Many of us have spent time trying to work out the best strategies for buying airline tickets. Choosing off-peak dates, searching for flexible destinations, including stopovers, can all help.
But to really understand ticket pricing, it pays to look at it from the airline’s point of view. How do they determine price, and what are the factors for changing the price?
The short answer is simply that airlines will mostly set prices to maximize revenues. But going deeper, how does this work? This article takes a look at these complex and largely hidden pricing strategies.
The early days of prices
It will come as no surprise that ticket pricing is a well-developed, constantly evolving process, mostly controlled these days by algorithms. Pricing is, in most cases, automated, based on airline experiences and set parameters. This, of course, was not always the case.
Before the 1970s, many countries had some form of regulated ticket pricing. For example, this did not fully change in the US until 1978 (with the introduction of the Airline Deregulation Act). Regulations in the US defined which routes an airline could operate and the fares that could be charged.
The changes to this opened up flying to many more travelers (and airlines) and generally lowered fares, but not without some pain and bankruptcies.
To give an idea of pricing before deregulation, some figures are given by Stephen Breyer in a 2011 Bloomberg article. He writes..
Airfares today – Pricing for the market
Of course, pricing these days is not fixed or controlled, and airlines will seek to maximize profits made through ticket sales. A ticket can be worth different amounts to different people, and pricing is about determining this value and making the most from it.
The concept of ‘booking classes’
Pricing and availability of fares are determined these days using a system of ‘booking classes.’ These are different to travel class (economy, premium economy, and business class, for example) and are a series of letters that define the fare level paid. IATA first defined these codes in the late 1940s to promote consistency across airlines and aid acceptance of tickets between companies (read more about this in IATA’s history).
These have changed and diverged since they were introduced, and different airlines use different booking classes. But some are generally consistent, including: F for full-fare first class, J for full-fare business class and Y for full-fare economy.
The booking classes used for discount levels below full fare differ between airlines. For example, with most oneworld airlines (including American Airlines and British Airways), discount business class is represented by D, C, R, and I class. With United Airlines, business class uses J, C, D, Z, and P (R is used for premium economy, and I previously for first class).
Revenue setting and management is a combination of setting fares for each of these booking classes and controlling availability by selling certain numbers of seats in each booking class.
Algorithm-based pricing and historical data
Each airline uses its algorithms and AI technology to set and change prices. This, of course, requires human oversight but is a long way from the days when fares were set and changed manually.
All price setting and analysis is backed up with extensive data analysis. This is an area that has seen significant improvement in recent years. Airlines have always been aware of past sales and booking data and used this to influence prices going forward. But with the improvement of data analysis and artificial intelligence technologies, this data can be analyzed and used much more precisely.
More purchases are now online, which adds to data that can be used. Airlines can track and store not just sales data but customer interest and searches.
To give an idea of the complexities in fares that airlines can offer, take a look at this report by ITA Software. This looks at a simple return flight between Boston and San Francisco. Just with one airline, American Airlines, there are over 25 million different valid fares (with different rules or via different cities). When we search, results are presented and sorted for the best options, but algorithms monitor and update all these fares behind the scenes.
What factors do pricing algorithms consider?
Airline’s algorithms, of course, are not made public and likely are a closely guarded secret. There are many things we know that influence prices, though.
Some of the main factors include the following (remember though, there are many more, and they will vary between airlines):
Leisure or business passengers / Customer profiling
One of the simplest but most important divisions is between leisure and business passengers. They each have very different requirements, buying habits, and budgets. In general, leisure travelers tend to book further in advance (often several months or more for long-haul routes) and are much more flexible. Business travelers will book closer to departure and be prepared to pay more for certain flight times.
The simplest response to this is that fares start high on leisure route fares and reduce closer to departure, and the other way around for business routes. If you take a look at last-minute short-haul fares between business cities, you will easily see this.
But there is obviously more to it than this. Many routes carry both business and leisure traffic, and of course, each passenger is different. The ability to be more flexible changes as technology and data improve. These days, this may include customer profiling and offering fares based on previous searches or purchases. Airlines are starting to do this, but there is a long way to go, both in ability and regulation.
Length of advance purchase
As we all have experienced, prices can vary significantly over the months leading up to a flight. Using historical data, airlines are increasingly able to predict the best way to price tickets to maximize sales and revenue.
Sales and promotions can affect this, as well. Again, airlines will look at previous sales data to determine the best time to offer sales and discounts on particular routes.
One area we have seen changes in recent years is in last-minute pricing. While it may sound like a good idea to lower prices last minute to fill seats, it could undermine earlier higher pricing if airlines did this regularly. Airlines have started offering last minutes upgrades, though, selling premium cabins for much lower rates.
Current sales volume
Of course, one of the main factors that influence price is the current ticket sales. You would expect that when there are only a few seats left on a flight, the prices will be much higher.
