Ancillary Revenues – A Mixed Blessing by liuhongmei


									                                Ancillary Revenues – A Mixed Blessing
                                by Ricardo Pilon

Seen by many as the quickest and easiest way to generate additional cash-flow in a challenging trading
environment, ancillary revenues carry with them an inherent risk and could complicate marketing efforts
for some airlines in the medium term, potentially leading to a backlash while encouraging new

For many, ancillary revenue activities (such as charging for checking a bag) have become a very
important financial component and in many instances a necessary ingredient of a demand mix that is
required to return a bottom-line profit at the end of each quarter or fiscal year. In fact, a study published
by Amadeus and IdeaWorks recently predicted that airlines will generate over $22 billion in ancillary
revenues this year. Given these numbers, one can practically assume that ancillary revenue activity is
here to stay.

Ancillary revenues in the airline industry typically refer to any revenues that are generated from non-ticket
sources, ranging from a fee for checked baggage to à-la-carte features such as seat selection, and
amenities such as lounge access at a fee. One of the categories of ancillary revenues involves the ever-
increasing footprint of frequent flier programs through the commercial exchange of points or miles at a fee
(usually a couple of cents per mile) to FFP program affiliates and partners, including co-branded credit
cards through which card holders accumulate points through spend. A last category of ancillary revenues
relates to commissions earned from facilitating the sale of hotel rooms, car rental, and travel insurance as
an add-on to tickets sold online in the booking process. Finally, airlines are increasingly evaluating the
extension of ancillary revenue streams aboard aircraft through in-flight sales of products and services, an
area that will become a prime focus for those that will offer in-flight wireless Internet service, allowing
aircraft to become flying shopping malls.

While there has been a trend towards “unbundling” service components or amenities that were typically
incorporated in the air transport service or travel experience passengers purchased since the late 1990s,
the item-by-item direct sales of some ancillary products can be perceived as punitive and provokes clear
negative emotions and perceptions. It is here where a word of caution is perhaps necessary to highlight
that different types of ancillary “products” carry different levels of business risk depending on the type of
airline business model a carrier deploys. The relationship between ancillary activities and frequent flier
program perks and services also requires careful attention.

Punitive Culture

From a customer or traveler perspective, some ancillary charges are considered punitive in that they
“punish” a customer by imposing a fee for a specific service for which the customer is not offered an
alternative or has no option in avoiding the charge by altering his/her behaviour. Examples include
travelers on a discretionary leisure trip that require them to bring personal items for their stay out of town
or out of the country and thus need to check luggage at the airport. It is also not realistic to assume one
would not bring luggage on an overseas trip, although international travel is still exempt from bag fees (for
now). It is however no surprise that baggage fees represent 43% of all ancillary revenues generated by
airlines, according to IdeaWorks.

Airlines would argue that the baggage fee is necessary to only pass on costs to those that incur
incremental fuel burn for the airline caused by the additional weight carried on the aircraft and that in
charging only those customers, others are not penalized. Others cite environmental benefits for reducing
weight on aircraft.

                       Millennium Aviation, Inc. (2010) | Ancillary Revenue – A Mixed Blessing       1
Nevertheless, the case of checked bags became even more illustrative when passengers en-mass
started to bring more bags onboard as carry-on items in order to avoid checked bag fees. So much so,
that the boarding process and availability of overhead bin space became an unmanageable problem, now
causing some airlines to consider whether there is an opportunity to charge for carry-on bags, further
penalizing customers.

                           Distinguishing punitive vs appreciation – a customer’s perspective

           Punitive Ancillary                              Added-Value Ancillary
           Checked-bag fee                                 Seat selection (economy class)
           Fee for use of credit card                      Lounge access fee
           Travel booking fee on airline’s website         Priority check-in (non-status pax)
           Fee for food and beverage service (long-haul)   Gourmet food and beverage service (long-haul)
           Purchase of low-quality earphones               Premium in-flight entertainment (potential)
           Seat selection (business class)

Commercial practices carry business risk

The above illustrates that commercial practices are not always in line with service delivery models and
have started to undermine the travel experience, the brands of some airlines, and the long-term
positioning of their service business models. The fundamental cause of this is that very few of the now
for-purchase services were in fact new, value-added, or driven by customer demand. They used to be
catered to in the past and have been isolated as separate items without proper or effective market
positioning or education, often causing a negative perception.

