Airline pricing and fare product differentiation: A new theoretical framework
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Airline pricing and fare product differentiation: A new theoretical framework TC Botimer1* and PP Belobaba2 1
Continental Airlines, Incorporated and 2Massachusetts Institute of Technology, USA
A basic premise in the development of yield management has been that the differentiated fare products offered by airlines are targeted to distinct segments of the total demand for air travel in a market, each of which compete for space on a ®xed capacity aircraft. Such representations of differential pricing assume that the airline can segment its demand perfectly and without cost to consumers, and further, ignore the dependence of the demand for a given fare product on the price levels and characteristics of the other available fare products. In this paper, we introduce a new `generalised cost' model of fare product differentiation that incorporates the relationships between available airline fare products as well as the cost incurred by consumers of accepting more restrictions. We extend the model to incorporate the diversion of passengers to lower-priced fare products as a result of their ability to meet the additional restrictions imposed by airlines, and then demonstrate how seat inventory control can be used to induce diverting passengers to `sell up' to higher-priced fare products by applying booking limits. An example of how the model can be used for joint fare product price level optimisation is presented, along with a numerical example that illustrates the extent to which the conventional model of price discrimination over-estimates passenger demand and, in turn, total airline revenues. Keywords: airline pricing; yield management; revenue management; product differentiation
Introduction The development and use of airline yield management, or seat allocation, models have centred on airlines offering a variety of different types of fares, or fare products, each with different attributes and price levels for travel on the same ¯ight. Virtually every seat allocation model described in the literature treats the demand for each fare product on a future ¯ight departure as completely separable, readily identi®able, and independent. Although such simplifying assumptions have allowed the development and implementation of tractable models for seat allocation, these assumptions are clearly unrealistic. The distinction between consumers belonging to different fare product segments is far from precise, and it is certainly not true that the choice of one fare product is entirely independent of the prices and attributes of other products. The generalised cost model of airline fare product differentiation developed in this paper represents a departure from the independence assumption of most existing representations of airline differential pricing. Most notably, the incorporation of both a cost for the inconvenience associated with meeting fare product restrictions and the interdependence of fare products more acc
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