Since the introduction of global distribution systems for airline tickets and hotel rooms like Sabre and Amadeas, the commoditization of coach flights was foretold. The internet has only exasperated the problem, leading to the despairing cry that, in coach pricing, “an airline can only price as smart as their dumbest competitor.” In response, airlines have reduced costs, leading to an eventual reduction in benefits. Coach customers have responded negatively. Just do a search for “I hate airlines” and you will get more responses than you can read in a lifetime.
To combat this horrid position, airlines may want to consider creating a new “Coach Plus” booking class.
To explain what a Coach Plus fare class would be and the challenges it would address, we have to understand how airlines put themselves in this commodity position in the first place.
Consumer Behavior of an Infrequent Coach Passenger
Consider an infrequent coach passenger booking a flight. That passenger is likely to search for their flight using one or more of the many online booking engines such as Orbitz (OWW), Expedia (EXPE), Hotwire, etc. In search of a seat on a city pair like New York to Los Angeles, a passenger will find no fewer than eight airline offers with similar direct flights from firms like American (AMR), Delta (DAL), and United (UAUA). Allow for one stop, and you will find another five including one from Southwest (LUV), if you visit their website. (Southwest does not participate with standard global distribution systems for many strategic fit reasons.)
Each of these flight booking websites allow customers to order their flight search by date and price, which makes perfect sense. An infrequent coach passenger is unlikely to perceive a significant difference in benefits between the competing airlines. As such, this infrequent passenger is likely to select an offer based solely on date and price.
In effect, coach seats on a city pair are perceived as a commodity by an infrequent coach passenger.
Price Compression by Airlines
For the airline, passenger seats are a high-fixed cost / low marginal cost item. Adding one more passenger to an existing flight adds little, if any, marginal cost to the operation of that flight as long as the flight is not full. Aircraft depreciation, fuel costs, gate fees, runway fees, flight crew, ground crew, and luggage handling are relatively fixed regardless of the number of people on a flight.
With prices being the major differentiating factor between offers, and with relatively low marginal costs, airlines face a strong incentive to price low in an attempt to increase their load factor. For an airline, almost all marginal revenue goes directly to bottom line even if the price is below average unit costs.
Followed by Benefit Compression
If a company is selling a commodity, they have little influence over their pricing, but may have some influence over their costs. Airlines have been hammering away at costs for years to some degree of success. However, one only has to look at the historic earnings performance of American, Delta, and United to conclude that, on the whole, neither has been able to strategically reduce costs at a rate faster than price compression. Forward looking expectations are not much better. The IATA forecasts that passenger traffic will grow by 4.5% in 2010, yet costs will continue to outstrip revenue, leading to an overall industry loss of $6.6 billion.
In the past few years, many major airlines have uncovered a new area for cost reduction, customer amenities. First, complimentary in-flight meals were discontinued and replaced by “add-on” purchases. More recently, complimentary luggage handling also transformed to an “add-on” purchase. Some airlines even charge for in-flight beverages.
If an airline can reduce the fixed costs associated with providing these amenities, it can then pass these saving on to the customer. One method of reducing the fixed costs of providing amenities is to reduce the quantity of the amenity supplied, therefore allowing the airline to operate with less infrastructure. To reduce the quantity supplied, airlines have wisely used the pricing mechanism to restrain demand.
Poor Information, Poor Customer Choices, Dissatisfaction
The new fee structures among airlines make comparisons of flight offers more difficult than an online booking engine might suggest. When buying a coach seat through an online booking engine, an infrequent coach passenger will have little idea of which airline provides which amenities, or the price of different amenities on different airlines. Moreover, online booking engines rarely provide this information and, when they do, it is less obvious than the issue of seat price. Therefore, infrequent coach passengers are unlikely to be able to identify which airline truly offers them the best package of benefits for a given price. This sorry state of affairs has created the opportunity for a new global distribution system, Farelogix, launched in 2008.
Even worse, the removal of benefits is perceived by some as a new form of price gouging. Once a customer hits “confirm”, they are trapped in a relationship with an airline which would be costly to exit. As they pay for items that were at one time complimentary, they may feel as though the airline lured them in with the promise of cheap travel only to be extorted through additional charges at the gate.
Today, it is not uncommon to hear stories about airlines that would have been bankrupt were it not for the fees collected through add-on purchases of what was once a complimentary service. If airline profits can be attributed to add-on fees from customers who otherwise didn’t expect to be forced to pay for service that was once standard, then the airlines are irritating their more profitable customers.
Companies are in business to create and capture profitable customers. Irritating the most profitable customers is not in the best interest of a company that is in business to attract and retain profitable customers.
Coach Plus Fare Class
A part of the solution to this challenge may be to create a new fare class, call it Coach Plus.
The Coach Plus fare class would be distinct from the standard Coach fare class only in the amenities offered. The seats could be identical (which is beneficial for an airline operating a fixed configuration and fixed capacity aircraft). However, the Coach Plus fare class would include many amenities that are currently being sold as “add-on” purchases such as meals, luggage handling, beverages, and perhaps even preferred boarding status. Standard Coach customers would have to purchase these amenities separately as add-on items.
In essences, Coach Plus is simply a bundled offer of several separate items that are currently being sold as seats and add-ons.
Why Coach Plus Would Be Preferred over Add-On Amenities
A Coach Plus offering would address several challenges for an airline.
- By offering a Coach Plus bundle, the airlines would have a new means to differentiate their offering in terms of types of amenities included. Customers who wish to return to the days where they could expect to eat, drink, and check their luggage could do so simply by upgrading to Coach Plus.
- By maintaining the standard Coach offer, airlines would be able to maintain their position within the online booking engines as having the lowest priced offer to capture those customers who select a seat solely based on price.
- Standard Coach customers could still purchase these amenities separately through additional transactions.
- As with other forms of bundling, the price of the Coach Plus bundle will be less than the sum price of the individual amenities. Thus, Coach Plus would appear as a “good deal” to the customer rather than the current status quo of turning the airlines into “price gougers at the gate”.
- Because most of the costs associated with providing the amenities of an airline are fixed, the sale of these amenities through Coach Plus represents increased marginal revenue with minimal increased marginal costs. In other words, profit.
- Because Coach Plus customers can be intermingled with standard Coach customers, that is, contained within the same booking limit of a revenue management system, the introduction of this fare class would have little effect on an airline’s revenue management system, booking systems, configuration, or other major cost factors.
The introduction of a Coach Plus fare class would address some of the challenges of commoditization, product differentiation, and customer dissatisfaction.
Changing the price structure can lead to a strategic shift in competition which favors the leader. But will Coach Plus ever be adapted? Perhaps it already has been. Just look at the Southwest “Business Select” offering and note that Southwest not only has the highest number of U.S domestic passengers, but it is also profitable. Is it time for American, Delta, and United to play catch up to the new leader?