For the global airline industry, ancillary revenue reached almost $60 billion in 2015, according to IdeaWorks, a consulting firm that tracks airline ancillary revenue. This revenue source for airlines has been said to be critical to current airline profitability. But, from an industry standpoint, there is still not a clear definition for "ancillary."
Based on current trends, depending on how one defines the term, "ancillary" could be reported to be $600 billion of the total $750 billion global airline industry revenue, or potentially 75% in just a few years. Yes, ten times the $60 billion figure. Unfortunately, the increase in ancillary revenue could be reported without an increase total airline revenue and with few actual changes in airline pricing – depending on how airlines define "ancillary."
The issue in reporting ancillary revenue is related to the "unbundling" that has occurred. Some "unbundling" does not provide materially more customer choice – which is considered a fundamental customer benefit of ancillary. Here’s how we could reach $600 billion in ancillary without real improvements in airline merchandising or increases in customer choice:
1. "Service" Fees
Spirit Airlines, a so-called "Ultra Low Cost Carrier" and the leader in ancillary fees in the United States, assesses a "convenience fee" that is over 10% of the base fare. Arguably, since this applies to most passengers – any one that books their travel either through third parties or via the airline website, potentially 99% of all passengers - this is more of an accounting device than a new fee (Spirit doesn’t have to pay airline tax on this "optional" fee). Since it is broken out, Spirit reports it as "ancillary". If other airlines followed Spirit’s lead, "convenience fees" could convert 10% of the industry’s base fare to new "ancillary" - without a change in total revenue.
2. Branded Fares
IdeaWorks includes in its estimated ancillary revenue any fare premiums associated with branded fares. So if an airline offers a bundled fare with services that are separately charged à la carte, the fare premium for the branded fare is termed "ancillary." This is certainly sensible – but as more airlines offer more such branded fares, potentially more "ancillary" revenue will be reported.
3. Full Fares
Given a convention of decomposing fares that bundle in à la carte services, "full fares" could conceptually be broken out. A portion of "full fare" could be termed an ancillary service: "fully refundable" or "ability to stand-by." With full fares representing potentially over 10% of total revenue, a large portion of these higher fares could be designated "ancillary," converting 5% of current revenue from "base fare" to "ancillary".
4. Bare Bones Fares
One way for airlines to sell more "branded fares" is to continue to further cut services associated with lower base fares. For airlines that pursue this strategy, arguably, the fare premium above "bare bones" could be reported as "ancillary." In fact, American, Delta, and United have each announced that they will offer new and lower fares with fewer amenities, in response to increasing competition from Spirit and Frontier (the "ULCCs"). Since both Spirit and Frontier charge for carry-on bags – which is included in the base fare for the larger carriers – a bare bones fare that charged for carry-on could overnight add $20-$30 for many passengers at American, United, and Delta – instant ancillary.
5. Barer Bones
In fact, "bare bones" could become even more restricted. Such fares could be aggressively inventory controlled – offered only greater than 21 days before the flight (21 AP) and only on flights where higher fare demand isn’t expected to fill the seats. Here again, fare premiums above "barer bones" could be reported as "ancillary." For example, the bare bones fare could be set at $79 and every fare above it, $89, $99, up to $499 as "base fare plus ancillary." Once again, instant ancillary.
Percent of Total Ancillary Revenue ($B)
|Current Global Ancillary (2015)||8%||$60 B|
Possible New Reported Ancillary Streams:
|Convenience Fee||10%||$75 B|
|Branded Fares||10%||$75 B|
|Full Fares as a Brand||5%||$40 B|
|Bare Bones||20%||$150 B|
|Barer Bones||25%||$185 B|
|TOTAL POSSIBLE ANCILLARY||78%||$585 B|
Could "ancillary" reach 80% of total revenue? It depends as much on how it is reported as it does on real airline merchandising initiatives. Thus, airlines need to be careful about focusing on ancillary in aggregate. Each ancillary fee needs to be analyzed on a granular basis and in conjunction with each other:
- Do the ancillary services offered represent real choice? For each ancillary item, are there particular customer segments that tend to purchase the service and others who do not? Are both groups satisfied with "Choice" and "Value"?
- Are branded fares "working"? Do they offer a new and relevant choice? Do they provide a better vehicle for customer communication of optional services? Do incremental sales offset dilution?
- Is total revenue increasing? For a healthy industry, ancillary should lead to higher overall revenue, not just a shift in accounting of the base fare.
Airlines should concentrate on the impact of their ancillary offerings on the customer - customer engagement, customer choice, customer satisfaction – and on total revenue. This is where the real opportunity lies for airlines in "ancillary" revenue.