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 The Brancatelli File

joe FAIRY-TALE FARES

BY JOE BRANCATELLI

May 2, 2002 -- Here is some good news: There's finally an airline analyst whose pronouncements we can all respect.

His name is Hans Christian Andersen. He must work for one of the smaller Danish investment houses because it has taken 165 years for his brilliant deconstruction of airline pricing to reach my desk.

Andersen writes in a flowery, allegorical style that I find completely inappropriate for a sober, high-minded column such as this, so let me give you the gist of his contention: Yield management is broken. The airlines know this pricing system is broken and disgraced. But the airlines are too vain and too frightened to take remedial action, so they'll continue the charade to the point of exaggerated embarrassment and financial ruination.

For those of you unfamiliar with Andersen and the fairy-tale system the airlines use to create their despicable cacophony of fares, permit me to explain. In a nutshell, yield management is a system where the seller attempts to charge each and every buyer the most money that buyer is willing to pay. Based on highly complicated matrices of historical demand patterns, available supply, competitive factors, guesstimates about future need and a couple of zillion other variables, the computers spit out a baffling array of prices for the same product. The computer constantly adjusts the pricing as customers purchase--or don't purchase--the product, as competitive factors intrude and as the flight time approaches.

In the hallowed halls of academia, where customers are merely statistics and markets are conveniently predictable, yield management works like a charm. And, theoretically at least, a case can be made for yield managing airline seats. Unlike paint or other consumer products, airline seats are a complex commodity to price. They are perishable and moved hundreds of units at a time, yet they are sold one at a time. And the market is fractious, since leisure travelers and business travelers have vastly different agendas and concepts of the product's use. Once upon a time, perhaps in Hans Christian Andersen's time, yield management must have seemed like a boffo idea for pricing airline seats.

In the real world, however, the major airlines are headed for fiscal and operational collapse thanks to yield management. In the years since Iraq invaded Kuwait in 1990, the industry has managed no cumulative profit. Three of the nation's legendary carriers--Pan Am, Eastern and TWA--have disappeared. Two more--United and US Airways--have hemorrhaged so much cash that they will probably apply for government-guaranteed loans or be forced into bankruptcy reorganization. American, the nation's largest carrier, is burning through $5 million a day. The major carriers have lost $11 billion in the last five fiscal quarters and they have no reasonable hope of profit this year or even next year.

What's gone wrong? Here in the real world, yield management the way the airlines practice it simply does not work. Here's why:

YIELD MANAGEMENT ASSUMES BUSINESS TRAVELERS ARE STUPID
The major airlines continue to insist, against all the evidence, that business travel is "price inelastic." That's a term of art for stupid. Airlines base their yield-management practices on the absurd assumption that business travelers will pay rapacious prices for an airline seat. Well, you know what? Business travelers wouldn't be in business very long if they paid $1,221 one-way walk-up for a coach seat between New York and Los Angeles or $7,400 roundtrip walk-up for a business-class ticket to London. The airlines have priced tickets for business travelers beyond the financial breaking point and business travelers have responded by sitting behind their desk and finding other ways to conduct business.

YIELD MANAGEMENT DRIVES AWAY UPMARKET BUSINESS
Those few business travelers who aren't repelled by airline prices are defecting from the major carriers anyway. Why? Because walk-up airline prices are so high that corporations can make a persuasive financial case for buying or leasing corporate jets. If you've got the kind of money--or the kind of clout--to pay what the majors charge, why not throw in a few extra bucks and go in comfort? The major carriers demand ultra-premium prices yet cannot compete with corporate jets on quality, comfort, flexibility or convenience.

YIELD MANAGEMENT DEPRESSES PROFITABLE BUSINESS-TRAVEL DEMAND
Airlines frequently trot out the old saw that you can't create demand from business travelers by lowering prices. That may, in fact, be true. Business travelers probably won't zip around the country willy-nilly if the airlines slashed prices. But reasonable prices would allow businesses to take an impromptu flight to cultivate a lead, assuage an unhappy customer, or send an extra staffer to a meeting or a convention. Most major airlines do not offer reasonably priced walk-up fares that would allow business travelers to act on their best business impulses. Eminently justifiable, spur-of-the-moment business trips are not taken because the major carriers refuse to offer flexible, reasonably priced one-way fares.

YIELD MANAGEMENT DEPRESSES PROFITABLE LEISURE-TRAVEL DEMAND
Another old airline saw insists that leisure travelers can only be induced to make additional discretionary flights with unreasonably low fares. So they put the yield-management computers to work creating waves of outrageously cheap seats which can only be used under the most onerous and restrictive terms. Leisure travelers get great prices--but only travel infrequently because the restrictions on those great fares discourage spontaneous demand. More rational--and slightly more expensive--walk-up leisure fares would actually allow discretional travelers to fly more frequently and generate profit for the airlines. Want a recent example? JetBlue's simple pricing structure between New York and Florida has stimulated demand for travel. Snowbirds who formerly traveled just once a year on the deeply discounted, heavily restricted fares offered by the major carriers now fly three or four or five times a year on JetBlue because the fares are reasonable and accessible. This is the model pioneered in other markets by Southwest: Fly 'em cheaply, but fly 'em often by making prices understandable, defensible and profitable.

YIELD MANAGEMENT INFURIATES CUSTOMERS
Axioms notwithstanding, the customer is not always right. But customers do know stupidity when they see it. When was the last time you stepped on a plane and didn't wonder what the other passengers paid? Passengers despise the fact that they never know what an airline seat costs--or what it should cost. The yield-management system has made passengers feel like victims. Even when they get a great fare, leisure travelers don't believe it because they are convinced someone else paid even less. And business travelers are incensed by a system that specifically targets them to pay so much more. No pricing system that creates a sense of victimization in its customers is good for business.

YIELD MANAGEMENT DESTROYS THE PRODUCT'S REAL VALUE
Finally, and perhaps most importantly, yield management has totally destroyed the value of an airline seat. By creating a computerized pricing bazaar, the airlines have tacitly admitted to customers that the product has no real, definable value. When a coach seat to London can cost as little as $99 and as much as $1,500, no normal human being can create a rational sense of worth for the product. When a coach seat between New York and Los Angeles can cost as little as $89 and as much as $1,221, no normal consumer wants to hear about the mechanics of the system. The customer simply assumes that the product is intrinsically worthless and the pricing is an elaborate shell game. Industries that convince their customers that the product they sell has no value are the modern-day equivalents of fairy-tale Emperors with a new set of clothes.

This column originally appeared at JoeSentMe.com

Copyright 1993-2004 by Joe Brancatelli. All rights reserved.