An increasing number of carriers are turning to ancillary products to bolster their profits as margins from ticket sales come under greater pressure
When it comes to growth, Ryanair is among the fastest. But at a carrier where scheduled passenger revenues rose by 26% to c924 million ($1.2 billion) in its last full 2003/4 financial year there is one area where business outstrips even this impressive performance: that is the sale of ancillaries.
Ancillaries come in a variety of guises, ranging from car hire and hotel reservations to in-flight catering and retail sales. With the notable exception of in-flight food, these revenues are a high margin, generally low-risk business stream that is becoming more and more significant to many low-fare carriers.
Ryanair's Santina Doherty, the Irish low-cost carrier's marketing and ancillary revenue chief, is bullish about the prospects for this secondary business stream. "These revenues are growing at over twice the rate of our ticket revenues - 45% year-on-year - and are an increasingly important part of our business." With yields still falling, Ryanair has to find new ways of driving profitability, she says. "This will be delivered by ancillary revenue growth." The numbers are beginning to speak for themselves. Ryanair made ancillary revenues of c149 million in 2003/4. Rival easyJet has not been as successful, but still made £61 million ($113 million) on ancillaries compared with just over £1 billion in passenger revenue in its year to September.
For some, the proposition is straightforward: customers pay a basic low price for their seat and then pay extra for all other value-added services like food, drink, extra legroom or lounge access. "We do it to give greater transparency to our product," says Neil Burrows, head of Brussels-based Virgin Express. "It's about being honest with our customers."
As the larger low-fare carriers are finding, the sheer volume of visits to their websites means they are becoming strong vehicles for selling ancillary products and advertising. Germanwings, for instance, recorded over 2.6 million visits to its website in October, making it the sixth largest travel portal in Germany, says director Dr Andreas Bierwirth.
Powerful sales channel
Ryanair, meanwhile, is logging 200 million page impressions every month and has signed 1.2 million people to receive flight offers in advance. This creates a powerful sales channel. Carriers have, however, been relatively slow to tap into the sales possibilities that these numbers represent - but not for much longer. "We are only scratching the surface of what the internet can do," says Doherty, and Ryanair for one is increasing its efforts to maximise returns from the medium.
For most, however, internet-based revenues represent a minor cash flow and it is the development of some form of "buy on-board offer" for low-cost and network carriers that is the main challenge. Malaysia's AirAsia, for instance, has been concentrating on its proprietary food and drink range, branded merchandise and duty-free sales, says Bruce Musick, chief executive of Crunch Time Culinary Services. This company, jointly owned by AirAsia, was formed exclusively to focus on ancillary business opportunities for the airline, including the operation of its buy on-board programme. The approach allows AirAsia to concentrate on the passenger-carrying side of the business, he says.
With AirAsia only two years old, and in its exponential growth phase, it is early days for ancillary revenues to make much of an impact, says Musick. But over time the hope for AirAsia, and other low-cost carriers, is that they will become significant contributors to profit. "AirAsia has said that someday, when the airline is mature, it wants 15% of its income to come from ancillaries. Buy on-board is one component of that." Bierwirth of Germanwings agrees that it will take time to build ancillaries. He believes that if his carrier reaches a fleet of over 30 aircraft - it will have 17 by mid-2005 - a realistic target is for 5-10% of revenues to accrue from products other than tickets.
With such prospects in mind, carriers are beginning to take a strategic view of this side of their business. "It is important that ancillaries are seen as a long-term business and part of the customer experience," says Musick.
Song, Delta's low-fare start-up, conducted intensive focus groups, mostly with women, about the make-up of its on-board product. These told the carrier that travellers want better quality catering, that they would be willing to pay for it, and that they liked brands. "We saw not only a revenue opportunity, but a chance to improve the overall customer experience on Song," says the carrier's head of marketing Tim Mates.
In North America the on-board product has changed radically since 2001, with most of the majors slashing their in-flight catering to save money. Today, apart from transcontinental and international flights, the amount of food served in the economy cabin is small, says Marc Occhuiti, menu planning manager at American Airlines. The movement to buy on-board has given the majors a chance to bring back food without having to pay for it.
American is one of the last majors to move to food sales, with only Continental Airlines resisting the temptation completely so far. The newer low-fare carriers in the US such as Song, Ted and Independence Air adopted the philosophy almost from their inception.
But there are major differences in outlook between the US and European carriers on the potential revenue benefits to be had. North American carriers generally see the initiative as a way to satisfy customers rather than a money-maker, whereas Europeans believe that both goals are possible, says Stephan Egli, global senior vice-president marketing at LSG Sky Chefs, one of the industry's two largest in-flight caterers.
"Among US carriers there are doubts about the revenue potential," says Occhuiti, who points out that historically the take-up of buy on-board products in the USA can be well below 50% of passengers. American, which is poised to make a decision on whether to roll out on-board sales across its domestic network, expects the initiative would be revenue neutral. "Over time it would become part of the fabric of the travel process," believes Occhuiti.
To charge or not to charge?
Another major difference between the USA and Europe is over non-alcoholic drinks. In Europe, virtually all carriers with a buy on-board programme charge for tea, coffee and soft drinks. The sale of these non-perishable items makes a crucial contribution to the profitability of in-flight sales since they have a higher margin compared to food. "Because US carriers are not selling beverages it is much more difficult to make money," says Egli of LSG Sky Chefs.
