
low-fare carriers, varying levels of sophistication exist on how to set the price level.
Another major dierence from the traditional carriers is that they usually oer oneway fares and therefore, by denition, do
not enforce any minimum stay condition.
As the low-fare carriers are primarily targeting price-sensitive customers, such segmentation of demand is, from their point
of view, not necessary. For a traditional
carrier, however, the minimum stay
restriction represents the most important
and eective segmentation criterion to
separate two groups of passengers business and leisure with signicantly dierent consumer characteristics.
Increasing competition due to the high
number of low-fare carriers leads to the

prediction that these low-fare carriers will

eventually start looking into more sophisticated ways of selling seats.
DESCRIPTION OF PROBLEM
Failure of the traditional revenue
management model
The traditional revenue management
model worked well as long as all players
were following the same rules. Traditional
network carriers, however, are now faced
with an increasing number of low-fare
markets dened by simplied fare
concepts primarily focusing on adapting price over time (undierentiated fare
structures).
Undierentiated fare structures
In this context, the term undierentiated
has to be understood as a concept that does
not use explicit restrictions to achieve price
dierentiation inside of the same passenger
segment. This means multiple booking
classes exist on the same O&D, which
dier only by fare level and do not have
dierent restrictions assigned.
It does not mean that there are no
restrictions at all. If these restrictions are
identical for multiple booking classes, however, only the fare makes the dierence for
the consumer. From this perspective, these
classes are undierentiated inside their
passenger segment. A simple example is
given in Table 2.

Table 2: Example of an undierentiated fare structure

Booking class

Page 392

Fare

Restrictions

Comment

Y
C
D
R

499
299
259
199

None

Fully exible

Not refundable
Rebooking fee

Optional list of fares for

a passenger segment

M
Q
W

149
119
99

Westermann

Incorrect assumption of independence of

booking classes
The pricing and revenue management processes and tools in place at traditional carriers have been designed to work with a
dierentiated fare structure. In fact, they
require such a structure to be able to forecast and optimise properly.
Because the traditional forecasting and
optimisation algorithms assume independence of booking classes enforced by rules
and restrictions, these two key components
of the revenue management systems do not
produce appropriate results in undierentiated markets.
Demand forecasting
The top chart in Figure 2 illustrates the
impact of undierentiated pricing on forecasting demand per booking class. At
lower fares, the observed demand is at least
the same as or higher than that observed at
the next higher fare level, because a consumer who accepts a specic price will certainly always purchase the same product at

any available lower price. The traditional

forecaster algorithms originally implemented and still primarily in production today,
however, assume no dependency between
passenger demand in the various booking
classes, and forecast each class separately, as
shown in the lower chart.
Revenue optimisation
Even if the forecaster is able to consider
this interdependence of demand correctly,
a traditional revenue management optimiser would still not function in an appropriate manner, because the optimisers would
still oer seats to lower fare classes because
of the implicit assumption that higher fare
demand does not book down into the
lower fare classes. Without any restriction
in place, however, in reality a consumer
will always purchase the lowest available
fare.
The airlines have been aware, even
before the massive introduction of undifferentiated fare structures, that the assumption of class independence of demand was

Figure 2: Impact of undierentiated fare structures on demand per booking class

Demand
In case of non-segmented demand a booking
class is just a different price and therefore the
demand at a lower fare always includes the
demand at higher fare

C
$ 299

D
$ 259

R
$ 199

M
$ 149

Q
$ 119

Demand
In case of a traditional fare structure each
booking class is an independent product
with its own demand

C
$ 299

D
$ 259

R
$ 199

M
$ 149

Q
$ 119

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(Realtime) dynamic pricing

Observation capabilities of current

revenue management systems
The problem for globally operating network carriers is even more complicated,
because they simultaneously serve domestic
point-to-point trac, connecting continental trac and intercontinental markets.

