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1. What did American Airlines initially do to counter the threat posed by low-cost airlines?

In order to counter this threat, initially American Airlines focused on labor cost reduction and
productivity improvement. In 1983, they pioneered a two-tier wage structure to reduce labor costs. The
new structure affected current employees only slightly, but sharply reduced the wage of new hires. For
achieving productivity gains, American Airlines negotiated with maintenance and transport workers,
flight attendants, pilots, flight engineers, and other employees for work rule concessions within
guidelines laid down by the Federal Aviation Administration (FAA). Over time they replaced their
older aircrafts with newer ones which were more fuel efficient, required smaller crew, had improved
electronics, and also cheaper to maintain.

2. What is the hub & spoke system of routing and why did it become important in the post- airline-
deregulation era in the US?

A hub is a central airport that flights are routed through and spokes are the routes that planes take out
of the hub airport. Airlines realized that to stay profitable they need to operate in favorable routes for
which they required fewer long-haul aircraft and more short-haul aircrafts with varying capacity
considerations for selected routes. In this model, Airline selects some major airports as their hubs.
These hubs are directly connected with point-to-point flights. Each of these hubs are connected to
spokes. Traffic is accumulated at a hub through small capacity aircrafts from the smaller places and
diverted through long-haul aircrafts to other hubs or short-haul aircrafts to other places.
Economies of scale can be achieved by Airlines through this model and helps them in staying efficient
and productive as they ply different capacity aircrafts at different routes depending upon the passenger
traffic. The airlines manages the connecting flights and the schedules at airports while providing
convenient connections to the customer with least delay. Over time this gives the airlines a competitive
edge as it controls the hubs it operates in and can charge premium or target specific regions/segments.
On the flip side the customer has to travel for longer periods as compared to point-to-point model. Also,
delay in operations in any spoke or hub will result in a domino effect and can render customer
dissatisfaction.

3. What was the goal behind frequent flyer programs initiated by American Airlines?

American Airlines introduced Frequent Flyer program in 1981 to reward customers for using the airline
and promote future customer loyalty. The frequent flyers of American Airlines were awarded with free
or upgraded flights and tried to lock in customers. Through this program, it was also possible to track
the buying and travel habits of its users which would help American Airlines in formulating pricing
and route strategies.

4. Apart from market segmentation, what other considerations did the revenue management system at
American take into account?
Maximizing revenue was the main objective of Americans Revenue Management System. Finding the
tradeoff between selling discount ticketing in order to fill up the plane totally, and selling full fare
tickets and only filling up a portion of the plane is the key to maximize the passenger revenues. For
this, Americans segmented the market into business travelers, who was willing to pay full fare, who
book tickets very close to the date of travel and leisure travelers, who book tickets much ahead of their
scheduled travel.
The displacement effect from the hub and spoke model was considered by American revenue
management system. If there are too many discounted passengers travelling from A to C via B, then
they may displace full fare passengers travelling from B to C. The system has to consider the revenue
being generated from discounted travelers is in excess of that of full fare travelers travelling a part of
the route. The system also considered the share shift which is the consequence of market share of an
airlines change in fares relative to that of its competitors, and stimulation which is the beneficial effect
that lower prices would have on demand from the segment of the population that would otherwise
would not have flown.

5. Referring to the discussion of the Chicago-West Coast pricing decision: Should American counter
Continentals $159 fare with a relatively-unrestricted discount fare on the non-stop Chicago-West
Coast flights?

American Airlines served 10 West Coast cities from Chicago. United and Continental were its two
major competitors.
American Airlines load factor were down to an unacceptable level due to superior flight schedule of
United and cheaper fares of Continental in connecting markets. American Airlines was thinking about
introducing relatively-unrestricted discount fare to tackle the low load factor.

Load Factor = Revenue Passenger Mile/Available Seat Mile

Even if low fare can result to an increase of load factor, unrestricted discount might result in
cancellation without any penalty.

So the metric used should be

Revenue per Available Seat Mile = Net Yield * Load Factor

Therefore, American Airline should look for better forecasting, better indexing and booking limits
levers.

6. Referring to the discussion of the New York-San Juan pricing decision: What additional information
should Doug Santoni collect to decide on a response to Easterns pricing initiative?

To decide on the response to Eastern Airlines pricing initiative of restricted round-trip fare of $198
midweek and $238 weekend, American Airlines has to decide the booking limit and protection level
for the three segment of passengers: Business, Leisure and Caribbean origin.
7. What were the challenges in implementing yield management at American Airlines?

Challenges for the implementation of yield management at American Airlines:

1. Some customers, who booked tickets, did not show up for their flights.
2. There were numerous fare types and fares
3. The demand for discounted and full fare seats were uncertain in every flight
4. Demand was variable over time
5. Demand was lumpy in leisure travel
6. Hub and spoke model made some customers in one fare type more attractive than other
customers in the same fare type

8. Example: An aircraft has 100 seats and there are two types of fares: full ($499) and discount ($99).
While there is unlimited demand for the discount fares, demand for full fares is estimated to be
anywhere between 10 and 30. How many seats should be protected for full-fare passengers?

Sales of all the tickets in full fare will happen only when the demand for it is more than the protected
limit.
Let a = unsold tickets to be used for full fare ticket
Cost of Understocking (Cu = 499-99 = 400
Cost of Overstocking (Co) = 99

Here we find that the service level or probability is:


Cu/ (Cu+Co) = 400/(400+99) =0.8016

When 99 499* {1- P(D<=a), we should keep a seats for full fare ticket
When a = 24, P[D 23]= 0.787: hold
When x= 25, P[D 24]= 0.843: sell
The aircraft should hold 24 seats for full-fare passengers.

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