Part of what makes my job interesting is the opportunity to hear guest speakers and experts at other conferences. A few weeks ago I had the good fortune to hear Dr. Xavier Drèze, Dr. X as it were, from UCLA talk about his theories on loyalty programs. Turns out a coffee shop frequent drink card that requires 10 cups for the next free one is more loyalty inducing if the first two drinks are already pre-stamped than a card requiring eight purchases to get the free cup. Of course in both scenarios the same amount of coffee has to be bought, but that is just how the human mind works.
Dr. X also shared some of his findings from the Southwest Airlines frequent flier program, which he was asked to help redesign. The fatal flaw of the original program was that revenue or profits played no role in the award. The system was simply: Fly eight times and you get a free flight. Obviously travelers gamed the system and flew eight US$49 advanced fares within California to get the free full fare transcontinental flight to the East Coast. So earlier this year the system was redesigned to allow for points based on revenues and presumably profitability. So far, so good.
But what changed in addition to the equation of revenues to points is that Southwest wanted to add transparency to its pricing structure and hence the point awards. To this end, each flight now only has three (count them: three) fares: the usual advanced discount fare, the regular fare and the premium fare with an early boarding group and drink coupons. Awards points vary depending on price paid.
Fares set in stone
But here is the real kicker: The fares never change. So once the three fares are set for a certain leg, they are fixed. No demand fluctuations put an ever more complicated pricing and yield management machine in motion. The fare is what the fare is.
Of course the tenet of yield management is to maximize revenues given a certain demand curve and to fulfill each potential transaction at the “right” price, which then leads to a proliferation of prices given that the demand situation changes daily if not hourly. The Southwest model circumvents this by setting prices “in stone.”
Now of course the counter argument against these set rates is that supposedly money is left on the table. Surely somewhere out there is a flier who would have paid more than she was charged, so the revenue gain is sub-optimal.
But imagine what is gained: complete transparency and no more confusion on the customer’s part about what is the “best” price. There are only three prices. Take the one that works for you.
Set rates for hotels
Given that I am hotel guy, I thought about the Southwest model in the hotel industry. Imagine three rates: advanced purchase; regular rate; and then a premium rate that includes Wi-Fi, breakfast, minibar, gym and late check out. Maybe add a fourth rate for corporate negotiated discounts. And then award frequent stay points based on these rates or better, on profitability. Imagine the transparency. No need for the consumer to shop for the lowest rate because that would obviously be on the hotel’s website. GDS rates would be loaded correctly. And the job of the yield manager would be so much easier because rates only would need to be set once and not second guessed multiple times per day.
Of course the downfall of the idea might be the overcapacity of rooms in certain markets and the inability of rooms to be “parked in the desert” just like airplanes to avoid over supply. And Southwest does not set rates five years out but only a few months into the future.
And then there is the nagging suspicion that indeed money is left on the table. But still, wouldn’t that be a fascinating way to change room pricing?