Once per calendar quarter, airline management teams have conference calls to discuss the previous quarter’s earnings and their expectations for the future. Yesterday was United’s turn, and it appears that, with fares falling, they’re going another route to generate revenues: ancillary fees. To be entirely fair, there are no new fees on items that were free in 2015, but they are going to push harder and repackage the existing ones to make them more, um, “appealing.”
The Importance of Ancillary Fees
For 2015, “other operating revenue” made up 11% of total revenue, versus a few percent from cargo and the remainder from passengers. But that number doesn’t tell the whole story. Forget taxes: In the absence of the ability to raise prices, fee revenue is extremely valuable to the airlines because there are no costs associated with it. If you can charge a passenger $25 for a bag that had previously been free, that’s $25 that is 100% profit. In an industry that has traditionally had trouble breaking even, every penny counts. And just because they’re highly profitable now, don’t expect them to reverse the added charges. They’ve grown addicted.
The Bundle
Another opportunity to grow earnings comes from further improvements to our pricing and segmentation capabilities. As we’ve seen in 2015, this has become an increasingly important component to revenue management. The more we segment our fares, the better opportunity; we will have to minimize revenue dilution. The first case is the rollout of our bundled fare offerings this month. This allows customers to purchase a collection of products, suited to their travel as opposed to a more manual process of selecting from an a la carte menu.
-Vice Chairman and Chief Revenue Officer Jim Compton, 1/21/16
United is about to imitate your cable company, which is not a good sign, since the only companies that people dislike more than the airlines are cable providers. The bundles were rolled out quietly at the end of last year and will become an integrated part of the booking process. They’ll still sell you individual “amenities,” such as a checked bag, day pass to the lounge or extra legroom, but they’re hoping that if they bundle the items together and offer a slight discount, you’ll buy several of them together. If you’re going to pay to check a bag, for instance, why not pay a bit more and get extra legroom on that transcon? Here’s how a flight from Boston to San Francisco looks after the extras:
Hey, good for them. They just gave you the opportunity to add up to 60% to your ticket price by offering amenities that cost them next to nothing. True, the extra bag is $25 they would have gotten otherwise, but Premier access has no additional costs, the lounge access might cost them a few cans of soda and some labor, the Economy Plus seating probably would have gone for free to an elite passenger and 500 miles is worth, well, a few bucks. And that’s what you get for your $194. I’m guessing the operating margin on that bundle is 80%+, not bad in an industry where anything above 10% has traditionally been considered heroic. And while elite customers get many of these for free, most customers don’t have status.
Entry Level Fares
The second phase, which we expect to launch in the second half of this year, will complement this bundle structure by introducing an entry level fare that will appeal to the purely price sensitive customer. We believe this slice of offerings will allow further segmentation across United’s customer base, while also avoiding some levels of revenue dilution built into our pricing structures today.
-Vice Chairman and Chief Revenue Officer Jim Compton, 1/21/16
Can’t blame ’em for this one. As deep discount carriers like Spirit have grown, one fact has become increasingly clear to airlines: The majority of passengers treat tickets like commodities, and he who has the lowest price wins. And while the customers don’t completely ignore the extra fees, the sticker price is what sells the tickets.
Delta has already rolled out Basic Economy Fares, their answer to the ultra low-cost carriers. The BE fares allowed them to match Spirit on overlapping routes in terms of both price and amenities (or lack thereof). BE customers board last and don’t get seat assignments or full medallion benefits. At least they give you a free can of Coke. By offering these fares, Delta’s revenue management team is able to carve out the segment of the market that only wants a seat versus those who want all the benefits. It’s not perfect, but it’s better than nothing, and it beats the blunt instrument of simply matching the ULCCs segment for segment.
United referenced a version of Basic Economy at an industry conference last year, but the announcement on the call yesterday was the first full public acknowledgement that this plan was in the cards. My guess is that their entry level fares will look a lot like Delta’s. If you want any of the extras, you’re going to have to pay for them, whether it’s in the form of fees or a full ticket price.
It’s Not All Bad
In regard to paid first class versus free upgrades, Mr. Compton added…
…we’ve talked about in the past growing our paid first class load factor and we continue to do that. I’ll tell you, we’re also focused on making sure that we keep that in balance with our loyalty customers. There is a lifetime value with our Mileage Plus customers, that’s very important to the overall economics as we go forward, so it’s a balance. And so, internally, we continue to debate what that is whether it’s fare products to offer to get into first class, lower price points in first class, but also balancing that with the upgrades to our loyal customers.
CEO Oscar Munoz added…
As I travel around our networking system, I spend a lot of time on our aircraft and I spend a lot of time with some of our high value customers, and that is a particularly sore subject with them and so that balance that Jim speaks about I think is a very important line that we have to strike.
Truthfully, I’m not sure if that’s the management team being diplomatic, or they simply have a different point of view on elite status. For example, Delta posted the following chart at its investor day in December:
I don’t know what the correct method is, the “hard” or “soft” sell. Both companies are publicly traded companies whose obligation is to their shareholders and, if they determine that eliminating the free upgrade to first, which is what Delta seems to be moving toward, is the best way to do so, United will follow its competitor from Atlanta. Ultimately, the first class seat will be like any other – you get it if you pay for it.
