Attention All Passengers (11 page)

The bad news for consumers today is much less competition for passengers based on service, comfort, or amenities. Michael Levine tells the tale from his airline days: “Anytime we experimented with the idea—we'll give them something a little better, but it will cost them a little more—they turned it down. And the purest forms of these experiments were run by American and TWA when they took seats out for more legroom programs.” Despite the clear advantage of these two programs, neither carrier made any money from offering more comfortable seats. Levine concludes: “Of course, we in the industry watched this with great interest. But the evidence is, there is something in the consumer mind that says I'm only going to be on the airplane for two hours, four hours, twelve hours, fifteen hours—and I'll put up with whatever it takes to save a few dollars.”

Many believe that commoditization in large part is driving the race to the bottom on everything from service to safety. Labor leader Pat Friend is not afraid to raise a corollary issue: “You hear consumers complain about getting bad service. I can't tell you how frustrating it is as a flight attendant to not have the tools to serve the customers. I tell my friends, when you stop surfing the Net for the cheapest fare you can find, then we'll talk about service.”

George Hobica and his colleagues at Airfarewatchdog.com spend hours every day surfing for airfare bargains, and he says that the irony is that some low-fare airlines are not even competing on flights, but on other products they are paid to sell online to customers booking vacations: “Allegiant Airlines doesn't make money on those low fares, it makes money selling tickets to Blue Man Group.” Hobica is right: in an examination of forty-seven carriers worldwide, Allegiant topped them all by notching 29.2 percent of its total revenue through ancillary fees; in second place was Spirit at 22.6 percent and in third was Ryanair at 22.6 percent. The only legacy airline on the topten list was United/Continental at 14.7 percent. As IdeaWorks stated: “Many of these airlines are becoming savvy retailers.” Lesson learned: for the airlines, getting you to shop on their own branded sites is critical.

Experts point to the world's undisputed low-fare leader—Ireland's Ryanair—and its mercurial CEO, Michael O'Leary, who continually makes headlines by promising airborne pay toilets and “stand-up” fares without seats. It was Ryanair that dared to impose baggage fees and made them stick, a move that was first emulated in the United States by Spirit.

That Dirty Little Word:
Fee

Like all Americans, I encounter ancillary revenue in all sorts of places. My bank recently docked me a fifteen-dollar “maintenance fee”; my gas station charges more for noncash purchases; and my apartment complex introduced a “Preferred Parking Program” by roping off the same old spaces and charging an additional twenty-five dollars per month (after midnight, tow trucks ensure compliance). But no other business can match the airline industry for sheer artistry in levying fees.

Ancillary revenue
. It's quite a term. A fine example of corporatese—specific enough to be understood in dog-whistle fashion by a select few, but vague enough to be unrecognizable by most of the population. So don't expect the airline industry to call ancillary revenue by more apt descriptions. Added fees. Nickel-and-diming. Gouging.

Dozens of airline executives are cursing me for that last paragraph. They'll patiently explain why “unbundling costs” is a necessity, a happy medium between raising airfares and filing for bankruptcy. But one thing absolutely cannot be denied: the U.S. airline industry has done a terrible job of communicating such needs to its customers.

According to the DOT, U.S. carriers raked in $3.4 billion in baggage fees and $2.3 billion in reservation change fees in 2010. But here's the kicker: that $5.7 billion is only part of the story, since the DOT cannot separately identify other types of fees lumped in with ticket revenues.

Still, the industry has its defenders. “The whole thing pisses me off,” says Brett Snyder of CrankyFlier.com. “Not that there are fees, but how the public perceives them. . . . Airlines have not done a good job of merchandising their products. People have these rose-colored glasses about how glamorous flying was before deregulation. Fees are a way to keep their heads above water.” On the other hand, even Snyder acknowledges some carriers go too far, especially the “convenience fee” of $14 with Allegiant Air and the “passenger usage fee” of $4.90 each way with Spirit Airlines—to book
online
!

