Can Airlines Keep Winning with Ancillaries?

Key Takeaways

  • Airlines have been making a lot of money from their ancillary sales, and ancillaries will continue to grow in scope and importance to the industry.
  • Low-cost carriers (LCCs) have traditionally been the leaders in developing ancillary products and revenue, although full-service carriers (FSCs) are also becoming innovative.
  • The future of ancillaries lies in bundling and dynamic offerings, but airlines must overcome a few roadblocks first.

1. The State of Ancillaries in the Airline Industry
2. What Airlines Are Doing Well
3. What They Are Doing Poorly
4. What Lies in the Future for Airline Ancillaries?
5. What Should Airlines Include in Their Ancillary Strategy?

1. The State of Ancillaries in the Airline Industry

As more and more airlines adopt the low-cost model, ancillary revenue has become nearly as important as ticket revenue for airlines. According to a CarTrawler-sponsored analysis, in 2007 the top 10 largest airlines took in a combined $2.1 billion in ancillary revenue, which swelled to $28 billion in 2016.

Coming from the same analysis, Spirit Airlines made 46.4% of their revenue from ancillary sales in 2016. For Frontier, Allegiant and Viva Aerobus, more than 40% of their revenue also came from ancillaries.

In a more extreme example, both Ryanair and WOW Air have said that some day in the future, passengers will fly for free. As WOW Air CEO Skúli Mogensen put it:

"Our goal, and we're working hard towards it, is for our ancillary revenue to actually surpass our passenger revenue. Whatever airline becomes the first to achieve this will be a game changer."

While LCCs were originally the pioneers of ancillary sales, FSCs have begun to mimic LCCs and are unbundling their most discounted economy class fares. This means bags (checked or carry-on), seating assignments and schedule changes are not included in the fare. In the United States, all three major carriers (United, American and Delta) have created unbundled "basic economy" fares, and the European carriers are not far behind.

As oil prices and political issues have hurt their bottom line, even Middle Eastern carriers - who avoided charging for ancillaries - are beginning to unbundle. Etihad, who previously had few ancillary products last year, became one of the first airlines to charge economy class passengers for empty neighboring seats. Emirates also considered charging business class passengers for using the onboard shower and selling lounge access to economy class passengers.

2. What Airlines Are Doing Well

Both LCCs and FSCs have been relatively effective at developing their own ancillary strategies. The cash cows have been baggage fees for LCCs and frequent flyer programs for FSCs.

Baggage fees contribute anywhere from 47% of ancillary revenue for Easyjet to 68% percent of ancillary revenue for HK Express. Qantas Airlines makes $95 dollars on average from their frequent flyer members, and 35% of all credit card transactions in Australia are with Qantas branded credit cards. This can provide them with revenue from selling miles to credit card companies as well as gaining information about customer spending habits.

For United Airlines, 60-70% of passengers who look for basic economy fares take the upsell.

The FSCs in the USA who have introduced basic economy fares have been fairly successful as well. The basic economy fares serve as an incentive to purchase their standard fares, leading to significant upsell. For United Airlines, 60-70% of passengers who look for basic economy fares take the upsell, while 50% of American customers do the same. This "good, better, best" model is easy for consumers to understand while at the same time keeps average fares higher.

(Check out our infographic about the top airlines for ancillary revenue.)

3. What They Are Doing Poorly

Even though airlines have raked in large profits with help from their ancillary sales, they haven't always taken the best approach to their ancillary strategy. In a consumer survey by Fusion, an ancillary consulting company, 61% of travelers were open to purchasing ancillaries, however only 37% thought the ancillaries offered were relevant. American Express also found that 83% of millennials are willing to pay more for a personalized experience.

There gives a big challenge for airlines but also a lot of opportunities. Airlines need to work on selling the right ancillaries to the right customers, cross-selling and upselling, and offering ancillaries at the right stage of the sales funnel.

The difficulty for airlines is the large gap in analytics for ancillary products. Ancillaries are often the responsibility of marketing/sales teams and are isolated from revenue management (RM) decisions. Most revenue management software has not incorporated ancillaries in modelling.

Some preliminary findings have shown that incorporating ancillary revenue effects in RM modeling can increase revenue by 1%, which is not trivial in the airline industry. One pain point however is that airlines have had difficulty incorporating ancillary revenue into their third party distribution channels and integrating with legacy systems.

4. What Lies in the Future for Airline Ancillaries?

In order to be successful when selling ancillaries in the future, airlines must ensure their ancillary strategy is providing additional value to consumers - not just squeezing them for every last penny. This means tailoring ancillaries to consumer demand and transparency. Practices like dynamic pricing and bundling must drive value for the customer, otherwise it risks confusing and angering them.

Companies like Amazon and Netflix are good at using big data to gain valuable insights about consumer behavior. They can create complex recommendation engines to maximize revenue. Airlines should be using passenger data in the same way for optimizing ancillary recommendations. We discussed this in a piece we published early in 2018, What If Airlines Were Like Netflix?

Although many airlines are unbundling their fares, they shouldn't depend on this strategy for future success. If done right, a good bundling strategy can create revenue uplift of 2 to 5%. Offering the ideal product at the point of purchase is the key to maximizing ancillary revenue.

The most innovative airlines in the future will know which ancillary services to package together for the right customer. Families might benefit from car rental. Other leisure travelers may want a bag and a meal with their ticket. Business travelers probably want lounge access and wifi on their flight.

A demand-based ancillary model will drive more revenue and better satisfy customer needs. For example, airlines could figure out which customers are flying on their birthday and offer custom products, or offer something to couples flying on Valentine's Day or their anniversary.

5. What Should Airlines Include in Their Ancillary Strategy?

The future success of an airline’s ancillary strategy will depend on a few factors:

  1. First is properly collecting analytics on ancillary sales. According to Diggin Travel, "Pricing of fares and ancillary pricing are two separate and unintegrated processes for most airlines."
  2. Secondly, airlines need to consider ancillaries and tickets as similar elements that constitute the final product offered to a traveler. Whether they are bundled together or not, the traveler’s interest needs to be taken account of in order to construct a personalized offer. This requires the alignment of ancillary pricing decisions and revenue management strategies.
  3. Finally, airlines need to select a technology partner that allows them to collect the relevant data and create intelligent recommendations for analysts to act on.
Ryan D'Souza

Ryan D'Souza

Product Research Analyst