The Increasing Significance Of Ancillary Services In The Aviation Industry

The air fares charged by U.S. airlines have been falling for a number of years now. According to Airlines for America, a U.S. industry association, the real price of fares is on average 40 per cent cheaper now than it was in 1980. This has eroded the revenue earned by the airlines in the form of core passenger revenue, that is, through the  sale of tickets. The drop in air fares has been facilitated by the slump in oil prices and increasing competition. While decreased jet fuel expenses result in lower running costs for the carriers, thus, allowing airlines to offer cheaper fares by increasing profits, increasing competition among the U.S. air carriers compels the players to woo customers by way of offering discounts and other benefits.

However, as the fares fell, the services offered by the airlines also degraded in quality. The era of discount fares meant tighter legroom and sitting beside people wearing track suits and packing a lunch. This opened the doors for airlines to resort to other means for additional revenue. These other means were additional services, such as hot food on the flight, more legroom, better services, and options to upgrade. Charging ancillary fees is the latest stage in the evolution that increases airline profits. As per the U.S. Department of Transportation, U.S. airlines made $4.6 billion from ancillary fees in the second quarter of 2016 alone, up from $3.1 billion in the comparable quarter last year.

Ancillary services help provide customers with a better travel experience, at an additional charge. It also prevents price disruptive competition between airlines, by letting them compete on quality and the variety of services offered. A good example of this is the Mint premium seating program offered by JetBlue and the launch of Polaris class on United’s international flights. The Mint service, at the low cost carrier JetBlue, became very popular rather quickly, mainly because of its affordability and higher quality of services compared to the expensive and poor services offered by other airlines. Thus, it proved to be a strategic move for JetBlue, since it allowed the airline to enter the high margin geographies, such as Los Angeles and San Francisco, and cater to the elite and corporate passengers in those markets to improve its profitability.

The problem with charging a fee for additional services is the typical customer mindset that historically the customers didn’t have to pay for them. But this isn’t true in the least. Earlier the air fares were so high that the ancillary services were just bundled into the ticket price. That meant people who did not want to use these added services, still had to pay for them. With bundling and segmentation, air travel becomes affordable for many, while allowing customers access to premium services at additional charges.

Ancillary Revenue Components

Recent Development

In an interesting development, we may see regulators allowing in-flight calls. Although this is subject to two caveats: airlines will have the option of whether to provide the service, and passengers must be informed well in advance if the flight allows calls, the scope of the service is huge for airlines.

Historically, the U.S. has banned all cellular systems on flight to prevent interference with cellphone towers on the ground. However, the technical possibility to make phone calls using in-flight Wi-Fi services provided by companies like Gogo and ViaSat, has opened the way for a possible move allowing passengers to make calls in the air using their own Android and iOS phones. If approved, this could be a major draw for passengers, especially on long distance flights.

However, the initial reaction from most U.S. airlines has been that of wariness. The Association of Flight Attendants, a union representing 50,000 employees at 18 U.S. airlines, said anything short of banning all voice calls is “reckless,” adding that “it threatens aviation security and increases the likelihood of conflict in the skies.” United said it was reviewing the proposal “and will carefully evaluate the views of our customers and crew members on this topic,” while Delta and JetBlue said they intended to prohibit voice calls on their planes, regardless of regulatory action. However, we believe that most airlines will, reluctantly or enthusiastically, agree to take on this new ancillary service, due to the huge potential of additional revenue to be earned. By allowing its passengers the option to purchase Wi-Fi aboard, the carriers can possibly earn millions of dollars. The table below shows the revenue earned off ancillary services offered by the U.S. carrier.

Revenue From Ancillary Services

Have more questions about JetBlue Corporation (NYSE:JBLU)? See the links below:

• How Did JetBlue Perform Operationally In November?
• Millennials And Their Increasing Contribution Toward Air Travel
• How Did JetBlue Perform Operationally In October?
• Higher Expenses Weigh On JetBlue’s Q3’16 Results, Even As Unit Revenues Improve
• JetBlue’s Q3’16 Earnings Preview: Reduction In Capacity Expansion To Arrest The Decline In Unit Revenues
• How Did JetBlue Perform Operationally In September?
• How Has The State Of Air Travel In The U.S. Changed Over The Years?
• How Has JetBlue’s Financial Position Improved Over The Last Few Years?
• Is Renewable Diesel The Way Forward For The U.S. Aviation Industry?
• How Did JetBlue Perform Operationally In August?
• Can Passenger Airlines Revive The Growth In The Air Cargo Industry?
• How Are The U.S. Carriers Taking Advantage Of The Restoration Of Diplomatic Ties Between U.S. And Mexico/Cuba?
• Why Has Trefis Revised Its Price Estimate For JetBlue To $18 Per Share?
• Capacity Growth Fuels JetBlue’s Q2’16 Revenues, Slightly Offset By Declining PRASM
• JetBlue’s Q2’16 Earnings Preview: Capacity Expansion And Mint Services To Drive Results
• What Impact Will Crude Oil Prices Have On JetBlue’s Enterprise Value?
• How Are US Air Fares Correlated To Crude Oil Prices?

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for JetBlue Corporation

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