Executive Summary

Executive Summary
American Airlines (AA) strategic approach to maximizing revenue from ticket sales is achieved through
yield management and strategic pricing. In order to achieve as perfect thirdsecond-degree price
discrimination as possible, AA utilizes quantitative and qualitative tools to optimize revenue generation.

When examining the Chicago-West Coast pricing decision, the choice of whether or not to react to
Continentals discount fare depends on the elasticity of the AA discount customer demand curve. If the
curve is relatively elastic, AA should consider lowering fares by 10-20 to capture greater revenue
through increased ticket sales. However, if customer demand for AA tickets is inelastic, then a price
decrease would result in less revenue due to a larger proportion of loss on originally priced tickets.
Under this reality, it would be wise for AA to hold their discount ticket price at $177.

A similar demand analysis framework was applied towards the New York-San Juan pricing decision.
Focusing on Leisure travelers, who are targeted for the restricted discount round-trip tickets, AA must
determine how to react to Easterns price discount in order maximize revenue. Two questions, if
answered, would help AA determine the most appropriate revenue maximizing pricing strategy:
1. What proportion of New York-San Juan travelers on American are Leisure?
2. What is the demand curve elasticity of leisure travelers?
Upon examination of the hypothetical 100-seat two-fare pricing scenario, we recommend allocating 30
seats for full-fare customers. When met by demand, this results in maximum revenue of $1980. There
is, however, a risk of choosing this allocation. If full-fare demand is less than 30, AA gives up unfilled
full-fare seats to those discount-fare customers that would fill them. If AA is risk adverse, it should
consider allocating full-fare tickets closer to 10. This would sacrifice potential greater revenue but
ensure all seats are generating revenue.

American Airlines Strategic & Pricing Decision MEMO

American Airlines Strategy
Deregulation of prices in the airline industry that allowed airlines the freedom to enter and exit routes
freely and alter fares they chose has made price discrimination possible and increased the complexity by
which airlines such as American Airlines maximizes profitability. AAs main strategic decision was to
employ revenue management through price discrimination and yield management in order to sell the
right product to the right customer at the right time and at the right price.
Secondary tactics to aid revenue management and boost overall profitability include:
1) AMRs SABRE distribution system that strengthens AAs presence in the ticket distribution
business
2) Frequent flyer programs to build brand loyalty and reduce a certain level of complexity in yield
management by having a stable customer base
3) Customer service in response to the implementation of hub-and-spoke systems that have
generally increased passenger flight demands who are now willing to pay for an opportunity to
travel, origin to destination with one carrier.
Yield management essentially allows American Airlines to effectively manage their large database of
customers and their reservations inventory (i.e. ticket classes), and includes a multitude of functions
that allows AA to figure out how many seats to make available at each of the listed fares and classes
through analysis of the following variables:
1) Origin-Destination
2) Time of Year and Days of Week
3) Remaining seats available
4) Remaining time until departure
Full fare versus discount fares are then offered based on the demand of each given variable. The key
component to managing fare structures (in this case, price discrimination) that include both full and
discount fares is to minimize revenue dilution by introducing restrictions such as advance purchase,
minimum stay requirements, cancellation penalties, and so forth.
In order to be successful in determining and optimizing the trade-offs associated with yield
management, AA needed to implement the following quantitative tools through both an automated
American Airlines Strategic & Pricing Decision MEMO

system and a revenue management organization that would at times, manually set prices and make
changes to system outputs. These tools include:
1) Demand data collection
2) Demand modeling
3) Demand forecasting
4) Price optimization price discrimination
5) System implementation and distribution
Yield management at American Airlines was successfully able to adjust levels of prices for differences
between forecasted and actual demand by indexing fare class to buckets and implementing initial
authorization levels for the different buckets. This allowed revenue to be maximized where possible,
while recognizing the inevitability of cancellations and no shows and therefore also allowing
overbookings to occur at a certain degree.
Chicago West Coast Pricing Decision
American Airlines is not able to optimize its capacity utilization, especially during fall months, because
the competitors are either providing better flight schedules (United) or providing lower fares
(Continental). The challenge for American Airlines is how to stimulate additional passengers for its
existing flights while also ensuring that the existing customers keep on paying the higher existing fares.
American Airlines, in offering reduced prices for new passengers would not want to reduce the price
that existing customers are paying. Hence, American Airlines need to segment its customers in two
categories (see exhibit 1):

Customers who are willing to pay the existing high fares and hence would face an inelastic
demand curve
Price sensitive customers who American Airlines hopes to capture in order to improve its load
factors by offering a lower fare. These customers would face a more elastic demand curve

