Before the airlines were deregulated in the late 1970's, operating an airline was in many ways a license to print money. Airlines had to apply to the CAB (Civil Aeronautics Board…later to become the FAA) for permission to offer service between any two points. When the CAB approved your route, they also approved the fare you could charge. If you found you weren't making enough money, you later lobbied the CAB to increase your fare, and within reason, it was always granted. There were few advance purchase rules, no minimum stay requirements, no penalties for changing your ticket. Fares were higher but refundable, and as competition in the market grew, the industry became more efficient and safe, and airlines competed on service (REAL service, like hospitality and decent-quality meals served on china) rather than price.
Deregulation threw that all out the window. You might make a pretty strong case that deregulation was a bad idea. But this is America. Free-enterprise and capitalism reigns supreme. Airlines lobbied for deregulation and got it. The end result is what we have today.
At the cost of bad service, surly airline employee attitudes, over-congested hub airports, and skyrocketing delays, airfare in America has become accessible to nearly everybody. In fact, when adjusted for inflation, airfare is actually much cheaper now than it was 30 or 40 years ago.
Nonetheless, the airlines became free to chart their own courses, open up new routes as they desired, and set their own fares without approval process. Some of the airlines of the day collapsed; many others were purchase or merged into larger carriers. Dozens and dozens of new airlines cropped up, most to fail under intense competition. (This was the era that defined as truth an industry joke: "How do you make a small fortune?" Answer: "Start with a large fortune and buy an airline.") In fact, only one of those early start-ups exists today, though not under its original name: America West took its first flight in 1983, and in 2005 took over the larger US Airways by which the company is now known.
The start to all the craziness in the fare system occurred when some math geniuses at American Airlines figured they could "maximize revenue and yield" with different fares aimed at different markets. They created lower fares that required advance purchase and minimum stay aimed for the leisure "vacation" market, and another set of much higher fares with fewer or no restrictions to the business traveler.
While this did in fact "increase revenue and yield", and made vacation fares much more affordable to the leisure traveler, it came at the expense of the business and last-minute traveler. This methodology is still largely in place today: less expensive "excursion" fares which are non-refundable and require a 7, 14, or 21 day advance purchase; and the more expensive "full fares" with little- to no-advance purchase requirement.
Further, airlines began designating certain days and times of day as "peak" and "off-peak", with the peak fares being more expensive. Peak times were generally when demand is highest, when many business people tend to travel...Sunday Noon through Monday Noon, and Thursday Noon through Friday. This gave the airlines the desired effect of motivating leisure travelers to move their travel to off-peak times to fill flights, while increasing revenue at peak travel times. These days the peak and off-peak times vary by each airline, and even by particular routes. (For example, Fridays and especially Friday afternoons are more popular, and therefore often designated as "peak", flying to Las Vegas.) Also, some airlines have stopped charging peak and off-peak fares, but instead add a "surcharge" to peak travel days (during the busy summer travel months of 2010, it was virtually every day on some airlines!).
But what those mathematicians at American really figured out was that in a deregulated marketplace, an airline seat is a perishable commodity, in that once a flight leaves the gate, an empty seat stays empty and generates no revenue or profit. So breaking up a particular flight's number of seats into"fare classes" was the way to "maximize revenue" by taking advantage of different groups of travelers with differing needs, and (ideally) entirely filling every flight with a variety of passengers paying a variety of fares.
To understand this a little better, let's take a look at the list of all the different available fares for flights on just one airline (in this case, United), for flights between Des Moines and Nashville, at the moment of this writing (mid-December, 2012) for flights in mid-January, 2013:
That's right, there are 29 different PUBLISHED fare codes between Des Moines (airport code: DSM) and Nashville (BNA) on just ONE airline. I emphasize "published" because in fact there could be a dozen or more "unpublished" fare codes for this route...but more on that later.
In any case, what do all those letters and numbers in the fare codes mean? The first letter is almost universally the "fare basis code". These are letters assigned for no particular reason, except for the fact that "F" generally means "first-class", "B" means "business-class" (whether or not there actually is a "business class section" on the flight...go figure), and "Y" means a coach-class seat with few if any restrictions (advance purchase, refundability, etc.).
The numbers are easy...they generally mean the number of days of advance purchase required to get that particular fare. In the case of the first fare on the list, this fare requires 21 days advance purchase. But the second fare is the same price, but only has a "3" in the code. Why is this?
This might be a 3-day advance purchase fare that has special requirements...perhaps taking a late or otherwise not-as-popular flight. This is the airline's way of helping to fill that particular unpopular flight's seats.
Looking further down the list, you see the number "14" pop up a lot (meaning a 14-day advance-purchase), and the number "7" (7-day advance purchase), etc. Finally, as you get towards the bottom (and more expensive) fare codes in the list, you see "0" show up (meaning no advance purchase required), and fare codes with no number at all (also generally meaning no advance purchase required).
Some of the other letters in the codes may indicate that the particular fare is for a round trip or one-way, requires a minimum stay (such as staying over a Saturday night), is for travel on "peak" or "off-peak" days or on specific flights, or any of dozens of other possible "rules" an airline might apply to fares as they see fit.