Page 394

Figure 3: Storage of booking data by market in

O&D revenue management systems
O&D Booking Class
A

A-Pax
B-Pax
C-Pax

D-Pax

Differentiated Demand

Spiral-down eect of total revenue

Because a revenue management forecaster
uses historical observations concerning the
number of bookings by class, and the optimiser uses the forecasts to determine the
number of seats to be allocated to each
class, the eects described above result in
an inevitable spiral-down of total revenue
in a market with undierentiated fares.
The buy-down behaviour leads to more
bookings in lower classes than expected by
the forecaster. By considering this shift in
the demand, the next forecast loop would
predict more demand in lower classes and
less demand in higher classes, which
would make the optimiser allocate more
seats to the lower class and protect fewer
seats in the higher class. This process
would repeat itself until it reached a situation in which all the seats were being
oered and sold at the lowest undierentiated fare level.

Therefore they may be confronted with

undierentiated as well as dierentiated
markets across their network.
The majority of all revenue management
systems in production are leg-based or segment-based systems. They do not store
PNR information or booking counts by
markets. From the historical booking data
stored in the revenue management system,
the airlines are typically unable to identify
an undierentiated market from a dierentiated market as long as the booking is
done in the same class on the same leg or
segment. Other indicators in the booking
data have to be used by a forecaster to
identify whether a booking has been made
based on one fare structure or another. Solving the spiral-down eect without having
the capability of observing how much of
the business is being eected by the buydown behaviour may only be possible as
an approximation.
Some network carriers have moved to
true PNR-based revenue management
systems. They have the capability of separating the two dierent market types,
because they store the passenger demand
information at a very detailed level (Figure
3). Although these carriers have primarily
implemented such systems to solve the network optimisation problem, they can use
them as the basis for addressing the revenue
management forecasting and optimisation

Undifferentiated Demand

articial and not really appropriate. There

have been several approaches in previous
years to consider buy-down and/or sell-up
in revenue management algorithms. The
current revenue management systems,
however, were successful in generating
incremental revenue even under this
assumption of independent demand. Consequently, there was never sucient economic pressure to get the attention of the
airlines to address this demand assumption.
Other aspects of the revenue management
problem (for example O&D forecasting)
received higher attention by the airlines
and by the various vendors of airline revenue management products.

Westermann

challenges in undierentiated fare structure

environments.

Figure 4: Example of inventory control problem

Conflict :
C open AAA-CCC may displace BBB-CCC
however
C closed Price is at uncompetitive $ 99

AAA
CCC
A9
C9

B9

A9

C
B9

C0

A = $ 159
B = $ 99
C = $ 59

B9

A9

Inventory control of undierentiated fare

structures
Control of inventory, especially in legacy
distribution channels (such as the GDS) is
performed by booking class seat allocations. Each booking class on a ight segment level has a seat availability assigned,
either numeric (09 seats) or non-numeric
(eg A=available, C=closed). In the case
of undierentiated fare structures, however, a booking class has to be understood
as a possible price step in a range of fare
levels that may apply at dierent times
during the booking period of the ight.
The lowest available class therefore represents the current price available to the consumer. Referring to the example from
above, a price of 199 in the respective passenger segment could appear as shown in
Table 3.
Under the assumption that an airline
would be able to forecast non-independent
passenger demand and optimise seat allocations appropriately, the problem remains
of how to control the sale of seat inventory. The traditional static class allocation
in the GDS also does not support separating an undierentiated market from a
traditional market. Inventory controls are
segment based, and therefore they can only

play one role at a time. They can be used

either to control the best current price for
the undierentiated market or to control
the booking class availability of dierentiated markets. But they can never full
both purposes at the same time, which is
illustrated by the example in Figure 4.
The simple network in Figure 4 consists
of two legs and three O&Ds. Only three
booking classes are used (A, B and C) in all
markets. The markets AAACCC and
BBBCCC are traditional markets in
which the classes have very dierent
restrictions. Owing to low-fare competition on leg AAABBB, the carrier introduced an undierentiated structure so that
the three classes only dier by fare. Therefore, the lowest available booking class
denes the current available price.
Consider the scenario in which the com-