The punitive nature of other ancillary services is more profound in that carriers are attempting to charge
for items that corner passengers into a crowded space of low transparency fees for which the customer
has no alternative. No less than 10 years ago did airlines tactically promote passengers to book air travel
directly on their business-to-consumer websites, but now doing so will likely cause the customer to incur a
booking fee for providing the airline with business, or worse, for using a credit card when no alternative
payment method is offered in the booking process.

The risk in creating a punitive culture around core airlines services is that it further exacerbates the
commoditization it is increasingly suffering from, although to some extent to its own doing. The underlying
perspective is that the negative perception associated with ancillary revenue generation depends on the
airline’s business model and communicative approach that underpins the latter.

No-frills, some frills, and service airlines

No-frills and so-called “low-cost carriers” have little to fear from a backlash against the rise of ancillary
revenue-based services, since it was predominantly these carriers that positioned themselves very
publicly as “pay-as-you-go” affordable base air fares with add-ons as applicable, in short-haul markets.

However, full-service network carriers that pride themselves in offering full-fledged frequent flier programs
that offer the perks associated with tier status, such as lounge access and upgrade coupons for business
class, as well as priority lines for check-in and in some cases airport security, do face certain challenges.
This is since with each sale of a premium service, package or lounge access, the service experience and
exclusivity associated with lounges and priority lines deteriorates.

In fact, overcrowded business class lounges have already become a source of irritation at airports where
people transit, attempt to work or rest, due to the abundant lounge access now offered through co-
branded credit cards, frequent flier program reciprocity between airline alliance partners and networks, as
well as the advent of selling lounge access passes.

                         Millennium Aviation, Inc. (2010) | Ancillary Revenue – A Mixed Blessing           2
In some cases, quiet space is now found at the boarding gate. As such, careful consideration is needed in
order to avoid making perks available for sale to the general public, as it may undermine the value of
frequent flier programs or the cause of loyalty management. The end result of this process so far has
been a new list of exceptions and exemptions based on the business interests of the various functional
departments within an airline, but it does fuel further market and customer confusion.

Alienating business class

In recent news, British Airways announced it went ahead with charging business class passengers in
“Club World” up to £60 for the ability to select a seat in business class more than 24 hours ahead of
departure. For most, this is a bold move in a market segment airlines religiously attempt to protect due to
the high disproportionate share in revenue generation for any given flight. Full-fare international fares in
this segment amount to up to $10,000 and charging for seat assignment is hardly justifiable.

Also, the sale of an array of perks or preferences become challenging when flights are cancelled,
consolidated, or otherwise affected by weather and mechanical issues, since protecting all the sold items
may not be feasible at all times, creating a range of customer service, compensation, and administrative

One cannot but wonder that a shake-up and refocus is required to balance the interest of short-term
revenue generation and the longer-term objective of sustainable and profitable growth.

All in all, the relationships affected by ancillary revenues create dilemmas for most involved in airline
marketing, including partners affiliated with airline frequent flier programs.

Enticing competition

One of the most compelling arguments for careful deliberation concerning the application of ancillary
revenue-based services is competition. The airline industry is renowned for disciplining carriers
attempting to raise fees or fares by re-levelling the playing field through a reluctance to follow suit, or
otherwise through new start-ups.

The point with ancillary revenues is that it allows new airline start-ups an easy entry and marketing
campaign by waiving any fees related to “services” now charged for by incumbents. In fact, Southwest
Airlines (who is adamantly against charging a fee for checked luggage) argues that it sustained the 2009
recession robustly owing through strong demand for its travel product and the ability to carry bags at no

                       Millennium Aviation, Inc. (2010) | Ancillary Revenue – A Mixed Blessing     3
What is next

Social media and day-to-day customer service issue will bring the practical problems associated with
ancillary revenues to the attention of all those involved in marketing, customer service, pricing, and
loyalty. It underscores the need to carefully carve out specific service bundles that can be effectively
positioned in the market, accurately delivered and serviced, while protecting the interests of the frequent
fliers and loyalty participants. This can only be achieved through cross-functional coordination and

Finally, passing on costs to customers for services is bound to be more sustainable when the items
clearly add value, and are not perceived as punitive or otherwise engender negative emotions. That
cannot be the objective of this “glamorous” business.

As such, the success of ancillary products and their revenue generation muscle is expected to proliferate,
albeit with a more refined approach around value-added amenities and positive customer experience.

A framework for the design, positioning, and delivery of for-fee value-added services has been
successfully applied and is now in use by several carriers. Contact for further

Millennium Aviation, Inc., 2010

                            Millennium Aviation, Inc. (2010) | Ancillary Revenue – A Mixed Blessing   4

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