A journalist recently asked me how it’s possible for low cost carriers to make money intentionally selling $7.50 tickets?
The answer is three-fold:
- They don’t sell all their seats at such low prices
- They earn a disproportionate amount of their revenue from fees and not fares
- They have lower costs
The primary ‘ultra low cost carriers’ in the US are Spirit, Frontier, and Allegiant. And they can sell tickets very inexpensively. For instance,
- In late September Frontier ran a ‘90% off sale’ which applies to base fares and not to taxes or extra fees for bags, etc.
- Spirit Airlines sells membership in what they call the $9 fare club.
Focusing on a limited number of non-stop routes where the airline believes they can fill planes, doing so with lower costs, and charging extra for anything else a passenger might want besides basic transportation is core to the strategy.
For instance there are no free beverages or snacks on Spirit. If you want an advance seat assignment (versus getting whatever is assigned to you) that can come with a charge. If you want to bring on a full-sized carry on you’ll pay for that, in addition to of course checked bags.
Low cost carriers are fairly advanced in Europe, and they inspired one of my all-time favorite song performances.
Jay Sorensen catalogs how much each airline is recording in ancillary revenue. Spirit is the #1 airline in the world for ancillary revenue as a percentage of total revenue (extra fees comprise nearly half their revenue). Frontier is #3 and Allegiant #5 in the world. It’s not just they fares you want to look at, but total passenger revenue.
In the 2nd quarter of 2018, these low cost carriers had some of the highest operating margins in the industry. American Airlines had a 10% margin, United had a 12% margin, and:
- Ryanair [European ultra low cost carrier] 18%, #1 in the world
- Allegiant 17%
- Frontier 15%
- Spirit 13%
So they’re certainly profitable.
The Canadian market can be tough, for instance in the second Quarter Air Canada had a 5% margin and WestJet a -2% margin. Not every lower cost carrier makes money all the time.
But what about making money on $0 fares? Tough but not out of the question. They aren’t selling all the seats on the plane for $0. These are a limited number of seats and for an airline that is running a flight with some empty seats it’s not actually bad business.
- The marginal cost of an airline seat is close to zero. There’s almost all fixed costs for flying a plane.
- Once that plane is going to take off, the costs pretty much are what they are. And once that plane takes off there is never going to be a chance to sell that seat on that flight again.
- So airlines take what they can get for spoiling inventory.
It’s not that different from Las Vegas hotels. They’ll drive the price of the room down as low as necessary to fill up a hotel if they’re making money on ancillary revenue (gaming, shows, clubs).
Plus there’s great PR value in $0 base fares, especially if there aren’t many of those seats being offered. The deals get reported. The airline builds brand awareness, consumers think of the airline as offering cheap fares.
Whenever Ryanair’s Michael O’Leary hasn’t been in the news awhile he spouts off about making passengers stand, eliminating windows from planes, or charging to use the lavatory. He gets attention and underscores that ‘this is the airline that will do anything for a cheap flight’.