Interesting and insightful. Looks like the airlines have dug a hole for themselves by ending their frequent flyer programs and maximizing the hassle factor-they are down at the bottom with cable. This is starting to look like the subprime mortgage crisis (and plenty of the actors are here in the shadows.) With only a handful of airlines, if they all collude, people will have no choice was the rallying call…. (The housing must always go up myth.) Many of their fares have fallen off a cliff (and you would know why if you noticed how many empty seats they had on NY-Chicago when they were trying to get $300 and Spirit was charging like $80.) This also shows they don’t actually know what they are doing with giant reductions in their market cap (United stock fell 40% in 2016-with $30 oil). The younger generation, struggling already to pay the bills, will never know frequent flyer programs and may well pass on air travel altogether (as they are passing on buying cars.) I am seeing a lot fewer Americans abroad, as air travel becomes much less an American thing than it used to be….It can’t not be terrible business to so flagrantly and ruthlessly attack your customers-I was not a big spender, but am committed to giving the airlines as close to nothing as I can and there must be others who feel the same way. It was a good 2 million miles before these vultures tried to make a meal of the air customer.
First, thanks for the feedback. I always appreciate it.
The problem that these guys face, among others, is that they are a 1980s business in a 2016 world. The model was built to be a network, which is both good and bad. It’s good in that it can get you anywhere you want to go. But that was before the day of low-cost competition. The secret sauce behind airlines such as Southwest and Spirit is that they keep their planes in the air, rather than on the ground waiting for connecting passengers. An airplane in the air is earning money and, because they connect so few passengers, their operations are that much simpler.
The biggest issue for the network carriers, though, is that they let their business get commoditized. Hey, a seat on American is the same as one on Delta is the same as one on United, etc. So for those people who weren’t trapped by a hub, price became the deciding factor. There’s simply no way to win a fare war. Pricing will fall to the marginal cost of doing business, and somebody always has a lower cost than you do. The big carriers feel like they need to compete with the Spirits of the world so that the latter doesn’t gain market share at their expense. Doing so, however, means that they are highly unprofitable on those routes, but it does contain the ULCC.
There is actually hope for the international traveler, however. Both Norwegian and Wow Airlines have increased service to the US, and they’re doing it cheaply. Of course, you’ll also pay fees for the basics, such as checked luggage, but the base fares are set low and you build from there.
So here’s where I usually get into trouble: I don’t begrudge the airlines making a profit. They’re publicly traded companies with shareholders and they have a fiduciary duty to their owners to maximize profits, so if they can raise fares on a route, they will. Until recently, the airlines were highly, highly unprofitable. Bankruptcies were common and most never had operating margins of greater than 10%. They’re also living in a world where they’re treated as a commodity product. True, they probably had a hand in that but, by far, the #1 reason that people book a particular flight is because of price. In that kind of market, airlines have an incentive to cut costs so that they can cut fares. Could a carrier with great service and a premium product generate a premium price? Possibly, but it hasn’t happened yet. They can sustain it for a few months or even years, but even JetBlue is adding fees and putting the seats closer together. Since deregulation, airfares on an inflation-adjusted basis are actually negative.
The airline industry is a bad one. It’s capital intensive, labor intensive and runs 24 hours per day. Often, its own customers and employees don’t even like the carrier. But they perform a valuable service: travel with speed.
I’m sure there’s a middle ground and I’m glad I’m not the one responsible for finding it. But the airlines are going to continue to try to segment the customer base.
Your point about autos is a good one: The real killer will be when self-driving cars are normal. No one will actually need to own one, since they’ll just be able to summon one.
Another industry that needs to keep its eyes open is the hotel industry. AirBNB isn’t going away and, one of these days, somebody will set up a “certified for business” model for business travelers, not just leisure.
Thanks, Mike, lots of moving pieces to be sure. The reality is that this is nothing more than mass transit. Public transit loses money, Amtrak loses money, Greyhound loses money, Truly competitive air travel is not going to make a huge profit and bankruptcies are inevitable (which is good for the consumer.) This is really not about airline companies,,, it is that a group of vultures moved in, our government allowed there to be basically five and 2/3rds uniformly terrible airlines for a 300 million person country and they have been turning short term profits of $1 billion a quarter. The media has also failed to do its job and it simply allows itself to be spoon fed propaganda in a most selective way by the aircartel, for example, there is some evidence that there is a rage about the decimation of ff programs (airline ceo’s are most recently talking how much revenue they depend on from once a year customers…) The problem for the airlines is they have their algorithms, they in their arrogance are promising to unlock all kinds of new revenue, but their product is terrible and as you point out people would rather go to a dental surgeon than do air travel now (Pity the poor people being stranded by the storm and trying to get through busy signals. So the customer, was, is and probably always will be king and American air travel was pretty bad already before the airlines went to war with their customers.
Yup. We have a situation where you have diverging interests.
I’m curious to see what happens if/when award tickets become revenue-based (i.e., based on the price of the underlying ticket).