Airline revenue management with dynamic offers : bundling flights and ancillary services

Abstract

Airline revenue management will have to adapt to a new world of airline retailing enabled by the New Distribution Capability. One area of interest is Dynamic Offer Generation (DOG), in which airlines respond to every booking request in real-time with a customized set of offers and prices. In these offers, ancillary services may be bundled with the flight. Selecting and pricing these offer sets represents a new joint pricing and assortment optimization problem in revenue management. We propose a formulation for the dynamic offer generation problem and study the robustness of its solution. We derive conditions under which selling the flight in a bundle with an ancillary service increases total net revenues over selling the ancillary as an optional add-on. We show how this model integrates with traditional revenue management systems. We simulate DOG under competition in the Passenger Origin-Destination Simulator (PODS) to show the potential revenue benefits.

The simulation results show that bundling the flight with an ancillary service can generate higher revenues than selling both services separately. This is especially true when the ancillary service is highly valued by passengers, can be provided at low cost by the airline and passengers make purchase decisions rationally. We also show that price segmentation between passenger types can increase revenue and that there is a first-mover advantage for airlines to implement dynamic offer generation mechanisms. When one of four airlines implements DOG, it can increase its total net revenue by up to 2.6% through ancillary bundling alone and up to 12% in combination with dynamic flight pricing. Most of these dynamic flight pricing gains are attributable to undercutting the existing fares offered by airlines with traditional RM systems. When all four airlines use DOG, their revenue increases by up to 0.9% through bundling alone and 7% with dynamic pricing.

Under more realistic market conditions, the simulated net revenue gain of DOG reduces to 1.7% when all airlines implement it.