If the demand for discount tickets is inelastic (-1<E<0), then American should not reduce their discount
ticket price because doing so will result in less revenue. The revenue gain via an increase in tickets sold
by reducing price is less than the revenue lost on existing customers that were willing to pay a higher
ticket price. However, if the demand for discount tickets is elastic (E<-1) American should consider
American Airlines Strategic & Pricing Decision MEMO

reducing their discount ticket price closer to Continentals price of $159 in order to capture more
customers and gain revenue. Contrary to the inelastic demand situation, the revenue gain via an
increase in tickets sold by reducing prices is more than the revenue lost on existing customers who were
already in the market. So which do you think it is? Elastic or inelastic? Dont just present the theoretical
options make a call on which one you think it is.
New York-San Juan Pricing Decision
When tackling the New York-San Juan pricing decision, it is necessary to examine both the type of
customers that American Airlines serves on this particular route as well as what disruptive impact, if any,
Eastern Airlines price discount has on Americans revenue stream.
The New York-San Juan flight route is American Airlines largest market when measured in daily
passenger capacity. The primary travelers on this route are local residents of either the New York or
the San Juan area. These local individuals for the most part are segmented into two groups: Business
travelers who handle matters in the highly commercial area of New York City (and vice versa) and San
Juan residents who travel to New York to visit friends and family (and vice versa). Business Travelers
value short turnaround (1-4 day) non-restricted roundtrip tickets that allow them to reserve last-minute
tickets as well as leave and return within the same business week. American Airlines would be wise to
protect these customers from switching to other airlines as they generate the most revenue per
passenger. How do we do this? Family and friend travelers value one-way unrestricted tickets that allow
them to make spur of the moment reservations without definite return plans.
Secondary Up-Line passengers are mostly those individuals enjoying leisure or vacation travel. Not
always could be business passengers from Europe These passengers frequently make their
reservations weeks or months in advance and may be selecting travel locations based on the airline
deals that are available. A price discount of $32.00 on weekday restricted ($230-$198) and $22.00 on
weekend restricted (270-238) roundtrip flights between New York and San Juan would be very attractive
to these individuals. But if theyre up-line transit passengers, they wouldnt qualify for these rates
From a revenue perspective, these price-sensitive travelers are less valuable to American, although they
should not be disregarded as the revenue they generate is greater than not selling out a seat at all.
In order to determine the impact that the Eastern price discount has on American we must need the
answers to two questions:
American Airlines Strategic & Pricing Decision MEMO

1. What proportion of New York-San Juan travelers on American are Leisure? Why just leisure?
The restrictions on the tickets?
2. What is the demand curve elasticity of leisure travelers?
An answer to the first question will help determine, from a capacity perspective, how valuable Leisure
travelers are to American. If leisure travelers make up a relatively small percentage, American may not
need to be concerned with only a small amount of price-sensitive customers temporarily switching to
Eastern. It can be argued that some of these deal-seeking customers still may want to remain with
American to leverage their vast flight Hub-and-spoke network and remain with the same airline from
origin to destination. If leisure travelers account for a relatively large percentage of overall passengers,
American may want to engage in a competitive response on price in order to ensure large amounts of
seats are not left vacant on its flights. The case says that they are about 1/3 of all passengers on this
route
However, from a revenue perspective, even if the percentage of leisure passengers is large, American
may be wise to not react and continue to maintain a higher discount price. This depends on the
elasticity of the leisure traveler demand curve (refer to Exhibit 1). If the leisure traveler demand curve is
elastic, a price discount from America would generate more revenue by adding more passengers than it
would lose by reducing the ticket price of travelers that would choose American regardless. Dilution?
Why does this matter if we have restricted fares? However, if the leisure traveler demand curve is
inelastic, a price discount would sacrifice more revenue from those who would have paid the higher
discount price than it would gain from adding additional passengers. Why do you think leisure travelers
have inelastic demand? Doesnt the fact they get discounted rates already hint at what their demand is?
Answers to these two questions will help Mr. Santoni select the revenue maximizing pricing decision on
the New York-San Juan route. What about stimulation effects?
Seat Allocation and Reservation
There is unlimited demand for discounted seats, between 10 to 30 full fare seats demanded, and once
full fare seats are allocated, they cannot be readjusted to fill the plane
Allocating 30 seats given demand between 10 and 30 is a revenue maximizing strategy with a much
higher upside and only slightly lower downside than allocation of 10 seats. Maximum revenue achieved
American Airlines Strategic & Pricing Decision MEMO

when bucketing for 30 seats is $21,900 and for 10 seats is $13,900, while the minimum revenue
achieved in both scenarios is $11,920 and $13,900 respectively (see Exhibit 2)
We recommend allocating 30 full-price seats because the difference of maximum revenues is $8,000
and favors bucketing 30 while the difference of minimum revenues is much lower at $1,980. You need
to be thinking of the broader set of tradeoffs depending on the full range of potential full fares that
purchase the tickets.

Good. There was a bit of confusion of interpreting the facts from the case, but be sure that you make
recommendations dont just propose what should be done, make assertions about what you think the
right answer is.
Executive Summary

[Exhibit 1]

American Airlines Strategic & Pricing Decision MEMO

[Exhibit 2]
Allocated
Full-Price
Seats
Demand for
Full-fare ticket
# of Discount
Passengers
Revenue Revenue Lost
30 30 70 ( ) ( )
$21900

No loss of revenue
30 10 70 ( ) (

Lose 20 certain
discount passengers


In this strategy, the maximum revenue is $21,900 and the minimum revenue is $11,920. The potential opportunity cost is $1,980.

Allocated
Full-Price
Seats
Demand for
Full-fare ticket
# of Discount
Passengers
Revenue Revenue Lost
10 30 90 ( ) ( )


Opportunity cost of
full fare less gain
from discount pas.
( ) (
)
10 10 90 ( ) ( )

Full plane, no loss

In this strategy, the maximum revenue is $13,900 and the minimum revenue is $13,900. The potential opportunity cost could be $8,000.