It is well known that ancillary revenues are high margin and the more ancillaries an airline fields, the more revenue it earns at a lower cost than operating an airline. Indeed, they have become critical to profitability given the fact that, in 2Q2011, US airline profits reached USD1.9 billion, of which USD1.4 billion was generated from ancillary revenues.
It is also well known analysts are worried that revenues, such as change fees, are declining. The continually pepper management during earnings calls regarding their plans for growing ancillaries. For their part, management only indicates it is working on new products.
Even so, technology changes and an increasing focus on developing new products, coupled with taking cues from low-cost carriers paints a picture that shows ancillaries have no limit.
Indeed, these new products have the potential of changing the earnings story the industry has written in 2011 when it posted rising revenues on falling profits. The future of ancillaries has the potential to offer rising revenues and profits.
Current ancillaries only scratch the surface
The world’s airlines are expected to make USD32.5 billion on ancillary products in 2011, according to IdeaWorks, the vast majority of which was from the sale of mileage. But that amount is paltry compared to what could be had if airlines turned a real focus on ancillaries. A recent Amadeus/Ideaworks study indicated that including travel agents in the sale of ancillaries could yield another USD67 billion for a total of over USD100 billion, although airlines say much IT, and GDS distribution in particular, work needs to be done for travel agents to process ancillaries.
Just three years ago, many doubted ancillaries could rise to 50% of the revenues from passengers. Not so for Ryanair. Ryanair CEO Michael O’Leary even saw a future without fares; just ancillaries. Spirit and others are at 30% now and rising. Even its controversial carry-on bag fee has earned it USD50 million.
The fact is travel agents still cover about 50% of bookings, giving them the ability to substantially increase revenues.
Airlines are already working on making it easier to track such costs for travellers, a leading concern for corporate travel managers. IATA has set year-end 2012 for all airlines to be capable of using the Electronic Miscellaneous Document (EMD) and 2013 for industry-wide usage. IATA reports 58 airlines have signalled they will implement the EMD in 2011 with another 220 set to meet the year-end 2012 date. That would cover 84% of the market.
IATA stopped short of mandating distribution of ancillaries in all booking channels but airlines seem to be doing just that since, according to the organisation, 96% have indicated this is what they plan to do.
Delta Air Lines and United Airlines are planning distribution of their economy comfort seats through GDSs but more products will be included once Expedia can get its technology together to offer such products.
A key transition is developing now and Delta Air Lines is leading the way. In an effort to shift the market from third-party booking sites, Delta has cancelled contracts with a handful of small booking engines. They will only work with booking engines that link fare searches to Delta’s site rather than Expedia or Travelocity. This is expected to be replicated by others.
Still, airlines are recognising the importance of the third-party channels in selling tickets and revenues as evidenced by the Delta and United deals.
Ancillaries necessary for growth
Management across the industry can be lauded for the painful restructuring since 2008. But they have only achieved that profitability by shrinking, which is not a recipe for a robust future.
While cutting costs and capacity has been transformative, it does not, in itself lead to profitability as evidenced by the importance of ancillaries in earnings statements. That means, of course, that the entire industry remains vulnerable for one simple reason. There is little growth in their future, especially if they keep trying to shrink to maintain their profitability against rising fuel.
Part of the problem is that ancillaries have so far focused on charging for what used to be free, hence the consumer jokes airlines will start charging to use an oxygen mask in an emergency. Charging for what used to be free is finite.
Airlines are already rebundling and sending out tailored solicitations to increase revenues, which will be an important part of their ancillary strategy. But they must do more if they are to tap the full potential of ancillaries.
Another method airlines have used to contribute to profitability is consolidation but the impact of this, too, is finite as long as foreign ownership laws continue to exist.
Taking a lesson from LCCs
The good news is that they are now following Allegiant and WestJet in commission-based ancillaries selling hotels, cars and vacation packages. Hotels, cars and ground transport represented a quarter of Allegiant’s third quarter profits of USD52.7 million.
While legacies have traditionally sold vacation packages, they have only focussed on 40% of passengers, the leisure sector. They have left the 60% represented by business travellers untapped and could be part of its tailored approach to selling based on customer preferences as outlined in frequent traveller profiles. However, airlines will face competition from separate corporate contracts companies sign with hotel companies.
This is only the tip of the iceberg and suggests airlines are far from realising the potential of ancillaries given the number of products on offer from various vendors.
