Optimal fare price differentiation with demand leakage in airline industry

Abstract

Airlines have been utilising differentiated fare pricing for more than four decades as one of the widely used revenue management (RM) tool which mainly segments the cabin capacity into multiple fare classes often distinguished using fare prices. Studies have shown that there can be significant augmentation in revenues from differentiated pricing, however, most studies have assumed that the market segmentation is perfect and demands observed in the perfectly segmented markets using differentiated prices are deterministic. In perfect market segmentation, there is no demand leakage between the market segments, and therefore, customers do not cannibalise (move) between market segments. It is not uncommon to notice that the market segmentation is seldom prefect with no exceptions to airline industry. In the airline industry, passengers are expected to cannibalise between fare classes. This research addresses the issue of establishing an integrated framework to optimise differentiated fare prices, and seat inventory control for an airline which experiences demand leakage. Mathematical models are proposed for an airline which experiences the price dependent stochastic demand whose distribution is known, and for the situation when the distribution of the price dependent stochastic demand is unknown. We analyse the models to outline an integrated optimal control framework for differentiated fare pricing, and seat inventory control decisions for an airline that experiences the demand leakage between its fare classes. Numerical example shows that the proposed integrated framework significantly improves the revenue gains of an airline.