A bilevel modelling approach to pricing and fare optimisation in the airline industry

The airline revenue management problem can be decomposed into four distinct but related sub–problems that are usually treated separately: demand forecasting, overbooking, capacity allocation and pricing. In recent decades, much interest has been devoted to overbooking and capacity allocation issues and, today, most major airlines rely on computerised tools to deal with these two sub–problems. Pricing, however, has received less attention, which can be explained by the technical and theoretical difficulties inherent in the implementation of a practical pricing decision support system. This paper presents a new modelling approach which allows for the joint solution of the capacity allocation and pricing sub–problems faced by a major North American airline. Using pre–defined booking limits, the resulting model can also be applied in a ‘pure’ pricing context. This approach is based on the bilevel programming paradigm, a special case of hierarchical mathematical optimisation. This modelling technique makes it possible to take into account matters such as customer segmentation, behaviour with regard to fares and other product attributes, and the interactions induced by overlapping routes, which are typical of modern air transportation networks.