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Dr Strangelove or How I Learned to Stop Worrying and Love the Commodity.

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Presentation on theme: "Dr Strangelove or How I Learned to Stop Worrying and Love the Commodity."— Presentation transcript:

1 Dr Strangelove or How I Learned to Stop Worrying and Love the Commodity

2 Dr Strangelove Will Tell You: n Cyberspace Poses a Great Marketing Opportunity: Do Not Get Left Out n Airline Engagement Model Destroys the Purity of Our Vital Revenue Essence n The KEY to Working Together is to Start Valuing Something Being Given Away for Free Today n How to Revenue Manage Negotiated Programs n Hugely Benefits the Airline and Allows Airlines to Profitably Distribute Product in Cyberspace

3 2001: A CyberSpace Odyssey n Reach Out and Touch People u eCommerce could become Primary Method of Selling Products in the 21st Century u New ways of Distributing Product, Interacting with Customers and Providing Services n Lets focus on Internet Ticket Auction Sites u Format is Appealing to the Cost-Conscious u Well Designed Auction is an Excellent Price Discovery Tool

4 n Treating Auction Sites as a Negotiated Program n Negotiated Programs are: u Direct Competition to our Revenue Managed Distribution Channels u Threaten Market Segmentation Assumptions u The Dilution Droogs A Clockwork Orange The Violence We Do to Ourselves

5 A Revenue Management Horror Story

6 Eyes Wide Shut Freud and Your VP of Revenue Management n The KEY is Managing Negotiated Programs n RM has Ignored Negotiated Programs u Shutting our eyes is easier than facing it n The Problem with Negotiated Programs is the Establishing a Ticket Price in Advanced n That Agreement has Financial Value

7 n Think Commodity: in the Negotiated Agreement you are Agreeing to a Strike Price on a Block of Ticket Commodities. n The Agreement is a Financial Instrument! u Ticket = Forward Contract u Agreement = Call Option on Ticket u Booking = Call Options on Ticket n Especially if you use Block Space Spartacus Its a Call Option, Stupid!

8 Lolita The Illicit Romance between Airlines and Consolidators n Negotiated Agreements are Free Options u This creates Market Inefficiencies u The airline shoulders the Price Risk n Block Space is Writing a Covered Call without any compensation, the worst of all worlds n This drives up Published Fares

9 Revenue Management Revisited n Revenue Management is an Inherently Speculative Strategy u Holding inventory is a Speculative Activity u Suppliers should Hedge against Price Risk to insure an acceptable profit n Market Conditions do not Always Warrant a Speculative Strategy u Flexibility of Strategies is Important to be able to Effectively Managing Risk

10 Financial Follies in Revenue Management n Revenue Management works well where Speculation works well u Great in High Demand / Business Markets where Prices can be Expected to Run Up u Poor Performance in Cost Conscious Markets n A Single Risk Management Mechanism Limits the Ability of Revenue Management u Need to Contrive Mechanism allowing Hedging

11 Full Metal Jacket Managing Negotiated Programs n Negotiated Programs Need a Hedging Strategy which Guards against Dilution n Charging an Option Premium per Booking Makes the Agreement Revenue Neutral n Writing a Covered Call is a Hedge u Price Goes Up, Dilution Offset by Premium u Price Does Down, Premium covers Lower Price n Better Yet, Buy Put to Insure Lowest Price

12 Pricing the Risk of Dilution n Goal: Achieve Financial Neutrality n Simplest Idea is use Black-Scholes OPM u Target Ticket Price = $300, Current = $200 u Volatility of Price = 5% u T-Bill Rate = 5% u Offer Expiration in 100 days n The Risk of Each Booking is worth $38.16 n The Premium = $38.16 + Handling Expense

13 The Killing Benefits to Airlines n Protecting against Dilution Stabilizes Expected Revenue n Hedge shifts Price Risk away from Airline n Risk Adverse rather than Risk Seeking u Better Corporate Financing Strategy n New Mechanism creates a Revenue Management Adaptive to Market Condition n Overbookings and DBs are History

14 Paths of Glory Applications to Cyberspace n Using the Option Premium allows Airlines to Cede Blocks of Bookings to Internet Auction Sites without Risk of Dilution n Internet Sites Partially Cover Premiums by Selling Airlines Puts and Information n Market Efficiency is Increased u Creating a Fairer Playing Field u Lowering Published Fares for Consumers

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