There has been no stronger hot button among passengers than added charges. But Michael Levine makes the case for some of these fees: “You charge more for the window seat so you can charge less for the middle seat. Your total revenue will be the same. . . . The customer will say, I don't see why the window seat costs more than the middle seat. But by the way, they have no problem walking into a theater and paying more to sit in seventh row center than in the second balcony. It's the same goddamn thing. The theater is the same size every night. It costs the same to put on the play every night.”

Glenn Tilton doesn't just defend baggage fees—the chairman of United/Continental goes further by saying he doesn't understand why the airlines
ever
allowed bags to be checked for free: “My first question when I joined the company was, how much investment do we have tied up in bags? The answer was more than a billion dollars. Then I asked how much it brings in and the answer was, it's negative. So I asked, why don't we charge for bags? I got nothing but blank stares. And every day we were bleeding five to seven million dollars.” Tilton can discuss the macroeconomics of the airline business and the need for ancillary revenue for minutes at a time, but in the end he agrees with me on one point: the industry has conducted a poor public relations campaign in explaining such fees to consumers. At a bare minimum, airline executives should endeavor to explain to customers what they explain to board members; if fees are so necessary to a company's financial health, then why should it be so hard to make consumers understand?

When the Bottom-Line Fare Isn't

Ancillary fees now constitute about 5 percent of the industry's total revenue, and for the last few years a small war has raged within the travel industry over full disclosure of such fees, particularly for corporate travel departments that have seen their budgets skyrocket. This has affected average consumers as well, even those traveling for pleasure. Some 60 percent of consumers buy airline tickets through sales channels where airlines don't provide all the data on optional services fees. In other words, customers can't obtain the bottom-line cost of an airline ticket, an otherwise sacrosanct consumer right in all other areas of American commerce.

In fact, many domestic airlines currently are in violation of pricing transparency regulations, because if a customer cannot get the total price in one click, it's a DOT violation.
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That's why Kevin Mitchell says, “The majors would argue, ‘These fees prevent fare increases.' But in my heart I feel these guys are double-dipping.”

The Holdouts on Bag Fees: Southwest and JetBlue

Jay Sorensen of consulting firm IdeaWorks believes airline ancillary revenue will “top” at about 30 percent of total airline revenue, which certainly seems to translate into a fare hike for most travelers, if a $200 fare becomes $260 with added fees. He also says charging extra for checked bags will become ubiquitous worldwide over the next two years, in part because of international codesharing and marketing alliances.

But with bag fees, there are two notable exceptions. For no matter how hard airline public relations execs spin on this topic, two irrefutable facts have emerged: the first is that Southwest and JetBlue are the only two U.S. airlines not charging for first checked bags and the second is that Southwest and JetBlue are the two most popular airlines in the country.

While JetBlue does not charge for first bags only, the Southwest “Bags Fly Free” slogan applies to both the first
and
second checked bags. And it's not just about surveys and awards—those good vibes are translating into added business in an industry notorious for a lack of brand loyalty: Southwest has notched market share advances since baggage fees were introduced.

So, will Southwest hold firm and buck the baggage fee trend? Some believe that if fuel gets any more expensive than it is now, Southwest will have no choice but to start charging baggage fees. Others think that because Southwest is so invested in its status as the low-cost airline, it will have to maintain its current policy. I asked CEO Gary Kelly if his airline will continue its bag policy, and he responded immediately: “I guarantee it.”

But Southwest's cost structure was aided in large measure by the long-term practice of “fuel hedging,” which locked in a set price for a considerable and volatile expense. It's a dark art that requires guessing right
and
having cash collateral. For 2008, the
Los Angeles Times
reported that about 70 percent of Southwest's fuel that year was purchased at approximately $51 per barrel, at a time when crude was pricing at $126 per barrel. While its competitors were reeling from fuel costs, it was a golden opportunity for Southwest to hike airfares or impose fees, which in turn would have helped other airlines do the same. Instead, Southwest did neither.