BBB

Table 3: Mapping of current price to booking class availability

Booking class

Y
C
D
R
M
Q
W

Fare

Non-numeric
availability

Numeric
availability

Restrictions

Comment

499
299
259
199
149
119
99

A
A
A
A
C
C
C

9
9
9
9
0
0
0

None

Fully exible

Not refundable
Rebooking fee

Optional list of
fares for a
passenger segment

Page 395

(Realtime) dynamic pricing

peting low-fare carrier has $59 as the currently available fare, and the network carrier wants to match this fare level.
From the traditional airline perspective,
the decision to match the $59 fare level
means that the airline must open C class on
leg AAABBB.
In the scenario in which high demand
exists on the long-haul leg BBBCCC, the
network carrier may want to protect this
leg against connecting trac from AAA
CCC in C class. Therefore, the network
airline would really like to keep C class
closed on leg AAABBB.
This creates a clear conict between two
business strategies. As class C has been
opened to ensure a price of $59, the connecting trac from AAACCC in class C
may now displace BBBCCC trac.
It is recognised that, in this scenario,
O&D-based control techniques oer a
solution to the problem. Using a realtime
evaluation enables the separation between
undierentiated and dierentiated markets
on the y whenever an availability or
booking request is received. Markets for
which undierentiated fare structures are
being used are identiable by their O&D.

As a consequence, the O&D control capable airline can treat these cases in the
appropriate way.
Figure 5 shows the dierence between
oine and realtime inventory control. In
the left-hand diagram, the oine aspect is
outlined. The airline calculates class availability using a revenue management system
and sends the results to the distribution systems in advance. These numbers are used
to display seat availability until the airline
sends updated availability gures. In the
scenario of no fences, the undierentiated
demand will buy-down to the lowest available class. In the right-hand diagram, each
individual request will be passed on to the
airline for evaluation purposes. This allows
them to reply to such a request in the best
way.
(REALTIME) DYNAMIC PRICING
Increasing dynamics and competition in the
airline industry demand a faster and more
exible way of distributing prices to the
end consumer. The pressure, however, has
never been high enough to force the traditional carriers away from their relatively
static traditional pricing process, which

Figure 5: Oine versus realtime inventory control

Leg-based Off-Line Control

O&D-based Real-Time Control

Undifferentiated tends to book

down
limited control

Request

Undifferentiated
demand

Real-Time Process

Airline

Airline

RM System
Booking Class
Availability
Offline Process

Low Fare competitive

Class Availability

O&D optimal
Class Availability

Reply

Page 396

Differentiated
demand

Westermann

pre-denes products and prices and provides this information in advance to the
various distribution channels. The problems described in the previous sections
now dramatically change the business situation, as the traditional carriers will either
lose market share or control over their
inventory in the event that they do not
adjust their forecasting and optimisation
algorithms and procedures. The section
below describes how a dynamic pricing
concept ts into the requirements of various airline types, ranging from pure lowfare carriers to network carriers facing
low-fare competition. It attempts to
explain how such a concept addresses the
challenges of undierentiated fare structures and ensures that revenue management
continues to function appropriately.
Future-pricing model for airlines:
Willingness to pay
The future-pricing concept is constructed
on the assumption that dierent segments of
passengers exist with a dierent willingness
to pay, which can and need to be identied
at the time of purchase. In theory, there
could be many customer segments, as long
as unique distinctions can be dened which
identify each segment from the others, and a

group of customers is formed with a dierent willingness to pay.

