Understanding How American Airlines Sets Pricing

There are a lot of people who think they know how to set fares better than the people at American Airlines. This chorus has grown somewhat louder lately as American has aggressively matched ultra low cost carrier (ULCC) pricing. Shouldn’t American be able to get more than those bottom-feeders? Doesn’t it hurt the brand to price so low? People are asking these questions, and on the most recent quarterly earnings call, President Scott Kirby gave an in-depth look at how the airline views pricing. There is absolutely a method to American’s madness.

American Low Fares Prices

It’s true that American has been aggressively matching ULCC pricing where it has nonstop overlap. As I write this, I can buy a ticket two hours from now from LAX to Dallas for only $88.10. It’s really cheap. My in-laws bought a roundtrip from Chicago to LAX a couple months in advance for about $80 each. (They were just here last week.) It’s incredible how fares have fallen in markets where there is nonstop ULCC competition.

But does American really need to be that low? Many would say no, but Scott Kirby would say yes.

The statistic that Scott trotted out that stopped people in their tracks was this.

87 percent of our unique customers fly us one time per year or less, and they represent over 50 percent of our revenue.

Yes, that means that 13 percent of the travelers account for a whole lot more revenue. Those are the elites, the road warriors. Those are people that American caters to in a variety of ways. But those 87 percent of other customers? American needs those people to make sure it can offer the depth and breadth of schedule that the road warriors need to stay loyal. It’s an important segment, and it’s a segment that is much more price sensitive.

The True Measure of Competition
But isn’t this overkill, you might wonder? The ULCCs all talk about how they’re pulling people off the roads. They don’t fly frequently in these markets. They just want to help a few people who can’t afford to fly. Of course, the impact is much greater than that. Here are some more interesting stats from Scott.

If you measure our overlap as our domestic [available seat miles] that have nonstop competition from someone, 28 percent of our domestic ASMs have nonstop competition with Spirit. That is much larger than our domestic overlap with Delta and United. Frontier, similar. Frontier, before American filed bankruptcy, had 1 percent overlap with the American Airlines network, and they’ve grown that by 1,000 percent. They now have 11 percent overlap.

And this brings up a good point. It’s not all that common for the legacy carriers to overlap on nonstop routes. Sure you have United and American in Chicago, more in New York in LA too, but other than that, competition is going to involve connections. With the ULCCs, that’s not the case. Spirit in particular has been aggressive at going into markets that are already served by legacy carriers. But it gets even more involved than that.

American’s nonstop flights are nearly always touching a hub on one end. That means these flights have a big mix of local and connecting passengers on them. For the ULCCs, it’s different. They tend to be almost entirely full of local, nonstop passengers. So while Spirit might only have one flight a day in a market like say, Dallas to Kansas City, it’s carrying as many local Dallas to Kansas City passengers as three American flights on average, says Scott. It’s just that American has a bunch of connecting passengers to fill the rest of the seats.

All of this means American is not going to mess around and let the ULCCs gain any more than they already have. When it comes to nonstop markets, American is going to match on price. Wall Street has been freaking out about this, but this isn’t just about having cheap fares on every single flight out there. This is where revenue management comes into play.

American files these super low fares in its lowest fare buckets. And it only allows the fares to be sold on flights that aren’t expected to be filled with higher fare passengers. So, people who are truly price sensitive will be pushed to off-peak flights. (My in-laws, by the way, left to go home at the ungodly hour of 5am on Saturday.) That means those off-peak flights will have higher load factors. Yes, the fares are lower, but American thinks its managing this appropriately. As Scott notes, its unit revenue performance in these competitive markets has been similar to what it’s done in the rest of the system.

Bring on the Product Differentiation
All this being said, American isn’t happy with the status quo. It wants to cater to those truly price-sensitive people with a product that matches their interests. Or as Scott puts it:

…doing more to further disaggregate the product, and really move to a world where we can offer fares that compete with low-cost carriers, and have a suite of attributes that are appropriate for those prices, and then fares that have a greater suite of attributes, and give our customers choice. It’s all about giving our customers choice.

Does this sound familiar? It should, because it’s the idea behind Delta’s Basic Economy. We don’t know anything about how American wants to implement this, but hopefully it’s better than the way Delta does it. I don’t see a problem at all with offering a fully stripped down fare that doesn’t include a carry on, a seat assignment, etc. But the operational implementation is the biggest issue with that.

Now that the US Airways code is gone and American is selling to the public as one airline, the airline can start to make these kinds of changes. Travelers can expect to continue to see these aggressively low fares, especially at off-peak times, but in the future, these fares will be tied to a truly unbundled offering. As far as American’s concerned, that’s the right way to price. And it’s likely to deter ultra low cost carriers from expanding in American’s way when there’s lower hanging fruit elsewhere.

[Original store photo by Mtaylor848 (Own work) [CC BY-SA 3.0], via Wikimedia Commons]

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15 Responses to Understanding How American Airlines Sets Pricing

  1. grichard says:

    This makes sense, I guess. But it seems to miss the lesson that the big airlines have finally sort-of learned: don’t go flying flights where you expect low load factors in the first place. Instead of trying to fill the empty seats at loss-making fares, downsize the metal or redeploy it elsewhere.

