EyeforTravel’s guest columnist Tom Bacon takes a look at the benefits of a new policy development at Southwest Airlines, and finds it is boosting revenues in two ways.

Southwest Airlines recently announced that it would change its policy with respect to unused tickets.  Customers will need to cancel their flight reservation before the flight in order to preserve the value of the ticket for use later.  The value is not re-usable by the customer if he has not properly notified Southwest before the flight.

Southwest announced this policy change along with some new bag fees – but without reversing its highly promoted policy of ‘No ticket change fees’ and ‘[Most] bags fly free’.  Southwest has said that these policies – which are counter to the industry norms – provide marketing benefits that offset its loss of associated fees.

But still, Southwest faces profit pressures.  And new ancillary fees and new policies – like the new no-show policy – are necessary for Southwest to meet its profit goals in the still ultra-competitive airline industry.

We instituted a similar no-show policy at Frontier while I was there four years ago.  The policy change helps Southwest in two ways: 

1. It should reduce no-shows

A key function of revenue management at airlines is predicting the no-show factor and overbooking appropriately to maximise revenue given a fixed number of seats.  Despite sophisticated algorithms, this is far from perfect – errors can include denied boarding or empty seats – neither of which is good!

With re-usable tickets and without change fees, Southwest likely has a bigger problem with no-shows than its competitors.

Ideally, customers will advise Southwest of their change in plans enough in advance of the flight that the airline can resell the seat.  Learning that someone is not travelling the day before the flight is of little direct value to Southwest since the expert revenue manager has only set aside the seats for the demand expected in the last 24 hours; learning that another seat is available a few days before the flight – long after most of the demand has already shown up -- doesn’t help much!

So Southwest seeks to be able to predict no-shows more accurately and re-sell the seats, driving a load factor closer to the industry average.

Can Southwest change customer behavior?  Perhaps but firstly it could take a long time for customers to learn the new rules and respond accordingly. Secondly, the new policy doesn’t distinguish between helpful notice of changes in plans (more than a few weeks before the flight) and essentially worthless notices (a day before the flight).

2. It also accelerates revenue recognition

Fortunately there is another benefit to Southwest’s new policy in the form of accelerated revenue recognition, or higher ‘aged sales’. After all, unused flight coupons have been an issue for airlines for decades.  Normal revenue recognition works like this:

a.  Airlines are paid for travel in advance.

b.  They collect the cash in advance.

c.  They record an ‘air traffic liability’ meaning they owe the customer the associated travel.  They can’t yet record the amount as revenue.

d.  They record the amount as revenue when it’s ‘earned’; that is when the customer flies.

Despite this ‘normal’ process, airlines can record significant revenue from passengers who never travel (never meet #d above).  This revenue is recognised both through non-refundable fares and from reusable fares that are never reused.  Has this happened to you?  Even at 1-2% of total revenue this is highly material for most airlines.

A policy of reusability and ‘no’ notice (Southwest’s former policy) means that the revenue associated with a no-show cannot be recorded for up to another year (the typical expiration period for reusability).  The industry calls the liability associated with reusable – but unused - tickets ‘aged sales’ and records a portion of this liability each month as the re-usability time period expires.

With the revised policy, Southwest could get a one-time boost.  Over the next year, they can record as revenue BOTH the previous year’s expired tickets AND current year cancellations.  This has no cash effect but for one it increases reported revenue and secondly it increases control/management over the somewhat uncertain ‘aged sales’.

Southwest can continue to exploit its ‘no fee’ image even as it gains ancillary revenue in less prominent ways than bag fees and change fees – and it must.  The ancillary phenomenon in the airline industry has truly saved the industry over the past five years and Southwest has the same profit pressure as its competitors.

Guest columnist Tom Bacon has 20 years experience as a former airline executive and industry consultant in airline revenue optimisation.  Questions?  Contact Tom at tom.bacon@yahoo.com.