The grouping by willingness to pay is a
very important characteristic, which needs
to be enforced by the segmentation criteria.
In the scenario in which segmentation is
weak or even articial and does not separate groups of customers with dierent
willingness to pay, all consumers will
inevitably buy-down in all situations in
which multiple prices are oered simultaneously. Compared with a traditional pricing structure, which consists of many
dierent products, the number of customer
segments dened for such a concept will be
kept small (eg 23).
For each of the passenger segments, there
will be a range of prices out of which the
optimal price needs to be determined.
Depending on the price level and the
volume of passengers willing to accept the
price changes, the higher the price, the
lower the number of customers willing to
accept that price. Conceptually, this can be
understood as: the volume of passengers
multiplied by the respective price denes
the expected total revenue for the airline.
As shown by Figure 6 the price that results
in the highest total revenue should be
charged to that passenger segment.

99
12
9
15
9
18
9
21
9
24
9
27
9
30
9
33
9
36
9
39
9
42
9
45
9
48
9
51
9
54
9
57
9

Total
Expected Revenue

18000
16000
14000
12000
10000
8000
6000
4000
2000
0

250
225
200
175
150
125
100
75
50
25
0
39
69

Expected Deman

Figure 6: Pricerevenue curve in monopoly situation and unlimited capacity

Fare
Demand
Total Rev

Optimal Price 139

sell 112 Seats

Page 397

(Realtime) dynamic pricing

99
12
9
15
9
18
9
21
9
24
9
27
9
30
9
33
9
36
9
39
9
42
9
45
9
48
9
51
9
54
9
57
9

Fare
Any Capacity above
Optimal Capacity 112
leave at Optimal Price 139

In a scenario in which there are more seats

available than demand at the optimal price,
the price should not be reduced to stimulate
additional demand. Figure 7 shows that the
total revenue will reduce, because stimulation can only be achieved with an over-proportional price decrease. Conversely,
however, under capacity constraints, the
price needs to be increased to throttle down
demand. The proper amount can also be
picked from the curve by simply nding the
price point that represents the highest
possible volume still tting in the available
capacity.
Over time, closer to departure the willingness to pay usually increases. This phenomenon is comparable with the
willingness by people to accept higher prices
for Christmas gifts the closer the holiday
period comes. The risk of ending-up without a gift supersedes the disutility of paying
a higher price. This behaviour can also be
observed in the airline industry. The need to
be at a destination on an agreed date is
higher the closer the agreed date is from
today. This results in dierent demand
curves for the same passenger segment for
the same ight event over time (Figure 8).
The examples above are simplied as
they try to illustrate the concept of dynamically dening prices based on willingness
to pay. The examples ignore forecasting

Page 398

Total
Expected Revenue

18000
16000
14000
12000
10000
8000
6000
4000
2000
0

250
225
200
175
150
125
100
75
50
25
0
39
69

Expected Demand

Figure 7: Price determination under capacity constraints

Demand
Total Rev
Reduced Capacity 60
increase to new
Optimal Price 229

uncertainties and assume a monopoly situation and therefore are not meant to replace
any more scientic algorithms.
Low-fare carriers in principle apply an
approach based on willingness to pay,
although some may use simple rules to
determine the current price. The important
concept is that the LCC change price over
time for a particular product. They do not
dene multiple products with unique
prices and then decide on a mix of these
products to be oered.
Monitoring the competition
The world of dynamic pricing is dierent
from traditional pricing in that the focus is
primarily on dening the optimal price
and making this best price available to the
market place.
The consumer willingness to pay,
under the assumption that the consumer
has certain knowledge about all prices, is
heavily dependent on the alternative travel
options available. Therefore, it is a must in
this environment to monitor the prices of
the competition constantly and include this
information when determining the current
price.
Denition of realtime dynamic pricing
Dynamically changing prices does not
necessarily mean it is done every few sec-

Westermann

Figure 8: Willingness to pay changes over time

Maximum Revenue
at t1

18000
16200
14400
12600
10800
9000
7200
5400
3600
1800Dem(t0)
0

Total
Expected Revenue

250
225
200
175
150
125
100
75
50
25
0
53
9
55
9
57
9

49
9
51
9

39
9
41
9
43
9
45
9
47
9

35
9
37
9

25
9
27
9
29
9
31
9
33
9

21
9
23
9

11
9
13
9
15
9
17
9
19
9

Dem(t1)

