Who is responsible for revenue? March 2001
Revenue on a plane is influenced by many different functions: network planning, which sets the schedule and assigns the fleet type; the sales force at each end of the route and in all the feeder markets, which negotiates contracts and launch promotions; the pricing function, which defines and monitors fares and restrictions; and finally revenue management, which controls capacity by allocating the right number of seats to each fare in each market for every flight every day.
If we look at how these functions have developed at major airlines over the last decade, they all have generally become highly sophisticated:
- Network planning has access to detailed data on origin/destination (O/D) and market share, receives timely and accurate route profitability reports, has network profitability tools that can simulate and assess different network scenarios, and has intelligent tools that enable the most profitable assignment of fleet types.
- Revenue management has been continuously improving forecasting techniques, and now uses advanced segmentation techniques, and has access to high–performance IT systems allowing the control of space at network level.
- Pricing can monitor competitors' prices in a timely way, and can simulate the impact of pricing decisions (own and competitors') and promotion campaigns.
- Marketing and Sales have detailed market share data for each O/D for every point of sale, possess timely and detailed advanced booking information, use segmentation to tailor performance–oriented contracts, and have a real multi–channel distribution network in place.
All this sounds great and it does represent a real advance. However, it seems that the price for this very high level of specialisation is that these functions tend to work as "silos" and that cross–functional management has lost ground. It is not uncommon to hear people from one functional department blaming other functions for lack of performance or for lack of understanding of "how things work".
Managing and measuring revenue
Nor is easy for a CEO to point to one specific person if revenue performance is below expectations, as so many people and functions influence it. If more revenue is needed, most people will look only to Marketing and Sales, not recognising that this is a cross functional challenge. And Marketing and Sales will typically react by using pricing and promotions in a quite undifferentiated way. So how can we manage revenue performance better? The first step is to be able to measure revenue performance.
Airlines typically use two basic tools to measure revenue performance:
- Route profitability reports
Although these help to show where money is made or lost in a network, they do not provide any particular insight into revenue performance — defined as the impact of all operational levers that can influence revenue. Thus, one route could be highly unprofitable even though its revenue performance is excellent. And such reports give no information whatsoever on the revenue improvement potential of a route.
- Revenue index
This is the typical incremental approach, where target revenue indexes are set on the basis of previous years' revenues. Most airline sales forces are measured and rewarded on achieving or beating the index. However, even if production increases and other factors are taken into account, an index will not say anything about absolute revenue performance and will not give any insight on possible performance gaps.
If new insights on revenue performance are to be gained, new metrics and processes are needed. Especially in a network environment, with a high share of connecting passengers, it becomes difficult to isolate parts of the network and find out whether they are doing well and, if not, what are the improvement levers.
A possible approach is to define new performance metrics that would make routes or markets comparable with each other — an internal benchmarking process. The different nature of competition in non–stop and connecting markets (markets are defined as O/D flows), means that two different metrics are needed:
- Non-stop markets
Revenue per ASK is the most appropriate performance indicator, as it reflects both yields and load factors. However, to make different markets comparable, two corrections need to be made. In a network environment, a significant share of the capacity on a route is "reserved" for connecting passengers, so that the "real" capacities (or "real" ASK) are smaller. Secondly, yields decrease with increasing stage length, an effect that can be filtered out with a regression curve.
- Connecting markets
Yield–adjusted traffic share of accessible market is one possible performance indicator. The accessible market is defined as the total O/D traffic minus the traffic flying non–stop. This might seem quite conservative, but reflects the fact that passengers flying non–stop can be diverted to a hub only by offering a substantial discount (if at all).
There is no "capacity" element in the metric, as there is no meaningful definition of capacity for connecting passengers. This case also needs two corrections. Yield deviation from the average yield should be used to correct the performance metric, so that the quality of the revenue is captured (as it is quite easy to "buy" market share in connecting markets). Secondly, here too, yields should be adjusted for different stage lengths.
How to compare revenue
These metrics can be constructed by combining data sources that are normally used in isolation, such as OAG schedule data, MIDT and revenue/traffic/yield information. performance across markets Assuming that the performance metrics have been calculated for the most important O/D markets, the next question is how these data should be used to identify revenue–enhancing actions. The first step is to compare markets that are in fact comparable — comparing strong markets with other strong markets, and weak markets with other weak markets. There are two main ways of segmenting the markets — by type of link, and by the "richness " of the traffic flow:
- Type of link
This reflects the structural competitive position in serving a specific O/D market. Possible segments are hub–to–hub, hub–to–strong spoke, hub–to–weak spoke, hub–to–competitor’s hub, spoke–to–spoke, and spoke–to–competitor’s hub. The slot position or the overall market share in a specific city will determine whether a spoke is strong or weak.
- "Richness" of the traffic flow:
It is easier to achieve better yields in markets which by their nature have a high share of premium passengers, i.e. less price–sensitive business travellers.
Apart from these two factors, any other difference in revenue performance can only be executional, i.e. something that can be improved by managerial decisions to act on one or several revenue drivers (pricing, schedule, capacity, etc.). In other words, comparing revenue performance and its drivers between comparable markets can reveal the reasons for any difference in performance, which can then be acted upon. The beauty of this approach is that quantitative targets can be set for each market.
How to manage revenue cross-functionally
To move from the traditional approach to a cross–functional means that key executives must adopt a new mindset on managing revenue performance. Instead of a marketing and sales–driven approach, they must adopt an O/D performance improvement approach. This requires a shift in focus:
- From local markets and accounts to the best balance between local markets
- From pure sales/pricing levers to a broader range of revenue–enhancing actions
- From incremental performance (the "index" approach) to the idea of absolute achievable performance (given the structural conditions).
In other words, it is necessary to take a more differentiated approach to increasing revenue performance, rather than pushing sales everywhere with the same intensity and methods. The full spectrum of actions should be considered, using the O/D performance metrics and their drivers as a platform for discussion, and to cut across organisational and functional boundaries.
A four–step process to manage revenue performance on an ongoing basis might look like this:
1. Identify and segment key markets
This is a one–off effort to select the markets to be included, and to define the performance metrics and the segmentation method (as described above).
2. Analyse performance drivers
At given intervals the performance metrics and their drivers are calculated and made available to cross–functional teams for a detailed analysis. It is important not to stop at the performance metric level, which is the benchmark, but to gain transparency on the different drivers as well (e.g., adjusted load factors, adjusted yields, traffic shares, shares of premium passenger traffic, frequency shares, shares of traffic sold in hub, etc.) and to look at the performance of every single flight serving a specific O/D market. This way, some potential issues can be identified, like weak flights within one route, directional imbalances in traffic or capacity, directional imbalances in yield, the effect of seasonality on load factors and yields, spill effects, etc.
3. Diagnose and set targets
The analysis enables the cross–functional teams to identify best performance through internal, or if possible external, benchmarking. Then the key drivers of the performance gap can be identified and targets set for each under–performing market.
4. Develop market-specific revenue enhancement measures
In this step actions are developed by brainstorming, formulating hypotheses on improvement levers, doing the appropriate validations and finally defining an action plan with all measures and responsibilities. Obviously, some actions will have to be traded off against each other — for example, price changes in a local market might trigger changes in the capacity allocated by the revenue management system, improving a specific high–potential connection might negatively affect other connections, etc. This is where functional expertise and IT tools can help make the best trade–offs, once that the full picture is clear.
This market–by–market cross–functional process for revenue performance management is not a substitute for functional excellence, but rather a way to complement it. It can contribute significantly to improving profitability, especially if an airline operates a large network with many markets served and significant connecting traffic.