I’ve heard the question from friends, media, colleagues… will fares rise because of rising oil prices? The answer is… they shouldn’t in the short term. In the long run, probably, but it remains to be seen. Why isn’t it obvious? Well, this requires understanding how airline revenue management works to really get the answer. It’s time to roll up the sleeves and dig in.
The goal of airline revenue management (RM) is to maximize revenue. That’s how it goes regardless of whether oil prices are high or low. What fares are available for sale comes from a combination of sophisticated computer algorithms, human ingenuity, competitive moves, dartboards, and everything in between. But in the end, the goal is always to maximize revenue. Costs do not matter.
For this reason, any time someone asks me, “oh man the price of oil spiked today, so will prices go up?” — my answer is always no. If the RM teams are doing their jobs, they are already getting the most out of the capacity that is for sale. If they could just jack up fares to cover costs, that means they could have raised fares before and failed to do their jobs properly.
This doesn’t apply if there is some shock to demand, but that has not happened. Demand is strong, and people want to fly. So why has oil spiked, and what changed in this chart?
We all know the answer to that. WAR. Oil spiked after the Russian invasion of Ukraine, and it has now settled back down somewhat, but it’s still high. Demand for travel to Moscow has disappeared overnight, but everywhere else there is no impact. In fact, demand seems to be at record levels. Because of that, fares aren’t going to just rise in order to cover costs.
How is it possible that costs don’t matter? Well, in RM they don’t. Costs really start to matter in the Network Planning world. They are making decisions further out about how much capacity to put in the market, and that can have an immediate impact on fares… but not for immediate travel.
I will point out it hasn’t always been this way. Airlines used to play games with fuel surcharges. They would slap on surcharges that would show up like resort fees, as a sneak attack after the fact which didn’t impact the advertised fare so it had less of an impact on consumer behavior. (They still do with award travel.) But ever since the government required that all mandatory charges get displayed in the advertised fare, they no longer had that lever. Without this mechanism, the best way to increase fares now is to restrict capacity.
It is exceedingly rare to see an airline cut back on capacity in the short term. Yes, a pandemic that stops every person from traveling is one reason to slash capacity. Airlines just basically stopped flying in March 2020, but that is a very rare event. For the most part, the fixed costs are already pretty high. Aircraft and crew schedules are set. To make changes can be a real logistical challenge. Airlines have gotten better at this during COVID, but without a major demand shock, big capacity shifts just don’t happen at the last minute.
Instead, what the Network teams are doing now is looking further out, thinking about May and into summer in particular. Those are time periods where they can make capacity decisions more easily. And why does capacity matter so much? Think back to that Econ class you were forced to take as an undergrad. Remember the part before you fell asleep where they had the two crossing lines?
Yeah, it’s that one. And I put the labels in Comic Sans to remind you that this was about as close as your Econ professor ever got to having a sense of whimsy. I know, it was bad.
But the point is that if you’re in RM, you are given the quantity and you just have to get the highest fares you can. In Network, you determine where to set the quantity. If demand increases, as it has since the depths of the pandemic, then fares go up. And if you cut capacity, fares go up since there are more people fighting for fewer seats. At the same time, if you add capacity, fares go down.
I make this all sound simple, and it’s not at all. But the basic concept is simple. That means the question is not “will fares rise?” They will rise if they can, and they’ve been doing a fair bit of that lately since demand has been so strong. The question is… what will airlines do with capacity? Capacity is the lever airlines can use to try to juice fares up if costs get too high.
The J.P. Morgan Industrials Conference was this week, and plenty of airlines talked about their plans and what they were seeing. And what they are seeing is roaring demand. The problem is that they don’t know if they can make money off that demand since oil is bouncing around like a ping pong ball. So they have to make some decisions and run with it.
Several airlines have said they’ll moderate their capacity this summer in the face of uncertain oil. Any capacity reduction will lead fares to be higher than they were at the previous level. This, of course, doesn’t mean that one flight you want will see fares change. That’s the problem with thinking about “will fares rise?” — it’s always a general trend, and when people ask if fares rise, they have specifics in mind.
So, will they rise? They sure will thanks to strong demand. But oil alone isn’t going to move the needle unless capacity drops… if it does, that means the airline wasn’t doing its job right in the first place.