In 1996, newly launched Lastminute.com stood out like a beacon of common sense in an ocean of obscurely br/anded websites with meaningless names such as Boo, Banana and Blikhein.
“The intervening decade has seen a pricing revolution that has turned consumer behaviour on its head and turbo-charged business profits.”
There was absolutely no room for confusion about what it did. The name said it all. Lastminute was a travel website and, as we all knew, fares and hotel rooms were far cheaper if you booked them at the last minute. It was fact. That was how the world worked.
Just ten years later, that ‘fact’ has become history. Today we all know that if you book at the last minute you are far more likely to pay top dollar than the rock bottom price. The intervening decade has seen a pricing revolution that has turned consumer behaviour on its head and turbo-charged business profits.
The name of that revolution is yield management (YM). It’s a technique first developed in the late 1970s by the airline industry and some, such as American Airlines, have done extraordinarily well out of it. Others, such as Pan Am and United, who spurned this technique soon went out of business. According to one estimate, Br/itish airlines had 60 per cent occupancy rates before YM was introduced. Today that figure stands at 85 per cent.
But it’s not just airlines that have benefited. Hotels, theatres, stadia, telecoms companies and many others have all received useful boosts to profits, say YM advocates. “A well managed YM system can increase profits by as much as ten per cent, although between three and four per cent is more typical,” claims Jon Siberry, Managing Director of YM advisor SDK Consulting.
Technically, YM is defined as “the process of understanding, anticipating and reacting to consumer behaviour in order to maximise revenue”. In plain English, this means “forecasting demand for your products and charging in order to maximise profit,” explains David Molian, co-director of Credo, the small business unit at Cranfield Business School.
“A well managed Yield Management system can increase profits by as much as ten per cent . . .”
So the first seats on an airplane are sold cheap, months in advance. This attracts people into the market who might not otherwise have travelled. But, as take-off approaches, some people’s need for travel becomes more urgent and there are fewer seats left, so the price goes up. This allows the airline to extract maximum revenue from people who will travel at almost any price.
It may sound like a licence to charge what you like but, according to YM theory, such techniques can only be used in certain limited conditions. “Firstly, the product has to be perishable,” explains Molian. “If there is no deadline, the consumer can just defer purchase.” Airline seats are particuarly perishable because after take-off they cease to exist.
Secondly, you need direct access to your consumers. “If you are selling through intermediaries or wholesalers, it is much harder to understand demand and often impossible to control and vary price,” says Molian.
That is precisely why yield management has exploded in the last decade. The internet has given many businesses direct access to their customers for the first time, allowing them to set their own prices.
So far, YM has tended to be the preserve of larger companies that can afford expensive software to analyse patterns of demand and alter prices accordingly. But smaller companies need it more urgently, argues Jon Siberry. “Big household names have br/ands to attract customers. Smaller companies often don’t have that luxury, so it’s crucial that they extract maximum goodness from the business they already have.”
“Big household names have brands to attract customers. Smaller companies often don’t have that luxury . . .”
In fact, many small companies already do use YM techniques intuitively. “Market traders do it when they sell off fruit cheap at the end of the day or when they drop prices because the weather is poor,” says Molian. “Fashion and technology retailers do it when they charge a premium for the very latest designs.I see no reason why window cleaners and other service providers shouldn’t at least consider doing the same.”
But those who use YM admit that it’s a precarious balancing act. For one thing, it does require educating your consumers to adopt a new attitude to pricing. Our culture has a history of having one publicly announced price for goods and services. YM involves having many prices, often subsidising ludicrously low prices with ludicrously high prices.
Cast your mind back to the early days of YM in airlines and remember how irritating it was to see a flight advertised for pennies yet end up paying top-wack some weeks later. “Once customers realise what’s being done to them, you can expect a reaction,” says Professor David Newton, head of the business school at the University of Nottingham. “It can make customers feel cheated and make your company look a bit spivvy if you aren’t very careful.”
On the other hand, the benefits can be substantial. Without it, it is doubtful that the low-cost flight revolution could have occurred at all. “It has been an essential feature of the development of many of our companies,” says James Rothnie, director of corporate affairs at easyGroup, which developed budget airline easyJet. “Without it we wouldn’t have been able to offer such cheap fares and we would not have been able to compete so well.
“It’s a powerful tool. But for it to work you have to understand your customers intimately.” For instance, you don’t want to set your early prices so low that you fill your plane with people paying peanuts. And when it comes to peak demand you don’t want to set your prices so high that people refuse to travel. “Get it right and it can transform your business. Get it wrong and it could put you out of business,” he warns.