79
99

39
59

Expected Demand

Maximum Revenue
at t0

Fare

Rev(T0)
Rev(t1)

Explanation :

Dem(t0) = Unconstrained demand to come per price level between t0 and t1

Dem(t1) = Unconstrained demand to come per price level between t1 and t2

Assumption :

Willingness-to-pay increases from t0 to t1 while

total demand-to-come decreases closer to departure (t0 to t1)

Optimal setting at t0  Sell 112 at 139

Optimal setting at t1  Sell 81 at 289

onds. Some carriers may nd it sucient to

change a price according to simple business
rules such as xed days before departure or
when certain booking thresholds have been
reached.
The highest level of exibility and
sophistication is reached when a carrier is
in the position to adjust prices dynamically
based on an individual market situation or
tactical decisions even in a GDS without
having to distribute new fares.
Such enhanced usage is best described by
the term realtime dynamic pricing
(RTDP), as it contains the key components
in a comprehensive way.
. Realtime: The prices are calculated and
distributed online and in realtime to
consumers on all major distribution
channels to allow the most exible
approach.
. Dynamic: The decision of which price to

display to the consumer is dynamically

inuenced by the availability of seats,
the expectation of competing demand
and its willingness to pay, the prices of
competitors,
alternatives
for
the
consumer and other relevant and observable criteria. The logic to come up
with the dynamic price can vary from
basic to highly sophisticated.
. Pricing: The revenue management and
pricing departments focus much more on
the price at a particular point in time
rather than number of seats to be oered
for a pre-dened price. Therefore pricing
plays an even more important role and
integrates its decision process very closely
with revenue management.
Realtime dynamic pricing components
and methods
A RTDP solution comprises the following
components and methods:

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(Realtime) dynamic pricing

(1) forecaster algorithm to enable the calculation of unconstrained forecasts by

considering potential dependencies
between booking classes
(2) pricing optimisation to determine the
optimal price based on forecasted
demand patterns of the various
passenger segments and their willingness to pay
(3) optimiser algorithm considering price
steps (not prices) and corresponding
volumes competing with traditional
segmented booking classes in mixed
markets
(4) integrated pricing information to
enhance
price
optimisation
by
including passenger choice models,
competition information and other
pricing relevant information.
(5) dynamic price engine for realtime and
context-based evaluation of availability, sell and cancel requests from
various distribution channels such as
GDS, web portals and direct reservations system terminals (ATO/CTO
and call centres)
(6) reservations control procedures, in order
to guarantee that bookings correspond
to the dynamic price oer, eg enforcing ticketing deadlines.
GROUPING AIRLINES BY FARE
STRUCTURES
As mentioned above, not all carriers have
the need to implement dynamic pricing in
a realtime mode. The identication of
what a carrier needs to handle undierentiated fare structures rst requires a look at
how their business model is being impacted
by such fare structures. Based on this
review, together with current revenue
management capabilities, a concept for a
solution can be dened. The level of
sophistication of a concrete implementation
can, of course, vary.
In principle, four groups of airlines have
been identied in respect of how they

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adjust their business model as a result of

the low-fare challenge and, in addition,
how much they wish to make use of the
opportunity of being able to perform
dynamic pricing in a competitive airline
environment.
Depending on the situation, these airlines
have to solve dierent revenue management problems. The four groups are
explained in more detail below and in
Figure 9.
Group 1 includes airlines applying the
low-fare business model across the entire
network. They do not publish dierent
fare products but change the price for a
ight over time. The revenue management
problem for them can be dened as the
task to calculate:
. the optimal price at a particular point in
time in order to maximise total revenue.
This pure low-fare carrier model can be
expanded by splitting up the demand into
multiple segments (eg by distribution channel) and starting to charge individual prices
for each of these segments. The key is that,
for each segment, only one price is being
oered at a particular point in time.
Group 2 includes network carriers that
responded to a low-fare challenge in the
respective competing markets with an undifferentiated fare structure without being able
to dierentiate them from the traditional
markets while using leg/segment-based revenue management. In the low-fare markets,
this may result in the spiral-down eect as
described earlier. Attempts to avoid the
spiral-down eect may have a negative
impact on traditional booking streams across
the network owing to the limited inventory
control capabilities of such carriers.
The problem to solve here is:
. how many seats to assign to each booking
class in order to maximise total network
revenue and at the same time avoid the buy-

Westermann

Figure 9: Four variations of the revenue management problem

?

