American Airlines Inc Revenue Management

Executive Summary:

Revenue management is a proven technique to help service industries maximize revenue. It involves management of inventory and distribution channels and prices to maximize profits over the long run. Simply stating, the technique involves selling the right product to the right customer at the right time at the right price.

The following are the primary activities involved: demand data collection, demand modeling, demand forecasting, pricing optimization, and system implementation and distribution.

ISSUES IDENTIFICATION

This case highlights the issues that American Airlines came into as a result of the deregulation of the Airline Industry in 1978. The Airline Deregulation Act gave airlines the freedom to enter and exit routes and alter fares at will. The changes in the industry were dramatic.

Some of the issues or consequences resulting from this deregulation that the Airline needed to address are: cost containment, route structure, marketing, pricing, yield management and revenue management.

Cost Containment

As the airlines no longer required approval from the Civil Aeronautics Board (CAB) for route or fare changes, the industry became quite dynamic. New airlines emerged with smaller scope and lower operating costs, allowing them to offer low-cost fares to customers. These airlines quickly captured considerable market share on selected routes causing aggressive price competition, with negative impact on profits for established airlines.

Route Structure

Another result of deregulation was the ability of airlines to enter and exit and/or change routes to remain competitive. Route structure became a competitive strategy. As a result, major airlines developed the "hub-and-spoke system" which consisted in establishing regional hub bases from which route spokes connected local markets. In order to adapt to this new process, new aircraft fleets were required to service an increasing number of short-haul routes.

Marketing

With the deregulation, the airline has the freedom to alter the fares. It is complex to alter fares and not leave revenue on the table. To optimize revenue aggressive marketing strategies have to be developed centered around revenue management, ticket distribution, frequent flyer programs, and customer service.

Pricing

The Pricing process includes determining the fare structure and restrictions based on the company's cost structure and pricing philosophy, competitor's behaviour and customer's travelling preferences. AA must factor all these criteria into the deregulated pricing structure to make them as profitable as possible. AA must also factor in displacement, share shift and stimulation as factors as well

Yield Management

With deregulation and increased competition, it is critical to the American Airline to effectively use its reservation inventory. It is a yield management function to control the number of seats in each fare category. The problem is very complex and the yield management model must continuously evolve to adapt to the competition in order to optimize revenue.

Revenue Management

Once the fare structure had been determined, it was now time to offer as many fares as possible and to juggle their availability so that revenue would be maximized. What the perfect mix of price and availability for each route such that revenue would be maximized?

ENVIRONMENTAL AND ROOT CAUSE ANALYSIS

Cost Containment

The new industry structure that resulted from deregulation included a lower market share, aggressive price competition and reduction of profits. In order to remain competitive within this new environment, major airlines were faced with the need to contain their operating costs, to maintain profits. Cost containment became an important element of their competitive strategy.

The aspects that American Airlines (AA) focused on in order to reduce operating costs and maximize profits, were:

 Labour cost reduction - instead of reducing its work force, AA changed their wage structure by introducing a two-tier pay system, that mostly affected new hires.

 Productivity improvement - AA negotiated with different employee groups for work-rule concessions under FAA guidelines.

 Reduction of fuel and maintenance costs - airlines had no control over fuel prices and little control over fuel-use efficiency (with their current aircraft fleet). AA addressed this point through the replacement program of their aircraft fleet. New planes were more fuel-efficient, cheaper to operate and maintain, and required a smaller crew (reduction of labour cost).

Route Structure

With the establishment of the "hub-and-spoke system" airlines had to re-design their whole route structure. The "hub-and-spoke" system was a complicated network of routes that required the following:

 A reconfiguration of the aircraft fleets

 An intricate design of the route structure that takes into account forecasted passenger flows, gate rights, maintenance schedules, personnel and fleet availability, coordination of arrivals and departures, and convenient connections for passengers, among other aspects.

 A reconfiguration of the technology used in providing service to passengers (ticketing, seat allocation, etc)

 Major infrastructure investment in airport terminals assigned as "hubs" to service the new route structure (baggage handling labour and equipment, sales & customer service offices and personnel, etc.)

The challenge to operate a complicated "hub system" relies in skilful coordination of all aspects involved in order to maximize terminal facilities and space, labour force, runway usage, etc. Thorough contingency plans have to be put in place in case of emergencies that would impair the hub's ability to operate (i.e. weather, security threats) and would take the whole route network out of balance.

One of the major consequences of the establishment of the "hub system" was the need for national carriers to merge or associate with regional smaller ones, in order to serve the desired routes from the hubs. This had a major