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The End of Branded Fares?  I pondered this early last year when Frontier and American, the two first U.S. airlines to offer this innovative fare structure, both radically changed their offerings.  Frontier, in fact, eliminated its most popular branded fare.

Frontier Airlines launched branded fares, the first U.S. airline to do so, in 2008. American Airlines followed in December 2012, the first U.S. Major to do so.

I also observed at the time that other U.S. airlines had been slow to follow.  Although branded fares have been introduced by airlines across the globe, in the U.S. no other U.S. Major had followed American and Frontier.

Just this year, 2015 — seven years after Frontier — Delta and jetBlue have announced their own version of branded fares.  So, perhaps they are not “dead” but there continues to be tremendous experimentation.

Why were other airlines been so slow to match?   Remember, in the U.S., airlines monitor each others’ fares three times a day to insure they are price competitive in what is often characterized as a near-commodity business. So, to leave American – now the largest U.S. carrier — alone in a prominent fare offering is not normal.

What’s going on? Why does there seem to be such a cautious approach?

Branded Fares are effectively a discount. The idea is to rebundle ancillary features into a new package and offer under a new fare. If customers are attracted to the new bundle – free bags and a bigger seat, for example – perhaps the airline can increase its revenue and profits relative to only offering the features ala carte. Think McDonald’s “Extra Value Meals” or the Deluxe package for a new car.

There are six major Challenges to such re-bundling for airlines:

  1. The right mix of features.

As with any discount scheme, airlines that offer branded fares need to consider potential dilution – they can’t make it too attractive so that people end up paying less for services they would have happily purchased ala carte. To reduce dilution, airlines with branded fares tend to offer features that effectively limit their attractiveness. Both Frontier and American offered checked bags in their first sell-up, potentially eliminating half of all passengers from their target (passengers who would prefer to carry-on and wouldn’t respond to a bundle that includes bags).

  1. Pricing.

Dilution, of course, is also related to the size of the discount on the bundle relative to ala carte pricing. I expect both Frontier and American were unhappy with the relatively high discount they offered on their initial branded fare packages.

  1. Transparency.

“Branded” fare implies that Customers know what they’re getting, that the “brand” stands for something. This however requires a tremendous investment in marketing and advertising – developing any “brand” often takes time and money but this is particularly true in the crowded and often confusing airline space.

  1. Distribution.

Airlines have had trouble distributing their branded fares through third party distribution channels that are not oriented to managing sell-up or promoting ancillary services for their customer airlines.

  1. Revenue Management.

Both American and Frontier chose to provide equal seat inventory across branded fares. Other airlines with branded fare offerings have chosen to limit availability of the low “no frills” fare when demand is high. Probably each approach is optimal in certain circumstances — jetBlue, which launches its branded fares this summer, may be the first U.S. airline to present a yield-managed branded fare.

  1. Taxes.

In the U.S. currently, base fares are taxed while ancillary fees are not. A branded fare, unfortunately, becomes a “base fare” subject to the full tax while the customer would pay lower taxes if he purchased the services ala carte. Both American and Frontier apparently felt the benefits of branded fares could offset the tax effect but United and Delta have kept base fares separate from their ancillary offerings.

Conclusion

Branded fares remain an opportunity – arguably, they offer a simplicity that can help passengers better navigate the new world of airline fees. And such discounted bundles of features have existed in many other consumer-driven industries. But airlines haven’t figured out yet how to best use them to increase revenue. As with most innovations, considerable experimentation is required to develop the optimum new offering. Therefore, the whole industry is watching the experience of leaders in this area; we can all learn from what Frontier and American – and other airlines across the globe — have done so far. What other forms will be tried? Who will develop a more successful version of branded fares? Stay tuned as airlines continue with such pricing innovations.

By Tom Bacon, 25-year airline veteran and industry consultant in revenue optimization.

