A few years ago, Delta Airlines introduced “Basic Economy Fares” as a response to increased pressure from ultra low cost carriers (ULCCs) like Spirit and Frontier. American and United have followed, and the general impression has been that this has hurt the ULCCs and given the major carriers an edge. This is not accurate, as the Basic Economy fares have actually helped both types of airlines!
Back in the early 1980s. American Airlines faced pricing pressure in local Texas markets from Southwest Airlines. American pioneered the use of Yield Management as a way to be able to match Southwest’s fares but not sell more than they needed to. That’s because American could also a attract customers that would pay more because of American’s premium cabins, airport lounges, and broader route network. American didn’t want to charge these customers the low Southwest fares, but still wanted to attract the customers that would choose mostly on price to keep their planes full. Yield Management techniques are now used in many industries, and have generally improved airline revenue performance.
With Yield Management, large airlines have matched low price airlines for over 30 years. Basic Economy Fares are an evolution of this idea, and this is to combine a change in the physical product along with the change in fare. When customers buy a Basic Economy Fare on any of the big airlines, they give up some benefits that could be related to seating, baggage, frequent flier benefit, or more. Before Basic Economy, one customer paying $60 and another paying $250 got the same product — the same seat, baggage rules, frequent flier, and other features. Now, with Basic Economy, the $60 flyer doesn’t get as much as the $250 flyer.
Basic Economy helps the big airlines in that they create an “instant sell up ” opportunity. When shopping for prices, a traveler may see an appealing Basic Economy Fare but then choose to pay a bit more to get the “full featured” product. Before Basic Economy, they had no reason to choose a higher fare. This means that some of the passengers that would have bought the lowest ULCC fare now pay a little bit more, and get more for that. This raises the big airline revenue. But doesn’t it also put pressure on the ULCCs? No!
ULCCs face price pressure from large carriers not when the large carrier matches a price, but when the large carriers actually sell seats at the ULCC prices. Yield Management systems allow airlines to save seats for customers who pay the most, and since some price-oriented customers are now “sell-ups”, the big airlines are actually selling fewer ULCC fares! If you think of the ULCC competitive world as the total number of seats sold at the ULCC price by other airlines, Basic Economy has reduced the total number of seats sold at that price by the number of people who choose to pay a bit more for the full big airline product. Add to this the fact that hubs that relied almost exclusively on connecting traffic have downsized or closed, and this means that the total price pressure actually faced by ULCCs is smaller than before Basic Economy and before industry consolidation.
ULCCs also benefit in another, less direct, way from Basic Economy fares. For most other products we buy, we understand that lower price generally means lower overall quality, but not necessarily lower value. No one expects a BMW to cost the same as a low-end Toyota, but people also understand that the Toyota isn’t the same car. Many choose to buy the Toyota because they feel it is a better value, meaning what they get for what they paid matches better. For many years, airlines were largely considered the same product and so it made sense to just aim for the lowest fare available. Now, airline prices do what most other products do — if you pay more, you get more, and if you pay less, you should expect less. ULCCs have felt this in terms of a high complaint rate, from customers who love the fare but then are disappointed that they don’t get the product features of a more full service airline. The big airlines are now sending this same message to customers, helping the ULCCs to more easily address their value proposition to consumers.
Basic Economy, or whatever airlines choose to call it in the future, is here to stay. It makes great economic sense for individual carriers and the airline industry and gives consumers more control.