But US carriers are not moving in this direction. Song looked at charging for non-alcoholic drinks, but rejected the idea, says Mates. It did not believe the extra revenue outweighed the negative perception of being seen as cheap by its customers. The problem for the majors, says Egli, is that they cannot ask passengers to pay for what is free on low-fare carriers. "It would have to be a low-cost carrier that starts this off," he believes.
The emphasis for carriers developing buy on-board is putting the right amount of food on to flights. "How much do you load?" asks Robert Shepherd, managing director-mainland Europe at Alpha Flight Services. "The risk is the wastage."
Carriers must strike the right balance: do they load more than enough food so that everyone can obtain their first choice, but risk wastage and losses; or do they carry less food, with the risk of running out and upsetting customers, but not losing money. "This is the most critical issue for network carriers in making this work," says Egli, of LSG Sky Chefs, which delivers buy on-board products to 1,000 flights a day around the globe.
Caterers are becoming smarter at predicting how much stock to carry. According to Alpha's Shepherd, which has seven years of experience running programmes for easyJet and Ryanair among others, it can model demand closely. "It's OK to run out," adds Shepherd, making an appeal to carriers that want to turn a profit from their in-flight food.
The potential cost saving element is just as important as the revenue opportunity, says Burrows at Virgin Express. His carrier, for example, has saved around c7 million a year in catering costs since moving 18 months ago from complimentary to paid-for food.
One possible solution to wastage is to encourage pre-ordering of food at the booking stage. Virgin Express has introduced an Alpha product range, D'Lish, that offers this option. But despite a high-quality and competitively priced range, it has been difficult to sell, with just 1-2% of passengers booking meals in this way, says Burrows. This compares with the 15-19% who buy food from the trolley.
Song axed pre-ordering because of low volumes. Alpha is considering whether to continue with its service, which has only two customers - Virgin Express and MyTravelLite. "I'm losing money on it," concedes Alpha's chief executive Kevin Abbott, about a project that is costing the business around £400,000 a year. "It may have come slightly ahead of its time," he adds. However, Egli of LSG Sky Chefs believes that the concept is the way forward although it may still be in its infancy.
In Asia, buy on-board is in its initial stages. The region's low-cost carriers are following the European model of asking passengers to pay for everything, says Egli. AirAsia has taken a step further by establishing its own food brand, Snack Attack. "The idea is to create a certain cachet to the products," says Musick.
Outside the USA, there are fewer network carriers moving to buy on-board food, says Egli. A few in Europe, like Aer Lingus, Iberia and Swiss, offer the service on some flights. But widespread adoption by most European and nearly all Asian network carriers is unlikely, he says. "There is little application of this model in Asia as carriers see food as an important part of their value proposition."
AirAsia, meanwhile, takes a holistic view of the on-board environment and particularly in terms of developing crew buy-in for the concept. "Carriers have got to have a sense of clarity of why they are doing the programme," says Musick. "You've got to think of it as consumer marketing," he adds, which means viewing the cabin crew as part of the sales force. The correct sales training should be a key consideration when recruiting crew, he says. For example, the carrier is seeing higher sales levels per passenger at its new Thai AirAsia affiliate compared with the original AirAsia because it spent more time on training its crew on its buy on-board offering, says Musick.
As carriers become more experienced with buy on-board tactics for their food and drink, many are looking for other chances to make money. After years of championing the most basic of low-cost concepts in the Southwest Airline mould, Ryanair is now prepared to innovate. "Our in-flight entertainment trial is testament to the commitment and focus behind ancillary revenues," says Doherty. Feedback from the trial, where passengers can rent a DVD player for the introductory price of c7, have been positive, with nearly a third of passengers taking them, she adds. If the devices are rolled out system-wide they could make the carrier c14 million in annual revenues if just 3% of passengers rent them per flight, says chief executive Michael O'Leary.
American is another to begin trials of portable DVDs, priced at $10-12, while Song introduced pay-per-view films and games on its seat-back in-flight entertainment system across its network in December. Others, like JetBlue Airways and Frontier Airlines, offer live television, but there is no charge. Ryanair will look at any possibility of boosting on-board sales, and will not discount live television or charging for priority boarding and front-row seats, says Doherty. One big success, launched in November, is the sale of lottery tickets on board.
But Musick at AirAsia is cautious: "There is a clear battle between the issue of taking advantage of your captive audience from a marketing sense and whether that clashes with the simplicity of being a low-cost carrier. Carriers can add more profit opportunities, but they must ask whether it brings complexity back to the business." The biggest enemies for a low-cost carrier are time, in terms of harming turnarounds, and space, in terms of storing buy on-board items, he says.
Carriers from all corners of the business are studying new ideas. Virgin Express has added the chance to book lounge access from its website. Valet parking is also being considered by the Brussels-based carrier, says Burrows.
Song believes there is an opportunity for internet-style shopping on transcontinental flights, says Mates. This would look much like a dot.com site such as retailer Amazon, with passengers ordering and paying by credit card during the flight, says Mates. The orders would be downloaded upon landing. "You could reasonably expect to see this kind of service in the next 12 months," he says.
This style of inflight shopping is just one example of the ideas being floated for raising ancillary revenues, with more sure to emerge. The interest in this area shows how crucial it is becoming for many carriers. As Jonathan Crick, sales and marketing director for UK carrier Monarch Scheduled, observes: "They are becoming part of our business model."
REPORT BY MARK PILLING IN LONDON