Yield Management¹ could easily turn out to be the most important pricing breakthrough of the 20th Century-Professor James Makens, Wake Forest University (1)

… look to yield management at the airlines as the model for future pricing in fields as diverse as health care, telecommunications, consumer financial services, insurance, hotels and government services. Yield management techniques will rewrite the supply-and-demand equations that determine service availability and price (2)

[Yield Management] promises to spearhead a revolution in pricing strategies during this decade (3)

Yield Management is the single most important technical development in transportation management since we entered the era of airline deregulation in 1979-Bob Crandall, former CEO and President of AMR and American Airlines (4)²

We estimate that yield management has generated $1.4 billion in incremental revenue in the last three year years [for American Airlines]…  We expect yield management to generate at least $500 million annually for the foreseeable future-Bob Crandall (4)

… our competitors used …  Yield Management in every one of our markets, and they pushed us straight towards bankruptcy … . Where did we go wrong? …  we didn't get our hands around the Yield Management-Don Burr, former CEO of People Express Airlines (5-8)

If I were in charge of the antitrust division, I would damn well see if I could build a case that yield management is predatory pricing—Alfred Kahn, former Chairman of the Civil Aeronautics Board under President Carter and known as the father of airline deregulation (9)

Yield management as it applies to airlines is the control and management of reservations inventory in way that increases (maximizes, if possible) …  profitability, given the flight schedule and fare structure. [emphasis added] (4)

Revenue Management is the art and science of predicting real-time customer demand at the micromarket level and optimizing the price and availability of products (8).

The methods and information used by firms in the travel industry that govern the range of products they offer for sale, the number of sales they make, and the prices they charge have undergone dramatic change in the past 30 years. As noted in the above quotes, these changes have revolutionized the travel industry and are penetrating other industries as well.

Whereas some of these decisions were once based on intelligent "rules-of-thumb," they now draw on sophisticated mathematical models. In some cases, the advances in decision support tools in combination with advances in electronic distribution and management of inventory have enabled travel firms to offer and manage products that would not otherwise have been possible. Further, the financial gains made possible by these developments, initially known as yield management (YM) and later as revenue management (RM), have been extraordinary.

This article provides an historical overview of why and how this transformation occurred. Much of the discussion on the early stages of yield management is oriented towards the airline industry, as it provided the initial setting for the early innovations-innovations that soon spread to other industries. As yield management evolved into other industries and became known as revenue management, the discipline broadened from optimizing capacity controls (e.g., the maximum number of sales that were allowed at previously established prices) to include pricing optimization (e.g., determining what prices should be). The latter portions of this article are oriented around the expanding practice of the discipline and its adoption by other segments of the travel industry.

Often misunderstood, yield or revenue management has now attained a prominent position among the strategies and tactics travel companies use to obtain a competitive advantage over their rivals. As might be gleaned from the quotes above, it is a relatively new way of doing business and many believe it to be an extraordinarily powerful technology. CEOs of companies that invested in it have extolled its virtues as well as its importance for achieving better financial returns. This article provides an overview of what revenue management is, how it evolved in the travel industry, and why it attracts strong interest.

It is frequently suggested that the science, if not the practice of yield management originated in the US airline industry in the early 1980s, shortly after it was deregulated in 1978. In fact, the early stages of yield management date back quite a bit further, probably to the 1960s. Until 1985, however, the practice attracted limited attention, was narrow in scope, and remained within the airline industry.

For many years, it would not be unusual for 15% or more of those who purchased airline tickets to fail to show up for their flights. In part, this occurred because unused tickets were fully refundable.³ For flights in high demand, more tickets would be sold than there were seats on the plane. Known as overbooking, this practice was routinely carried out by the airlines but it did not attract widespread attention until Allegheny Airlines did not allow Ralph Nader to board his flight in 1972. Nader sued Allegheny and the lawsuit eventually went to the US Supreme Court in 1976 (10). Overbooking decisions based on mathematical models that seek to maximize financial returns subject to customer service constraints constitute a core element of many airline revenue management programs. Indeed, the first phase of revenue management essentially consisted solely of overbooking.

