Ancillary revenues: a new chapter opens

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With passenger unit revenue down, airlines need to start experimenting more with ancillary revenues, writes Tom Bacon, a former airline executive and industry consultant on revenue optimisation in this exclusive guest article for EyeforTravel.

United Airlines recently announced that its third quarter PRASM (passenger revenue per available seat miles or passenger ‘unit revenue’) was down year on year.  In fact, third quarter US airline industry PRASM is expected to be flat or down year on year for many large carriers.

The industry has enjoyed substantial unit revenue increases for ten quarters and has even, for the most part, been able to offset large fuel price increases over the past three years. Analysts have attributed this to two major factors namely the proliferation of ancillary fees and industry consolidation 

So is this positive revenue trend over? One thing seems clear: the industry will need to continue to explore and exploit ancillary fees.  With many of the benefits of industry consolidation behind us, ancillary is the single most promising opportunity for further increasing unit revenue.

With this in mind what is the next chapter in ancillary fees? Will it take the form of more new ancillary services or improved merchandising? 

Although much is made of the proliferation of new charges, bag fees and cancellation fees still represent the largest new revenue streams for airlines – and both have been around for over five years.  In fact, these two charges represented 52% of total ancillary revenue at American and 65% at Delta in 2011 (based on total ancillary revenue reported by Amadeus and airline Form 41-reported bag or ticket cancellation fees).  None of the other new fees -  ‘big seat’, expedited security, in flight WiFi or meals - have been as significant as baggage or cancellation fees.

A spirited approach

According to report by Amadeus on airline ancillary revenues for 2011, Spirit Airlines continues to be the US leader.  A third of its total revenue comes from ancillary compared to less than 10% at American, Delta, and US Airways; United leads the legacy carriers with 13.9%. 

Some of Spirit’s unmatched fees include:  carry-on bags, airport agent printing the boarding pass and seat assignment at booking.  Allegiant Airlines, another leader in ancillary in the US, bills itself as much as a travel supplier as an airline. It comes out tops with commissions and advertising – another under-leveraged ancillary opportunity for many carriers. 

Spirit’s approach may not jive with the brand image other carriers want to project and Allegiant, arguably, has its own niche. But consider this: if Delta were able to reach just 15% in ancillary, it would mean $2.5 billion in additional revenue!

Raising fees for existing ancillary services

The industry has experimented with different price points for bag fees since the second bag fee was first introduced in 2008.  Bag fees are less price elastic once the customer has already made the flight booking so such experimentation is warranted.  In fact, for the first half of 2012, higher bag fees contributed once again to United’s unit revenue growth – all due to pricing not from introduction of any new fees. 

Spirit, in fact, just announced a $100 bag fee for excess bags checked in at the last minute.  Again, Spirit’s approach may be unique, but other airlines need to continue to explore elasticity for different dimensions of bag fees (first versus second bag, last-minute versus planned, non-stop versus connect, low base fare versus high base fare).  Monitoring competitive pricing and analysis of purchase rates in different markets or segments can provide insight into new opportunities.  Systems permitting airlines can arrange for limited ‘test’ cases to learn the impact of varying fees.

Airlines are known for their sophistication with respect to varying base ticket prices with purchase date, peak travel periods and other factors.  However, no airline has achieved such sophistication with ancillary fees.  Although any variation in pricing needs to be balanced against simplicity and transparency, there remains an opportunity to vary ancillary fees to increase overall airline revenue.

Think branded fares

Given the extent of ancillary fees, there is an opportunity to re-bundle some of the a la carte features into ‘branded’ fares.  Frontier was the first US airline to offer ‘branded fares’ and American now offers a menu of fares too.  Yet surprisingly three and a half years after Frontier’s branded fare launch, most airlines have not followed suit.  As with ancillary pricing in general, the science that has been applied to airline revenue management and scheduling has not yet been applied to branded fares – including market segmentation, targeting, product definition and pricing of branded fares.

Frontier found early on in its experience with branded fares that over one-third of the passengers ‘bought up’, selecting one of the higher bundled fares rather than the ‘no frills’ fare. 

As passenger unit revenue growth slows, airlines need to push harder on ancillary fees.  The next chapter will likely require more creativity – in segmentation, in pricing, in marketing, in competitive analysis - than existing ancillary revenue streams.  Each airline should be experimenting with new ancillary services, different ancillary price levels and branded fares to continue to grow unit revenue.

Tom Bacon is a former airline executive and industry consultant on revenue optimisation.

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