Airlines' profits lie in their capacity management
I was recently asked by a journalist why is it that British Airways is currently selling business class flights to New York from Dh13,870, while some of our key competitors start selling at almost double that.
Likewise, the journalist wanted to know how we could offer economy fares from Dh4,080 against fares 20 per cent higher elsewhere.
Let me explain a little bit behind why we are willing and able to do this while some airlines do not.
In 2007, I watched a highly entertaining programme called The Apprentice. I am sure a few of you have seen it, or even the regional copycat The Hydra Executives. The premise of the show was simple. A group of young wannabes compete to earn a position working for a highly successful entrepreneur, the former Amstrad boss, Sir Alan Sugar in the case of The Apprentice.
The candidates all undertook a number of business challenges, all designed to test how the individuals could adapt their entrepreneurial skills and maximise profit. In this particular show each team were given £200 (Dh1,073) to invest in selling flowers on the streets of London and the winning team would be the one that generated the most profit by the end of the following day.
The successful team managed to sell all its stock and produce several hundred pounds of profit by buying the right stock at the right price, selling in an appropriate location and selling all stock by reducing their prices as the day neared its end. The key decisions being, what stock to buy at what price (inventory), where should they sell their product (distribution) and how they should price their product given that by the end of the day any stock they have remaining unsold is worthless (selling strategy).
As I reflected on the decisions made around inventory, distribution and selling it made me wonder what exactly had driven their decision to discount their product at the end of the selling window. After all, this is the complete opposite of the way the vast majority of airlines price their inventory.
The conclusion I reached was that given the resource, time and distribution constraints facing them at a specific point during the day, they were forced to change from a strategy that "maximised profit per transaction" to one which "cut their losses per transaction".
Fortunately, successful airlines have a significantly larger selling window (typically a full year). We also have significantly more resources, as well as sophisticated distribution and data systems, which give us the information we need to predict what demand there will be for our services during sustained periods of economic growth.
We also understand that we can maximise profits until very near to the end of the selling cycle by making sure we hold inventory for those customers willing to forego the inflexibility of having to choose a specific date/flight combination for a more flexible ticket, i.e., one which allows changes to be made to their flights.
This flexibility attracts a substantial premium as allowing customers to make changes close to the end of the selling cycle (departure date), does not give the airlines much opportunity to sell that seat to someone else before the flight actually takes off.
So, our model for profitability is the complete reverse of the flower seller by "cutting our losses" first and then "maximising profit" closer to the end of the selling cycle.
All clear so far? I'm sure there are still a few of you scratching your head out there so let's keep it nice and simple. Airlines operate very different capacity management systems to flower sellers.
If you want to get the best deal possible from a flower seller you would hang around until the end of the day and hope he hasn't sold all his stock earlier in the day. If you want to get the best deal from an airline, then you should book, pay and ultimately travel on a specific flight well in advance of when you intend to travel.
Easy huh? So now you know why we are able to offer such fantastic fares that undercut our key competitors in both business class and economy cabins. The combination of economic uncertainty, global slowdown and drop in business travellers means I'm "cutting my losses" by giving more inventory to those prepared to book, pay and travel on specific flights. Planning saves money.
-The author is British Airways' Commercial Manager for the Middle East
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