INTRODUCTION:
American Airlines was the U.S.'s largest carrier in 1992. It had a fleet of 622 jet aircraft, flying 2,450 flights daily to 182 locations. It also had innovative technology and programs. They were the first to introduce a computerized airline reservation system called Sabre, ‘Super Saver' fares and frequent- flier programs. Despite these innovations, American Airlines and the airline industry as a whole was still not operating as profitably or providing customer satisfaction the way it should in 1992. There were two main reasons. First, the airline industry was suffering from the economic downturns in 1990 and 1991. In 1991 alone, the industry's cumulative losses were $1.87 billion, which exceeded the total amount of profits the industry had ever earned throughout its 60-year history. American Airlines itself reported losses of $77 million in 1990 and $165 million in 1991. In terms of customer's flying, the dollar volume of pleasure travel grew only 8% in the 1989-91 period compared to 19% for 1987-89. The comparable figures for business travel were a 9% increase for 1989-91 in contrast to 28% growth experiences in 1987-89.
April 9th, 1992 American Airlines announced that their yields were too low and they were going to bring value back to air travel through a new pricing strategy termed, ‘Value Pricing'.
SWOT ANALYSIS :
Strengths
Problems:
Opportunity
Increase the demand for air travel through reaching more customers and increasing the frequency of travel per customer: There is already a growing percentage of Americans is using air travel. In 1991, 76% of American Adults reported that they had flown at some time in their lives and 32% had flown in the past year. The increase in American air travel can be seen in the table below:
The table implies that American's are increasingly adapting to air travel and this means that their is an opportunity for American Airline's to continue their expansion.
Price discrimination models: Price discrimination models provide an opportunity for American Airlines to capture the two main customer segments, business and pleasure travelers in the most profitable way. Using price discrimination models provides an increasing opportunity.
This provides an opportunity for American Airlines because the two segments have different demand fluctuations and buying characteristics and if American Airlines can capture both markets through different pricing fares then it will increase their yield per customer, smooth out overall demand fluctuations and achieve profit maximization. The differences can be distinguished by demand and buying values.
Threats:
The operating expenditure passenger and their operating margin are also significantly higher. American Airlines does not have the ability to compete directly through matching such low prices because they could never achieve such low costs, nor does the brand image of American Airlines compliment this strategy.
Key Issues
1. Value Pricing
The main objective of this pricing strategy was to provide ‘simplicity, equity, and value' for air travel, compared to the existing system with a multitude of ever changing fares and discounts.
Value Pricing:
Pros
Business travelers will benefit from ‘value pricing'. The advantages for business travelers is that, theyno longer need to worry about inflexible restrictions attached to reduced fares, forcing them to pay higher prices. Now they can get the advantage of being able to book at short notice but ensuring that they will still receive the same 38% off full Coach with no restrictions with any time fares. Furthermore, if they can book in advance they can pay even less.
Reduced Costs: American Airlines forecasts cost savings of $25 million per year through the reduction in the number of fares offered, as it will reduce its CRS from 500,000 to only 70,000. Secondly, as all flights will be priced based on the distance of the flight path, so the variable costs actually determine the prices, in theory providing higher revenue.
Cons
Price elasticity: Air travel has quite high price elasticity as a review found that the majority of estimates were between the range of -.8 and -.2, with the elasticity for business travel generally being less than unity, while that for pleasure travel typically exceeding unity. Therefore, leisure travel demand changes with changes in price more than business travel because of a price change.
American Airlines, the price sensitive customers will be highly dissatisfied by the new ‘value pricing' and they will be encouraged to switch to low cost airlines.
American Airlines will no longer benefit from the business travelers that were typically price insensitive but time sensitive and so prepared to pay the higher costs. This will have incremental affects on yield and profitability as the high fixed costs of airlines previously depended upon business travelers to buy higher priced tickets.
American Airline's yield and revenue assumptions are flawed because the value pricing is assuming that all present factors in the industry will remain the same but in reality competitors will match prices and travel agents will not be so cooperative.
Break Even changes: American Airlines would need to increase their sales dramatically in order to break even, which will be very difficult.
Pros
Cons
Recommendation:
Recommended that ‘Value Pricing' be adjusted and combined with alternative three, to focus on long haul flights and segmented pricing through service differentiation as despite ‘Value Pricing' being a very innovative pricing strategy it has many shortcomings. The ‘value pricing' must be embedded in a broader and consistent marketing strategy.
The ‘value pricing' aim to simplify fares through offering four fare structures should be implemented as this will reduce CRS costs and increase customer understanding of fare prices. However, the restrictions imposed should be reduced on the discount fares, otherwise customers will go to low cost airlines. Instead, it is recommended that fences be built between the different fares to prevent customers from switching from higher fares to discount fares through service differentiation, not just the transportation and a few marginal restrictions. Furthermore, American Airlines should focus on long haul flights as opposed to short-medium haul flights within America because it is within these flights that service differentiation is highly valued. In addition, if American Airlines can expand into more markets it will increase their market share and long-term profitability. This will also prevent the erosion of profitability in the airline industry because it will prevent a price war.