Airlines will make a certain number of seats available in each booking class, and as the lower booking classes sell out, only higher fares are available. On some routes, though, airlines may keep selling heavily discounted fares on full flights (if they don’t think anyone will pay the higher rates).
Sales volume can also have a very short term effect. Algorithms will constantly look at sales volume and increase prices if there is a pick-up in demand.
Length of trip
Several factors that can affect the fare are related to the characteristics of the trip booked. You will often see these specified against particular fares or promotions. Again, this is another way airlines try to maximize revenue from different types of customers. And again, this will be different for every route. But in general, lower fares will usually require a long stay, and likely over a weekend.
Historically, most ‘full service’ airlines have offered lower prices for return trips and much higher fares for one-way flights. While this is still the case with many fares, more airlines have started to offer attractive one-way fares. Low-cost airlines usually operate such a ‘point to point’ pricing system, so other airlines are adapting to compete.
Level of competition
Airlines monitor competitor fares on the same or similar routes as part of determining their fares. If one airline lowers prices on a particular route, it is common to see others follow quickly.
This has been reported and studied several times. For example, an in-depth study by the MIT International Center for Air Transportation in 2013 looked at the effect on airfares when low-cost carriers moved into new routes. It showed significant reductions from ‘legacy airlines’ when Southwest Airlines, JetBlue, Allegiant, or Spirit Airlines started routes.
Peak and ‘blackout’ dates
Airlines will often set different fares or limit the availability of lower booking classes at certain times. Departures around major school holidays are an obvious example of this, where prices may be higher even when booked far in advance. But all routes and countries can have specific dates considered peak. And for events not seen in advance, algorithms will often pick up on spikes in booking and raise prices.
Level of overbooking
It remains common for airlines to ‘oversell’ flights, particularly on certain routes. This can be an inconvenience for passengers and costly for airlines when regulations demand customers are compensated. But it is still part of pricing and is another area that improves with better data analysis. Predicting how many passengers will not travel (perhaps no shows, changes of plans last minute, or missed connections) allows airlines to manage this better and reflect in pricing.
Fuel and oil prices
Fuel is a major part of airline costs, and this obviously needs to be covered by prices. With sales often months in advance, airlines need to consider how prices are changing and predict future costs (although they also hedge and fix prices in advance).
Reporting by the travel website Nomadic Matt explains how this has changed, for example, between 1996 and 2019:
“The price of airline fuel has increased tremendously. Back in 1996, airline fuel cost $0.55 per gallon. Now, it’s $1.95 per gallon. Airlines can’t absorb all of that increase, so they pass some of that on to the consumer, leading to higher fares.”
The effect of this can also be seen by looking at ‘fuel surcharges.’ These additional fees added to tickets were introduced by many airlines amidst rising prices in the 2000s (it peaked in 2008). Some airlines removed these once prices lowered (and hedges expired), but many still remain.
Setting new ticket types and unbundling fares
One of the pricing trends we have seen in recent years is airlines offering lower fare types but with fewer inclusions. This began with low-cost airlines, but the main ‘full service’ airlines have now followed.
Airlines will set a low base fare but exclude extras such as luggage allowance, seat selection, and even entitlement to some frequent flier benefits. All the major US airlines now offer such fares (with Delta being the first to introduce it fully.).
This has been done not just to stay competitive with low-cost carriers but also to improve ranking in search engines. More and more passengers search for fares online, and airlines with a higher base fare will be penalized in such searches.
How to find the best fares
Airlines are making full use of algorithms and AI technology to price tickets. But passengers can take advantage of similar technologies to find the best prices. While we can’t look at how airlines are setting or changing prices, we can use tools to improve our chances of finding a better fare.
This can either be through searching currently available fares to find better options, often by increasing flexibility in dates, times, or routes. But we can also analyze historical prices and trends to predict how prices will change.
Future of airline pricing
How will airline pricing change over the coming decades? One thing is certain; airlines will continue to set prices to maximize profit. And the power of analysis, and data available to airlines, will continue to grow, as it is in most industries.
Prices in late 2020 are certainly changeable as airlines deal with a slowdown in aviation. Post-COVID, there are going to be several factors affecting prices. Airline debt and ongoing coronavirus policies and restrictions could push fares up. But on the other hand, low oil prices and slimmed down airline businesses could help reduce them.
Longer-term, one area set to grow is the maximization of total revenue. Algorithms and forecasting have developed to set base fares and plan seat availability and demand. For many airlines, there is still much more that can be done to predict and optimize revenues from ancillary products and services.
So-called ‘Total Revenue Optimization’ will become increasingly important as the split between base and ancillary revenue increases. According to an interesting report by SABRE in 2017, ancillary revenues for airlines reached $59.2 billion in 2015 and was growing at nearly 20% a year.
To succeed with this, airlines will have to analyze even more data and link several sources. Low-cost carriers are probably ahead in this area, and many of their systems and sales processes have been designed around total fare and addons. In contrast, many legacy carriers will have more of a challenge to match pricing levels to predictions for extra sales.
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