Questions? Contact Tom at tom.bacon@yahoo.com or visit his website https://makeairlineprofitssoar.wordpress.com/

A classmate of mine at Harvard Business School, Jonathan Byrnes, has written a book titled Islands of Profit in a Sea of Red Ink.  Jonathan discusses the fact that most companies offer unprofitable products or serve unprofitable customers without fully understanding it.  “Most companies aare doomed to carry significant embedded unprofitability,” he writes.

For almost a decade, I was in charge of compiling and assessing product profitability for the 4,000 flights per day of American Airlines.  I developed a cost and revenue accounting system to support decision making and I reviewed results with the CEO and other senior executives monthly.   Despite this discipline, some unprofitable routes were deemed “strategic” — until fuel spiked or recession hit, losses mounted, and we were forced to cut back these flights.

 

The regiment of compiling and analyzing product profitability drove a highly integrated marketing organization:  product “fixes” included additional sales effort, new pricing, or product changes (flying a different aircraft type or at a different time of day).  The reviews drove a corporate focus on key parts of our world-wide network.

 

 

writes of product and customer profitability

Flight Profit Metrics – Decision Making

Generally, the profitability of a particular flight as calculated above is not useful for decision making unless combined with other flights: flights may be unprofitable in one direction and make up for the loss on the return flight; multiple flights in a market may be attractive to passengers as a pattern of service; a short haul roundtrip may provide variable contribution at the end of the day to position the aircraft for a profitable flight the next morning. So, most often flights are collected into groups of flights for decision making.

The most appropriate profitability metric, of course, depends on the decision at hand

• A group of flights versus sitting the aircraft on the ground
• A group of flights versus alternative flights at a similar time
• A group of flights versus selling the aircraft
• A new group of flights versus the cost of acquiring a new aircraft

The most common decision is a relative one: Is this the best use of this aircraft at this time of day? Given the high fixed costs in the business, airlines strive to use their aircraft intensively – sitting the aircraft on the ground is rarely the best alternative. And given the mobility of aircraft assets and the longer timeframe associated with acquiring or selling aircraft, most product planning revolves around relative aircraft deployment options: a group of flights versus alternative flights at a similar time. However, historic product profitability reporting does not give much insight into the profitability of “alternative flights at a similar time.” Therefore, airline most often use historic reporting for highlighting the “best” and the “worst” flying:

Is there a better alternative for the aircraft than flying the “worst” flights?

Is there more flying like that for the “best” products?

Of course, different aircraft are more or less suited for particular markets or flights. A flight may be unprofitable with one aircraft type but become profitable with a more suitable aircraft. This, again, highlights the complex network decisions an airline faces. Here, if a flight is performing poorly with one aircraft, one needs to find 1) a more suitable aircraft, 2) a flight at the same time with the preferred aircraft that is making less money at the same time of day, 3) a new flight with the unsuitable aircraft that would make more (or lose less) at the same time of day as the existing flight. Once again, the Network Model is much better suited for “what if’s” and optimization across fleets and hubs, than is a historical accounting view. Regional jets – an industry phenomenon introduced in the 1990’s–allowed network carriers to make money on feeder routes that previously had been unprofitable with larger aircraft – but this also bumped the larger aircraft up to other opportunities or ultimately resulted in their departure from airline fleets

Monthly reports are likely to highlight aircraft, city and hub performance, including the least profitable flying in each subgroup. Given such “red flags” of historic performance, airlines will run “what if’s” with their Network Model, in an attempt to fix the worst flights and add more flying in strongly profitable markets. Persistent losers – despite many attempted “fixes” by Schedules or Sales or Revenue Management – will ultimately be cancelled.

ACTION!

Although the allocations are often imprecise and the performance metrics for such a complex network business similarly complex, route and flight profitability remains a critical piece of airline management. As a highly centralized business, there are many players and functions who contribute to the success of any specific “product.” Thus, there are many levers that can be pulled to improve product performance. If nothing else works, airlines enjoy the mobility of their assets – they can redeploy an aircraft and stop providing unprofitable products in favor of more successful products, strengthening their overall product portfolio. So, it is important for airlines to regularly review flight profitability and to develop action plans to improve the performance of their least successful products. The action plans need to be cross-functional, potentially including pricing changes, sales and marketing initiatives, schedule modifications, and airport cost initiatives. The senior leadership team then needs to monitor those action plans on an ongoing basis with consistent reporting – are the action plans working?

