Ancillary revenue has become a major part of airline industry revenue, but few realize just how important it is to airlines. In a previous article, Fools learned about how ancillary, or add-on, revenue is defined and which airlines are the biggest revenue generators. Unsurprisingly, the budget/discount airlines rely on ancillary revenue the most, but traditional airlines such as United Airlines (NYSE:UAL) are increasingly relying on it, too. Let's take a look at some industrywide figures that help explain the importance of this revenue to airline profitability, and at who is doing what.
Growth of ancillary revenue
It's hard to put an exact figure on industrywide profitability from ancillary revenue, because not all airlines disclose the data and/or break out profits generated from ancillary revenue. However, it's safe to assume that activities like baggage checking, seat allocation, booking fees, and on-board entertainment are high-margin activities. With this in mind, here is a comparison of industrywide ancillary revenue, garnered from The CarTrawler Yearbook of Ancillary Revenue by IdeaWorksCompany, versus estimates for airline profitability.
The data tracked only 59 of the largest airlines in 2013, but the net profit estimates are far wider in their coverage. In other words, the real amount of ancillary revenue is higher than the data suggests.
To put these figures into further context, the IATA forecasts that net profit per passenger will be $5.65 in 2014, while industrywide ancillary revenue per passenger (from the data charted here) was forecast to be $16 in 2013. It's fair to say that without ancillary revenue, a lot of airlines wouldn't be profitable.
Moreover, increasing ancillary revenue is clearly a large part of airlines' growth strategy, and the stock markets have woken up to it. The latest airlines to introduce checked-bag fees include Air Canada and WestJet Airlines (and both stocks rose on the day of their respective announcements), while even JetBlue Airways Corporation (NASDAQ:JBLU) is reported to be considering how to increase non-ticket revenue.
Airlines with growth opportunities
In a previous article, readers saw that United Airlines is the leading revenue generator by total revenue, and also the leading traditional airline in terms of revenue share from ancillary sources (14.9% in 2013), with ancillary revenue of $41 per passenger. Just over half of this revenue comes from miles sold via its frequent flier program, but even excluding that, United is still generating around $20 per passenger -- a figure notably above Delta Air Lines (NYSE:DAL) and Southwest Airlines (NYSE:LUV), at just about $15 and $12, respectively.
The implication is that Delta and Southwest have an opportunity to play catch-up to United, and investors should look out for this in their statements. Meanwhile, budget airlines such as Spirit Airlines (NASDAQ:SAVE) and Wizz Air generated 38.4% and 34.9% of their revenues from ancillary sources in 2013. It's harder to see how Spirit and Wizz Air can significantly improve their ancillary revenue per passenger, especially as the figures are already more than $51 and $34, respectively.
The bottom line
All told, ancillary revenue has become a key profit and revenue growth driver in the airline industry. The trend is upward, and investors should look at airlines like Delta and Southwest for their potential to increase ancillary revenue in the future. In a sense, these fees and charges allow airlines to differentiate pricing to customers-- helping airlines keep ticket fees down for customers who can avoid paying certain ancillary fees. This is good news for customers
It's also good news for airlines, as it could help keep load factors (a measure of the capacity utilization in terms of seat-kilometers) stay high in the industry -- there are fewer things that hurt airline profitability more than empty planes. Ultimately, investors can look forward to airline stocks that are trying to increase this source of revenue in the future.
Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. 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.