Yield Management System Crashes Airline Industry

Being a very frequent flyer (several hundreds of thousands of miles flown every year for the last 30 or so years), I cannot help but to follow the woes of the airline industry. Unfortunately, I do this with some considerable amount of schadenfreude – they did it all to themselves!

Hailed at the time as the industry savior, the yield management systems of the mid and late 80’s provided a significant, but relatively short-term, revenue and profit boost. After a while, it completely commoditized their offering and drove profits deep into negative territory. Even before 9/11, airlines were in financial trouble. The consequent recovery (supported by dips into chapter 11, in many cases) was only temporary. The ongoing deterioration of the industry is just hastened by the current oil price shock. America Airlines' then-CEO, Robert Crandall called yield management “the single most important technical development in transportation management”. How, then could it be the most significant reason for the current industry problems? Well, here is why:

Yield management systems change the price of the airline seat based on the number of seats available. So, the simplified theory is that, say, 3 months before a flight, when there are many seats available, so the price per seat is low. As the plane fills up, the price of a seat increases. If sales of seats are slow, prices are kept low to increase demand. If there are still unsold seats near the date of departure, those seats are discounted heavily as, in the view of the airlines, at that point, every dollar is a good dollar. This sounds like a good theory, and it is, except for that little nagging fact the airlines forgot; they are transporting humans, not cattle, not pigs, not chickens, not packages, but people – people with the ability to think and to change behavior based on experiences and external inputs.

I’m sure you, the reader, have been seated with somebody paying a fraction of what you paid, for exactly the same uncomfortable, crammed seat with lousy service. Or maybe it was you who sat with me and bragged about your bargain ticket, 70% lower than what I paid! Thus, it did not take very long for travelers to be thoroughly trained by the airlines to exploit the theory and shortcomings of yield management systems. Because airlines offered no meaningful differentiation between themselves and between a cheap and expensive seat, passengers shopped around for the best price only; found the cheapest airline, regularly booked their flight earlier, or, if their schedule were flexible, they waited to the last minute. (Meaningful seat differentiation could possibly be: the cheap tickets are for the back of the plane, mid seats only, expensive seat in the font with extra legroom and a free drink - only consumer market research could find out.) The advent of the internet, with easy price comparison and ticket auction sites further accelerated the commoditization of airline seats to the point that no airline made any money on any flight (with a few exceptions).

So transposing this scenario to other businesses, what can be learned? The key words here are “meaningful differentiation” and “every dollar is a good dollar”.

If you are in an industry where your customers meet and talk, you cannot sustain a policy of selling your product or service to different customers at a different price unless there is “meaningful differentiation”. This means that you must be providing something meaningful, or valuable, to those who are paying more and not providing it to those who are paying less. When I say “meaningful”, I mean meaningful to your customer, and not necessarily to you.

Furthermore, the notion of “every dollar is a good dollar” must go away – even if you are in a commodity business with high fixed cost (like the airlines), you must keep firm on a cost based floor under which you will not sell your product or service. If you (like the airlines), train your customers that they can buy at pathologically low prices – they will – and your business will enter a death spiral from which recovery is almost impossible. The trick for you is to de-commoditize your offering, and find segments of your marketplace where you can add unique value and be meaningfully different than your competitors.

Warm summer regards,

Per Sjofors
Founder & Managing Partner
Atenga, Inc