Airline pricing: Why it's all wrong

March 8, 2012: 11:01 AM ET

A coach flier might pay more for extra services, if only they weren't offered in such an aggravating way.

airline_passengers

FORTUNE -- It's hard to think of a more amazing product with poorer presentation than air travel. Despite the fact that airlines provide an incredible service (they let us fly, in the air), we love to hate on them, in part because they confuse customers. Most unpleasant of all is how airlines obfuscate what, exactly, their customers are purchasing.

The cost of fuel will be high for the foreseeable future, and jet fuel is the airlines' greatest expense. To boost profit margins, companies will need to squeeze more money from passengers. Recently, carriers have tried to do this by offering economy passengers the lowest possible prices on flights and charging fees for other services. That strategy has ticked off fliers unused to paying for services such as meals or exit row seats.

But it doesn't have to be this way, says Paul D'Alessandro, a global practice leader at PwC. On the contrary, if executed correctly -- and that's a big if -- the strategy that many airlines are already pursuing could make flying more pleasant.

The key is in the coach cabin. Traditionally, the largest companies, also known as legacy carriers, have sought profit by going hard after their most frequent fliers, mostly with rewards programs, to hoard their purchasing power. To attract all other passengers, airlines have played the price game, often de-bundling services that were previously included in the ticket price, pushing the advertised fares down.

But there's evidence that offering services in an intelligent way to cost-conscious customers might be a better strategy than focusing almost exclusively on elite fliers.

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Coach fliers are valuable. Airlines who bill themselves as low-cost carriers tend to do better when the demand for tickets decreases, says Adam Shapiro, an economist with the U.S. Bureau of Economic Analysis. (His opinions are his own, not the Bureau's.)

During a bust, Shapiro says, the price of legacy carriers' most expensive tickets fall dramatically, whereas low-cost carriers don't experience the same drop in top-paying customers. "A lot of the low cost carriers weren't really selling to these high-willingness-to-pay consumers," Shapiro says, "so they're perhaps more prepared for a bust."

In other words, low-cost carriers don't face the same problem when elite flyers drop out because they are always flying with a plane full of coach cabin passengers (with coach expectations). Some of these airlines' efforts to create different economy-class experiences seem to have worked. For example, Southwest Airlines (LUV), which is relatively new to priority boarding, now offers an "EarlyBird" automatic check-in option for $10, each way. That program specifically generated $36 million in revenue during the fourth quarter of 2011, $7 million more than the previous year.

Legacy airlines -- including United (UAL), Delta (DAL) and American Airlines -- have similarly tried to break up their coach fliers by charging for additional services, but they've done it in a pretty clunky way. The way they are currently offering customers the ability to choose extra legroom, in-flight entertainment, meal service, and charging baggage surcharges simply comes across as tacking on extra fees.

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To successfully charge for these services, airlines will have to monitor what their customers want. "A lot of these airlines already capture necessary information, they're just not sharing it and using it across the organization," says Jonathan Kletzel, U.S. transportation and logistics advisory leader at PwC. "It wasn't until loyalty programs that they started tracking repeat customers." Airlines are using that data, but not well.

Airlines have several opportunities to sell services like added legroom to a customer -- online, at check-in, at the gate. Certain types of fliers want to pay for extra services. "But if they've declined a hundred times, they're probably not going to change their minds on the 102nd when you try to sell these things," says Kletzel. Spamming customers without tracking individual preferences can make customers feel nickel-and-dimed.

Airlines could also pay attention to the type of trips individual customers take. People behave differently on business trips then they do with their families, Kletzel says. They are generally more likely to spring for a more comfortable coach experience when they're flying for work.

Many customers actually prefer services to be bundled, according to a PwC report, which claims that 65% of leisure travelers prefer all-inclusive airfare over scattershot options. At this point, the technical challenges behind re-bundling ticket prices are pretty daunting, Kletzel says. But who knows. If airlines start to use some of the data they already have about what people actually want, we might be less ticked about getting where we need to go.

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Shelley DuBois
Shelley DuBois
Writer - Reporter, Fortune

Shelley DuBois writes on management issues for Fortune.com. Before joining Fortune, she was a producer for National Public Radio's Science Friday and worked for Wired. Shelley has a graduate degree in science, health and environmental reporting from New York University. She lives in Brooklyn.

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