Every strategy expert advocates a holistic formation of strategy, resulting in the integration of operations, commercial, pricing, and branding. Each function is linked and inter-dependent, and so every decision must be aligned with an overall consistent customer positioning within the chosen marketplace. This prescription applies to airlines too, of course. And pricing, as with other commercial functions, needs to be aligned with all other dimensions of an airline’s strategy.
On the other hand, when airlines pursue similar commercial and operating strategies, pricing does not tend to be a differentiator. Mega-airlines, pursuing similar commercial and operational strategies, also have a standard approach to pricing. These global carriers, with hundreds of planes in multiple fleet types and numerous seating configurations, serving over a hundred destinations out of various hub airports, with strong frequent flyer programs and corporate partnerships, all have similarly complex pricing and sophisticated revenue management systems - they seem to match each other on ancillary pricing and e-merchandising. Pricing almost appears mechanical and there is limited price differentiation.
Smaller carriers pursuing different corporate strategies than their mega-carrier competition, require unique pricing that aligns with those strategies. Many of these smaller carriers choose a lower cost operating strategy – point-to-point services with high aircraft utilization, for example. Airlines with such an operating cost advantage in turn adopt creative pricing to exploit their cost advantage and to differentiate them from the mega-carriers.
In the U.S., the largest and most successful point-to-point, “low cost” carrier is Southwest Airlines. Although Southwest’s cost advantage has narrowed over time, they still enjoy a cost advantage versus the U.S. mega-carriers – United, American, and Delta – with their different business model. Unfortunately, their business model also results in lower unit revenue – less total demand for flights given fewer connect traffic opportunities, fewer corporate deals, less powerful frequent flyer programs, fewer distribution channels. Thus, Southwest pursues unique pricing to attract more than their “fair share” of passengers in the markets in competition with the mega-carriers.
Contrary to the U.S. airline industry norm, Southwest is still bundling checked bags into their base fare. Their pricing strategy, a key differentiator versus their global competitors, follows from their entire commercial and operational strategy. It exploits their cost advantage while positioning the airline as uniquely customer-friendly. Some financial analysts believe Southwest is “leaving money on the table” by not assessing bag fees but, in my mind, it is their way to exploit their cost advantage and drive incremental passenger loads. Consistent with this conclusion, the Southwest CEO has declared that he has no intention of charging for checked bags.
SOUTHWEST AIRLINES: OVERALL COMMERCIAL & OPERATIONAL STRATEGY => PRICING
Another example of strategy-based price differentiation is Spirit Airlines, a so-called “ULCC,” or “ultra-low cost carrier.” Like Southwest, Spirit is focused on lower cost and point-to-point services. But unlike Southwest, Spirit has a low-frequency schedule model, offering 2-4 flights each in some of the largest markets in the U.S., often in competition with mega-carriers offering 8-12 daily flights in those same markets. With a low-frequency schedule, Spirit operated “under the radar” for a long period, accepting a small share of passengers in the markets they chose to compete in. In order to gain passengers versus the many strengths of the mega-carriers, Spirit needed a price differentiation strategy that could exploit their lower cost business model. They adopted an aggressive ancillary fee strategy that offers ultra-low base fares along with a plethora of fees; the base fares are so low, in fact, that the larger carriers often don’t match them. With their expanded list of ancillary fees, Spirit supplements their base fares with another 60% in optional fees, on average.
SPIRIT AIRLINES: OVERALL COMMERCIAL & OPERATIONAL STRATEGY <=> PRICING
Now that Spirit has reached the $2 billion revenue mark, the mega-carriers are responding more aggressively. United Airlines, Delta Airlines, and American Airlines have each launched - or announced the intent to launch -- new, lower fares with fewer amenities that are designed to gain back customers who otherwise would be attracted to Spirit.
The mega-carriers are generally not well-positioned to offer the lowest fares given their higher cost structure. In addition, their “capacity discipline” – keeping capacity growth below total demand growth – automatically translates into “spill”, unaccommodated low fare demand that could be carried by a few ULCC frequencies.
The mega-carriers will likely pursue the Spirit-match strategy to fill empty seats, not to replace the higher fare local passengers they already attract or the key connect traffic upon which they have built their hubs. Thus, it will be most prevalent in markets with too much low fare capacity. Arguably, the ULCC’s – fundamentally built on carrying “spill” -- should match their capacity to estimated “spill” from the larger carriers, insuring overall demand and capacity are in sync.
In the end, there is no one optimal pricing strategy; no “one size fits all.” In contrast, each carrier needs to match their pricing strategy with their overall commercial and operational strategy.