Two years ago, United Continental (NASDAQ:UAL) and American Airlines (NASDAQ:AAL) decided to introduce "basic economy" fares in order to compete better with budget airlines. Both carriers' basic economy tickets carried a number of restrictions. Most significantly, customers purchasing basic economy fares from American and United were allowed to bring only a personal item on the plane -- not a full-size carry-on bag.
However, American Airlines announced late last month that basic economy passengers will be allowed to bring a carry-on bag, in addition to a personal item, starting Sept. 5. The end of the "bag ban" at American will put a lot of pressure on United Airlines to follow suit.
A new kind of basic economy
Delta Air Lines (NYSE:DAL) was the first U.S. airline to start testing basic economy fares, and it rolled them out broadly in 2015. Delta's basic economy tickets have no carry-on bag restrictions, but they don't permit flight changes, seat assignments prior to check-in, or upgrades. Basic economy passengers also board last.
Basic economy serves two purposes for Delta. First, it's a stripped-down product that Delta can offer to price-sensitive travelers, while encouraging customers to buy up to a regular coach ticket. Second, it ensures that price-sensitive travelers (who tend to book early) don't have a chance to snag better seats than high-fare business travelers who book at the last minute.
United Airlines decided to add the no carry-on allowance policy when it unveiled its basic economy offering in late 2016. American Airlines made the same decision when it announced its basic economy plans in early 2017.
In addition to giving customers an even bigger incentive to step up to regular coach fares, the bag ban was designed to solve an operational problem for United. Flights were being delayed due to the difficulty of fitting every customer's carry-on bag into the overhead bin. Ensuring that a large number of passengers on each flight don't use the overhead bin has helped United improve its operational performance substantially.
American Airlines abandons its bag restrictions
Last month, in conjunction with its Q2 earnings report, American Airlines acknowledged that basic economy had not provided as much of a revenue lift as expected. Management explained that certain flight-comparison tools had started to ask users whether they wanted to bring a carry-on bag. Those who said yes were shown American's regular coach fares rather than its basic economy prices. As a result, its prices didn't appear to be competitive with those of Delta, for example.
This is what drove American Airlines to eliminate the bag restriction for its basic economy fares. After the change, American's basic economy product will be relatively similar to Delta's. That leaves United as the only full-service airline in the U.S. that doesn't allow every customer to bring a full-size carry-on bag.
United can't afford to be the outlier
Despite the operational benefits from its carry-on bag restrictions, it's unlikely that United will be able to maintain them after American Airlines' policy change goes into effect.
Last summer, United Continental posted dreadful results, which it blamed in part on rolling out basic economy too aggressively, while American Airlines was still testing basic economy in just a few markets. This caused some customers to book away from United, since other carriers were offering more features (such as a carry-on bag) for the same price.
The legacy carriers compete with one another extensively, but United and Delta have relatively little overlap in their route networks. By contrast, United Airlines and American Airlines both have big hubs in Chicago, as well as competing hubs in New York; Washington, D.C.; Texas; and Los Angeles.
United Airlines made some tweaks to its basic economy strategy last year that should help it compete with airlines offering less restrictive fares. Nevertheless, with its main competitors all allowing carry-on bags for basic economy passengers soon, it's only a matter of time before price-sensitive travelers wise up and start avoiding United again. Thus, United Airlines will probably be forced to loosen its basic economy carry-on bag policy sooner or later.