As the temperatures in the UK soar over the 30C mark many people heading off on holiday may be wondering why they are ever leaving, but as millions of holidays makers leave for a couple of weeks of relaxation on the beach the wily Tour Operators will once again be giving a pat-on-the-back to their Yield Management Systems that are entirely responsible for the clever price discriminatory behaviour that has become the norm in the Travel industry.
The Holiday Season Is Upon Us
The holiday season is upon us and as we begin to pack our bags the usual moans and gripes will set in. Why do tour operators hike their prices up during busy holiday periods and more importantly why is it that we, as consumers, give in so easily to such blatant price discrimination?
The weapon of choice of holiday companies in bringing about this discriminatory behaviour in the travel world is their Yield Management Systems (YMS). These systems are designed to generate an optimal price that, at that moment in time, maximise revenues and/or profits and now more than ever these will come into play as the cruise industry looks to make drastic changes to its operations
Breaking the Mould
In a rather ground breaking and radical strategy one of the biggest cruise lines in the world has decided to pay 3rd party agents commission based on yield rather than passenger targets.
Some operators were paying as much as 20% of the booking revenue if the agent reached set passenger targets. The change to yield targets will be a real shake up in an industry which historically has a culture of heavy discounting. But how are the 3rd party agents able to discount so heavily?
High Commission Levels Do Not Incentivise Agents Correctly
Consider a typical 7-night transatlantic cruise. Normally this would retail at approximately £1,000 per passenger. This means that the 3rd party agent can earn £200 in commission or conversely, as has become the case, they can use part of this £200 to discount the cruise (to secure the sale) and still hit their passenger targets overall.
Cruise operators do not have the capability to sell their entire capacity themselves, they need the 3rd party agents and those agents know this fact very well and as such they demand commission for the sales they generate. Additionally the cruise industry has typically relied on the on board spend once the passenger is on the ship for almost 40% of their revenue for items such as the casino, spa facilities etc. So the loss of booking revenue has often been offset by on board spend.
However, the recession has forced the cruise industry to rethink its operational strategy and in a bid to reduce costs the capacity has been reduced. Cruise operators now need to earn more revenue per passenger than they were doing before due to the reduced capacity.
In order to maximise this yield per passenger they have turned, more then ever before, to the power of their YMS.
How Does YMS Work In the Cruise Industry?
Yield management as a methodology relies on certain criteria for it to be fully effective and these criteria are basically the same in the Leisure & Hospitality Industry:
1. There is a fixed capacity at any one time
2. Excess capacity is difficult/impossible to store
3. You can price discriminate based on different customer segments
4. Although you price discriminate the product is still homogenous
5. The cruise company has dynamic pricing – it can change prices relatively easily as and when it needs to
Underpinning the entire YMS is the price elasticity of demand (PED) for cruises and with the rise of package providers such as Expedia and Lastminute.com it is possible to get exactly the same holiday but at a cheaper price and more often than not, unless the customer has some personal affiliation with the holiday provider, they will go for the cheaper option, all other things being equal.
The purpose of the YMS is to price optimise and maximise revenues but in order to do this effectively it needs to take into account the element of demand that will inevitably change each time the price changes.
It will also factor into its model the current, expected and forecasted demand for cruises, the required revenue per passenger needed to meet targets and dynamic capacity updates.
How Do You Yield Manage?
The Major Cruise Line (MCL) knows the level of demand they are experiencing for their cruises at any time and thus they know how this compares to where it should be and where it has been historically. Basic economic principles dictate that this demand, given the current supply (or capacity), will produce a particular price that customers are paying. MCL will then identify the capacity left to sell so that if the ship is currently at 90% load factor with 30 days left to the sailing and this is a 3000 passenger ship then that means they have 30 days to sell 300 passengers at an average of 10 passengers per day. MCL will then decide whether they should sell the cabins as the demand arises or “hold” them till later on when demand exceeds supply and thus they can charge a premium on top of the price.
In terms of selling the currently unsold units there are 3 possibilities:
1. Sell the cabin now at a discounted price +£
2. “Hold” the cabin off and sell it at a premium nearer the time of the sailing to make excess profits +£££
3. “Hold” the cabin off later on the demand falls and it remains unsold at the time of the sailing -£
If current price £1,000 and they still need to make a further £300,000 from the remaining 10% of the capacity then they need to ensure that the remaining passengers are sold at this price. If the demand is faltering then they may reduce the price, take a loss on a few passengers worth of sales in order to drive the demand back up and then make up for lost revenue on the higher demand later on.
My YMS is Better Than Yours!
This change in commercial strategy of commission payments based on yield targets will certainly reverberate throughout the industry as cruise operators looks to recover from a fairly difficult couple of years. It is no coincidence that the operators that have come out of this period with prices and revenues still intact are those that have invested heavily in their YMS.
Any system can generate a price but the most efficient system will be the one that is most representative of the current trading position.