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Baggage charges: this year's fuel surcharges?

29-May-2009

FRIDAY REFLECTIONS, WITH RON KUHLMANN & THE CENTRE. Recently US Airways announced a loss of USD103 million for the first quarter of 2009. Concurrent with this report was the institution of an additional fee for each checked bag if not pre-registered online. This is in addition to the carriage fees of USD15 and USD25 already levied for the first and second bags. I was struck by the fact that the knee-jerk response of US legacy carriers when facing losses these days is to find another fee and push up the consumer cost to whatever the market will bear - or simply not notice.

It could be that baggage and related charges have become this year's fuel surcharges.

US Airways already discovered the hard way that the market was not willing to bear an onboard charge for soft drinks and water - a fee it recently rescinded. Nonetheless in a recent statement the president, Doug Parker, expressed the view that he still believed it had been a good idea and failed simply because others did not match.

Nonetheless, whether a good or bad idea, ancillary revenues are delivering additional revenue to US legacy carriers. US Airways predicts up to $400 million in additional revenue, much of that coming from baggage charges.

The European comparison

By contrast, European legacy carriers have until now maintained many of the traditional amenities. Also some, surely not all, of the European carriers posted positive results for 2008 while their American counterparts were awash in red ink. So, has this flurry of unpopular fees and charges by US carriers done the trick and saved their fiscal hides?

One of the justifications for the US service cutbacks and fees has been the need to reduce cost by pricing travel a la carte. By putting a value on each non-essential product or service the airline theoretically makes the base fare representative of only the cost of transportation. Thus each passenger may purchase only those goods or services that are needed for each journey. With all the "frills" stripped away, it follows that the US carriers would be able to profitably offer base travel at significantly lower prices and successfully compete with their lower cost competitors.

To test the theory, I searched city pairs that were roughly equidistant from each other and priced an advance-purchase economy ticket on US Airways and Lufthansa. Outbound travel in each case was on June 1 with a return on June 8. The results are in Chart 1 and reveal just how effective the US efforts have been.

The Lufthansa-US Airways comparison

Lufthansa offers a suitable comparison for a number of reasons.

  • First, it is an alliance partner with US Airways and it is likely that frequent travelers might, at some point, experience both in a code-share arrangement, thus able to make direct service comparisons;
  • Second, Lufthansa made money in 2008 while US Airways lost quite a bit;
  • Finally, Lufthansa has been generally just as resolute in keeping the traditional service levels intact as US Airways has been in trying to dismantle them.

So, let's move column by column to look at the components and calculations that allow us to unpeel this onion.

Chart 1: US Airways-Lufthansa fare comparison

1

2

3

4

5

6

7

8

9

10

11

12

City Pair

Carrier

Distance

Base Fare

Yield/mile

Charges

Total Fare

Fare/mile

Drinks

Meals

Bag 1

Bag 2

FRA/BCN

LH

669

209

0.31

119.24

328.24

0.49

Free

Yes

40kg free

PHL/ATL

US

665

188

0.28

21.20

209.20

0.31

No

No

15+5

20+10

FRA/ATH

LH

1117

195

0.17

147.86

342.86

0.31

Free

Yes

40 kg free

PHL/MIA

US

1015

240

0.24

21.20

261.20

0.26

No

No

15+5

20+10

MUC/GVA

LH

303

193

0.64

121.43

314.43

1.04

Free

Yes

40kg free

CLT/WAS

US

332

306

0.92

19.20

325.70

0.98

No

No

15+5

20+10

Source: Websites April 26

 

 

 

 

 

 

 

 

 

Columns 1 and 3

Finding comparable city pairs that were of similar distances is not easy. Travel needed to be from hub cities where the carrier has dominance and, ideally there would be some sort of parallel traffic flows. Miami and Athens both are sunny spots, likely to attract leisure travelers. Geneva and Washington have both leisure and business clientele. Atlanta and Barcelona, well, they are really similar mileage-wise.

