Case study series on dynamic pricing: Airlines

There’s no business like show business, but to better inform the shape of the dynamic pricing in this project, I decided to take a closer look at dynamic pricing in the other industries in a series of case studies. The airline and hotel industries famously use dynamic pricing (tens of thousands of times daily, according to some reports). Dynamic pricing has also spread to other sectors: some sports teams (the SF Giants), at least one restaurant (Next in Chicago), and transit (Uber). At best, this series allows the project to shamelessly crib best practices and sidestep pratfalls. We kick things off with a study of the airline industry. Just like movie theaters, airlines seek to maximize the revenue they can generate per person and balance the challenging operating metrics they must meet to maintain their thin, thin margins. Bad news: the differences between the airline and theatrical exhibition mean we should not replicate airline dynamic pricing practices. Good news: research on dynamic airline pricing has indicated price discrimination grows both revenues and consumer surplus (aka satisfaction) for airlines. This is encouraging news for the scope of our project.

Let’s dive into the pricing mechanics.

Up in the Air

Airline prices usually follow this trend: prices are cheap the earlier you buy, peak when demand is particularly uncertain, then dip again as the airline attempts to fill as many seats and minimize unfulfilled demand, and spike to take advantage of last-minute purchases and very inelastic demand.

The components of the airline ticket price are: cost of service, cost of not selling that seat on a substitute flight, and the forgone option of selling the seat later on the same flight. Airline purchasers must weigh the expected gain from delay against the cost of failing to acquire a seat. This is something that moviegoers are unlikely to spend much time considering due to a number of inherent differences.

The biggest difference is demand elasticity. The power of demand for the ticket is quite different. Theater attendance is more responsive to price changes than the airline industry because movie tickets are discretionary. Airline tickets are often purchased because the consumer must absolutely get there. Consumer demand is often unfulfilled until they buy the ticket, offering some leverage to airlines. In contrast, movie theaters can go empty because the audience just chooses to go elsewhere or see it on another platform.

The power of competitors varies greatly between the airline and movie businesses. The airline industry has very few competitors and few substitutes. Buses and trains tend to be perceived as cheaper and worse because they are quite demanding on personal time. This leaves airlines as the dominant mode of long-distance travel. The same can’t be said for movies in the content landscape. Everywhere you turn, there’s a new competitor for your hard-earned leisure time: television, video games, online video, and plays, just for starters. This ties back into how price sensitive moviegoers are versus fliers.

Though airline industry is a bad proxy for this project, there were some good takeaways from this case study, including:

• Airlines tend to do: peak user pricing and time of purchase – how can this be applied?
• Focus on the customer dynamics and use this to shape how we build this model
• Cannot assume that an efficient market will include fully sold out seats. The optimal amount may not be the case.

Next up in this research series on dynamic pricing: sports.