Ancillary revenue – money earned for services or features not included in the base product — has become an important part of airline revenue generation. Spurred by the low cost carriers, but eagerly adopted by larger legacy carriers, ancillary products generate billions of dollars for the world airline industry.
Not everyone is happy about this. Consumer groups and some government officials think of ancillary revenues as “hidden fees”, or “bait and switch.” But the strength of this revenue stream is undeniable, and the reasons it is here to stay and likely to grow further is how it offers from core product revenues. Consider the following:
It’s All About Price Elasticity
“Price elasticity” is an economic term that measures how much demand changes when prices change. How many more hamburgers are bought if the price of hamburgers is lowered, or how many cars are bought if the price of cars increases? Airline tickets are highly elastic, meaning that even small changes in airfares drive big changes in travel demand. Deciding which airline to choose, or indeed whether to take the trip by plane at all, is often affected by as little as $10 or $20 per ticket.
As fuel prices began to rise in the late 2000s, airline struggled to keep their revenues in line with their fast-raising costs. “Fuel surcharges” and ticket price increases were matched with big drops in sales, and this was a big problem for the industry. Ancillary revenue, initially in the form of charges for checked baggage, proved to be a reliable and effective way to deal with this. That’s because the price elasticity for bringing a bag is lower than for buying a ticket! People bring less luggage when there is a charge for bags, but not nearly at the same rate as they choose to change their purchase behavior for airline tickets. Airlines learned that charging for checked luggage was a more effective way to deal with fast rising fuel costs.
It Lowers Airline Costs
It might be odd to say that charging ancillary fees lowers and airlines costs, but it does. Ancillary charges often work as incentives for people to behave a lot differently. Luggage charges result in fewer bags being taken, which in turn lowers the airlines’ costs to carry and handle the bags. Charging for “human interaction” in the airport or call center results in more self-service, lowering wage and facility costs. B.F. Skinner is alive and well in the airline industry design today!
It Gives Consumers More Control
Customers have little control when they fly. Ancillary revenues allow customers to make positive choices about what they value, and adjust their price accordingly. We are all comfortable doing this in restaurants – you expect to pay more if you buy a beverage or a dessert, and you don’t pay for those things if you don’t order them. Travel is a large expense for most travelers, and being able to make modest adjustments to how they interact with their airline, how much luggage they take, or what they do onboard can significantly affect their total price. But they can pay more or less based on how they choose to act, not based on what the airline mandates them to pay.
Transparency = Value Control
Ancillary revenue is not unique to airlines. In fact, consumers see this in many things they buy including cars, food, and services. Most businesses will benefit if they think about how to initiate or grow the ancillary revenue streams for their company. Recognizing that “product” can mean a lot of things, each product delivery can be priced and managed for its own characteristics. But relying on ancillary revenue brings a responsibility to be clear to the consumer about what they are paying for and what they get. When customers are clear about what is included in their purchase, they make smart decisions about what to buy, what extra to buy, and can better reach a good value proposition.