Flight Profitability is iterative; it requires ongoing disciplined management. It is a helpful tool for highlighting opportunities in the system, both positively and negatively. It is helpful for tracking whether flight or market-specific schedule or marketing changes are working. And it is helpful for aircraft and hub profitability analyses. Product profitability management is likewise critical for airlines in the context of constantly changing markets, competition, and costs – as changes occur, airlines must change their tactics accordingly and exploit new opportunities. All airlines should be using flight profitability as a key tool for identifying potential adjustments in their “product line” to meet changes in the marketplace.

Distribution Costs – Frontier Airlines Case Study

In 2010, American Airlines grabbed headlines as it has exited certain online travel agent sites when it couldn’t reach terms with the distributors. Frontier Airlines tried the same thing in 2008-9, while it was trying desperately to cut costs in bankruptcy. I was in charge of revenue planning at the time, responsible for bringing in cash for tickets every day. Below is a Case Study of Frontier, as we endeavored to cut travel distribution costs.
Frontier Airlines declared bankruptcy in April 2008 when its main bank demanded a huge cash injection with only a few days notice.  Frontier was already operating as a low cost carrier – one fleet, focused operations at one hub airport (Denver International), and no legacy costs (no pension, for example).  Still, while in bankruptcy, we lowered costs further, including additional reductions in labor costs and by returning higher cost aircraft.  Our corporate goal was to achieve unit costs (excluding fuel) lower than Southwest – specifically under six cents cost per ASM.

CORPORATE GOAL:  LESS THAN 6 CENTS COST/ASM
Distribution costs were targeted as a real opportunity for Frontier.  According to industry sources, Frontier already had somewhat lower distribution costs than most legacy carriers.  However, Southwest had approximately half the cost per passenger in reservations and distribution as Frontier had: $4.78 per passenger enplaned versus Frontier’s $9.77 per passenger enplaned in 2007. Southwest passengers were much more apt to use the Southwest website for booking their travel, a low cost distribution channel.

 

COULD FRONTIER REDUCE DISTRIBUTION COSTS EVEN MORE?
Channel Cost Analysis
Our first step was to determine the cost of distribution for each channel.  We distinguished between external channels and internal channels, defined by whether Frontier has the direct relationship with the traveler.  In calculating the cost of each channel, we identified costs that were directly attributable to specific channels (Online Travel Agent commissions, for example) and those which needed to be allocated across multiple channels (credit card fees, for example).
We calculated the cost for eight distinct channels, four external and four internal.

External Channels included:

  • Traditional Travel Agents
  • Online Travel Agencies (OTA’s)
  • Wholesale
  • Interline, that is,  sold through other airlines

Internal channels included:

  • Booking on the Company Website
  • Through Reservations
  • Using the Group Desk
  • At the airport or a city ticket office (ATO/CTO)

The costs shown below are not precise but are representative of the economics we faced at Frontier in 2008-2009.

 

Travel agents

Two decades ago, travel agents accounted for over 80% of airline bookings. With the growth of online distribution channels, this has fallen significantly. Still, much of the higher fare corporate travel is managed by travel agents. Although airlines do not pay travel agents straight commissions any more, airlines do pay GDS’s (global distribution systems) for bookings made by travel agents using their automation systems.

With a GDS fee that can be more than 5% of a fare, the total cost of a flight segment booked through agents is normally much more than $10. The distribution cost is, therefore, relatively high but the average fare is likewise relatively high due to the large component of corporate business. At 10% of the average fare per flight segment, the percentage distribution cost for bookings through travel agents was less than 2 percentage points above the Frontier average.

 

Online travel agencies (expedia, orbitz, Travelocity, etc.)

