Forecasting for Airline Revenue Management

Describes how revenue management system is used in the airline industry to optimize profit... RM cannot work without adequate forecasts of capacity, demand and prices ... improvement in forecast accuracy significantly improves revenue ... details all the challenges that the airline industry faces. It is a common knowledge that the purpose of the airlines industry is to profitably move people from one airport to another. Although on the surface it looks very simple, it is very difficult to do it. Airlines have to make strategic and operational decisions, considering numerous factors and forecasts. Strategic decisions include such things as how many aircraft to buy (fleet sizing) and where to fly (network structure). These decisions are called strategic because they have a long-term impact on all aspects of the airline business, and they are costly to change. Elaborate market share projections and long-term demand forecasts are important inputs for such decisions. There are many cases where airlines got bankrupt because of ill-conceived strategic decisions. Airlines also have to make numerous operational decisions on a daily basis. Some of the most financially rewarding operational decisions are made using revenue management techniques. As Robert Crandall, former Chairman and CEO of AMR and president of American Airlines, puts it, management is the single most important technical development in transportation management since we entered the era of airline deregulation in 1979. In this article we will focus on the airline revenue management techniques and the supporting forecasts. WHY FORECAST? To address this question, we present a brief overview of what is revenue management in the airline industry. Then, we will highlight the importance of revenue management and forecasting accuracy. REVENUE MANAGEMENT The short answer to the question, why forecast, is to support revenue management (RM). So, what is revenue management? The main objective of RM is to sell the right seat to the right customer at the right time for the right price to maximize profit. To achieve this, the airlines need to sell the optimum product mix. On the surface it might seem that the airlines sell one product, which is a seat on an airplane going from point A to point B. In fact, an airline sells numerous products. A single flight may have hundreds of fares each is associated with only one product. The underlying premise of the practice of revenue management is that there exists an optimum mix of products that can maximize the airline's profit. The mechanism the airlines use to capture this optimum product mix is simply the accept/reject decision made by the airline reservations system. It is important to note that this mechanism does not require adding new airplanes nor does it require adding more flights. It does not create additional demand and does not change the current prices. Instead, it strives to match the passengers' demand with the airline's supply of seats in such a way that maximizes the airline's profit from existing assets. The accept/reject decisions are typically based on the results of solving one or more optimization problems, collectively called the revenue management problem. The fundamental data components of the revenue management problem are price, demand and capacity. Forecasting helps to estimate these components. FINANCIAL IMPACT Revenue management significantly adds to the airlines' income. According to Robert Crandall, RM adds $500 millions a year to the income of American Airline. It adds about $100 millions to the income of United Airlines (UA). In general, airlines realize additional income as a result of RM anywhere between 1 % and 10%. Forecasting accuracy plays a very important role in realizing income from the RM system. Studies show that a 10% reduction in forecast error increases revenue by 0.5%, $80 millions additional revenue a year for a $16 billion airline e. …