Until 2000 or perhaps even later, most airline yield management departments did not set prices, but rather focused on controlling the availability of reservation or seat inventory at different prices with the objective of maximizing net revenue. The actual prices at which tickets could be sold were determined by Pricing Departments. Although Yield Management had no responsibility for setting prices, it determined which fares and how many tickets at each fare could be purchased on each flight. In part, this resulted from the organizational structure of most airlines, whereby the Pricing Department and the Inventory Control or Yield Management Department, were separate.⁴ Indeed, in 1985 when American Airlines launched its Ultimate Super Savers fares-discounts of up to 70% with restrictions such as 30-days advance purchase, 7-day minimum stay, and only partially refundable-enabling the airlines to compete for passengers in radically new ways, its yield management department was not made aware of the new fares until they were announced to the public. This organizational decision resulted in significant revenue dilution. The fares stimulated so much demand, so quickly, even for flights 6-12 months in the future, that American's yield managers could not react fast enough to reset fare and booking controls on all flights to limit the sale of Ultimate Super Saver fares to appropriate levels. Seats that could have been sold to business travelers who were willing to purchase tickets at higher fares, but would not do so until closer to the date of their flight's departure, were instead occupied by those who purchased fares for up to 70% less. Many flights generated less revenue and profit than they otherwise might have.

Prior to the late 1980s and the adoption of revenue management by travel firms other than airlines, yield management decisions were essentially limited to two decisions:

• the number of reservations to accept for a flight;
  
• the fares, previously established by the pricing department, that should be offered for purchase to potential customers for a flight at various times prior to departure (the actual setting of fares was thus done outside of yield management; yield management only controlled which of the fares were available for purchase).
  

As we will soon discuss, one of the most innovative as well as revenue enhancing elements of airline yield management programs was that by introducing purchase restrictions on airline tickets-often termed fences-a single product could be sold, simultaneously, at multiple prices.

Yield had a specific meaning in the airline industry, being related to revenue in two ways:

1. Revenue per available seat-mile or revenue per available seat-kilometer (RASM and RASK) provided a measure of revenue per unit of capacity.
   
2. Revenue per passenger-mile or revenue per passenger-kilometer (RPM or RPK) offered a normalized measure of fares paid.
   

Because the two types of reservation controls noted above had clear and direct impacts on both measures of yield, the term yield management seemed apt.

In the late 1980s and early 1990s, as the practice of yield management spread to hotels, car rental firms, passenger railroads, cruise lines, and other segments of the travel industry, the phrase "yield management" was often viewed as airline jargon. Other companies typically focused on revenue and profit, not yield. The term became increasingly controversial. Even as they embraced its concepts, many sought a different label for the practice of revenue maximization through inventory allocation controls.

The search for a new label may well have been accelerated by the airline industry's financial difficulties in 1990, 1991, and 1992. Table 1 highlights the financial difficulties experienced by the largest seven US airlines during these years. With some exceptions, the airlines generally lost at least several hundred million dollars each year and sometimes much more than that (11, 12). The seven airlines combined for a loss of more than $7 billion during these three years.

Revenue management, a name far more industry neutral, began to gain favor. References to revenue enhancement and revenue management replacing yield management can be found as early as 1990 and began to proliferate thereafter [13, 14].

For many, the desire to "rebrand" yield management dovetailed nicely with the desire to broaden its scope to include a wider array of reservation inventory controls than used by airlines, explicit recognition of variable costs, and price optimization (that is, the determination of the best prices to offer). For example, cruise ships might offer 8-12 cabin categories; cruise line yield management inventory controls explicitly considered the financial impacts of alternative upgrading (and upselling) policies when taking reservations, such as allowing some customers to make a reservation for a less expensive cabin category but guaranteeing them accommodation in a more expensive cabin category. Yield management also led cruise lines to reevaluate and modify the price differentials between cabin categories, as supply and demand imbalances at the cabin category level were analyzed with greater precision. The wider array of variable costs associated with hotel stays led hotel yield management efforts to consider profit, rather than revenue. Yield management thus expanded to include practices beyond those adopted by airlines.

By 1993, revenue management was well on its way to replacing yield management. Presentations at multiindustry conferences on this topic included sessions in which speakers differentiated revenue management from yield management. Perhaps as testament to the strength of this conversion, the annual International Air Transport Association (IATA) Conference on Yield Management, initiated in 1988, was rebranded as the IATA Conference on Revenue Management in 1993; in 2001 it experienced further rebranding, becoming the IATA Revenue Management and Pricing Conference. There now seems to be growing support for relabeling revenue management as revenue and pricing optimization (RPO).

Firms in virtually every segment of the travel industry now possess revenue management programs. And each year, these programs improve. But let us not get ahead of ourselves. Every story has its beginning and this is certainly true of revenue management. To tell it, we begin with the airline industry.

To read the rest of this article, click here to send request to request@veritecsolutions.com.