Dynamic pricing and the death of PeopleExpress
Perhaps one of the most annoying aspects of traveling by air. With thousands of different prices for a single flight—most of which don’t seem to make any basic economic sense—it almost requires a Ph.D. in quantitative statistics to fully understand the basic concept.
But 30 years ago, the use of dynamic pricing for airlines was still in its infancy. Airlines had just begun to mine the data that was being produced by their proprietary reservations systems—systems that linked the tens of thousands of domestic travel agents to each of the major airlines’ ticketing systems. While the primary purpose of these systems was to automate the ticketing process from agent to airline and keep track of seat availability, most airlines soon found that the data that resulted from the process (passenger names, frequency of flight, destinations, load factors, ticket price, etc.) became just as valuable as the process itself.
American Airlines’ SABRE computer reservation scheme was just such a system. In use since the early 1960s, it was considered the most technologically advanced among the other proprietary systems in use. By the early 1980s, the data produced by SABRE had become a gold mine for American’s marketing department. The airline could now accurately predict the number of empty seats for each flight and thus sell those seats at discount. Additionally, American began to implement “fences” (Saturday night stay requirements) necessary to prevent full-fare passengers (e.g., business fliers) from taking advantage of much lower discount fares. It was the first version of dynamic pricing. But as more and more of American’s major rivals came to similarly utilize data produced by their own reservations systems, American spent the vast majority of its resources defending its current route and pricing structure from major competitors, including United, Eastern and Delta.
At about the same time American was battling its major rivals, the advent of low-cost upstart airlines came on the scene. Unencumbered by the high cost of union labor, these newcomers competed solely on the basis of price. One such upstart was People Express. Founded in 1981, the new airline operated out of an abandoned terminal at Newark Airport and pretty much stayed off the radar of the more established airlines by initially offering low-price flights to Buffalo, Norfolk and Columbus. It later added flights to Florida, and by 1983 it was offering low-cost flights throughout the continental United States and to London. Unlike its initial foray to destinations where the majors lacked routes, People Express was now competing head-on with the major carriers in both its domestic and international routes.
But while the major carriers had established reservations systems spewing out mountains of valuable price and load factor data for each flight, People Express had no such technology. If People Express offered a flight from Newark to Los Angeles for $99, every seat on that flight was sold for the same price. It didn’t matter that some of its passengers may have been willing to pay two to three times that amount—People Express had no way of knowing which ones they were and how many seats to reserve on those flights for full-fare passengers.
It didn’t take long for the majors—American Airlines in particular—to realize that its most potent weapon against upstarts like People Express was its technology-driven dynamic pricing strategy. In early 1985, American made the first move. It essentially declared war on People Express by matching the competitor’s low fares but used its dynamic pricing analysis to only offer a fraction of the number of total seats on each flight at that low fare.
According to Thomas Petzinger, author of the book Hard Landing: The Epic Contest for Power and Profits That Plunged the Airlines into Chaos, People Express and its CEO Donald Burr knew immediately that a war with American was underway.1
"This is it!” [Burr] cried, slamming the newspaper down on the desk of one of his marketing executives. “This is the shot across our bow! If we don’t invent a way to deal with this, we’re history! We’re going to be dead meat.”
In his panic, Burr wanted to know how many seats American was offering at these prices. Two seats on any plane, or 20, or 200 on a DC-10? There was no way of telling from American’s ads or public comments. Burr began rounding up people to dial the phones like mad, posing as American customers and keeping track of which flights had sold out of discount seats and which still had low-fare seats available, but the answers kept changing. The advertising agency working for People Express was pressed into action; hundreds more calls went out. But the more they called, the less they knew. As days progressed, calls went out by the thousands, eventually to United as well, once it matched American. The answers kept changing there too! Burr was beside himself. How could he compete with something that he couldn’t see? How could he fight the devil?
But there was no way for People Express to compete. The pricing strategy derived from data as the result of millions of historic SABRE transactions could not be overcome. Losses quickly mounted and the airline became soon became desperate. In the following months, People Express looked first to build (from scratch) a reservation system to compete against American and its SABRE system. Upon determining that the build-from-scratch process would take years, not months, People Express looked to acquire a system. But about the only way to acquire an existing reservation system was to also acquire the airline that owned the system.
Enter Denver-based Frontier Airlines. Burdened with a high cost structure along with high debt, but with a reasonably good reservation system to its credit, People Express acquired the airline with the hope that Frontier could somehow be the white knight needed to keep its company alive. The merger was a disaster from the start. The much-needed reservation system was antiquated and unable provide any type of dynamic pricing strategy. By 1986, People Express was on the verge of bankruptcy—saved only when the airline was sold for pennies on the dollar to Texas Air Corporation. The airline ceased to exist in early 1987 when its operations were merged into the operations of Texas Air subsidiary Continental Airlines.
While most experts attribute the demise of People Express to its ill-fated merger attempt with Frontier Airlines, its ultimate underlying cause was the fledgling airline’s inability to compete with American Airlines’ technology-driven pricing strategy. Once American discovered that it could compete by selling at an advertised price and not feel required to sell every seat at a discount, People Express had no response. This early dynamic pricing skirmish and the swift results that followed underscore the strategic power of dynamic pricing. While few people may recall People Express, its lessons resonate across all industries and everywhere business pricing strategies are formulated.
1 Thomas Petzinger Jr., Hard Landing: The Epic Contest for Power and Profits That Plunged the Airlines into Chaos. (New York: Random House Digital, Inc.), Kindle edition.