Price Discrimination Strategy In The Airline Market

Pricing strategies in the airline industry

Question:

Discuss about the Price Discrimination Strategy in the Airline Market.

Being the fastest and costliest means of transportation customers are always looking for best deals within their budget. In today’s competitive world, it becomes a matter of serious headache to find airline tickets at a reasonable price. The objective of Airline companies is to maximize their revenues by making more money. While, customers willing to spend least possible price. In this situation uniform price charging is cannot be considered as the best pricing strategy. Setting too high price hurts company’s income by making the tickets less affordable. Too low price on the other hand may be insufficient to recover companies cost.

Therefore, airline companies go for a discriminating strategy based on different condition. Ticket fare depends on time of booking the tickets. However, there is no hard and fast rule regarding the time dependency of tickets. In case of advanced ticket booking for a long distance journey, it is observed that people experience a comparatively low fare. Fare also depends on particular season of the year or particular day in a week. Discount often offers to particular group of customers like military personnel, students and senior citizens. To make a clear pricing strategy airline groups distinguishes the ticket-booking customers in three basic classes- business class, economy class and first class.  The class differentiation is depending on different affordability of customers. The economy class contains cheapest tickets. For business and first class passengers, the fare is higher subject to providing them different comfort facilities.

In the paper, pricing strategies of airline business is viewed. Analysis has been made to find the rationale of such pricing strategies and its implication on welfare.

In order to earn maximum profit from each flight traveled airlines go with optimization of each seat. The strategy devised by airline in times of determining seat price is called “yield management” (Nagle, Hogan and Zale 2016).  It allows the company to charge differentiated price for identical seat. While deciding on fare price the airlines differentiated buyers according their willingness to pay. There is one group who does not care for price and other group that do not purchase tickets beyond a certain price. The first group consists of passengers traveling for business, family emergencies or may be one who has a very high margin of income.

When airline charges uniformly high price, then only first category of buyers make purchase. Yet, such pricing enable sellers a high profit. Then problem will be leaving the flight with many empty seats. Thus, the airlines miss scope for earning revenues from the empty seats. Another extreme to make the flight completely booked is to set a lower price, making it affordable for both the groups (Lawton 2017). By selling ticket at low price airline owners, lose the additional surplus from consumers with a high willingness to pay.

Yield management

As a result, the company chooses to adapt strategy in between the two extremes. Here, they first sell their tickets to the first high paying groups and then sell the rest to the second group of consumers. Marginal cost for each additional seat is almost negligible. Yet, from discriminatory practice, they earn greater marginal revenue. Hence, the profits of airlines are maximized with filling every seat for the flight (Koh and Seager 2017)

 The substitute good of one companies airline tickets are tickets sold by other company for the same journey. In case of substitute produce price of one good has a positive effect on demand for other, the indifference curve so obtained here is a negatively sloped straight line.

Figure 1: Consumption for Substitute goods

(Source: As created by Author)

In case of complementary good demand of one good is related with the demand for a related good. The willingness to buy airline tickets depend on the other package related service or facilities provided by the company. In this case, the indifference curve showing locus of different consumption points is ‘L’ shaped.

Figure 2: Consumption for Substitute goods

(Source: as created by the Author)

Before deciding price, airlines first consider which category of plant will be used for the flights. This gives idea about the number of seats in each travel class.  The quality of class is considered as travel class and type of tickets refer as booking class. The travel classes include first class, business class, economy class and premium economy class (Bilotkach, Gaggero and Piga 2015). The ticket price for each class depends on different factors. The categorization of class is again guided by the profit motive. The airline travelers are mainly of two types- business travelers and leisure travelers.  The ticket for demand is more elastic for leisure travelers. They are able to adjust their travelling schedule with dates. In contrast, those travelling for business purpose cannot postpone their schedule and has end with an inelastic demand.  The leisure travelers enjoy their time advantage by booking tickets for their pre planed trips and book cheaper class. Those have business objectives or any other emergencies books tickets at a much closer time for flight departure. All the tickets of cheaper or economic class have been already sold and they have no choice but to purchase tickets from expensive business class (Homsombat, Lei and Fu 2014).

