What's on the table : revenue management and the welfare gap In the US airline industry

Abstract

This thesis explores the potential improvements in Revenue Management from two distinct perspectives. The first piece of work is to explore the potential operational improvements, in which we aim to develop competitive and robust dynamic pricing rules in a market whose evolution can be highly volatile and hardly predictable. We do specifically by considering the 'classical' single product dynamic pricing problem allowing the 'scale' of demand intensity to be modulated by an exogenous 'market size' stochastic process. This is a natural model of dynamically changing market conditions. We show that for a broad family of Gaussian market size processes, simple dynamic pricing rules that are essentially agnostic to the specification of this market size process perform provably well. The pricing policies we develop are shown to compensate for forecast imperfections (or a lack of forecast information altogether) by frequent re-optimization and re-estimation of the 'instantaneous' market size. The second piece of work is to understand the potential first order changes. We choose US airline industry to investigate and measure its resource allocative efficiency. The past decade has been a difficult one for the US airline industry. On the one hand, airline profits have been highly variable with net losses over the last ten years standing in the tens of billions of dollars. On the other hand, consumers continue to complain of predatory pricing and other such tactics (See Wirtz et al. [2003]). Our goal here will simply be to get an estimate of what is possible moving forward. We approach this task from an econometric perspective: we produce a status-quo dollar estimate of total welfare in the US airline industry. We then compute a number of benchmarks that we posit are conservative estimates of what optimal welfare in the industry might look like under mechanisms resembling existing dynamic pricing practice. Our benchmark estimates will leverage a unique, proprietary data set on ticket purchases via the 'micro' BLP approach Berry et al. [2004]. We will show that the welfare gap is surprisingly large, raising the possibility that a combination of innovative selling mechanisms and legislation can make a dramatic difference to airline profitability and consumer satisfaction alike.