How many A -D?

At what price?

At what price(s) ?

How many mixed A-D to

maximise total revenue
AND
avoid buy-down?

1
2
A-Pax

A
B-Pax

4
3

A-Pax

B-Pax

C-Pax

D-Pax

O&D Control

How many A, B?
How many for step price
AND
at what price?

A-Pax

B-Pax
Fare
Restriction

B
C-Pax

C
D-Pax

down behaviour in the undierentiated

markets.
Maximisation of revenue may become a
theoretical goal here, as the carrier is facing
conicting results when it comes to controlling the inventory. Therefore, in practice, only an improvement in the current
situation is possible compared with using
algorithms based on the incorrect assumption of booking class independence.
Group 3 represents the network carriers
that did not react to the low-fare competition by matching their model completely
in these markets. Aware of the lack of control the new price models create when
using traditional revenue management systems, some carriers, such as Lufthansa, at
rst limited themselves to a few booking
classes, which they only published in the
respective low-fare markets.
This requires a dierent revenue management problem to be solved. Revenue
management has to determine:
. in order to maximise total network revenue,
how many seats to assign to each of the

traditional fare classes, how many seats to

assign to the low-fare market and at which
current optimal price they should be sold.
Group 4 includes the sophisticated network carriers applying an O&D control
mechanism. They are able to dierentiate
and maintain both business models across
their network in the various markets as
required. This enables them to match fully
the low-fare business model in the competing markets.
Their revenue management problem
looks like this:
. in order to maximise total network revenue,
how many seats to assign to each product in
the traditional markets, and what optimal
price to charge for each segment in a
dynamic priced market.
Group 4 can apply the full scope of RTDP
capabilities to their undierentiated business or any other market they feel appropriate. At the same time, they are in a
position to achieve additional revenue
benets by making use of sophisticated

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(Realtime) dynamic pricing

O&D revenue management in their traditional markets.

Approaches to a solution per group
As there are four generic revenue management problems to be solved, dierent
approaches to the problem are required.
Similarity exists between the problems,
however, so that a part of the solution may
be applicable to each of the business
models. Primarily, the revenue management, pricing and reservations system are
aected. To enable the realtime part of the
evaluation, a new dynamic price engine
needs to be provided. The following paragraphs describe solutions for each of the
groups.
Pure dynamic pricing
This assumes that the airline is a Group 1
carrier and applies step pricing across its
entire network.
In case the airline wants to go beyond
manual overrides or a rule-based approach,
an enhanced revenue management forecaster needs to estimate the number of passengers willing to pay the various price levels
at a particular point in time before departure. Such a forecaster estimates demand
for each booking class by considering their
interdependencies. In cases where multiple
passenger segments are used, observing
occurrence and estimating demand at each
of the passenger segments and its price
levels are required.
A pricing optimisation module calculates
the price level, which maximises the total
revenue of the airline. When demand is
being split into two or more segments, a
dierent valid price for each of them has to
be determined by the system.
In the case where a carrier distributes via
the GDS, the price(s) must be converted
into the respective booking class availabilities and sent to the GDS by an AVS/AVN
message.

