United and American Have Claimed Basic Economy Will Mean $1 Billion a Year in Profit
Scott Kirby when he was President of American Airlines talked about Basic Economy as something that would be worth $1 billion to the airline. He modified somewhat to talk about segmentation (basic economy and premium economy combined) as worth $1 billion. He’s used the $1 billion figure at United now that he’s President there as well.
Now that it’s rolled out across United’s network Kirby says they’re actually losing business because of Basic Economy. Customers are choosing other airlines that offer their ‘full product’ (seat assignments, being allowed a carry on bag) at the lowest price. But he knows American Airlines will jump in with Basic Economy fares in fact they plan a full roll out come September and he thinks that will stop the bleeding.
How Basic Economy is Doing So Far — How That Justifies the $1 Billion Claim
Basic Economy is a fare increase, albeit a complicated one. The airline offers less value at the same price hoping the travel experience at Basic Economy proves unpleasant enough so that customers will spend more money rather than choosing to fly someone else.
American Airlines in its earnings call on Friday shared that in test markets:
- 50% of customers who buy American tickets are buying up to regular economy
- The average buy up is $23
These numbers likely aren’t precise, but let’s take American’s statements at face value and literally.
Again, this is customers who actually buy tickets rather than choosing to buy from someone else because of Basic Economy. However it means that on average per passenger American is bringing in an addition $11.50 ($23 x 50%).
At an average domestic airfare of $352 (first quarter of 2017, per Department of Transportation) that’s an average fare increase of 3.3% ($11.50 / $352).
A 3.3% increase over American’s $34.6 billion in passenger revenue in 2016 — if Basic Economy performance in test markets applied consistently across all markets and if Basic Economy was rolled out to all markets — would mean an additional $1.14 billion in revenue.
Alternatively, with 144 million passenger enplanements last year if American received an additional $11.50 per person on average they’d generate $1.65 billion.
But You Don’t Get to Upsell Everyone From Basic Economy
Not every customer was booking the cheapest economy fare to begin with. There are corporate travelers who are getting higher fare classes contractually. And customers buy premium cabin fares. There’s no ‘Basic Business’ or ‘Basic First’ (yet?).
And even for those customers looking for the cheapest coach fares, American can hit customers over the head with how miserable the Basic Economy experience will be.
Book elsewhere and the information is there, but it’s not a pop up warning pushing the upsell.
If Airlines Could Just Raise Fares 3.3%, They’d Just Raise Fares 3.3%
The truth is that if airlines could hold a 3.3% fare increase, they’d have done it already without Basic Economy. The trick to Basic Economy is that they increase fares more than that on some customers who are especially misery-averse in their travel and have the resources to spend more, while offering the same fare as before to other customers. In other words the goal is a fare increase on only some customers, while making other customers less comfortable.
The problem with this is that:
- Some people stay home
- Other people fly other airlines
- Still others drive or take alternate transportation
$80 Million is More Realistic, Customers Aren’t (All) Stupid
You can play all sorts of games with spreadsheets and assumptions! A year ago Delta said Basic Economy was worth an annualized $80 million. Delta was years ahead with Basic Economy and their experience should dampen expectations.
And there’s even reason to be skeptical of Delta’s $80 million number because it doesn’t appear to factor lost revenue from customers booking away.
We know — and United admits — that customers are smart enough to book away from Basic Economy. Southwest, JetBlue, and Alaska offer better value to consumers at the same price. They offer more legroom, they allow customers to bring carry on bags onto the plane.
Even Delta offers more value with its Basic Economy fares because they don’t restrict customers from bringing a personal item and a carry on.
American Will Start Losing More Customers in September
So customers will continue to book away from United and come September American because those airlines will offer less value than competitors at the same price.
During United’s quarterly investor call analysts pressed Kirby — he was suggested that Basic Economy would be ‘immediately accretive’ but that hasn’t been the case. If his predictions aren’t coming true so far, why should we believe predictions even farther into the future will be correct?