How do airlines price tickets? | CNBC Explains

Summary

The video script explores the complex world of airline ticket pricing, driven by dynamic pricing and AI. It traces the history from regulated markets to deregulation, leading to competitive pricing. The script delves into how airlines use revenue management strategies and algorithms to maximize profits, factoring in demand, capacity, and customer profiles. It also discusses the impact of consumer behavior and the role of AI in both airlines' pricing strategies and consumers' search for the best deals.

Takeaways

• 🛫 Buying plane tickets can be confusing due to the dynamic pricing system that seems random but is actually based on AI and market factors.
• 📈 Dynamic pricing is influenced by artificial intelligence rather than just the cost of flying, aiming to maximize airline revenue.
• ✈️ The first scheduled flight was operated by British Overseas Airways Corp. with the Comet, marking the beginning of commercial aviation.
• 📊 Initially, airfares were regulated and based on distance, but deregulation in the 1970s and 1980s led to more competitive pricing based on demand.
• 🌏 Deregulation spread globally in the 1990s, but it also led to a few dominant airlines controlling a large portion of the market, affecting pricing power.
• 📉 Despite increased competition, ticket prices have fallen between major hubs, but less competitive routes have seen higher average fares due to reduced flights.
• 🚀 The demand for air travel has grown significantly, with nearly 1.8 billion more passengers in the last decade, impacting ticket pricing strategies.
• 💺 Airlines use revenue management strategies to set ticket prices in real-time, considering factors like network status, capacity, and demand.
• 🔢 Algorithms adjust fares based on past bookings, remaining seats, route demand, and the likelihood of selling more seats at a higher price later.
• 🔄 Pricing for connecting flights can be higher for shorter segments if the airline wants to reserve seats for longer, more profitable routes.
• 🏖 Leisure travelers are often charged higher initial prices and see adjustments based on market response, while business travelers pay more for last-minute bookings due to less price sensitivity.
• 💼 Airlines may use consumer data, such as browser cookies, to personalize pricing, although this practice is disputed and not proven.
• 🛒 Consumers can use fare monitoring sites with algorithms to predict the best time to buy tickets, creating a counterbalance to airline pricing strategies.
• 🤖 The role of AI in airfare pricing is significant and likely to continue as airlines manage increasing passenger volumes and consumer demands for better options.

Q & A

What is the concept of dynamic pricing in the context of air travel?

Dynamic pricing in air travel refers to the use of artificial intelligence to adjust airfare prices in real time, taking into account a variety of factors such as passenger demand, flight availability, and booking history, rather than just the cost of the flight.

How did the commercial aviation market change after deregulation?

After deregulation, the commercial aviation market became more competitive, with pricing based on market forces rather than government control. This led to lower ticket prices on major routes but potentially higher prices for less competitive routes due to reduced competition.

What was the impact of the 1978 deregulation in the U.S. on the aviation industry?

The 1978 deregulation in the U.S. removed government controls over routes and market entry for new airlines, leading to more competition, lower fares on major routes, and a shift in the industry from a regulated to an unregulated market.

Why might longer flights sometimes cost less than shorter ones?

Longer flights might cost less than shorter ones due to dynamic pricing strategies used by airlines. For example, if a longer flight is part of a connecting route with higher demand, the airline may price the longer route lower to ensure seats are filled for the full journey.

How do airlines use algorithms to determine ticket prices?

Airlines use algorithms that analyze past bookings, remaining capacity, average demand for certain routes, and the probability of selling more seats later to adjust fares. These algorithms work in real time to maximize revenue and fill seats efficiently.

What is airline revenue management and what is its goal?

Airline revenue management is a strategy used by airlines to maximize their profits by dynamically pricing tickets based on various factors. Its goal is to make as much money as possible from each flight by filling seats at the highest possible prices.

How do airlines differentiate between leisure and business travelers when pricing tickets?

Airlines differentiate by profiling their customers and placing them into leisure or business groups. Leisure travelers are often charged higher prices initially and the price is adjusted based on market response, while business travelers are offered lower initial prices that increase steeply for last-minute bookings due to their price insensitivity.

What is the 'basic economy fare' and why do airlines offer it?

The 'basic economy fare' is a lower-cost ticket option with limited amenities, designed to compete with low-cost carriers. Airlines offer this fare to attract price-sensitive customers and to ensure they appear on the first page of search engine results.

How do consumer websites use algorithms to help customers find the best flight deals?

Consumer websites use algorithms and past data to monitor fare changes and predict the lowest price a seat will reach. They then alert their customers to these deals, helping them find the best prices for their flights.

What was the controversy surrounding United Airlines and the website Skiplagged?

United Airlines sued the website Skiplagged, which helps passengers find loopholes for cheaper tickets, as it posed a threat to the airline's dynamic pricing system by revealing lower fares that could be found through connecting routes.

How has the growth in the number of airline passengers affected ticket pricing strategies?

The growth in the number of passengers has led to an increased use of complex algorithms by airlines to manage the higher volume of travelers and to cater to consumers' demands for better choices and easier booking processes.

Outlines

00:00

🛫 The Evolution of Airfare Pricing

This paragraph delves into the complexities of airfare pricing, highlighting the shift from a regulated market to a competitive one following deregulation in the late 20th century. It explains how dynamic pricing, driven by artificial intelligence, has replaced distance-based pricing. The paragraph also touches on the impact of deregulation, the dominance of a few airlines in the U.S., and the paradoxical effect of increased competition leading to higher average airfares in less competitive cities. The growth in global air travel and the introduction of airline revenue management strategies are also discussed, emphasizing the real-time pricing adjustments based on various factors such as past bookings and remaining capacity.