OTA’s have grown significantly as customers have learned to shop for travel themselves. Customers appreciate seeing multiple airline listings and the convenience of specifying their preferences with respect to departure time, arrival time, lowest fare, non-stop or connect.

Like bookings by Travel Agencies, bookings through OTA’s are subject to the GDS booking fee — plus a smaller commission to the OTA itself. The cost of a segment booked is therefore relatively high but, unlike with Travel Agents, the average segment fare booked through OTA’s is lower than the average fare. OTA’s, of course, orient passengers to the lowest fare and airlines find it hard to differentiate themselves within the OTA channel. OTA’s, on the other hand, point out that some customers shop on the OTA to find the lowest fare and then access the airline’s company website to book the trip – tapping into the value of the OTA while still giving the airline the lower distribution cost of an internal channel.

The cost of an OTA booking is similar to bookings through travel agents but, due to the lower fares, almost 15% of the fare booked. The net contribution of an OTA booking (fare less distribution cost) was the lowest of any channel.

 

Wholesale

Travel consolidators and other tour companies are an important distribution channel for many carriers. Tour companies package the airline trip along with hotel and events and often are able to get a significant discount off the retail price of the ticket. The cost of this channel is likely to be the highest of any channel. The net contribution of a wholesale booking at Frontier, however, was also relatively high, reflecting the fact that, for Frontier, these bookings tended to be longer-haul, international flights.

 

Interline

Frontier participates in an inter-airline system whereby passengers can buy a ticket on one airline into a hub, for example, and connect onto another airline to get to their ultimate destination. Passengers from many other airlines fly into Frontier’s Denver hub and then sometimes connect on to Frontier flights to the mountains or other destinations. Rather than pay for two separate flight segments on two different airlines – and reclaim bags in Denver — the interline system allows passengers to pay one airline a combined fare and be assured that the two airlines will coordinate bag transfers. The first airline in the itinerary collects the whole ticket value and reimburses a negotiated portion to the other airline. This is a growing piece of airline distribution as codesharing has driven passengers to pay a “marketing” carrier for an itinerary that includes multiple “operating” carriers.

Despite a significant range among interline partners, the average interline distribution cost per segment is relatively low – approaching the cost of bookings on the Frontier website. As a percent of the fare received, the cost was approximately 6%. The larger issue with interline connections is whether Frontier could better serve the customer with an all-Frontier itinerary. On the other hand, if interline connections allow Frontier to capture a portion of a customer’s trip that, otherwise, would not include Frontier at all, interline benefits Frontier tremendously.

 

Company Website

As with most travel suppliers, the Company Website, frontierairlines.com, was the lowest cost channel. It did not involve the same “intermediary” charges of external channels. The cost per segment booked, in fact, compared much more favorably to Southwest’s average cost of $5. As a percentage of the fare, bookings through the website cost approximately 6%.

 

Reservations

Frontier had two Reservations centers to handle customer requests via the telephone. Bookings through Reservations has gotten very efficient over time with significant inroads in technology and manpower scheduling. In fact, we calculated the cost of a RES booking to be very similar to the cost through the website and with a similar average fare.

However, much of Reservations resource is allocable to customer service, including changing a booking made through other channels. In fact, the total cost of Reservations remained significant and there were certainly opportunities to further reduce the cost of this channel.

 

ATO/CTO

ATO (airport ticket office) and CTO (city ticket office) are physical locations manned by airline personnel where customers can buy their tickets, with services similar to travel agents. Airlines used to have CTO’s in major cities but there are few CTO’s left in the U.S. today (CTO’s remain more important internationally). Customers who seek a face-to-face meeting with an airline will likely have to go to the airport. Of course, ATO’s more often service passengers who need to change their flight plans once they’ve arrived at the airport (United offers a bank of phones to call their Reservations offices).

Using reasonable assumptions about allocating airport manning and overhead between checking-in passengers and handling new ticket sales, the cost of a booking at the airport is comparable to the cost of the other two key internal channels (website, Reservations).

