Once upon a time things were simple. Budget carriers got you from A to B, all frills excluded. With legacy airlines you could expect perks, like meals in economy. Next came the Internet add-ons: car hire, hotels, travel insurance. Then things became a bit blurred. Economy meals on legacy carriers began to disappear and all of a sudden everyone was unbundling. The low-costs pushed harder still, breaking out even the basics like check-in and checked bags.
In the latest twist, even the legacy product has been reduced to the basics, with a huge variety of "a la carte" add-ons. And now some of the majors are turning to re-bundling, like United Airline's Premier Line, which combines checked luggage, airport fast-track and extra legroom. We have gone from complexity to simplicity and back again; it is hardly surprising that passengers are getting increasingly confused and frustrated.
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And it shows. In response to a Dallas Morning News blog about Premier Line, one passenger vents: "How about spending some time on this marketing concept? How can we improve customer satisfaction from the 'unmerciful beating level' to something as high as 'bamboo spikes under the fingernails'? Finding ways to screw your customer out of another fee for something that should come with the base price of a ticket is not 'marketing'. The mafia has a better understanding of customer satisfaction."
But the myriad of charges is undoubtedly here to stay. In 2008 airline ancillary revenues more than tripled to over $10 billion, providing an "intravenous injection" to the sickly airline sector, according to data from US consultancy firm IdeaWorks.
Meanwhile, IATA expects non-ticket revenue to make up 12% of airline turnover in 2010. On an individual airline level, JetBlue Airways chief executive Dave Barger says: "We continue to be encouraged by the success of our ancillary revenue initiatives, which have helped mitigate some of the weaknesses we have experienced in passenger revenue." The story is similar over at US Airways, where chief executive Doug Parker says a la carte revenues are having "a significant impact on our financial performance".
The attraction is clear. "While capacity growth has slowed, we've seen 30-45% growth in this area over the last two years," says AirTran Airways chief financial officer Arne Haak. But, while the net margins are very high on ancillaries, he cautions: "We have to be very careful, you don't want to make your customers feel like they're being nickel and dimed to death."
Quite simply this lucrative revenue stream is too strong to be ignored - even for the legacy carriers. American Airlines alone generated over €1.6 billion ($2.3 billion) from a la carte pricing, commission-based services and frequent flier activities in 2008, topping IdeaWork's top five leader board for sheer revenue volume. United and Delta complete the top three, leaving Ryanair to represent the ancillary-rich budget sector at number four.
Paying The Price
But the change has come at a cost. Traditional airlines, such as United and British Airways, have bravely attempted to tap this glittering gold mine with mixed results. United experimented with charging for meals on long-haul flights, but swiftly reversed this decision when passengers made their objections known. Meanwhile BA was slated in the UK press when it rolled out its checked baggage charges. Passengers have become increasingly sensitised as each new fee gets tagged on to their travel bill. On the flip side, they are winning from the dynamic market, while airlines are losing millions.
Costs have been cut to the bone and price competition is so fierce that airlines have little option but to unbundle their fares to increase their revenues. Continental Airlines
chief executive Larry Kellner says he would have preferred to keep baggage fees as part of the fare, but this would have caused it to slip down in price-based searches. He simply could not ignore the $200 million in potential revenue or risk this kind of competitive disadvantage, so the fees were introduced.
However, some airlines have not followed the herd. The grandfather of the budget airline sector, Southwest Airlines, has gone against the new low-cost rule book by not charging for first or second bags - something which it draws on heavily in its marketing.
Bucking The Trend
Southwest chief executive Garry Kelly explains: "We all know that if we charged a bag fee, we would get money. What we don't know is how many people would change their behaviour. It's been our view that we are, at worst, neutral by not charging the bag fee and we believe we are ahead of the game, getting more customers, by not charging." And this strategy has not gone unnoticed. Our irate passenger continues: "Take a look at airlines like Southwest, who not only pride themselves on customer satisfaction, but do not charge every time you sneeze."
