Question

In 1992, American Airlines (AA), the market share leader in the airline industry, announced a new pricing strategy—Value Pricing. AA narrowed the number of possible fares from 500,000 to 70,000 by classifying each into one of four classes (first class, coach, 7-day advance purchase, and 21-day advance purchase). It also began pricing based on flight length. According to AA, the purpose of Value Pricing was to create “simplicity, equity, and value” in its prices. AA believed that Value Pricing would address customer complaints, stimulate demand by lowering prices, increase market share, and reduce costs by increasing load factors.

Based on the above situation:

Analyze the key economic issues in the case.

Recommend three different business solutions to each case using managerial economic models and methods.

Justify the role of managerial economics by identifying the metrics you would use to assess the success of your decisions.

Answer 1

The term Value Pricing is based on the customer's perception of valuation for reaping benefits from the products and services. A company carrying out the process, tries to focus more on its customer's reviews for pricing a product.

In the above case American Airlines is doing value- pricing of its different services. The major key economic issues mentioned are :-

i) Demand - Inorder to increase the demand of its aviation services, American Airlines decided to carry out value pricing. It classified its fares according to the class of service chosen by the customers. This reduced the fares of lower class and thus, increased the demand.

ii) Competition - To face-off the cut-throat competition in the market, American Airlines attracted its customers through new fare prices and providing better services to each segment.

iii) Cost Control - By taking the cost-effective measure to regulate fare prices on the basis of class of ticket and flight length. As pricing the same for all costed more to the company as well as the customers who chose lower class flight bookings or travelled on a shorter distance flight.

iv) Customer Satisfaction - The main purpose of any company must be customer satisfaction through providing best of its services and solving all of the customer complaints and grievances.

Thus, the approach of Value-Pricing by American Airlines will increase its market share in the aviation industry. By regulating its cost scenario and yielding more profits at the same time, it will acquire new customers as well with the existing one.

The narrowing of fares according to the classification of seats of the flight, it gave the customers a chance to select their preferred class according to their income capacity and purchasing power. It also helped the company to carry out its operations in a more cost effective and well organized manner.