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.
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.