Fees for checking bags, choosing your seat, buying something to eat or, in some cases, using a live agent to check in. People hate airline fees, yet they continue to rise in both volume and price. Global airlines collect more than 20% of their total revenue from fees, which are called ancillary revenue, according to Ideaworks. Fees represent an important and now standard part of how any airline operates.
There’s more here than simply adding fees to things that, long ago, were included in the basic fare. The economics of ancillary revenue are very strong, and it is this reality that best explains why fees have multiplied. President Biden has called some things “junk fees,” but the fees that drive most of the industry’s ancillary revenue are not under serious threat. Airlines can help themselves by ensuring they are fully transparent about what is charged and when. Here are the compelling reasons that drive the thinking of most airlines:
Lowers the Base Fare
As airlines have collected more ancillary revenue, not just through fees but from many sources, base fares for travelers have fallen. This gives more people the ability to travel by air, even if they have to give up a few things to make it happen. What happens most of the time, though, is that people attracted by the low entry price end up buying something else, like a drop bag.
Airline passengers are particularly resilient. I don’t mean their body, I mean their financial behavior. Small changes in prices result in relatively large changes in demand. Low-cost airlines see this all the time. They might enter a market that carried 350 people each day, and by lowering the base fare a bit, the market increases to 500 people a day. Thus, by creating ancillary revenue streams, airlines can increase their passenger base by making the entry point less expensive.
It better reflects consumer price elasticity
Back to elasticity, different products react differently to price changes. A family can decide whether to fly at all, or where to go, based on just a $5-10 difference in fare. But once they’ve committed to travel, a $25 or $35 bag fee makes almost no difference in the number of checked bags. If you’re thirsty and bored, a dollar isn’t likely to change the way drinks are sold. The point is that for each part of the journey, consumers’ reactions to prices change based on what and when they buy.
By unbundling the ticket price, airlines can better reflect the price elasticity of each product and ultimately increase their revenue. This helps them boost ancillary funds, in turn further reducing the base fare. It’s a much more efficient way of pricing, and consumers see that in a lot of the things we buy. There are not many restaurants that include drinks or desserts with the main course. By pricing each product differently, they better reflect both consumer demand and willingness to pay.
It somewhat balances the seasonality
Airlines are a very seasonal business. There is variability in demand based on the time of year and even the day of the week. Weekly airline demand is not evenly distributed over seven days, with many more people traveling Thursday-Friday than Monday-Wednesday. Balancing this seasonality is a challenge for airlines, as their capacity is often fixed. By doing maintenance earlier than needed and pushing crew vacations to certain times of the year, airlines can build more capacity for some busy months.
Base fares are often adjusted for this seasonality, with higher fares at peak times and incentives for lower fares during periods of weaker demand. This results in large fluctuations in monthly and quarterly revenues. Two air costs, people and aircraft, are largely determined during the year. This means that earnings vary a lot, and ancillary income helps with that. That’s because while ticket prices can change by hundreds of dollars based on the season, baggage and other fees remain largely constant throughout the year. Frontier Airlines now sells more than half of its total revenue as subsidiaries. This means that over half of their revenue has very different seasonality. Even the 15% to 20% of ancillary revenue common to most airlines in the world stabilizes top-line revenue against a largely flat cost base, and that somewhat stabilizes quarterly earnings.
It improves the cost structure
Airline fees don’t just raise revenue for airlines. They also act as incentives for consumers to behave differently, and these differences often lead to lower costs for the airline. When airlines charge for bags instead of bundling them into the base fare, like Southwest, customers check fewer bags. This means baggage belts last longer, airlines lose less luggage, and perhaps not as many people are needed to load and unload luggage. RyanAir in Europe and some airlines in the US charge a fee to check in with an agent, while smartphone check-in is free and easy. As fewer people need a person to check in, airlines can hire fewer agents over time and lease less airport space.
As airport costs are reduced thanks to consumers choosing new behaviors, this allows an airline to invest more in people and hard assets and its consumer product. So while many people and the media complain about airline fees, they love the lower fares and better service that come with them.
It requires transparency
As airlines charge for different services provided, it is important that they emphasize transparency in all their media. Customers shouldn’t be surprised to be charged a fee to check a bag or take a bottle of water on board. This is most easily done in direct media such as an airline’s website or app. It becomes more difficult when you sell through third-party websites, as it is difficult for them to be clear about what each airline includes or charges.
Much of the consumer and media frustration with the fees is about this issue of transparency. When I was CEO of Spirit, I used to joke that I’d go to a Chick-fil-A, look at the menu and yell, “What, you don’t sell hamburgers here?” I’ve never done that, of course, but the expectations are clear when you walk into Chick-fil-A that you’re not looking for a hamburger. Airlines need to be equally clear about what is included at what price and more options means a greater focus on transparency.