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Basic Economy Fares – Revenue optimization strategy

noviembre 28, 2017

Recently, AerolatinNews had the opportunity to interview international consultant and IATA external instructor, René Armas, concerning a major airline industry trend – Basic Economy Fares. They are not only already rolled out in the US domestic market but also being tested globally by a number of network and discounter carriers.

The executive focused on product penetration, conversion rates to a standard main cabin product, network carrier strategy, international market developments, United Airlines rethinking and refining its approach to this type of product, strategic differentiation vis-à-vis competitors including Delta Airlines differentiated approach, cabin segmentation and yield protection.

ALN: What are Basic Economy fares (“BEFs”)?

Basic Economy Fares are part of a broader revenue strategy in an already depressed global passenger yield environment that allows airlines to further segment their cabins and optimize revenues per passenger. For network carriers, it is a strategy that improves its ability to compete head-to-head with Ultra Low-Cost Carriers (“ULCCs”) and Low-Cost Carriers (“LCCs”). Furthermore, BEFs target cost conscious customers and it’s an interesting way of increasing competitiveness through and enhanced market segmentation philosophy. Moreover, BEF allows network airlines to craft tactical upsell strategies based on its ability to offer more choices and comfort benefits to passengers, for example an upgrade to a standard cabin product that will ultimately assist to maximize route profitability.

ALN: When given a clear choice by a network carrier to upgrade to the next fare level let’s call it standard main cabin product that includes additional benefits such as carry on allowance, seat assignment privileges and upgrades, what’s the conversion rates from BEFs to a standard main cabin product by a network carrier? Any indications of what this new type of fare is worth for an airline?

Based on press releases, United Airlines has commented conversion rate runs between 60% to 70% of its passengers that have chosen to select the standard main cabin product over BEFs when given a clear choice and a clever communication campaign has been executed. Likewise, American Airlines commented that 50% of its customers are buying up to a standard main cabin fare product. In addition, AA is currently testing a fixed differential of $20 to $23 USD between BEFs that don’t allow carry-on bags and its standard economy cabin fare product that includes among others a free carry-on bag. For United Airlines, the differential between the two products varies from $15 to $25 USD.

On the same hand, and what is key for network carriers is to push aggressively an upsell strategy that includes clear messages regarding what the benefits for each fare class product category are and what an enhanced travel experience will provide; ie. if a passenger buys a standard main cabin product. You will observe as well that even before passengers click on the lowest fare product, network carriers will try to upsell a standard main cabin fare product by different means even including questions such as “Are you sure?” This is a must and an important upsell strategy.

Finally, both United and American Airlines have claimed BEF product segmentation is believed to mean $1B USD a year in profit for them. Therefore, one can observe why many network carriers are testing and rolling out these types of low fares with no extra benefits.

ALN: Can you explain how network carriers react when an ULCC or LCC enter their markets with a BEF product strategy? Do they match lowest fare provided by the ULCC? Can you provide examples of how network carriers respond to this potential revenue leakage threat?

When an ULCC competes with a network carrier in a specific market, a BEF product will allow network carrier to match ULCC low fares. The focus for the network carrier is to compete and develop a sell-up strategy that through the many benefits offered will deter its customers to buy down to a lower fare product. Moreover, the network carrier should look at what price point said ULCC is selling its product; for example, its 1st carry-on bag. Then, price its bundled offering a few dollars lower (maybe $2 to $10 USD) than what a ULCC with a BEF product plus one carry-on bag is at. Consequently, said discount will position the network carrier to compete effectively vis-a-vis an ULCC airline.

Route frequency is an important factor as well. If a network carrier provides 20 daily frequencies and the ULCC has only 4, there is no need to offer a BEF product outside where the two airlines compete head-to-head. In addition, route scheduling is another important factor to consider. For example, if a network carrier leaves 15 minutes before the ULCC departure time, there might be no need for the network carrier to offer a lower fare product as it is already better positioned in terms of competitive scheduling than its rival based on something that is called in the airlines business an improved quality service index factor.

The other way is true as well. If no ULCC is competing and only a route is served by network carriers with similar products and price point strategies, the need to launch a BEF product might only serve to dilute revenues. Unless, and in the very unlikely event that a network carrier decides to launch such lower fare product, the strategy among those network carriers will be one where no BEF product is offered in order to not disrupt higher yield fare products and to protect/maximize revenues.

ALN: BEFs are available by network carriers in the US market, what is the trend observed in international markets?
Basic economy fares are increasingly common not only in the US. Today, they are being tested outside the US for example to Canada and even rolled out in selected transatlantic markets especially when one or more Long Haul Low Cost (“LHLC”) carriers are present, and/or when a network carrier offers such low fare products with limited seat inventory.

ALN: Regarding BEF product offering in the long-haul market, can you comment on what the airline & market strategies are? What developments are being observed today?

It is believed that the strategy of unbundling a carrier’s product and creating sell-up opportunities is something that will work in more markets than just the US domestic one. It is important to remember as well that in the long haul transatlantic market, competitors led by discounter carriers have been increasing capacity at 6% to 10% per quarter this year alone. That’s a lot of extra seats and capacity put in the market that need to be filled at potentially very low fares in order to attract passengers. Moreover, a number of airlines believe revenues are being diluted in a number of transatlantic market which is a profitability concern as it is considered a high yield, lucrative and airlines’ bread and butter market especially for network carriers.