05:04

🔍 The Role of AI in Airfare Dynamics

The second paragraph explores the role of AI in airfare pricing, focusing on how algorithms use past data and real-time information to set prices that maximize revenue. It discusses the strategic pricing of connecting flights, customer profiling to differentiate between leisure and business travelers, and the different pricing strategies for each group. The paragraph also mentions the potential use of consumer data, such as browser cookies, to adjust prices and the denial of such practices by airlines. It concludes with the benefits of targeted dynamic pricing for customer satisfaction and the emergence of 'basic economy fares' to compete with low-cost carriers, as well as the use of AI by consumers to find the best flight deals through monitoring sites.

Keywords

💡Dynamic Pricing

Dynamic pricing is a strategy used by businesses to adjust prices of goods or services based on real-time market demands and other influencing factors. In the context of the video, it refers to how airlines use artificial intelligence to set airfare prices that are not solely based on cost but also on demand, availability, and other variables. The script mentions that dynamic pricing 'has less to do with cost and more to do with artificial intelligence,' highlighting its importance in the airline industry's revenue management.

💡Deregulation

Deregulation refers to the reduction or elimination of government control over a particular industry. In the video script, it is discussed in the context of the U.S. government's actions in 1978 that began to remove controls over airline routes and market entry, leading to more competitive pricing and the growth of the aviation industry. The script notes that this shift from a regulated to a more liberalized market influenced how airfares are determined today.

💡Airline Revenue Management

Airline revenue management is the process by which airlines maximize their revenue by optimizing the price of their tickets based on various factors. The script explains that this strategy's end goal is to 'make as much money as possible' by using real-time data analysis to set prices. It is a key component of how airlines use dynamic pricing to manage their inventory and maximize profitability.

💡Algorithms

Algorithms are a set of rules or procedures for solving problems or performing calculations. In the video, algorithms are used by airlines to adjust fares based on a multitude of factors including past bookings, remaining capacity, and demand for certain routes. The script provides an example of how algorithms might determine that a passenger flying a connecting route might pay more to discourage booking on a popular leg of a flight, ensuring higher prices for the full journey.

💡Connecting Routes

Connecting routes refer to flights that require passengers to change planes at one or more points to reach their final destination. The script uses this term to illustrate how airlines may price flights differently based on whether a segment is part of a longer route. For instance, a passenger flying from London to Miami might pay more than someone continuing to Bogota because the airline wants to keep seats available for the full journey, which can be sold at a higher price.

💡Leisure Travelers

Leisure travelers are individuals who travel for pleasure or personal reasons. The script describes how airlines categorize passengers and price tickets differently for leisure versus business travelers. Leisure travelers are likely to book flights months in advance for holidays, and airlines set high initial prices for these seats, adjusting them based on market response to maximize profit without leaving seats empty.

💡Business Travelers

Business travelers are individuals who travel for work-related purposes. The script explains that airlines often start with lower prices to fill a minimum capacity for business routes and then increase prices for last-minute bookings by business travelers, who are typically less sensitive to price changes and more likely to book closer to their travel dates.

💡Internet Browser Cookies

Internet browser cookies are small pieces of data stored by a website on a user's computer to remember information about the user. The script suggests that some analysts believe airlines might use cookies to track which flights consumers have been looking at and adjust prices accordingly. However, the script also notes that solid proof of this practice is hard to find and is denied by airlines and price comparison sites.

💡Loyalty Program

A loyalty program is a marketing strategy that rewards repeat customers for continued business. In the video, it is mentioned that airline loyalty program members might receive personalized 'just for you' prices based on their purchasing history, which can increase customer satisfaction and encourage bookings.

💡Basic Economy Fare

Basic economy fare is a type of airline ticket offering that comes with limited amenities at a lower cost. The script discusses how full-service carriers have introduced this fare type to compete with low-cost carriers. This fare is crucial for appearing on the first page of search engines like Google Flights, as it attracts price-sensitive consumers.

💡AI Technology

AI technology, or artificial intelligence, refers to the simulation of human intelligence in machines that can perform tasks that would normally require human-like reasoning. The script highlights the significant role of AI in air travel pricing, with complex algorithms used by both airlines for dynamic pricing and by consumer sites to predict the best time to buy tickets.

Highlights

Buying plane tickets involves dynamic pricing influenced by AI rather than just cost.

Commercial aviation was initially a regulated market with uncompetitive fares based on distance traveled.

Deregulation in 1978 removed government controls, leading to more competitive pricing by the 1990s.

Critics argue deregulation led to airlines becoming dominant, creating an unregulated cartel.

In the US, four airlines control 68% of domestic capacity, impacting fares in less competitive cities.

Despite oil shocks, ticket prices are not focused on costs like taxes and fuel but on revenue management strategies.

Airlines use real-time algorithms to set prices based on factors like network status, past bookings, and demand.

Algorithms predict future seat prices and adjust availability to maximize revenue, as seen with connecting routes.

Airlines profile customers into leisure or business groups, with different pricing strategies for each.

Leisure travelers often see higher initial prices that adjust based on market response to maximize profit without unused capacity.

Business travelers, who book last minute, are charged higher prices due to their price insensitivity.

Airlines may use consumer browsing data to adjust prices, though this is disputed.

Dynamic pricing can increase customer satisfaction by offering personalized prices, like loyalty program discounts.

Airlines have introduced 'basic economy fares' to compete with low-cost carriers by offering limited amenities at lower prices.

Consumers now have access to fare monitoring sites that use algorithms to predict the best time to buy tickets.

Airlines and fare search sites are in a constant battle, with some legal disputes over pricing strategies.

AI will likely continue to play a crucial role in airfare pricing as airlines manage growing passenger numbers and consumer demands.

Transcripts

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.