Second Thoughts on Hybrid Airline Strategies

 

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As has been frequently discussed at this blog, there is a discernible trend in the passenger airline business towards convergence of the so-called low-cost and full service business models. This convergence has focused primarily on cost control and additional revenue generation separate from the ticket price. Airline executives at full-service carriers have dressed up the cost control measures as increasing customer choice and flexibility, arguing that unbundling the service offering into separate parts allows the customer to choose which elements that they wish to pay for and those they would rather not pay for.

The numbers on this are extraordinary. According to US Department of Transport data, US carriers earned US$3.35bn in baggage fees in 2013. This was in addition to US$2.81bn in change fees for tickets purchased. For a typical U.S. airline, about 25% of total revenue comes from baggage fees and 10% come from other services, such as paying for early boarding and the sales of soft drinks on board. Worldwide, the figure stands at US$35bn for so-called fees and incremental revenues. Now of course much of this comes from the emergence of new low-cost competitors into the market but an important part of the increase has also come from full service carriers. Over 38% of US domestic carrier Spirit Airlines’ revenue came from fees in 2013 including a fee for printing your boarding pass at the airport or for a drink (even water) mid-flight. Ryanair, the ultimate low-cost operator has employed similar tactics. Ryanair head Michael O’Leary called his customers “idiots” in 2012 for paying exorbitant fees levied by Ryanair such as penalty fees for not printing boarding passes at home.

The benefits to low-cost carriers of this convergence is obvious for three reasons. First, the full-service carriers are agreeing to fight them on their own turf thereby allowing them the low cost airlines to play by their own rules of the game. Second, it also means that having dragged the full-service airlines down to their service level, the low-cost carriers can then up their game and start offering premium services to match or even surpass the full-service airlines. Third, full service airlines are often hampered by structural costs (labor agreements, legacy contracts and so on) that cannot be easily eliminated to become more ‘lean’ competitors.

Recently though United dropped plans to test buy-on-board on transatlantic flights only weeks after announcing the program, because of passenger protests. And US Airways before its merger with American Airlines had to reverse its policy of charging for soft drinks and bottled water on domestic flights after only seven months. Does this suggest that there are limits to the hybridization of full service carrier models? Is there evidence of push back from some full service carriers?

Rather than a slowdown in hybridisation, expect to see more segmentation in the service offering as full service carriers – especially in Europe and Asia – begin to offer different ‘bundles’ of economy class service. By way of example, Brussels Airlines has pioneered a segmentation of their economy class product with Check & Go, Light & Relax and Flex & Fast. LOT Polish Airlines has done something similar with LOT Economy Plus, Economy and Economy Simple. The logic is simple: we need to be able to see how much we can fleece the customer for and manage capacity on board at the same time. So if you are price sensitive, book early and we’ll offer you less and you pay less. Book later and find yourself paying more…and getting the same as someone who booked earlier!

Seriously though, airline executives have failed to act upon the difference between a business process and a customer experience. Seen from a cost perspective, airlines operate a series of complex processes. Cost optimisation dictates that we need to trim on what we offer. From a product development perspective, airlines differentiate themselves by offering valuable experiences to customers. Seen from this world, we focus on how we can convince customers to pay more for what we offer.

Take a look at Etihad’s economy class product: reclining seats and headsets that offer more space than anyone else; full meals and drinks service with a choice of three main courses; touchscreens in all economy class seats with noise cancelling headphones; internet to be rolled out across the fleet. Everything is included in the price. No add-ons. Unfortunately, Etihad appears to be an exception as the sheep like mentality of industry executives persists.

 

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