Columns 4 and 5

Each base fare is the amount displayed by the booking engine before taxes and fees, representing the core revenue that would accrue to the carrier for the transport of the passenger. In column 5, this amount is divided by the mileage to reveal a comparable base passenger cost for the carrier on each route at this fare. Lufthansa wins the low and US Airways the high.

Column 6

This is where it gets very interesting. The US Airways charges are consistent and include:

  • Domestic passenger segment tax
  • US security tax
  • Passenger facility charges (PFCs)

The first two are set amounts while the PFC can differ by location. But all are pass-throughs and not retained by US Airways. Most interesting though is that the 7.5% federal tax on air travel is included by the carrier in the base fare amount, rather than in the tax box.

Because all of the Lufthansa flights cross borders, they are international flights and each carries a bevy of taxes and fees that are ultimately determined by the countries involved.

As a for-instance, the Munich/Geneva tax amount of 121.43 (75% of the base fare) is composed of the following components:

  • CH - a Swiss passenger security and noise fee
  • DE - a German airport security fee
  • RA - a German international passenger service charge
  • YQ - a fuel and security charge

While the first three are government imposed and not kept by the carrier, the ubiquitous YQ is, as defined by one web source, pretty much "anything airlines want." It is a way of keeping the base fare low and still extracting additional revenue. While it is the largest amount of these "fees", it is also, as a fee rather than a mandated tax, subject to change should market or competitive conditions dictate.

All this means is that in both markets there is somewhat less transparency than might be desired. In the US case, the federal tax is incorporated into the base fare amount - possibly justifiable because it is a set percentage of the segment charges. But it is a tax nonetheless and should be expressed as such.

In Europe, the government-imposed fees and charges are mind-boggling to decipher and each country has its own definition as to what needs to be addressed; eg. noise in Switzerland. In the UK there is the hotly debated air passenger duty, or APD, that has its own rationale for imposition. And the French wished to chip away at world hunger by taxing air travelers.

The YQ, substantial in this case, is not exclusive to either Europe or Lufthansa and is applied around the word in various guises. Its primary task is to provide airlines a convenient category for pumping up the bottom line.

Columns 7 and 8

Column 7 is the amount actually paid by the passenger after all fees and taxes were added. Because of the ubiquitous nature of Column 6 this raised the Lufthansa fare, with the YQ portion destined for the bottom line.

As a consequence, the actual fares paid by passengers were higher in Europe, substantially increasing the cost per mile for the total fare. However, despite this, the composite number was not hugely different in two of the three examples.

Columns 9 through 12

These are the charges that differentiate the basic service level. On Lufthansa flights, drinks, including alcohol, remain free and complimentary (often hot) meals are offered if the flight occurs during normal mealtimes. Light snacks are generally available on request and at no charge. Luggage within the allowable limits remains free.

If we assume that our fictitious passenger from Philadelphia to Miami checks two bags[1] ($25 each way if done online - add $15 if not), has a light meal ($7 each way if purchased on board) and has two drinks each way ($7 a pop for wine, beer or liquor), Mr. or Ms. Average could add $142 to the actual fare. This would mean that the very same items provided free on Lufthansa to Athens at $342.86, would total $403.20 en route to Miami on US Airways.

Also bear in mind that Lufthansa has been profitable in supplying its unified product while US Airways has not moved into the black with it's a la carte approach.

Is there a correct strategy?

This is a limited hypothetical exercise that makes assumptions about the needs and/or desires of passengers when they travel and the value of various service components.

We know from the example of Ryanair that many Europeans are more than willing to purchase travel as a set of ad hoc components as well. The difference, of course, is that if one uses Ryanair without buying ancillary goods or services (if that is possible!) the fare can be astonishingly low. It also must be noted, however, that those famous €1 fares rarely actually end up costing €1.