    • Jeffery says:

      This is more yield management and competition response than pure capacity. Cost are higher on a legacy in general, but in particular on a connecting pax vs a nonstop. As cranky pointed out though legacies need to off a robust network to its elites and pulling in a portion of the low cost crowd into flights that are off peak versus dropping the flight or losing money on it makes sense. The ulcc matching fare isn’t a problem as long is it is primarily a incremental revenue replace mostly empty seats vs cannibalizing higher paying options

      • grichard says:

        I take your point, and obviously the answer is somewhere in between. I guess my response is that they *don’t* need this particular flight to provide adequate schedule choices to their frequent fliers, since their frequent fliers are–by definition–not filling it.

        If they routinely have a bunch of seats that slide down into these super-low-fare buckets, then they have too much capacity on that route and should kick it down to a regional flying something smaller.

        • grichard – But who says the frequent fliers don’t really need a flight? Frequent fliers never fill entire flights. It’s a combination of a bunch of different segments that fill an airplane. But take the 5am flight from LAX to Chicago. That’s a full hour earlier than United’s first flight, and it enables someone to be in Chicago for a lunch meeting. That flight is a real differentiator that might create true value for some frequent fliers. Will that fill the entire flight? No way, and on the margin, most leisure travelers aren’t going to pick that flight. So if American can discount fares to get people on that flight, then it might be the right strategy.

  2. TDR says:

    Left unsaid — they are also hoping they can push the ULLs out of those markets. Before B6 started to cover my usual route, AA was priced at over $400. Now: $120. I don’t want to go back to the monopoly fares.

    • Noah says:

      JetBlue PIT-JFK is a great example. JB came in, fares crashed down. US threw capacity and lower prices and FF bonuses. People flew US as a result. JB dropped the route.

  3. David SF eastbay says:

    We know by “our unique customers” he means cheap low-life scum suckers who want everything for nothing.
    Which could also mean those who want to be upgraded to First or Business but not want to pay for it.

    The whole airline industry seems to have turned into a ‘I want everything for nothing’ business. How to people expect airlines to still stay in business and give them everything for nothing? And how much of that is the airlines fault in the first place?

    DL/UA/AA want to be every where doing everything the other guy wants to do, but airlines like Frontier, Spirit, Allegiant seem to pick and chose where the market is hot and make money while they can. Maybe if DL/UA/AA stop trying to do what each other does, they may fair better by focusing in on their strong markets only.

  4. A says:

    To me it sounds like competition means that the legacy (AA) has more capacity on a route than may have previously been needed. Back in the early days of Priceline I routinely got tickets for $50-100 on routes when there were tons of empty seats and the airlines just wanted to get something. That all ended when capacity was drastically cut post 9/11.

    I understand that AA doesn’t want to lose ground to a ULCC and targets those routes but if you have to sell that 5am flight so cheap to fill the seats why not drop the flight? If the intent is to starve the ULCC and get them to drop the route, that’s fine, but don’t give me any BS about caring for those people that fly AA once a year stuff. This is nothing new and all the legacies have done it one way or another when threatened.

  5. MeanMeosh says:

    “I don’t see a problem at all with offering a fully stripped down fare that doesn’t include a carry on, a seat assignment, etc. But the operational implementation is the biggest issue with that.”

    The operational implementation is a significant issue, but perhaps not the only one. AA has been aggressively price cutting for months out of Dallas now, for example a $111 round-trip to LA that was advertised a while back. If AA does decide to implement a “Basic Economy” type fare, are we going to see the standard “Choice” fares jacked up by $50, with the current $111 roundtrips to LA restricted only to the stripped-down buckets? If so, it’s going to come off as taking away benefits that were previously included, which isn’t going to go over very well. Hopefully AA will try to be innovative about this, at least.

  6. Prashanth Kuchibhotla says:

    The 87% passengers flying AA at most once an year was the key insight. Co-incidentally this weekend’s Financial Times magazine section had an article on Advertising and quoted research circa 2010 that the vast majority of buyers are “light buyers”, those who buy a product relatively infrequently. Jibes with AA’s numbers.

  7. jonathan reed says:

    The experience of occasional flyers on legacy carriers is crappy. So an occasional flyer a t AA on a cheap ticket is not getting a superior product at a cheap price. Carriers like Hawiaan, Jet Blue and Virgin America realize this and offer a better experience to occasional flyers, without necessarily having to offer a cut-rate price.

  8. Kilroy says:

    The key takeaway for me here is that AA knows that its 5a flight on a given route orobably isn’t going to have as much high dollar demand as its 8a flight on the same route will have.

    Even without competition from ULCC(s) on the route, AA would still probably have to price the 5a flight a bit cheaper, just to make enough price sensitive pax choose the 5a instead of the 8a, such that the 5a flight still has enough ticket revenue (lower prices per seat than before, yet more butts in seats) to be worthwhile, while the 8a flight may have a few more empty seats but with higher prices. With ULCC competition, AA cuts fares on the 5a flight even more.

    I’d really like to know how AA decides to throw in the towel on a given pair of cititles and cut capacity back.

  9. iahphx says:

    Obviously, the idea that Scott Kirby doesn’t know how to “price” AA is absurd. Anyone who knows the history here knows he’s a true pricing genius. He figured out how to stay alive in PHX when WN was trying to kill little impoverished America West after the 9/11 attacks. He later drove WN out of PHL when it thought US Airways was dying (AWA bought US and drove them out). And there are countless other examples of low fare airlines being driven out of Kirby’s markets. There is certainly method to the “madness” that outsiders don’t appreciate.

  10. Ed says:

    The problem is not the 87%. The problem is the paltry low number of 13% recurring passengers (elites, etc.). American needs to increase that number. Get it to 20-30%. Then, American no longer has to worry about the cheapskate kettle who flies American once a year to Disneyland.

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