A recent study by airline revenue management experts simulated adopting a form of more personalized airline pricing (“Dynamic Availability of Fare Products with Knowledge of Customer Characteristics” by Wittman and Belobaba in the April 2017 issue of the Journal of Revenue and Pricing Management). Increased personalization is a hot topic for airlines and all e-merchandisers, and so many airlines are experimenting with various approaches.
The simulation analyzed a potential first step toward personalization: differentiated pricing between business passengers and leisure passengers. Recognizing that business passengers tend to have lower price elasticity, the simulation offered the category a higher fare for the same flight than leisure passengers. Conceptually, exploiting the different price elasticity of business versus leisure through personalization can increase total airline revenue more effectively than the generic pricing strategy, as everyone sees the same fares that airlines pursue currently.
The study findings, however, concluded that such personalization could be revenue negative for both business and leisure customers. The simulation resulted in lesser revenue for the leisure passengers who were offered somewhat lower fares than under a generic strategy (there was substantial buy-down as many leisure customers would have paid the higher fare). And the simulation increased fares for business passengers – deemed less price sensitive – but this resulted in fewer passengers than before the personalization because some business passengers booked on other airlines that still offered the lower, generic pricing.
The primary conclusion is that both “business” and “leisure” represent too-high level segmentation schemes – even assuming each can be identified accurately. Both still represent highly diverse populations with differing needs and values. Applying a new generic approach to each is not the way personalization should proceed. As airlines embrace personalization, they need to become as refined as possible, identifying micro segments that will respond/behave in more consistent ways.
But, however refined personalization becomes, there will always be a cost-benefit calculation: discounting will drive both some dilution and some additional purchases, and a higher fare will drive both higher average fares and some share losses. “Personalization” will need to be assessed like any other pricing initiative.
Another conclusion is that current fare rules and inventory control processes, while not “personalized”, already do segment subsets of both business and leisure demand. Although business passengers tend to book closer in, and are thus subject to the higher fares available close-in, many are still price sensitive – some do buy the lower fares if they can plan further ahead of time. Similarly, some leisure passengers book close to flight departure when a new event (a sports event or concert, a family gathering) is announced or planned. New “personalization” needs to complement, not replace, current segmentation.
Finally, the simulation demonstrates that, as in all pricing initiatives, competitive response is critical. Personalization that drives your fares above the competition, even by a small premium, can drive share losses. Personalization cannot be viewed as an opportunity to exploit less price sensitive customers with higher fares but a way to better meet their needs. Arguably, a personalized offer for a less price sensitive passenger includes bundling more amenities rather than focusing on a higher fare for the base product.
The simulation suggests that a baby step approach to personalization has considerable risk. With any major change in pricing strategy – or any large corporate change -- it is normally recommended that airlines ease into the new way of doing business, taking small steps and measuring success before moving on. But with personalization, doing it wrong – or in too broad a way – can be revenue negative. Rather than a crude segmentation scheme like business versus leisure, perhaps personalization should begin with a very small, highly-refined segment, like road warriors in high frequency markets, or families with young children traveling on holiday.
Potentially, an even more effective approach is to use personalization for other customer elements than price. Personalization can apply to ancillary merchandising, to promotional messaging, to channels and to search content, among other factors. Using information about the customer – business versus leisure, individual versus family, tech-savvy versus not, frequent purchaser of “big seat” or “priority boarding” -- to form offers that don’t focus on price has already proven rewarding for travel merchandisers without the same downside that may be associated with “personalized” pricing.