Similarly, in the US, a passenger choosing basic but non-fee Southwest would pay $219.20 from Philadelphia to Ft. Lauderdale with free bag check, lots of peanuts and cheaper drinks. This more inclusive fare is lower than the US Airways base fare, prior to any additional fees. As you might imagine, this advantage has not been ignored by Southwest's marketing department.

Southwest has lost money in the last two quarters, mainly due to hedging losses. But overall it remains very healthy and has taken measures to reverse the trend. The other US legacy carriers continue to lose money despite the imposition of these ancillary fees. This indicates that passenger fees are being used primarily to offset higher costs and greater inefficiency rather than to "enhance" the customer choice menu.

It is also true that on both Lufthansa and US Airways there were more expensive options if different flights had been chosen. On Lufthansa especially, even far in advance, considerably higher amounts could have been paid using different flight times. The number of variables is vast.

Do passenger needs and airline branding coincide?

However, the essential question presented is whether or not passengers and airlines have benefited financially from the shift away from inclusive to a fee-based system. The answer again is mixed.

If you have only hand baggage and purchase nothing onboard, the answer is yes. If however, you have more stuff, get hungry enroute or want a drink to numb your knees, the savings rapidly disappear and can actually result in paying more than the fare for a similar journey on a full service carrier-in a place where they still exist.

There are other considerations as well. Lufthansa's brand is consistent by essentially offering the same service components across its network. That means an unused price component for consumers who don't check bags or consume items on board. In both Europe and Asia, that brand integrity remains important.

In the US, across all legacy carriers, the shift to fees and charges raises consumer cries of being "nickeled and dimed" for every item. The constant imposition of new charges/rules, as with the new US Airways bag rules, also creates frustration and ill-will. But in the US - as the saying goes - (almost) everybody's doin' it. Consequently, in the US domestic market, there is little brand impact.

Finally, has this new approach been the financial panacea that the US carriers sought? So far, no. And that is probably the most disheartening aspect of the practice. The US pattern seems to be that if revenue gaps persist, the solution may lie in yet more fees, which may prove even more unpopular. The best that can be said for them is that they have reduced losses. Mr. O'Leary may have been the first to mention charging for the toilet, but...

Looking at the Lufthansa example, current negative figures notwithstanding, it would appear that for their markets, a more sustainable operational model supporting both brand and profitability has been a more successful strategy.

And are European legacy charges simply a bit more subtle?

Do traditional full-service carriers have supplemental charges as well? The information presented in Column 6 indicates that they do. The elusive YQ is not a government mandated charge and while it may appear to be required, the revenue collected derives directly to the carrier and is a de facto surcharge. Some carriers go so far as to include it in the taxes and fees when issuing reward tickets as a way to get revenue from these "free" tickets without showing a fare.

So, the goal is the same but the tactic may be different. The major difference is that YQ amounts are variable at the airline's discretion and may be altered without revising a complex (but more visible) fee structure. They can also be variable by market in order to maintain a competitive position.

The most noteworthy difference is in the presentation to customers. In the US, passengers are led to believe that fee schedules are a positive development, allowing passengers to pay for only those goods and services used. Meanwhile, the Europeans tack on a (variously labeled) surcharge and maintain traditional service levels.

In the end, Southwest may have the most honest, increasingly rare and transparent presentation; no fees, a low fare and a predictable, but lean service offering.

Will these distinctions persist? Or will everyone follow suit?

Are we then in a situation where these two approaches will continue to exist as contrasting service models? Probably not. Every carrier in every geography is having to cope with new challenges, almost on a daily basis. Singapore Airlines, that icon of service and profitability, and Southwest Airlines, the winner in the "most profitable quarters" category have both of late demonstrated and that anyone can lose money. And crystal balls to predict the future are in short supply.

Whether this is a consequence of the current global recession (no doubt) or a broader change in travel, purchase and/or competitive pressure is yet to be seen.

While we are probably some ways away from having to pay for ancillary services on Singapore Airlines, these days it is wise never to assume never.

[1] The amounts shown reflect the new policy, effective 9 July.


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