Applying Dynamic Pricing to Airline Ancillary Fees

     

Blog-Header-images-blog.png

We all know that it’s possible to pay different fares for the same flight. One passenger pays $79 and the traveler sitting next to them could be paying $579, based on advanced purchase, inventory controls, and other often complicated rules.

Of course, to truly get the lowest fare, passengers now must look beyond the base fare to ancillary fees, which in some cases doubles the amount in the base fare. Keeping it somewhat simple for customers, most airlines have fixed fees for many such ancillary services; for example, $25 for a checked bag, or $6 for an on-board drink.

In explaining the new “Basic Economy” fares recently, however, the VP of Revenue Management at American Airlines, implied that certain features could be priced differently in varying markets at different times. He observed that the new low fares that prohibit carry-on luggage will have a number of competitive effects across markets. 

American Airlines, VP of Revenue Management

“Obviously, the key thing is trying to figure out what the price premium can be for the main cabin “Economy” product compared to “Basic Economy”. And that is going to be a function of the competitive environment. And we are just going to have to figure that out as we go. Obviously, where we compete with Southwest but that does not have a bag fee we are going to have to, again, test to see what kind of premium we can get for our main cabin product versus the Basic product.”

The fare differential between Basic Economy and Standard Economy is intended to represent product differences. Basic Economy, most controversially, does not include the use of overhead bins for carry-on luggage. As American Airlines points out, this product difference is of varying values in different markets.

American Airlines is currently testing a fixed differential of $20 between the Basic Economy fare (no carry-ons) and the Standard Economy fare (free carry-ons). United Airlines’ test for a similar product, however, varies the differential between the two products from $15 to $25. Let’s think through the suggestion that the differential should change with the competition.

Vs. Ultra-Low-Cost Carries (ULCC’s)

Where a ULCC is a major competitor, the new lower fare will presumably allow American Airlines to match their low fares and sell-up from there. American Airline’s Standard Economy, with free bags, can thus be priced at least $20 more given that the ULCC’s equivalent service assesses a $25-$30 fee for carry-ons. 

     - American should find that the $20 discount is a great way to compete against the ULCC’s. They may even find that a higher discount is warranted.

If the ULCC has significantly less competitive service – for example, 1-2 flights a day versus an hourly schedule for American Airlines – then American Airlines would not need to bring its Basic Economy fare down to the ULCC fare. In this scenario, American Airlines should begin to be concerned about fare dilution – having customers totally willing to pay the extra $20 opt instead for the new lower Basic Economy fare.

Vs. Delta Airlines and United Airlines (Legacy Carriers)

In many markets, American Airlines competes primarily against other legacy carriers with similar product and pricing strategies. However, each of the three legacy carriers currently have somewhat different philosophies for Basic Economy. (Delta Airlines doesn’t have a no carry-on restriction; United Airline’s has varying discounts). In these markets, it is not helpful for any of these carriers to disrupt the market or to make widely available a new lower fare that brings down the whole fare structure. Although both American Airlines and United Airlines may want to try to raise their entire fare structure above the new Basic Economy fare, Delta Airlines may not wish to have its lowest fare be $20 higher than its competitors. Arguably, to maximize revenue and not disrupt their competitive positions vis-à-vis each other, none of these carriers would even offer the Basic Economy fare in markets where they only compete with each other.

Vs. Southwest Airlines

American Airlines competes with Southwest Airlines even more than it does with the ULCCs, and Southwest Airlines' fares include free checked bags as well as free carry-ons. Today, free carry-ons contribute significantly to American Airline’s ability to compete successfully against Southwest Airlines in certain markets. Questionably, American Airlines has worked out a way to compete against Southwest Airlines – on a combination of price, product, and rules - and wouldn’t want to disrupt it. Southwest Airlines, too, appears satisfied with the status quo.

If American Airlines now introduces a fare lower than Southwest Airlines, even with its no carry-on restriction, Southwest Airlines would need to review its current policy. If Southwest Airlines concludes that it needs to match American Airlines' Basic Economy fare, it could spark a fare war. 

The main impetus for the new fare is the ULCCs, which have assessed a carry-on bag fee for some time. American Airlines is not seeking a price advantage versus Southwest Airlines, so when competing against each other, and not a strong ULCC, American Airlines would not need to be offering its Basic Economy fare. If it does offer a Basic Economy fare in such markets, I would expect a much lower fare differential - $10 or less – or very limited availability.

     - American isn’t testing any markets with just Southwest Airlines as a major competitor.

Besides charging different premiums based on the market, like United Airlines does, each of the airlines can vary availability. In many test markets, in fact, the Basic Economy fare is unavailable for American Airlines or United Airlines flights within 2-3 weeks of the departure. Although the airlines say they will offer the new low fares everywhere, aggressive revenue management will restrict their availability depending upon local demand and market-specific competition.

Diagram_1-1.png

Conclusion

Basic Economy fares, now introduced by all three global U.S. mega-airlines, were designed to compete more effectively against ULCC competition. The fares – with new restrictions including in some cases, no access to carry-on bins, allow the airlines to match the ULCC fares while limiting dilution. They have a much smaller role in non-ULCC markets, however. In fact, they can disrupt the competitive dynamic among both legacy carriers and with Southwest Airlines. Thus, in markets without ULCC competition, the fares should have both lower fare premiums/discounts (driving less customer appeal) and/or less availability (less supply).


Learn more about the tools that enable your airlines to develop business rules for dynamic pricing.

Comments

Subscribe Here!