How do airlines price tickets? | CNBC Explains

How do airlines price tickets? | CNBC Explains


Buying plane tickets can be exhausting. Many of us spend hours on the
internet researching flight deals, trying to figure out an airfare
pricing system that seems random. Fees appear to fluctuate without reason, and longer
flights aren’t always more expensive than shorter ones. But behind this is actually the
science of dynamic pricing, which has less to do with cost and
more to do with artificial intelligence. It’s been more than a hundred years
since the first scheduled flight. The Comet, scheduled by British Overseas Airways
Corp., to start the world’s first jet passenger air service. In the beginning, commercial aviation
was a tightly regulated market place, where airfares were based on distance
traveled rather than passenger demand. Most international routes were
operated by a single national carrier and the lack of choice resulted in
uncompetitive fares for consumers. Deregulation, however, changed all that. In 1978, the U.S. government began the
process of removing government controls over routes and market
entry for new airlines. In 1983, fares followed. And by the early 1990s, the
liberalization of the aviation industry had spread around the world,
making pricing more competitive. Critics also say there was too much competition
in the first years after deregulation. Airlines merged and became more
dominant, changing the industry from a regulated cartel into
an unregulated cartel. In the U.S., just four airlines control
68% of the domestic airline capacity. While ticket prices have been falling
between major hub airports, the lack of competition
and a reduction in flights has resulted in higher average airfare
for smaller, less competitive cities. But this hasn’t halted the
demand in air travel. The number of airline passengers across the globe has
continued to grow, particularly in the last ten years, with the amount of people choosing to
fly skyrocketing by nearly 1.8 billion. So what does this increasing volume of
passengers mean for pricing tickets? Despite steep surcharges and baggage
fees tacked on during the 2007-2008 oil shock, ticket prices aren’t actually focused on the
seats’ combined cost such as taxes and fuel. Instead airlines price tickets using a strategy
called airline revenue management. Its end goal? Make as
much money as possible. This is working in real time. So when a customer goes to book a seat,
the airlines determines the price they see by analyzing a wide range of factors
including the status of their entire network. Of course, these decisions
aren’t being made by humans. Algorithms adjust fares by using information
like past bookings, remaining capacity, average demand for certain routes and
the probability of selling more seats later. One example of this process being
used is for pricing connecting routes. Let’s say you want to fly London to Miami. The flight you want to book also serves as
the first leg of a connected flight to Bogota. While you’re traveling less distance to
Miami, you may end up paying more than passengers flying
through to Bogota. That’s because airlines are trying to
discourage you from buying seats that they want to keep
available for the full journey. This entire thought process
is done by the algorithm, which predicts those seats will
sell for a higher price in the future. Airlines also profile their customers
to help them adjust prices. This often means placing passengers into
one of two groups: leisure or business. And the way each group
is priced is very different. An airline offering a flight from London to
Bali can assume that the people on that route are largely holidaymakers, so it
places them in the leisure bracket. These passengers usually
book months in advance, so airlines tend to start the price
for these seats relatively high. It then adjusts the price according to market response,
making sure it’s high enough to maximize profit, but low enough so that it doesn’t
result in unused capacity. While on a typical business route,
such as London to Hong Kong, airlines usually start with low
prices to fill a minimum capacity. Then it increases prices steeply for
business travelers who book last minute. That’s because airlines know
business travelers tend to book later and are far less price sensitive
than their leisure counterparts. In fact, business travelers are willing to
pay 60% more on average to secure a seat. Some analysts believe airlines use
consumer’s internet browser cookies to determine what flights
they’ve been looking at. This way, they can increase those
prices to encourage them to buy. But solid proof of this
practice is hard to come by, and it’s something airlines and price
comparison sites strongly deny. Targeted dynamic prices however
can increase customer satisfaction and encourage consumer bookings.
For example, a member of an airline loyalty program could receive ‘just for you’ price displays
based on their purchasing history. Technology has also allowed some
airlines to create a ‘basic economy fare’ with limited amenities to compete
with minimal service, low cost carriers. That lower fare is key if full service
carriers want to appear on the first page of search engines like Google Flights.
But it’s not just airlines that are using AI technology to their advantage.
Consumers now have access to sites which monitor fares, using
their own algorithms and past data, to predict the lowest price a seat will
reach to then alert their customers. The threat airfare search sites pose to airlines’
dynamic pricing system even saw United Airlines suing the website Skiplagged, which helps
passengers find loopholes for cheaper tickets. With AI having such an important role
in the field of air travel pricing, it’s likely that complex algorithms
will continue to fight the airfare war. That may not be a bad thing, as airlines
manage a growing number of passengers and consumers push for better choices
and easier ways to book their trips.

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