Airline growth: why ancillary revenue is the way up!
Growing an airline business without new aircrafts is an ideal scenario but generating that ancillary revenue requires a shift in mindset, writes Tom Bacon
All successful companies seek growth. For airlines, most growth is based on acquisition of more aircraft and building out a schedule: more routes, potentially more cities served. American Airlines is adding gates at DFW to expand its schedule in one of its already strongest hubs. United Airlines has further expanded some of its key hubs. jetBlue is now exploring European flights.
But, there is a new alternative approach to airline growth that is built on pricing and e-commerce. Continued innovation in ‘ancillary’ can offer new services or unbundling/rebundling designed to grow revenue without additional fleet or routes. Ancillary revenue growth, in fact, has been a significant contributor to airline industry revenue growth for the past decade.
To execute a new strategy around such [ancillary] growth requires a fundamental change in airline thinking based on consumer needs, innovation, and technology
Growth without more airplanes sounds fabulous to airline analysts and investors. But to execute a new strategy around such growth requires a fundamental change in airline thinking based on consumer needs, innovation, and technology. Multiple airlines like to position themselves as ‘technology’ or ‘e-commerce’ companies but the daily operational challenge of running the airline generally overwhelms any such customer-focused positioning. And, from an operations perspective, you can’t grow without more airplanes.
‘Ancillary’ remains a tremendous opportunity; it has multiple advantages relative to standard capacity growth:
- Airlines are known to be highly capital intensive and labour intensive, not to mention cyclical. Ancillary growth comes without the huge capital costs and can help smooth earnings.
- Ancillary has potentially high margins. A 2% growth at a 50% margin is twice as valuable as even 1% capacity growth at only a 5% percent margin.
- Aircraft growth can result in industry overcapacity. It always results in competitive battles and disruptive market share shifts.
Despite its attractiveness, however, continuous ancillary growth has not proven easy for many airlines. It requires a totally different mentality:
- Greater engagement with customers, that is not simply transactional. E-commerce today is based on relationships while many airlines still focus on ‘bookings’.
- Creativity/innovation/experimentation. Adding a new route to a hub is a ‘natural extension’ of the existing business model. Adding a new value-added ancillary product requires more fundamental change in both the airline’s organisation/processes and traveller behaviour.
- New segmentation. Airlines generally try to meet the needs of all kinds of passengers to fill a plane, including business travellers, leisure, couples, and families. There is often a notion that ‘we serve all’. Ancillary needs to be far more targeted.
- Marketing/merchandising. Airlines spend little on marketing today. A presence on the airline’s own website or on third-party travel search sites offers broad distribution. Third-party sites can immediately present new flights and fares alongside other airline alternatives. Just as e-commerce represents a more targeted business strategy, marketing the new ancillary services will be a critical element of success. The most successful e-retailers dedicate far more resource to marketing than airlines do.
- Product risk. Product innovation always has the chance of failure and frequently requires ongoing learning and adjustment. In fact, viewing product experimentation as a process in itself – not a normal view for a highly capital-intensive firm – is critical to optimal introduction of new ancillary products.
At many airlines, ancillary revenue remains at 10% of total revenue or less. Even for the so-called ancillary leaders, baggage revenue continues to be the largest revenue source with limited new ancillary sources emerging over the past five years. On the other hand, there continue to be travel start-ups that offer potentially promising new services for travellers. Airlines need to continue to pursue ancillary product innovation, whether internally or with start-ups, as a far more lucrative way to grow.
Tom Bacon has been in the business 25 years, as an airline veteran and now industry consultant in revenue optimisation. He leads audit teams for airline commercial activities including revenue management, scheduling and fleet planning. Questions? Email Tom or visit his website