Tuesday, September 22, 2009

A nickel and dime is worth a nickel and dime - airline ancillary revenues

In some way, shape or form, every one of my blogs touches upon the topic of someone trying to get money from someone else. For example, in my Empoprise-IE Inland Empire blog, I often talk about how Ontario International Airport is trying to get more money from the airlines. At the same time, of course, the airlines themselves are trying to get more money out of their passengers - in June, for example, I only checked a single bag on a cross-country trip...and had to pay for it.

Now anyone who's had any exposure to economics or business knows that there are trade-offs in setting prices. If Ontario Airport or an airline sets their prices too low, then they may not get as much revenue as they could. However, if they set their prices too hight, then they may drive their customers to find alternatives - airlines landing at Burbank instead of Ontario, companies flying fewer people to distant meetings.

Yet airlines still charge the extra fees anyway, as BusinessWeek notes:

Increasingly, the airlines' goal these days is to have the fare be just one piece of the travel experience and to segment every other aspect, from drinks to baggage, HBO to legroom. Whether it's a fleece blanket and travel-pillow set (US Airways) or extra frequent-flier miles (United), the airline cabin has become a virtual bazaar. And nearly every carrier, low-cost or legacy, is getting in on the action.

BusinessWeek notes that part of this is offering new services that airlines previously didn't offer - tours once you get to your destination, for example. But, of course, the airlines are also charging for other things, such as the privilege to eat airline food, or the privilege to take a bag.

They have to.

A leader in the unbundling movement, Dublin-based Ryanair Holdings (RYAAY), reported that ancillary revenues made up nearly 20% of its total revenues in 2008 and outpaced overall revenue growth by a wide margin—35%, vs. 21%. At Allegiant, one of the few profitable U.S. airlines, nearly 23% of total 2008 revenue came from ancillary sources. Worldwide, ancillary revenue totaled $10.3 billion for airlines in 2008, a 345% jump since 2006, according to a study by IdeaWorks, a Wisconsin market research firm. "If it weren't for ancillary revenue, we probably would have seen at least one of the major airlines fall, given the recession," IdeaWorks President Jay Sorensen says.

And Sorenson speculates that this ancillary revenue stream won't disappear once the recession ends. He's not the only one who thinks that:

Even when good times return for airlines, many analysts say, free checked luggage will remain as distant a memory as the smoking section at the back of the airplane—charging for it is just too profitable. Yet with the fees permanent, consumers could be forgiven for wondering where the new charges might end: Is the U.S. market destined to be dominated by ultra-spartan flights, such as those pioneered in Europe by Ryanair, whose CEO has asked Boeing (BA) to explore installing credit-card-operated toilets?

But perhaps paying to pee won't be implemented here. Simpler moves have backfired, and backfired badly.

USAirways' (LCC) failed attempt to charge for soft drinks and water, which the company abandoned in April, resulted in a loss of market share...and obscured the fact that the airline had dramatically improved its operational reliability. The industry declined to follow up on that effort, and nonalcoholic drinks have remained largely free...

So what WILL happen in the future? It depends upon the airlines' two markets - business, and leisure. Now business travel is controlled by the CFO, and the CFO, responding to shareholder or private investor pressure, is going to insist that any travel be done on the cheap. ("Excessive restroom visits on the airplane will not be eligible for compensation.") Of course, the CFO is only going to have control up to a certain point - eventually, some employees may respond by saying, "You can fire me if you want, but I'm NOT making that trip to New York! My back STILL hurts from being stuffed in the luggage compartment on the last trip!"

(Incidentally, if my employer is reading this, let me assure you that I love our travel policy and our generous per diem allowance. Really.)

The more interesting battle will be in the leisure market. As I've noted elsewhere, a lot of businesses are dependent upon air travel. And the resort hotels in Los Cabos and elsewhere may run into problems if vacation travelers decide that they'd rather NOT have to board Sardine Airlines to get to a resort destination.

Perhaps then you're going to see the pendulum swing again, as it always does, and all of these airlines that are cutting corners at every opportunity are going to find competition from a new player in the airline industry - not one who targets the rich, but one who wants to snag the business of the middle class leisure traveler, and perhaps the middle class business traveler. Imagine the lines that would form if an airline used this advertising slogan - and could back it up:

Fly Human Airlines to the Caribbean
on our all-inclusive, luxurious aircraft!
Our planes are so nice that when you get to your destination,
you'll want to stay on the aircraft!

Trust me - within five years, some airline will differentiate itself by entering this market, and the Ryans and Americans and Uniteds are going to lose market share because of it.
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