It was reported in local dailies January this year that Singapore Airlines, arguably one of the most successful airlines in the world, has established a new unit to explore new revenues sources apart from traditional ticketing revenues, such as as travel insurance and in-flight duty-free sales. While this is encouraging news for its shareholders, ancillary revenues are hardly new concepts in the airline industry. According to research by IdeaWorksCompany, airline ancillary revenues doubled from $13.5 billion in 2009 to $27.1 billion in 2012.
However, airlines such as Spirit Airlines (NYSE:SAVE), Southwest Airlines (NYSE:LUV) and United Airlines (NYSE:UAL) have taken vastly different approaches, when it comes to earning extra dollars from passengers.
The ultimate price discriminator
Spirit Airlines practices the most extreme form of price discrimination. Except for the airfares, all other items and options are priced a la carte. Those who fly solo may pay for wider and bigger front seats with additional legroom, which cost anything from $12-$250 extra. Families with kids are likely to choose their own seats for as much as $50; and kids help to drive onboard snacks and drinks sales. Spirit's $9 Fare Club membership will interest frequent flyers as they will enjoy discounted fares, baggage savings and exclusive access to certain vacation packages. Spirit claims that its Fare Club members save about $75 on average per booking.
Industry research validates Spirit's approach toward pricing and ancillary revenues. Based on a survey conducted by Elliott, price is the single most important factor for passengers when choosing airlines. On the other hand, IdeaWorksCompany research shows that Spirit was the top airline in 2012 based on revenue contribution from ancillary services (about 38.5% of sales). In a nutshell, the winning formula for Spirit is simple: grab the attention of consumers with mouthwatering low fees and then aggressively promote paid options that boast better convenience and comfort.
Making the right trade-offs
In contrast with Spirit's unbundling strategy where fees are charged for any checked baggage, Southwest doesn't charge passengers check-in fees for the first two bags. This has served to be a very effective branding strategy for Southwest, as a significant proportion of its customers are business travelers who tend to carry more luggage. In fact, according to a November 2012 survey by Topaz, a business traveler checking in two bags will pay the lowest all-in fares with Southwest 88% of the time vis-a-vis other airlines in 100 U.S. markets. By sacrificing potential revenues from bag check-in fees, Southwest keeps its core customers, business travelers, loyal.
Instead, Southwest chooses to earn extra dollars in other areas, such as with early bird check-in and pets. For $12.50, Southwest's early bird check-in service allows passengers to have a better chance of choosing desired seats, early boarding and access to overhead bin storage for their hand-held luggage. Also, pet-loving travelers can take the flight with their pets at $95 per pet carrier with a maximum of two pets of the same species per carrier allowed. Furthermore, less price-sensitive business travelers can also upgrade to Business Select to enjoy priority boarding, priority lane access and a premium drink.
Full service carrier challenges
Full service carriers tend to be at a disadvantage compared with their low cost carrier peer from the start, because of differing expectations. When a passenger buys a flight ticket for a full service carrier, he usually expects to have full services embedded in the cost of the fares. Therefore, it has always been an uphill challenge for legacy carriers to justify their paid services and products.
For full service carriers, United has done remarkably well. It was the sixth most profitable airline in 2012 in terms of ancillary revenues per passenger ($38.11), just one place below ultra-low-cost carrier Allegiant ($38.86). This also represents a 4.5% increase over 2011, where United earned $36.47 in ancillary revenues per passenger.
United has been creative in unlocking hidden revenues with a suite of high-margin ancillary products and services. Its FareLock service functions like financial futures contracts, allowing buyers pay a fee to hold their itinerary and price for either 72 hours or seven days. Buyers of FareLock needn't worry about flight availability or price flucutations. Similarly, United's passengers can pay more to upgrade themselves to a premium cabin depending on individual flight availability. New products like onboard Wi-Fi are available on selected flights from as low as $4.99.
Foolish final thoughts
Taking advantage of ancillary revenue opportunities isn't a straightforward decision for airlines, as they need to take into account their individual brand positioning and customer segmentation strategies. Southwest gives up baggage fees to benefit business travelers, while Spirit gives its passengers the full option of paying for what they really want .On the other hand, legacy carrier United is mindful of charging for extras while balancing the expectations of its customers who already pay full fares.
Fool contributor Mark Lin has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.