Source: Lufthansa Cargo, Anrd Huchzermeier

Lufthansa Cargo AG
Capacity Allocation and Dynamic Pricing

I acknowledge assistance from Prof. Arnd Huchzermeier and Dean Eric Johnson for portions of these slides.
Prof. Arnd Huchzermeier, Dean M. Eric Johnson, Prof. Warren H.
Hausman

Source: Lufthansa Cargo

Filling the hold

Prof. Arnd Huchzermeier, Dean M. Eric Johnson, Prof. Warren H.

Hausman

How is air cargo different from the passenger business?

Prof. Arnd Huchzermeier, Dean M. Eric Johnson, Prof. Warren H.

Hausman

Basic set-up of air cargo supply chain

5%

Airport-toairport

Air
cargo
carrier

Shipper
Door-to-door

95%

Forwarder

Consignee
Forwarder

Prof. Arnd Huchzermeier, Dean M. Eric Johnson, Prof. Warren H.

Hausman

Elements of Lufthansas Revenue Management

Prof. Arnd Huchzermeier, Dean M. Eric Johnson, Prof. Warren H.

Hausman

III.
Buffer
High
margin
products

Rate (EUR/kg)

Allocation and reservation system

Express
products

II.

III.

GCA*

Presold

II. capacity

I.

Capacity
Purchasing
Agreements
(CPA)

Capacity
Access
Price

I.

Controlled
space

?
12

1
0
Months before departure

* GCA = Guaranteed Capacity Agreements

Prof. Arnd Huchzermeier, Dean M. Eric Johnson, Prof. Warren H.

Hausman

What is the value of Lufthansas Contracts?

Capacity Purchase Agreement

Guaranteed Capacity Agreements

Prof. Arnd Huchzermeier, Dean M. Eric Johnson, Prof. Warren H.

Hausman

Capacity Agreements No Overbooking

Spot Market Volume

Forecast of 10,000lbs @ $1/lb (nonrefundable)

Average Actual/Forecast = 1, St. Dev. A/F = .3
Capacity = 10,000 lbs
Beyond capacity, turned away (at no cost).

Expected Revenue?

What would you be willing to sell the 10,000 lb for on a Capacity

Purchase Agreement (fixed, non refundable contract)?

Prof. Arnd Huchzermeier, Dean M. Eric Johnson, Prof. Warren H.

Hausman

Customers View - Capacity Purchase Agreement (CPA)

Forecast volume of 500 lbs. A/F=1., St. Dev. = .3

Non refundable contract @______
Walk-up volume at $1/lb.
How much to contract?

Prof. Arnd Huchzermeier, Dean M. Eric Johnson, Prof. Warren H.

Hausman

Lufthansas View of CPAs

What if customers lock-in 2/3 of the volume on CPAs?

Non refundable contact @______

Walk-up volume at $1/lb.
Forecast of 10,000 lbs, Average A/F = 1, St. Dev. A/F = .3
Capacity = 10,000 lbs
Beyond capacity, turned away (at no cost).

Prof. Arnd Huchzermeier, Dean M. Eric Johnson, Prof. Warren H.

Hausman

Overbooking in Cargo

Case 1: We did not overbook enough - we underestimated no-shows

There were 700 lb of no-shows, but we only overbooked by 699 lb - how
much more could we have made if we had overbooked by 1 more lb?

cu
Case 2: We overbooked too much - we overestimated no-shows
Over-selling cost is estimated to be $4/lb (reroute, bad will, )
There were 700 lb no-shows, but we overbooked by 701 lb - how much more
could we have made if we had overbooked by 1 fewer lb?

co

cu
CriticalRatio =
=
cu + co
Prof. Arnd Huchzermeier, Dean M. Eric Johnson, Prof. Warren H.
Hausman

Overbooking Example
Assumptions:

Plane capacity (on a certain lane) is 10,000 lb

Price is $1/lb (one price, refundable)
Over-selling cost is estimated to be $4/lb (reroute, bad will, )
For this route, historical no show Average 500 lb with St. Dev. of 100

Question: By how many lbs should we overbook the flight?

Question: What is the value of overbooking?

Prof. Arnd Huchzermeier, Dean M. Eric Johnson, Prof. Warren H.

Hausman

Capacity Options Customers View

Forecast volume of 500lbs. A/F=1., St. Dev. = .3.

Option cost $.10/lb. Exercised at $.78/lb.
Unused options are worthless.
Walk-up volume at $1/lb.
Assume demand is realized before exercise decisions made.
How many options?

Prof. Arnd Huchzermeier, Dean M. Eric Johnson, Prof. Warren H.

Hausman

Lufthansas View of Capacity Options

What if customers lock-in 2/3 of the volume via Options?

Option cost $.10/lb. Exercised at $.78/lb.

Walk-up volume at $1/lb.
Forecast volume of 10,000 lbs. A/F=1., St. Dev. = .3.
Capacity = 10,000 lbs.
Assume demand is realized before exercise decisions made.

Prof. Arnd Huchzermeier, Dean M. Eric Johnson, Prof. Warren H.

Hausman

Schematic diagram of dynamic pricing

Rate

Demand
Forecast

available
Capacity

Weight
Max. Revenue

Not accepted Demand

Prof. Arnd Huchzermeier, Dean M. Eric Johnson, Prof. Warren H.

Hausman

Source: Lufthansa Cargo

Bid-Price

Wrap-up

Channel coordination can be addressed

through:
Pricing
Flexible contracts
Options

Prof. Arnd Huchzermeier, Dean M. Eric Johnson, Prof. Warren H.

Hausman