 

Group

Universities, conventions, and other groups represent an important segment of demand. Typically, groups deal directly with the airline for bulk seats for their members – at a negotiated rate. Each relationship requires a contract and often defines special payment terms. This has historically been very administration-intensive for the airline – not a simple booking process. At Frontier, we had a group desk as part of our Reservations operation with special experience and training. The cost per booking was comparable to that of the more expensive external channels.

 

Frontier’s Plan for Distribution Cost Reduction

The highest cost channels were:

  • Travel Agents
  • OTA’s
  • Wholesale
  • Group

All of the highest cost channels were external except for Group, which was handled by our Reservations group.  The lowest cost channels were:

  • Interline
  • Website
  • Reservations
  • ATO/CTO

Among the low cost channels, only Interline was an external channel.

Of course, distribution channels are not perfect substitutes for one another. Travel Agents, for example, provide access to corporations that cannot be reached via other channels. At Frontier, in fact, Travel Agents provided the highest value passengers.
Given that the website was the lowest cost distribution channel, Frontier already benefited from a high percentage of bookings coming through that channel – the website represented the largest single channel producing almost 40% of all bookings.  The second largest channel was OTA’s (approximately 25%), and then Travel Agents (almost 20%).  Reservations handled up to 10% of bookings with all other channels smaller channels for Frontier.
Our strategy was twofold:

 

  1. Reduce the cost of bookings made in each channel.
  2. Shift the mix of bookings from higher cost channels to lower cost channels.

1.  Individual Channel Cost Reduction
Reducing the cost of a booking by $1 in each channel was valued at $10 mm annually.

OUR COST CONTROL EFFORTS WERE DIRECTED TO EACH CHANNEL

Of course, we had more control over the cost in our own internal channels – and here the company website, Reservations, and ATO’s all had relatively low costs already.  Group, although representing a relatively small portion of our total bookings, was a high cost internal channel; thus, we explored ways to reduce the administrative burden of a group booking.

REDUCING THE COST OF GROUP BOOKINGS
We investigated third party group automation opportunities.  A number of vendors recognize the challenges of group bookings and have developed tools for online contract administration combined with links to revenue management.  However, for our small sized group operation, the expenditure was not justified.

We reviewed all of the group contracts to identify the “best” group flying to see if we should preserve a subset of more profitable customers, particularly during off-peak days or times. However, the burden of an even smaller group desk did not support retaining these contracts.  So, we developed an exit plan from Group, notified our customers and phased out of the group product entirely.  With contracts extending out for up to 12 months, it took a year to phase out completely.

REDUCING THE COST OF RESERVATIONS
We also pursued cost reductions in Reservations.  We identified a number of opportunities for reducing costs:

  • At-home agents
  • Consolidation of the two reservations centers into one larger center
  • Deployment of voice recognition technology
  • New fees

A new fee for making a booking through Reservations significantly reduced the net cost of Reservations’ bookings. We also assessed a fee for ticketing at the airport (ATO).