Today, you have both network and LHLC carriers fighting for transatlantic cost-conscious customers. One example is WOW Air has announced $69 USD one-way fares from many U.S. cities to popular European destinations. All flights, however, will include a layover at WOW’s home base in Iceland and only limited seat capacity of less than 2,000 seats are expected to be offered. Another example, this time from a network carrier, is Aer Lingus. It has priced its one-way transatlantic fares at $47 USD and they come like comparable BEF product rolled out in the US domestic market with many restrictions including limited seat availability and extra costs for items such as advance seat selection, blankets, headphones and even checked bags. This is clearly a competitive reaction to a number of LHLC operators that have dumped capacity at very low passenger yields.

In addition, very recently at least one US major network carrier commented is observing a weak pricing environment in its transatlantic coach cabin due to LHLC competitors such as Air Europa, Norwegian Air and WOW Air operating between the United States and Europe using a combination of BEF product strategy and other discounted and bundled fares. Therefore, an important revenue leakage threat is very real for network carries flying transatlantic routes these days and in fact at least one US network carrier is considering low frills transatlantic tickets as soon as 1Q 2018 because a number of passengers now fly on LHLC.

In case, this US network carriers decides to go forward with a BEF product, it is not expected to replicate its BEF product strategy it currently sells on many domestic flights to compete head-to-head with ULCCs. This is due to the fact that a Long-Haul customer (defined as 6+ hrs. flight customer) expectation differ from short to medium haul (defined as 1 to 5 hrs. flight customer) ones. In the former, seat assignment, one or two checked bags, food and drinks are expected to be included in the price of a ticket. In the latter, they are not.

The good news for a network carrier flying transatlantic services with a multi cabin product offering (typically 3 or 4) is that a low coach fare disruption can be offset by a potential strong demand for premium traffic which is observed today in many dense transatlantic routes. This premium cabin revenue can account for close to 50% (or more) of a transatlantic flight revenue. The same can be said for a LHLC with a two-cabin product offering (typically business and economy class) as they will be in a better position to derive premium revenues and even subsidize (if that is the case) lower fare products such as BEF ones.

Finally, in the long-haul arena and whether to offer a BEF product or not, one needs to consider competitors offering and position at market by market level, clear understanding of passenger profiles, cabin configuration, product offering (bundled/unbundled) and clear market segmentation strategies to remain price competitive and ultimately maximize route revenues.

ALN: As of Sept. 2017, United Airlines has commented it is either pulling back on BEF in selected US domestic market or rethinking its strategy toward those fares. Can you comment?

As commented by United Airlines in press releases, pull back is in response to competitors’ slower-than-expected rollout of a comparable product. This really does not make much sense as we know AA has rolled out similar BEF products throughout its domestic network and Delta Airlines is doing the same with a differentiated product (it allows 1-piece carry-on bag included in its BEF product).

In my opinion and due to continued passenger dissatisfaction, United is now rethinking and refining its approach to BEF. Accordingly, it is believed United plans to scale back BEF product to only a selected portion of its domestic network releasing more routes to traditional man cabin pricing. In addition, this pull back seems related to operational issues, poor communicational and educational campaigns. Based on research, it seems UA boarding process at many gates has become more complicated and tense with BEF product introduction, as it strictly limits passengers to one bag that must fit under the seat (no carry-ons).

In addition, BEF passengers are also assigned seats only when they arrive at the airport or even at the gate and that means based on aircraft loads that a group including families with children might not sit together. Moreover, it seems a number of back packers (certainly cost-conscious customers), showed up at airport counters with no extra money to pay for carry-on charges which shows a lack of understanding (or poorly communicated BEF restrictions by the airline) concerning what type of fare they bought and what benefits they are entitled to. And then, there were those that did not know that as a BEF customer, they are the last to board the plane. All these are believed to have caused a number of issues for the airline and many customer complaints which escalated rapidly. In addition, remember that United Airlines has been recently in the eyes of many customers and the media especially as a passenger was dragged from one of its airplane few months ago. Finally, one has to remember that go-to-market strategies for new products especially as this BEF one – a low fare product with plenty of limitations and restriction – needs to be clearly communicated to customers. Employee training/buy-in must be executed and processes that are clearly defined should be implemented for a smooth entry to market phase.

ALN: Can you share any final thoughts on BEFs?

Network carriers don’t really want passengers to purchase a BEF product, they have deliberately designed them to be punitive for its customers as they want passengers (when given clear choices and extra benefits) to buy up to the next fare level or main cabin fare product.

Several carriers, including LCC Southwest Airlines, differentiate its product and offer better value to consumers at the same price as those that offer a BEF product. In addition, they allow customers to bring a carry-on bag onto the plane at no extra cost. Even Delta Airlines offers more value with its BEF product as it allows customers to bring a personal item and a carry-on bag at no extra cost. Which is done, regardless if a ULCC is a direct competitor or not.

To conclude and to protect revenues, yield managing BEF products and seat inventory are key to minimize main cabin revenue leakage. Although, many network carriers say they will offer the new lower price fares everywhere (even in transatlantic services), focused revenue management techniques should restrict their availability depending on local demand, market-specific competition, profile segmentation and seat availability. For example on the latter, making BEF products unavailable within 3-4 weeks of departure day.

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Fuente: René Armas para AeroLatinNews

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