At the other end of the spectrum is Ryanair, which deliberately introduced baggage fees to alter consumer behaviour. "When we starting charging for checked baggage 80% of passengers took a bag. It's now less than 40%," says chief financial officer Howard Millar. "Fewer bags meant that we could take out a whole series of costs. Most other carriers used it as a mechanism to increase revenues. We never saw it like that."
Looking at legacy airlines' ancillary efforts, he rebuffs: "Fiddling about with bag and meal charges is the death knell for these airlines. They are in downward spiral which they can't do anything about." Millar believes they should instead develop their long-haul onboard sales: "You have to tailor your product to suit your business. You can charge for entertainment and meals on board, but knowing these airline's they'll continue to give it away. We'll have to wait and see whether they've got the nerve to charge for it."
Janet Titterton, who is business planning director at marketing and loyalty specialist Collinson Latitude, cautions that expectations are all important. With low-cost carriers, you expect a basic product, but passengers expect the price premium of traditional airlines to be justified. "It goes back to the customer proposition and value promise. If the brand makes no promises to deliver, that's one thing. But if a premium brand is looking to make a quick buck, passengers won't like it. For legacy airlines the challenge is to bring in ancillaries which fit the customers' needs, and don't come across as another way of charging for something."
Traditional airlines have been battling with low-cost airlines for short-haul market share and, now that stripped down products are in vogue, it is tricky to see much differentiation between the two. The change has been so dramatic that, in a similar style to Southwest, Swiss International Air Lines is using the unbundling trend to highlight its all-in product, using taglines such as "Swiss: one price, everything included" and "travel with Swiss in style with no hidden surprises".
"It boils down to price and product competition. Either you're the lowest price or you're differentiated," says former Ryanair chairman and IATA executive Patrick Murphy, who chairs the aviation group of Performance Consultants International. "When US carriers started switching to a la carte pricing, they cut their basic fares," says Murphy. But a number of airlines have had "a terrible experience" because of either not following this strategy or failing to communicate it - both internally and externally.
"It is inevitable that passengers will react unless they get a price reduction," he says. "Traditional European airlines competing with low-cost carriers have to consider if [charging for ancillaries] makes sense. If it does, then they have to make sure that the items they charge for are perceived as good value. It's a case of saying to the customer 'you have a choice, if you don't want to do it, you don't have to.' You are giving the customer effective veto power."
Choice and value are watchwords which seem to dominate ancillary revenue strategy discussions. Continental president Jeff Smisek says: "We're beginning to offer our customers more control over the product and services they buy from us by giving them a broader range of choices. We believe that unbundling our product and service offering is fairer to the consumer, as there's less cross subsidisation that results. Customers are beginning to be able to pay more precisely for the product and services they use and not pay for production and services they don't use. You can expect to see us do quite a bit more of in this 2010 and beyond."
Delta executive vice-president for network planning and management Glen Hauenstein agrees: "If price is the single driver we want to be able to give customers the lowest price per seat and then charge for all the options they want to upgrade to. That seems to be the way we're seeing customer choice working."
But value perception is not universal. Nigerian Eagle chief executive Dapo Olumide says the cheapest fare is perceived as value in Europe, but not in Africa. "It is counter-intuitive that, amid the widespread poverty, you need to give Africans a full-service airline. You have to give passengers what they perceive to be value." Kenya Airways chief operating officer Bram Steller succinctly summarises: "At this stage it is more important for us to improve our network and frequencies than start a battle over who pays for a sandwich."
In Latin America, Gol has grown its ancillaries revenues - from cargo, excess baggage, charter flights and its loyalty programme - to R600 million ($345 million), or just over 10% of its total turnover. It is aiming to hit 15% in three to four years, but chief executive Constantino de Oliveira Junior does not believe Brazil is ready for checked luggage charges, and he does not expect to match the 20% level of some European or US carriers.
Gol is, however, experimenting with a buy onboard food and drink service, on top of its standard basic refreshments. "With this we are definitely changing the culture of how people are flying in Brazil. It will be expanded [in 2010] because passengers are accepting it very well," he says. Gol is also preparing to take advantage of the sheer weight of traffic to its website. "The plan is that it will become a strong ancillary revenue driver. We can exploit the number of people who access this website every day," he says.