The "E" inserted in a fare code, in this example, generally means an "excursion" (or "round trip") fare (that's why the fare code on line above or below it that is almost exactly identical is exactly half the price of the fare code without the "E"). The "N" at the end of a fare code generally means "non-refundable", which you'll notice is on ALL the fares except the most expensive.
Take a look at the last two fares codes, and you'll see what could be considered the airline's "base price" or "MSRP" for these flights. Just as every product you might buy at any store has a "Manufacturer's Suggested Retail Price" (MSRP) (even if hardly anybody ever actually pays that price), the 28th fare on the list is a "Y" fare for a coach-class seat costing $1189, and the last fare is an "F" fare for a first-class seat costing $1408. But just as hardly anybody ever pays MSRP for anything, the airlines also offer lower prices than their "base" prices. In this case, if you walked up to the airline ticket counter in Des Moines an hour before a nearly-sold-out flight, you'd probably be offered a "YUA" fare of $865 for a coach seat or an "FUA" fare of $1108 for a first-class seat. If the flight was only 80% sold out, you might be offered a "BA0FY" fare of $616 for a coach-class fare that automatically upgraded you to first-class.
So why all this rigamarole? The airlines have learned that some people are only willing (or able) to pay the lowest fares (and therefore plan ahead for their trip), while people with a little more "price flexibility" (as it is called in marketing terms) are willing to pay more with less advance planning, and finally that those that got the money and aren't afraid to spend it (generally business executives) are more than willing to pay the big bucks for a last-minute ticket that is totally refundable should their plans change.
So do all the people who bought "V" class tickets sit in one part of the plane, and the people who paid a little more for "Q" class tickets get better seats someplace else on the plane, etc.? No, the different fare classes (with the exception of First Class tickets) are merely a way for the airline to divide up the total number of available seats on a given flight in order to maximize revenue.This might get a little confusing, but try to follow along:
Let's say a particular flight has 150 coach seats available (we'll ignore those fancy-pants up in first-class for the moment). Based on the airline's research and statistical data, they figure they can sell 70 seats at 21-day advance prices, 40 seats at 14-day advance prices, and 25 seats at 7-day advance prices. That's 135 seats, divided up between various "budget-conscious" and "price flexible" customers. Even if they sell all 135 seats as planned (and they rarely do), they probably still won't break even on that particular flight.
That leaves 15 seats to sell to people who have to fly on short notice, using pricier 3-day and no-advance tickets. THESE are the customers who make a money-losing flight into a profitable flight: Business travelers who don't particularly care how much they have to spend if it helps them make a half-million-dollar sale; People with more money than time to go where they want and when they want; and "Regular-Joe's" like us who, for some unexpected reason like a funeral or a family emergency, will pay what the airlines demand even if we have to max out our credit cards to do so.
Of course, this is an EXTREMELY simplified version of the triginometry that goes on in an airline's pricing department. At any given time, the airline may decide to start a sale (or respond to a competitor's sale) for a given period of time. Or if the 21-day "deadline" is arriving and they still haven't sold near their expected 40 seats, they may lower their fares on 14-day-advance fares and advertise it, hoping to fill their seats. On the other hand, they may find that 2 months before the flight, they have already sold out of their 21-day allotment due to some unexpected reason, and therefore RAISE their price on 14- and 7-day fares. Or their statistical geniuses may determine that overall profitability will be enhanced by only offering 60 seats at 21-day-advance fares, and increasing their allotment of 14-day-advance seats to 50. Plus there are "unpublished" fares alotted for tour and vacation operators, convention fares, specially-negotiated corporate fares for big customers, and on and on and on. It's higher-math at a level that only MIT professors understand, and yet it's still not quite as accurate as predicting the weather. But, that's more-or-less how they do it, for better or worse.
A question many of you will have is "If an empty seat makes no money for an airline, why don't they offer it at the last moment at a big discount to those of us who have flexible schedules but not a lot of money? Isn't a little money better than nothing?" Back in the old days, this is exactly what the airlines did, in offering "stand-by" fares. The term originates in that you would 'stand by' the gate waiting to see if there was an open seat at the last minute...if there was, you got on board for a bargain price (and if there wasn't, you just went back home.) Today, the airlines sometimes gain a little extra revenue by offering short-notice round-trip vacation flights on exceptionally-empty flights via membership in their website marketing programs.
But in general, by using the current convoluted (but apparently effective) "revenue management" system, the airlines have trained us to buy early for a low price, or pay more by waiting. The airlines are fully aware that if they start offering "stand-by" fares on a large-scale basis again, a large population will stop planning (and paying) in advance, and they'll also lose their control and ability to charge outrageous fares to last-minute travelers. And while the airlines commonly used to offer "bereavement" or "compassion" discounts for family members traveling for a funeral, these are policies of long-ago history.
In the process, they've also trained business travelers to favor a particular airline for practically worthless frequent-flier miles that are paid for by their employer's travel budgets, but that's a rant for another day.