Delta says their basic economy fares generated $20 million in incremental revenue during the first quarter.
Delta reported today that its new Basic Economy fares, which offer lower prices, no ticket changes, and seat assignments only after check-in, generated $20 million in incremental revenue in the first quarter, and the airline plans to expand the service to new U.S. markets.
On the one hand, it’s not that much in the context of $5.5 billion in domestic revenue for the quarter (so far these fares are only in domestic markets). If true, of course, since domestic revenue was up only 1.4% basic economy would account for a quarter of the increase in year-over-year first quarter revenue.
However, the figure is likely to be grossly exaggerated based on faulty assumptions.
Still, other airlines — some of which are already preparing to follow down the road of stripping away assigned seats and elite upgrades from the cheapest fares — will be listening and take the claim at face value.
There’s not actually any incremental revenue that’s attributable to passengers actually flying on these fares. The fares aren’t cheaper than what Delta used to offer. They used to match competitor fares while still offering assigned seats in advance. The act of taking away assigned seats doesn’t in and of itself generate incremental revenue.
Actual incremental revenue would be in the form of:
- Unused tickets, minus Delta’s standard change fee. These tickets do not allow changes of any kind, so if unused the value is completely lost. So they can count revenue from passengers who bought a ticket and then didn’t travel as incremental, whereas in the past they’d have captured only a $200 change fee. [But then these fares are usually on the very inexpensive side anyway, so the incremental revenue here will be small.]
- Upsell revenue from passengers choosing to buy more expensive tickets that allow seat assignments and elite upgrades. This is the biggest area of incremental revenue, getting the same customers to pay more. Although lost revenue has to be accounted for as well from passengers who no longer choose Delta because its value proposition has less of a spread compared to ultra low cost carriers than before. It’s not enough to simply add up the upsells.
If Delta is claiming an annualized $80 million in revenue off of these fares then numbers have lost meaning.
Delta Led the Way in Legacy Airlines Offering Less
Delta introduced ‘basic economy’ fares to compete against Spirit Airlines where Spirit is offering super low fares on non-stop routes Delta is flying. The idea was that Delta offered more legroom, complimentary beverages, and other things that Spirit either didn’t offer or sold for a fee. So they introduced fares that stripped out things like advance seat assignments and used those fares when matching Spirit’s prices. Customers could spend more to get more, or spend less and get something akin to Spirit but still with better legroom and free carry on bags.
Elites don’t get upgrades on these fares. With Delta there’s a minimum revenue requirement on an individual trip for elite benefits, not just minimum revenue across the year to earn status. Delta has minimum revenue requirements for elite status, so presumably customers fly on these fares are doing so only occasionally. Delta sees the customers as profitable enough to reward — just not all the time.
Delta’s elite frequent flyers need to shout from the rooftops, “I am not my fare.” I am a valued customer, or I am not, and how welcome I’m made to feel should not change between Tuesday on a full fare and Thursday on a discount one when I’m buying a ticket pretty much every week. For the rest of customers though Delta is (for the most part) probably doing what they ought to do. It’s totally fair to sell airfares this way, as long as customers know what they’re getting. It only becomes a problem with systems that default to the lowest fare, don’t flag extra restrictions, and especially with systems that business travelers are forced by their employers to use, that make it harder to buy up.
Although these fares are spreading and are no longer limited to markets where Delta competes with Spirit or other ultra low cost carriers — and they’re talking about expanding the use of these fares to international routes, too. So Delta plans to give you less on more routes going forward.
United and American Plan to Follow This Year
United has told investors not only that they are going to copy Delta in offering Basic Economy fares, but that they’re going to limit elite benefits on those fares.
They see (3) customer types and three benefit types, and it seems illogical to them that all three customers get the same ‘stuff’.
What they fail to recognize here is that there may be three types of fares in their conceptual model, but that doesn’t mean there are three types of customers.
Business travelers are leisure travelers. The person who buys a full fare ticket at the last minute for work also buys a weekend getaway with the family. They’re the same valuable customer. And you earn their loyalty based on how they’re treated every single time they walk into the airport and onto one of your planes. In fact, how you treat them when they’re with their family may be even more important. Abuse them during the week, but treat them right with a partner, with their kids, make their life easier and make them a hero and you’ve won them.
Going forward, if you buy the cheapest fares United wants you to have ‘segmented expectations’.
“Premier benefits” won’t apply to “entry level fares” although United hasn’t said which Premier benefits.
American also plans to roll out these fares while limiting elite benefits. They’ve said they believe their elite customers will give them more revenue to be eligible to upgrade. They’re asking customers to play a lottery, because of course elites whose upgrades do not clear won’t get refunded the difference of the higher fare they had to buy.
American has said that 87% of customers fly the airline 1 time per year or less, and represent 50% of the airline’s revenue. That means more frequent flyers are only 13% of customers but contribute an outsized 50% of revenue. So it’s a real gamble to sell an important customer a pricey ticket one day, and then the next when they buy the cheapest fare to make it clear to them their business doesn’t matter.
Basic Economy is a Fine Idea if Done Right
Legacy airlines still offer more legroom than Spirit even at the same fare, and don’t charge for carry on bags. So they’re a better value. And they offer miles which are more valuable than Spirit’s (though not very many under the new revenue-based earning model).
There’s nothing inherently wrong with offering less than an airline used to offer, and charging more for certain things that used to be a part of the base fare, as long as it’s clear upfront that’s what they’re doing. And Delta makes it abundantly clear. United and American, when they follow suit, will need to follow Delta’s example on this.
Telling your most valuable customers that they are only valuable on certain days when buying certain fares — rather than every time they step onto one of your planes — is a bad idea. It undercuts the very notion of loyalty.
Airlines have succeeded in turning commodity products into differentiated products, into instill a brand preference into the customers who spend the most and most frequently. They’ve succeeded in making lucrative customers relatively price insensitive.
Treat those same customers badly on an occasional discount trip and you make price the most important factor in their buying decision again. And that’s not in the interest of the business. And it’s not in the interest of the business to pretend the initiative is even more successful than it can possibly really be. That will only lead to counterproductive decision-making.