Class differentiation in ticket pricing

Depending on elasticity of different markets, monopolist devises price discrimination strategy and attains maximum profit. In the same way airline company by following discriminating strategy maximized their profit (Wen and Chen 2017).

Figure 3: price discrimination strategy

(Source: Varian 2014)

The forces of demand and supply determines price in the free market. In the context of airline service supply refers to availability of seats and demand refers to demand for available seat.  There are some times when the demand for flight tickets is high than its usual time. In times of holiday, high demand generated from leisure class (Grant 2016). During this time, airline companies can respond in two ways. First, in order to accommodate all of them in economic class they can increase the fares for economic class. Another strategy they can adapt is to reduce ticket price for business class. In this time, there are less rush for business travelers. Instead of leaving the seats empty it is better to fill them with travelers that have willingness in between the business and economic class. Because of elasticity of air ticket among the leisure-class a small relaxation of price gives a high boost to ticket demand and increase profit of airline owners

Figure 4: Peak load pricing

(Source: as created by the Author)

Singapore airlines:

Singapore airline is one of the top ten airline companies in Singapore. In order to maximize its revenue it devises a mix marketing strategy. In the mixed strategy different group the company mostly target customers belonging to middle class and upper middle class. The reason for targeting this group is to their comparatively higher willingness to pay for therir comfort. Customers from these groups look for a comfortable and reliable journey and even pay some extra money to have additional comfort. Therefore, the pricing policy is known as premium pricing policy as the prices are set for targeted premium groups. This prmium airline company use social media sites like facebook, blog, twitter, you tube for promoting their marketing strategy.

Air Asia

Pricing strategy that is most successfully and profitably followed by Air Asia is the Penetration strategy. Under this strategy a low fare is set for newly opened and mostly visited destinations. It is a unique strategy used by Air Asia, known as Low Cost Carriers (LCC). The rationale behind keeping a low price is that air travelling is considered as a luxury items having elastic demand. Therefore, a slight low price attracts a large traveller base for the company. To keep the price low cost efficient strategies are used by the company.

Factors affecting demand and pricing of airline tickets

Jetstar

Like Air Asia Jet star also uses LCC strategy. However, it does not use LCC strategy in its pure form. Fares are substantially higher in some situation than it is under LCC. Its close competitor is Tiger Airways which is a Singapore based airline. Dynamic pricing strategy is more appropriate form of pricing to justify its pricing strategy. Dynamic pricing strategy involve charging different prices based on time of booking the tickets, consideration also given on peak season or off season. It also uses segment pricing method by segmenting different class of customers.

There are factors apart from own price that affects the demand for airline tickets and its price.  Fuel price is important factor determining the cost of the airlines and hence their fares. Fuel cost constitutes highest share of airline cost (Ferguson 2014). If there is an increase in fuel prices overtime, then fare price increases for all classes. Change in social and demographic composition affects the demand for air travel. Increasing population in metropolitan areas results in road congestion. Then people prefer to travel by air to save their time and find suitable deal.

Factors causing change in personal life style affects the demand for airlines tickets. There are evidences that trends household composition and formation, potentiality of physical trip substitution with electronic substitutes affect household demand for air travelling. With economic growth people’s income changes and thus their attitudes towards travelling expense are also changes (Lazarev 2013).  They value their comforts more in response to increasing income. Changing structural composition in the economy leads to change profession of the people that may influence demand in business class travel. The factors causing change in demand directly affects the pricing strategies of airline companies.

Welfare of each economic agents and overall social welfare is understood by analyzing the concept of consumer surplus and producer surplus

Consumer surplus is the benefit enjoyed by a consumer and it calculated as a difference between willingness to pay for a good and its market price. Producer surplus is the gain enjoyed by the producer from production activity. It is obtained by subtracting the minimum cost to the producer from the existing market price.