So what next? "The biggest opportunity today is from much higher margin sales of unbundled in-house products, such as extra leg room or lounge access," says Amadeus vice-president for marketing and distribution Ian Wheeler. Historically the GDSs have not been able to offer full ancillary exposure, leading to lost revenues, but Wheeler says: "In 2010 we will enable full unbundling of the fare through the Amadeus GDS."
North America, with its mature low-cost industry, seems to have become the test ground for legacy airline ancillary trends and carriers like United have made huge strides in repackaging their own inventory. United president John Tague says: "We lead the industry in this area, generating about $13 per passenger compared with about $10 on average for the industry. We have been aggressive and creative, and we are working to maximise our opportunities to deliver our customers the right product at the right price and at the right time."
United gives the Premier Line bundle to its "Elite" frequent fliers as part of their loyalty benefits, while regular passengers are charged for the service. Titterton believes this is the right strategy: "Legacy carriers have solid loyalty programmes, but they need to move outside thinking that they can only generate revenue from the top 10-15%. The business model has changed. Some people can't and won't ever earn the status, so there's an opportunity to charge them for what they can't earn. Airlines have a philosophy of protecting their elite status passengers, but we've asked a few and they don't care."
But the Premier Line blog responses suggest otherwise. "It's bad enough that the moo-cows can buy economy-plus seats on the spot at the gate and annoy me, a frequent traveller. Now they can annoy me by buying their way into the 'fast' line? Aaaaaarg. Too much," says one passenger. Another retorts: "Telling me I don't have to pay this fee is insulting! I've already paid." But regular travellers validate the strategy, leaving comments like: "It's worth my sanity" and "I'd buy it!"
It seems that United is already aware of this issue. Tague says: "We have announced significant new steps to enhance our Mileage Plus program, improving the value proposition for our most loyal customers." This means Elite member will have access to unlimited automatic domestic upgrades from the second quarter of 2010.
Moving this idea still further, Titterton believes that the next generation of ancillaries will take the form of annual membership products, similar to those offered by the banking sector. "You could sell it to the people who can't earn it, using your own products and more." She proposes non-airline benefits such as wireless Internet access, travel and gadget insurance, dining vouchers, spa and gym membership, which could all come under one annual fee which business passengers could charge to expenses and renew automatically each year.
Titterton also questions whether carriers are maximising the potential of their existing ancillary streams. "Airlines find a partner, chuck it on their website, but they don't know about customer usage and have no insight into passengers' lifestyles. They simply get a cheque. The way they are currently doing it is short-term quick fix, to bring in the cash. In a recent survey which we did, over 50% said their priority was to put money on table. Less than 12% prioritised customer satisfaction. The next generation of ancillaries will be customer-centric, not airline-centric, focusing on value, relevancy and generally enhancing the customer experience."
The Next Step
The next generation of ancillaries is on the minds of budget and legacy carriers alike. Murphy from Performance Consultants International is swift to identify new technologies such as onboard Wi-Fi, audio-visual on demand, mobile phones and onboard sales technology as "the drivers for the next stage", but he adds: "It's all early days."
Meanwhile, Millar is reluctant to discuss the concepts which Ryanair is working on, but in the near-term the carrier is rolling out an onboard point of sale system to sell items such as mobile phone top ups. Ryanair is also planning to expand its dynamic packaging to include Hertz car hire from January, building on the travel insurance which it offers in partnership with AXA. Hotels are up next and the passenger will pay for the whole package at the end of their booking. But Millar adds: "The jury's out as to whether it will increase penetration rates."
BA chief executive Willie Walsh is pursuing a similar strategy. He says: "I believe we're only seeing the beginning of what could be an exciting revenue stream from our dynamic packaging on BA.com. That is ahead of where we thought we would be and I think we well benefit from the general economic upturn when it comes. It is clear to us there is significant opportunity for growth in ancillary revenues."
