Evaluate American's 1992 announcement of a new rate structure: a. What changes did American make? American Airlines (American) made four fundamental changes to its rates. First, it moved to a four-tier rate structure; American offered first-class rates and three tiers of coach: full-fare, 21-day advance purchase and 7-day advance purchase. Overall, it expected to reduce coach fares by 38% and first-class fares by 20% to 50%. Though full fare coach prices dropped by about 38%, advance-purchase fares dropped by 6% when compared to the advance purchase tickets already being offered. Through this fare structure, American also eliminated deep discount tickets.
Second, American eliminated the negotiated discount contracts of many large companies. Though it intended to fulfill any outstanding contracts, it did not intend to renew any of these contracts. Third, American realigned its pricing with its costs. Under the new structure, American fares were more distance based (therefore cost-based) than they had been in the past.
Finally, American changed its non-refundable policy. Advance purchase tickets could now be rescheduled for a $25 processing fee. b. Which customers benefited most from the move? Were any customers made worse off? There are five groups of customers that are affected by the rate changes. Travel agents are affected financially by reduced fares that will result in reduced commissions. On the other hand, American's four-tier structure substantially reduced the number of fares in the database by 86%.
This simplification will enable travel agents to better service their customers. Travel agents therefore are both positively and negatively impacted. Small business customers are positively impacted by the fare changes. Previously, the higher full fare prices discouraged small business travel; small businesses would either decide against travel or incur the cost of a Saturday night stay and purchase a reduced fare ticket.
By reducing the full coach fares, small businesses will be able to purchase more convenient flights at more economical prices. Large businesses, on the other hand, may be negatively impacted. Since many large businesses had negotiated discount rate contracts with airlines, the new full coach fare may be higher than these negotiated fares. For large businesses that did not have negotiated contracts, the fares will be lower than the previous full fare rate. Leisure travelers overall will be made better off by the new fare structure. These travelers have more flexibility and can take advantage of the advance purchase discounts and Saturday-night stay discounts.
An exception to this is leisure travelers who had found "loop holes" in the old fare system by using "creative ticketing" and waiting for deep discounts. These leisure travelers may pay higher rates because the deep discounts will no longer be offered. c. Why did each of American's competitors react to the fare changes the way they did? Continental, Northwest and United Airlines intended to adopt part of the new fare system. Continental, because it is in Chapter 11 bankruptcy would likely be reluctant to lower prices.
Similarly, competitors like Northwest still have incentives to undercut American; thus they may not adopt the structure in its entirety. On the other hand, TWA and Southwest already differentiate themselves by providing low-cost service and would therefore have no incentive to adopt the new fare structure. Finally, Delta, who claims to not provide corporate discounts, may not benefit from adopting the new structure. Presumably business travelers on Delta are not paying negotiated discount fares, so reducing its full fare prices would significantly reduce Delta's business traveler revenue.
d. What were American's goals in making this move? American had financial, customer-service related and competitive goals in revising its fare structure. American expected to save $25 million in administrative costs by reducing the number of fares offered. Similarly, the reduced number of fares should enable simpler, more accurate yield management and demand forecasting.
In the past, full fare and discount fare seats were allocated based on the forecasted demand for each. Inherent in this process is a risk of loosing a full fare customer in favor of a discount customer. The new fare structure enables customers to self-select into price points based on individual travel needs and degrees of flexibility. American also intended the new fare structure to invigorate small business travel. Prior to the four-tier structure, small businesses were at a significant disadvantage because they could neither negotiate discount contracts like large businesses nor maintain the flexibility of leisure travelers.
The new lower full fare coach rates will encourage small business travel at times when these businesses may have opted out. The rate structure change also addresses the growing consensus of consumers that air travel is too expensive. The overall reduced rate will reduce this perception of high prices. Finally, the new fare structure will tame the competitive price wars between major airlines. The defined structure of the fares creates transparency between companies and will enable other major carriers to follow suit, thus relieving the competitive pressure.