Introduction
American Airlines was the largest carrier in the US by 1992 since it owned a fleet of close to 622 modern jets that flew more than 2450 flights per day to close to 182 global destinations. In addition, the company was quite innovative and it was the first one to introduce SABRE, a computerized system of airline reservation, frequent-flier, and super saver fares programs that were among the best in the industry for a long time. Nevertheless, despite such innovation, the firm and the industry continued to struggle with profitability. Therefore, in 1992, opted to venture into a new pricing strategy called Value Pricing. This essay analyzes the effectiveness of the new strategy as described subsequently.
The Decision behind the Development of the Value Pricing Strategy
The firm was convicted that the value pricing strategy that it had adopted would deal with the issues of customer complaints and aid in reversing the operating losses through the stimulation of demand, raising the market share, and minimizing the costs of operation (Froeb, Shor, & Ward, 2005). Through this strategy, the business reduced the number of possible fares that clients would pay from 500000 to 70000 through classifying each of them into one of four classes, 21-day purchase, discounted 7, coach, and first class. In addition, the company embarked on pricing its tickets based on length. Resultantly, the strategy meant that the leisure and business travelers would experience lowered list prices (Froeb, Shor, & Ward, 2005).
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The case study of the company indicates that its management thought the new approach would develop value, equity, and simplicity in its prices. Through the simplification of the structure of pricing, American Airlines considered that it would stabilize the fluctuations in its prices in addition to establish a price floor for its services. This novel approach to pricing required that the prices for the flights be set on the number of miles flown and restrictions as well as the removal of corporate discount prices.
While the strategy appeared promising for the case of American Airlines, it failed to deliver the desired outcomes. The corporation had failed to anticipate the effect of its new strategy on its competitors. The then CEO, Robert Crandall, missed to comprehend the critical lessons in the game theory that would have warned him of the price war that would ensue in response to the strategy. This failure attracted the rest of the competitors to engage in an aggressive pricing war, which caused profits in the industry to plummet a great deal. The management then resorted to abandon the value pricing strategy within only a few months after adoption.
An Evaluation of the Effect of Competitors and Other Economic Factors in the Value Pricing Strategy
The discussion above indicates that the value pricing approach that the American Airline company had adopted caused a response from its competitors that were willing to engage in a price war. First, it is needful to note that the airline industry is price sensitive and that the clients will always strive to find the most attractive price packages (Borenstein & Rose, 2004). In this case, the competitors of the firm realized the need for them to match the prices that American Airline was offering since it was critical to raising their load capacity. When many companies had done so, they were ferrying more clients at reduced prices through long distances. Considering that other factors of the economy such as the costs of operations resulting from issues such as maintenance, fuel, and labor to the employees remained constant meant that the industry would soon realize reduced profitability. American Airlines experienced the same problem, which is why it opted out of the strategy. Second, clients in the industry are also sensitive to the quality of services they receive from the carriers. Therefore, the fact that the company resorted to offering the most attractive prices at the highest quality levels meant that it was supposed to meet the high costs of operation with low revenue generation because of the stiff competition.
Recommendation of an Alternative Strategy to the Value Pricing Approach
The travel industries, such as the airline industry, have been known for attacking the quality of services offered to their clients at different prices. It means that the company should have opted for the versioning pricing strategy instead of the value pricing approach. The objectives of versioning are first to ensure that the companies that adopt it offer new products and services to serve their clients with unique needs. In this case, American Airlines would have assessed the segments of the market that it serves and provided a pricing incentive for each unit according to its unique needs. The clients who seek premium prices would have been charged higher than those who sought regular ones. The second objective of using the versioning pricing strategy is that when companies offer high-quality prices to their customers, they invite them to unconsciously decide the prices that they would like to pay (Shapiro & Varian, 2008). Therefore, American Airlines would not have had to deal with direct price wars since the versioning strategy is diversified and does not group all its clients into one segment as the value pricing approach had done.
References
Borenstein, S., & Rose, N. L. (2004). Competition and price dispersion in the US airline industry. Journal of Political Economy , 102 (4), 653-683.
Froeb, L., Shor, M., & Ward, R.M. (2005). Managerial economics: a problem-solving approach . Cambridge University Press.
Shapiro, C., & Varian, H. R. (2008). Versioning: the smart way to. Harvard Business Review , 107 (6), 107.