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Mixed business model for leg-based

carrier
For airlines using a leg-based revenue management system but applying both business
models in dierent parts of their network
(Group 2), the situation becomes much
more complicated. As a booking class
could contain both types of customer segments (undierentiated fare customers and
traditional dierentiated fare customers),
the class seat allocations need to be calculated in a way that considers buy-down
behaviour of parts of the passenger
demand. To be able to perform such a calculation, the forecaster needs to alert the
optimiser as to how much of the demand
in a booking class is undierentiated and
which may buy-down if a lower fare product is available. To ensure best possible
results, frequent recalculations and inventory updates have to be done in this environment.
As for Group 1, standard leg/segment
class availability controls the inventory.
Dynamic pricing using special booking
classes
Group 3 includes some of the major European traditional carriers. In responding to
the low-fare challenge, they often steer the
low-fare classes with a rule-based concept
in a more or less manual and static way.
To improve this approach, some
enhancements to the current revenue management system are necessary.
For the undierentiated classes, the forecasting problem is identical to the pure
dynamic pricing scenario described for
Group 1. In this case, however, the dierentiated traditional booking classes also
exist and compete for seats on the same aircraft. The optimisation step has to be a
combined logic, considering the demand
and values of the traditional classes, and at
the same time include the optional prices
for the undierentiated classes and their
associated forecasted demand. Based on

Westermann

these parameters, the allocations for the

traditional classes, the number of seats
given to the undierentiated markets and
the current price are determined.
For control purposes, again leg/segment
class availability is sucient.
Realtime dynamic pricing using O&D
control
Group 4 includes the sophisticated network
carriers that distribute a signicant proportion of their business via the GDS. They
make use of the realtime O&D control
mechanism to distribute dynamic prices in
undierentiated markets in the legacy
channels. To do that, they convert the
price to be oered into booking class seat
availability by opening or closing the
respective classes.
The advantages of this approach are
signicant. Not only does the approach
allow the application of dynamic pricing
across all booking classes and therefore the
ability to match a low-fare carrier on the
number of potential price-steps, it also
means that the fare structure for the undifferentiated market no longer aects the
fare structure for the traditional market.
For the undierentiated market, the fare
can change dynamically even down to the
individual booking request, which replaces
the traditional revenue management solution with a realtime optimal price calculation.
For undierentiated markets and booking classes, the forecaster enhancements
applicable for Group 1 can also be applied.
The price optimisation in conjunction with
the optimisation module calculates class
allocations and optional bid prices or virtual bucket parameters used in traditional
markets as well as optimal prices per
passenger segment used in dynamic price
markets.
This concept works under the assumption that an RTDP engine is in place able
to perform the evaluation of all incoming

availability, sell or cancel requests independent from which distribution channel they
are being generated.
Realtime dynamic price engine
The purpose of such a component is to
perform the following steps.
For each request received, the pricing
engine identies whether this booking
request is for a market applying dynamic
pricing or a traditional market.
In low-fare markets, it identies the passenger segment for which the request has
been made. The ability to determine the
correct customer segment is obviously limited to the information that can be collected at time of the request. Flexible
business rules dene how to assign requests
to specic segments. Based on the determined passenger segment, the current price
is selected from an internal database and
sent back to the requesting system. These
prices have to be calculated by revenue
management and price optimisation as part
of an oine process. As GDS distribution
channels require booking classes, the price
needs to be converted into the appropriate
class seat availability.
In traditional markets, there are two
options. The airline could decide to return
leg/segment availability to the requesting
system. In this case, only the O&D control
mechanism, eg seamless availability, needs
to be implemented, but no O&D forecaster
and network optimiser is needed. For network carriers, however, it could be economically suboptimal to have such a
sophisticated engine in place and not make
use of all the possibilities. Therefore, they
may wish to use bid prices or virtual buckets determined by an advanced network
optimiser to calculate the availability. Even
a simple O&D or point-of-sale logic in
most cases produces better results than a
standard availability response. In this
approach, two features generate a positive
revenue impact for the airline (handling of

