From fees that border on fraud to those necessary to provide a great customer service, Tom Bacon reckons airlines need to reassess

Fred Kleinburg of Boston Consulting has coined the term: ‘bad profits’.  According to Kleinburg, ‘bad profits’ come at the expense of customers – sales selling customers items they don’t need, exploiting customer relationships as opposed to building customer relationships.  The Wolf of Wall Street took ‘bad profits’ to the extreme.

In response to declining revenue after the tech bubble burst in 2000-2001, Charles Schwab – like other brokerage firms -- implemented various transaction fees to offset the decline.  In 2004, however, they reversed this strategy, taking $1 billion back out of their revenue when they eliminated so-called ‘nuisance fees’. They considered the abundant fees ‘bad profits’, in accordance with Kleinburg’s definition.  In fact, the chief executive attributes Schwab’s success - and consistent growth in market share - over the past decade to a focus on the customer that considers such fees counter-productive over the long term. 

In the US airline industry, Southwest has, at least in part, embraced Schwab’s strategy. Southwest has avoided some of the most visible fees (bags, ticket changes) that other airlines have introduced over the past five years.

The big question then: are airline ancillary fees really ‘bad profits’ – and potentially, in the end, ‘bad business’?

In fact, Kleinburg actually uses an airline practice as an example of what he terms ‘bad profits’.  He has cited charges for same day flight changes as an example of airlines’ exploiting the customer relationship.  The customer wants an earlier flight, he is at the airport, there are empty seats, and airlines charge $100-$200 for the convenience.

Perhaps Kleinburg is right about same-day changes, but I’d like to offer a way to review airline fees and not paint them all with the same brush.  Rather than characterise all airline ancillary fees as ‘bad profits’, I propose we categorise the fees as follows:

Unavoidable

To me, it borders on fraud to have an ancillary fee that isn’t truly optional. For Spirit and Frontier Airlines to charge for both checking luggage and carrying onboard fits into this category even though I acknowledge that there may be some subset of people who travel with just a handbag. 

To me, it borders on fraud to have an ancillary fee that isn’t truly optional

However, I believe most airline ancillary fees are, in fact, optional and avoidable – you don’t need to check a bag; you don’t need to change your flight; you don’t need to occupy a bigger seat.

Hidden

Many fees began as hidden but have become better recognised over time.  A higher charge for checking your bag at the airport or printing your boarding pass at the airport or changing your ticket – these have a business purpose but are particularly annoying if the customer is not informed ahead of time and is surprised when the charge is revealed.  Airline websites have become much better at communicating fees but some third-party channels still have challenges achieving full disclosure. 

Cost/service-justified

Even though pricing experts tell us to avoid a cost-plus mentality (noting that software margins can be >90%), for airline passengers, it is more annoying when the fee bears no relation to the apparent cost.  So, airlines talk of the cost of connecting bags and the opportunity cost of an empty seat when someone changes his flight.  A few airlines vary the change fee based on when the change is made – in recognition of the fact that a change made far in advance has a much lower opportunity cost than a change made right before the flight.

Exploitative

Are charges for same-day standby (Kleinburg’s example of an exploitative fee) ‘bad profits’?  The only explanation I can give for the high charges for same-day standby is that, if this standby were free, customers could game the airline, buying a cheap ticket for the last flight of the day, hoping to get out earlier. 

Any fee that isn’t communicated well and becomes a ‘gotcha’ for the customer ends up being exploitative

Does concern about gaming by a few such customers justify violating the customer relationship of many?  Perhaps not.  In any case, customers are no longer surprised by same-day standby fees.  For me, any fee that isn’t communicated well and becomes a ‘gotcha’ for the customer ends up being exploitative.

Focus on transparency 

In the end, the biggest challenge for ancillary fees is transparency.  Clear customer communication of the fees puts the power back with the customer.  Non-transparency, on the other hand, turns into ‘gotcha’ fees. 

As such, I think that it isn’t fair to categorise the whole movement toward ancillary as ‘bad profits’.  But I also think that having too many of these fees begins to do so, as it becomes difficult for customers to evaluate or anticipate them. Perhaps airlines need to take a fresh view of their fees periodically:

• Which fees represent too small revenue amounts? If the fee doesn’t add much revenue, it may just add to complexity and customer confusion. Early in my airline career, I learned to carry out analyses to five digits since, multiplied by millions of passengers a day, everything adds up.  But as Kleinburg points out there is a cost, potentially a high cost, in customer relationships from excessive ‘nickel and diming’.
• Which fees are essentially unavoidable?  If the fee is assessed to 80-90% of passengers it may not be considered optional
• Which fees drive the most customer dissatisfaction? Do these require better communication or is there an opportunity to differentiate your airline on this item by not following the industry norm?

So, although I totally support the industry movement toward ancillary fees (even Southwest makes significant revenue from ancillary fees), I acknowledge that not all such fees are good.  Some fees drive more customer resentment than incremental revenue and some fees can serve to impair an airline’s competitive position rather than strengthen it.  And, of course, the movement to such fees leaves carriers vulnerable to a competitor’s ‘no fees’ strategy. 

Just as airlines regularly adjust their schedules based on changing demand (adding/deleting/re-timing flights), they need to regularly adjust their ancillary fee structure in response to financial, competitive, and customer-service factors.

Tom Bacon is a 25-year airline veteran and industry consultant in revenue optimisation. Questions?  Contact Tom at tom.bacon@yahoo.com or visit his website http://makeairlineprofitssoar.wordpress.com/