Figure 5: Consumer surplus in the market

(Source: as created by the Author)

Figure 6: Producer surplus in the market

(Source: as created by the Author)

By charging discriminatory prices, surplus of the airline companies are maximized. However, this does not always maximize consumer surplus by offering them best deals. At times of emergency buyers have to pay a higher price and hence have very low or zero consumer surplus. The strategy of price discrimination enables airline companies to enjoy the entire consumer and producer surplus (Bergantino and Capozza 2015).

Conclusion

In the airline market, government should relax regulation regarding the entry barriers in the industry. Entry barriers in the market establish monopoly in the market. Increasing market power provides greater scopes for price discrimination.  Relaxing entry barriers does not mean complete deregulation of the industry. Public policy makers should encourage competition in the market. Government should still control air traffic, arrange programs for safety and participate in the development of airways (Escobari, Rupp and Meskey 2016). The regulation of airline fares by imposing price ceiling or floor can also be the desired interventionist strategies.

Conclusion

Price discrimination is a well-known strategy in the airline market. There are different factors on which air tickets price depend. Time of tickets booking is one such factor. In times of advanced booking, fares are generally low whereas person, booking tickets under some emergency pays a much higher price for the same tickets. Fares are also subject to people willingness to pay for the ticket, which in turn depends on their income and preference. People willing to travel comfortably and has affordability travels in business or first class. Economic class is for people having lowest affordability.  During holiday, there can be a mismatch between availability of air tickets and its demand. This influences ticket prices by forces of demand and supply.  Apart from these, there are factors than effect pricing in the airline market over time. The changing composition of income, social and demographic features, change in fuel price are come such factors. Finally, there are scope for government to correct distortion in the by preventing the discrimination. One way of government intervention is to increase competition in the market by reducing entry restriction.  In addition to relaxing entry barriers the government can make some intervention in areas like air traffic management, air way development and other areas.

References

Bergantino, A.S. and Capozza, C., 2015. One price for all? Price discrimination and market captivity: Evidence from the Italian city-pair markets. Transportation Research Part A: Policy and Practice, 75, pp.231-244.

Bilotkach, V., Gaggero, A.A. and Piga, C.A., 2015. Airline pricing under different market conditions: Evidence from European Low-Cost Carriers. Tourism Management, 47, pp.152-163.

Escobari, D., Rupp, N.G. and Meskey, J., 2016. Dynamic price discrimination in airlines.

Ferguson, J.L., 2014. Implementing price increases in turbulent economies: Pricing approaches for reducing perceptions of price unfairness. Journal of Business Research, 67(1), pp.2732-2737.

Grant, R.M., 2016. Contemporary strategy analysis: Text and cases edition. John Wiley & Sons.

Homsombat, W., Lei, Z. and Fu, X., 2014. Competitive effects of the airlines-within-airlines strategy–Pricing and route entry patterns. Transportation Research Part E: Logistics and Transportation Review, 63, pp.1-16.

Koh, C.Y.C. and Seager, T.P., 2017. Value-Based Pharmaceutical Pricing From the Patient Perspective Could Incentivize Innovation. Pharmaceutical Medicine, pp.1-5.

Lawton, T.C., 2017. Cleared for take-off: structure and strategy in the low fare airline business. Routledge.

Lazarev, J., 2013. The welfare effects of intertemporal price discrimination: an empirical analysis of airline pricing in US monopoly markets. Unpublished manuscript.

Nagle, T.T., Hogan, J. and Zale, J., 2016. The Strategy and Tactics of Pricing: New International Edition. Routledge.

Varian, H.R., 2014. Intermediate Microeconomics: A Modern Approach: Ninth International Student Edition. WW Norton & Company.

Wen, C.H. and Chen, P.H., 2017. Passenger booking timing for low-cost airlines: A continuous logit approach. Journal of Air Transport Management