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(Realtime) dynamic pricing

undierentiated markets by dynamic

pricing and revenue maximisation by
O&D revenue management).
SOME WORDS ABOUT COSTS
In commodity markets, the manufacturer
with the lowest unit cost of production
tends to be the long-term survivor. Consequently, in the airline environment in
which many of the competitors are deliberately emphasising the commodity nature of
an airline seat, very strict cost control is
vital. Therefore, the total cost impact of
implementing a RTDP solution must be
considered. Two areas have been identied
as primary cost drivers.
Forecasting and optimisation
The costs of such modications are primarily driven by the level of sophistication and
are usually covered by a one-time implementation fee and some yearly maintenance cost. As most of the revenue
management systems are today running on
either Windows or Unix platforms, hardware upgrade is not usually a signicant
cost driver.
Inventory control
When distributing over a GDS, seamless
availability and other products are
required.
As GDS normally charge nothing or
relatively reasonable amounts for implementing their additional products and services, this is usually not an issue.
Depending on the airlines reservations
system and its capabilities, it may be necessary to implement the realtime interfaces to
the GDS. Implementation cost could be
high, as most of these systems are mainframe based (eg TPF, USAS). An alternative is to implement this interface as part
of the dynamic price engine, which would
reside on a modern platform such as
UNIX or JAVA.

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For day-to-day usage, GDS and airline

reservations systems may either charge premium booking fees or a fee per message
sent (transaction based). The former is an
all or nothing option and the number of
messages does not really matter. In cases
where a transaction based price model is
used, there are many options available to
the savvy airline to keep the volume under
control. For example, realtime evaluation
is only required for requests traversing a
market with undierentiated fare structures. In addition, unproductive channels
producing massive numbers of low-fare
search messages should be provided with
standard availability. For them, realtime
evaluation can be limited to sell and cancel
requests.
CONCLUSIONS
Market segmentation by fare rules and
restrictions to gain additional revenue no
longer works eciently in an undierentiated market, because revenue management systems have been designed for a
dierent business model. The increasing
number of low-fare carriers forces traditional carriers in these markets to follow
their exible pricing approach in order to
remain competitive. The failure of traditional revenue management under such circumstances has made some airlines revert
to manual control of their seat inventory
and question the function of revenue management.
Some top airline managers even explain
the current situation by stating that the traditional approach has always been the
wrong path. By also introducing simplied structures, their airlines are now realising this and listening to the customers
needs.
Although there is some truth in such
statements, they are not fully describing
the economic competition situation. Traditional fare structures worked well as long
as all players used them, and they gener-

Westermann

ated a lot of revenue for the airlines over

the years. It is true, however, that the network carriers have had to adapt and learn
from low-fare carriers about how to implement and control more rational pricing. In
addition, it must be recognised that the
current airline business models are not
static, and the LCC are themselves evolving their business to extract revenue more
eciently from each market.
To be able to support this, the network
airlines must adapt their traditional static
approach to pricing to become a dynamic
process. In addition, revenue management
and inventory control systems need to be
enhanced to produce correct seat control
results in these markets. As network carriers are faced with a mixture of both pricing models, their solution must be more
complicated. Some of them, however, can
build on highly sophisticated and existing
O&D revenue management systems. With
reasonable eorts, they can introduce an
RTDP concept. This will allow them to
introduce undierentiated fare structures
exibly without losing control over their
inventory. At the same time, they can con-

tinue to achieve additional revenue in their

traditional markets by applying their O&D
control concepts. This enables the opportunity of moving dynamic pricing into
deregulated but still traditionally priced
markets.
There are, of course, challenges to be
managed to achieve such a result. Solving
the forecasting and optimisation issues are
part of them but can be managed. In deed,
algorithms exist and have been implemented already at some carriers, with dierent
levels of sophistication.
The bigger challenge is how to adapt the
business processes and make sure that the
revenue management departments are
changing their mindsets to concentrate
much more on prices than on class seat
allocations. In addition, meaningful user
interfaces need to be provided to employees to allow them do a good job. Performance measures need to be adapted to ensure
that results are always monitored to allow
the identication of weak areas and to support a continuous improvement of the
work done by the revenue management
and pricing analysts.

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