REDUCING DISTRIBUTION COSTS THROUGH EXTERNAL CHANNELS
To reduce the costs in external channels – Travel Agents, OTA’s, Wholesale, and Interline — required lower negotiated rates with the various distributors. Generally, as a regional airline with only one hub, Frontier did not have the negotiating power to extract better terms in these channels.  Of course, if we could make internal channels more compelling for customers, we would increase our leverage with these external distributors.
We did “turn off” an OTA distributor in 2009 when we failed to reach an agreement on a lower fee – much as American Airlines has done more recently. OTA’s, of course, are a “two-sided market,” an economic term referring to a business that relies on making matches between parties in two industry segments (to be successful, OTA’s need a good supply of travel suppliers to attract customers and a good supply of customers to attract travel suppliers; thus, OTA’s are like dating sites).  Frontier Airlines was not deemed critical enough to the OTA to offer a much lower fee (in effect, just another interested male); on the other hand, Frontier felt that OTA’s offered it customers that it couldn’t reach with other channels (many new prospective mates!). We ultimately reached agreement on a somewhat lower fee but it wasn’t dramatically lower.  The OTA’s are now learning how important American Airlines’ presence is to their customer base – certainly, competitive fare and flight information that excludes American is of less value to potential airline passengers (American is, in fact, a quite attractive “date”).
2.  Shifting the Mix of Channels
Of course, huge cost savings could be realized if we could shift the mix of bookings to lower cost channels. In fact, increasing bookings through the website to 70% of total bookings (more like Southwest Airlines) could save almost $20 million per year.
One way to shift bookings to the website is to heavily advertise the website. Southwest Airlines has a very large advertising budget in support of their web-focused distribution strategy. In bankruptcy, however, Frontier Airlines was not in a position to increase its advertising spend.  We had to seek other ways to pull potential customers to our website.
To shift bookings to the website we made the website more customer-friendly and provided some incentive to move from external channels.  We accomplished this with release of a new website and new “branded fares,” available in late 2008 just seven months after entering bankruptcy.
“Branded fares” is an industry pricing innovation that has now become somewhat more common.  Frontier, however, was the first U.S. carrier to offer new fares that packaged certain ancillary services (checked bags, lower change fees, on-board snacks) into the fare.  With the industry introduction of many new ancillary fees in 2008, offering new, lower-priced bundles of ancillary services was a compelling customer proposition.
For any given flight at any given time, we offered multiple fares including different combinations of ancillary services. But because “branded fares” required new pricing, revised displays, and new information for customers, customers were not immediately able to buy branded fares through external distribution channels. Thus, customers had tremendous incentive to use the frontier website in order to access these new fares.
At a time when many customer groups complained about the transparency of new airline fees, Frontier received awards for customer transparency on the website. Customers could clearly see what services were included in the base fare and what services our branded fares included.
Outcome and Conclusions
These combined initiatives reduced our distribution cost by approximately $1 per segment – a $10 million annual savings.

  • Our new website and “branded fares” attracted new customers to our website and we reduced costs in most channels.

However, under the severe financial pressures in the industry, other airlines were pursuing similar cost initiatives.  In fact, our relative distribution cost did not change significantly over the following 12-18 months.  We certainly did not achieve Southwest’s success with website penetration.  Now, more than two years later, Frontier may be seeing more relative success but, with the Cost Reduction plan we put in place in bankruptcy, we did not achieve the leapfrog in relative Distribution costs that we sought.
There is no quick fix to travel distribution costs without taking on significant risk, as American has now done.

However, with American’s aggressive approach and continued financial pressure on airlines, I expect airline distribution costs to continue to decline over the next few years for two major reasons:

 

  • Industry Consolidation

The larger carriers that result from industry consolidation have more negotiating power versus the OTA’s and other external distributors. Five airlines (Delta/Northwest, United-Continental, American, Southwest-AirTran, and USAirways) now account for two-thirds of domestic flying, each with a large advertising budget and national brand awareness.

 

  • Company Website Enhancements

Company websites are the lowest cost channel for all airlines and additional enhancements will drive additional penetration.  American Airline’s website now offers bundled ancillary services, like Frontier, that are not available in most other channels.  American also now displays all competitive fares – providing a service like OTA’s.  External channels will need to innovate to stay ahead of travel supplier websites and will, ultimately, need to offer improved value propositions to travel suppliers – either more value or lower cost.  Along with low cost distribution, company websites offer more opportunity for a travel supplier to engage their customers and develop loyalty.
Frontier, along with other airlines, is likely to see continued reductions in distribution costs.  Both travel suppliers (airlines, hotels) and travel distributors (travel agencies, OTA’s) will continue to innovate.  Mobile technology, new customer loyalty initiatives, new search algorithms – to name a few current frontiers for innovation – are opportunities for travel distributors to add more value and, at the same time, for travel suppliers to try to shift distribution to their internal channels.  Although travel distribution has changed dramatically over the past two decades, change now is coming more rapidly – which represents an opportunity for everyone involved in travel.

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