In 2008, when Southwest was heavily invested in fuel, it declined to raise its fares. And by not raising ticket prices, Southwest helped force other airlines to impose fees instead—and then Southwest declined to match those fees, gaining further advantage over its rivals. Southwest passengers won—twice.

A report in February 2011 noted that United/Continental imposed fuel surcharges, yet another add-on fee not always captured in the bottom-line price of a ticket. In turn, this caused price hikes from American, Delta, US Airways, Alaska, and AirTran—but not Southwest. Pricing analyst Bob Harrell posits an important theory: “I think there's a lot of whining about fuel costs. Fuel cost fluctuations have been around for thirty years now, but airlines use it as a way to justify fare increases. So I think airlines like the price of fuel going up. It improves their margins. The increased charges go in immediately but they come out slowly.”

In 1993, the DOT issued a landmark study titled “The Southwest Effect,” which demonstrated how the nation's low-fare leader gains market share, drives down fares, and generates new air traffic in the cities it enters. The study also included this key observation: “Southwest's demonstrated ability to quickly dominate markets and force out competitors may not be perceived as a problem in the near term because Southwest offers lower prices, even as a monopolist, than other major airlines offer even in the most competitive markets.” But now more and more industry experts are contending there's been a change, and I hear it over and over. George Hobica sums it up: “With Southwest, the game is over. They're not as low-fare anymore.” Even the American Antitrust Institute noted the “Southwest Effect” has not always occurred in recent years.
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CEO Gary Kelly doesn't deny this, and notes, “Our cost advantage has narrowed.” But he says fares are tied in with costs, and as Southwest's costs lower, so will its fares.

Bob Harrell believes the overall demarcation between low-cost carriers and legacy airlines is becoming more obscure: “The lines are definitely blurring. The LCCs are trying to maximize their profits and the legacies are pushing back. They used to just run away from Southwest but there's only so much geography in the country.” And the same can be said of JetBlue, which some claim has been “coasting” on a low-fare reputation.

How the Southwest Effect affects the rest of us is critical: if America's leading low-cost airline is not so low cost anymore, the fallout on airfares will be tremendous in coming years. But columnist Joe Brancatelli bucks the conventional wisdom when it comes to Southwest: “Everybody's always looking for the trapdoor. But thirty-six years later, they're still making money. I think [CEO Gary] Kelly gets the benefit of the doubt.” Point taken.

Frequent Flyer Programs: Rewards or Ponzi Schemes?

The introduction of frequent flyer programs injected just a pinch of long-lost romance into the airline experience. Sure, it sucks to be squeezed into a middle seat, swiping a credit card for a Sprite Zero. But . . . a quick calculation . . . maybe . . . let's run the numbers . . . just maybe . . . Cancun! Victory!! Who didn't root for George Clooney in
Up in the Air
? (It's worth noting that in Walter Kirn's novel it was the fictional Great West Airlines that was featured, but in Ivan Reitman's film the brand placement of American Airlines was so heavy the company seemed like a character unto itself.)

As with other pursuits, mileage expert Randy Petersen says everyone wants to earn low and redeem high. But those who entered such programs in the early days have done much better than those who have entered more recently. And that's a model that really doesn't resemble the stock market. It actually resembles a Ponzi scheme.

Consider that just a few years ago—before expiration rules tightened—there were more than 10 trillion outstanding miles, while members were redeeming less than 900 billion annually. And further consider that today more than half of all frequent flyer miles are generated without ever boarding an airplane. That's a staggering factoid for programs that were touted as “loyalty” and “rewards” plans to steer passengers to Carrier A rather than Carrier B.

The statistics have become more elusive, but experts estimate about 9–10 percent of all airline seats are occupied through redemption. Linda Burbank, the travel ombudsman, says she no longer sees airlines offering frequent flyer mileage as compensation in resolving customer service disputes, which undoubtedly is a reflection of the growing percentage of unredeemed miles on airline balance sheets.