Meanwhile, AirAsiaX chief executive Azran Osman Rani is seizing his airline's advertising potential, marketing exposure on its website, in-flight magazine, aircraft exteriors, overhead bins, tray tables, product placement, onboard sampling and in-flight radio sponsorship. He says: "This allows advertisers to explore a unique mix of media assets and a 25-million captive audience." Osman Rani adds that ancillary products and services benefit from being seasonally insensitive, but he adds: "The competition for wallet-share becomes tougher. It is not enough to just offer food, we need to make sure that the food is of the highest quality, with the best menu selection and the right prices so that guests will prefer to dine onboard."
Alex Cruz, who heads Spanish budget carrier Vueling, believes there is still untapped ancillary potential. "We've probably run punitive ancillaries as far as we can, but there's significant room to develop non-punitive ancillaries which are under an airline's control, such as seat selection." One innovative idea which Cruz recently brought to market was an Internet feature, giving passengers the option of paying a fee to lock their fare for a 24- or 72-hour period, allowing them to plan other elements of their trip.
All airlines are on the look-out for "the next big thing" which will grow revenues without alienating passengers still further. Summarising, Cruz concludes: "Ultimately passengers will pay for real value. That is where the growth is ready to be unleashed. All the easy things have been done. At this point we will begin to see true market leadership, through innovations and new products. It will not be punitive. It will be real development based on new ideas, rather than combining a flight with an opera ticket. That's old hat and the margin is low. We are really racking brains for new services."
Continental and Delta have just joined Alaska, American Airlines, Hawaiian, Frontier, JetBlue, Spirit and Southwest in introducing a cashless cabin on some flights, where flight attendants use hand-held credit and debit card readers to process onboard purchases.
Continental chief executive Jeff Smisek says this opens the way for new onboard sales opportunities. "You could see us experimenting with higher-end products onboard - such as cocktails, energy drinks, chocolate bars, things like that - to see whether it makes sense. With the cashless cabin, it's easier to do and experiment with various price points."
Never one to lag too far behind the curve, Ryanair chief financial officer Howard Miller says his carrier has been investigating onboard point of sales technology for the last two years. By the end of January it will be available across Ryanair's entire fleet. This will allow Ryanair to offer travel and attraction vouchers and mobile phone top-ups onboard. "It gives us access to a whole load of products that we didn't sell before and will increase penetration on existing products," says Millar.
This system may open up product bundling and ancillary revenue management opportunities. Millar says: "I think onboard point of sales technology means we will be able to more dynamically manage what happens on board. At the moment that is quite a complex process. We are looking at bundling some items together, but we need a platform for it."
Seat Selection: More Scope Yet?
"What's really interesting is some things that you never think would produce revenue produce revenue," says AirTran chief financial officer Arne Haak. "One example is seat assignments, introduced two years ago. Today that produces $24-30 million in revenue a year."
The concept may not be new, but it still has potential. "The ability to assign seats is a fantastic area for growth," says Vueling chief executive Alex Cruz. Vueling passengers can already reserve an XL seat for €10 ($14) or block their neighbouring seat for €25. Cruz believes there is potential to upsell these features closer to the travel date and at the airport. He adds that there is scope for seating segmentation, as extra room is worth more on a three-hour flight than on a shorter sector.
US Airways president Scott Kirby agrees: "I think the next big area for ancillary revenue is allowing customers at any point in the booking process to pay a fee to sit in a better seat. The reality is that sitting in the first row of economy, on the aisle, is a better than the middle seat, next to the lavatory, in the back of the airplane. Today we charge exactly the same price for those. So, to allow customers to differentiate between those two seats is something we are eventually going to do, I believe. It is remarkably challenging technologically, but we are working on that. We may be able to do some of that sometime in the middle of next year."
Over in Asia, Jetstar head of commercial Leslie Ng says: "We are launching 'Upfront Seating' where JetSaver and JetSaver Light passengers will be able to confirm a seat in rows two to four of any Jetstar Asia flight for a charge of S$10 ($7)." But he adds: "JetFlex passengers will be able to continue to select these seats free of charge."