The three largest barriers, vendors say, are the lack of time ancillary management gives to these ideas from product vendors, the fear they will alienate an already alienated passenger and their IT infrastructure and workforce.
Judging from the number of vendors offering ancillary products at the recent Airline Information conference, it is little wonder ancillary executives may not have the time to interview each and every one to see if their products could fit. What they may be thinking instead is to incorporate new things that will take tremendous IT time; time that is already booked with other projects. But both philosophies only stymie the increase in revenues airlines so desperately need.
Ancillary specialists suggest that airline management stop thinking of growing ancillaries as an IT issue but rather as a commercial issue. First, however, airlines will need to make investment in human resources.
Airlines in transition
They want airlines to become e-commerce retailers. At least two, US Airways and Delta, have e-commerce executives, with Delta’s filled by a former Target e-commerce executive.
Speaker after speaker during the Airline Information conference on airline merchandising said the industry was so focussed on selling online tickets and not distracting customers during the booking process, it was ignoring hundreds of billions of dollars that could be earned by keeping them longer in the booking process and upselling products related to their trip. This is exactly what online retailers do and airlines are little more than online retailers. However, some retailers like Amazon and iTunes have seen a tremendous response from their one-click purchasing options. The ease of those purchases keeps consumers coming back knowing they will not be kept for longer in the purchase process.
Leveraging IFE to increase revenues
They also criticised legacies for failing to have more nimble in-flight entertainment systems (IFE) which could capture travel wallet share during the entire trip, not just on the front end. While movies remain the number one preference for passengers, that, too, is changing.
Experts suggest destination programming could be used during the flight to sell destination tickets for attractions, concerts and sporting events. It can also be used for the sale of ground transport, a USD120 billion a year industry.
The two largest IFE producers, Panasonic and Thales, are already accommodating on-board selling through the IFE system. US carriers, however, face the problem of not having high deployment rates of IFE. One exception is Virgin America, whose Panasonic IFE system ("Red") sells items on-board.
As such, the key for next generation IFE will be leveraging the on-board system by connecting it to passenger mobile and other devices. It must also connect passengers to airline-partner retailers.
For those without imbedded systems the key is to leverage Wi-Fi, offering content including shopping and destination programming, in order for passengers to use their own devices to watch movies and surf the net.
Even so, for total maximisation of on-board revenues airlines must control passengers through their own entertainment portals rather than just let them leave the airline’s environment and surf on their own.
More changes ahead
Perhaps the most revolutionary change has been the transformation of Wi-Fi providers Row 44 and Gogo from mere internet service providers to full-scale content providers. Delta and American use Gogo for Wi-Fi. American launched a video streaming ancillary product last summer.
But that is not what makes Row 44 and Gogo revolutionary. What does is the fact that they can extend IFE to airlines and aircraft that have never had it before, further increasing revenues for the carriers.
In the US, short-haul flights, whether mainline or regional, have traditionally not fielded IFE before but could now become full content providers as fast as they can equip aircraft with Wi-Fi. Southwest, which is equipping its aircraft with Row 44, has been one of the few LCCs not to have in-flight entertainment. But it will likely announce it is offering Row 44’s full content which allows retail and destination shopping as well as movies, games and other entertainment in the not too distant future.
Virgin America, which already has an impressive, industry-leading IFE system, has announced a deal to deploy Lufthansa Systems BoardConnect to develop a new IFE platform by the end of 2012. Virgin America is the first US carrier to field the Lufthansa Systems programme that essentially replaces legacy IFE systems, and their associated heavy and expensive wiring, via an on-board Wi-Fi network.
Legacies are already equipping regional aircraft with Wi-Fi so a new in-flight pastime could be shopping which offers airlines a huge potential for revenue and passengers more opportunities to redeem miles or pay by credit card.
Increased focus on ancillaries
It is no surprise that airlines are now putting increased focus on ancillaries and this is happening for a reason besides increasing revenues.
Ancillaries revenues have always been based on airline needs to boost revenues. The new ancillaries rolled out at the end of 2011 and expected to be launched in 2012, will be based on passenger needs; services passengers would buy anyway as part of their trip. Airlines are now trying to provide these third-party services such as hotels, cars and ground transport to get commissions.
Consequently, 2012 will be the year ancillaries transition from largely fee-based to commission-based products.