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White Paper

Ancillary Revenue and Revenue Management

OverviewThe airline industry is not only subject to an unknown price pressure, but it is also

and regulations are among the more prominent ones. (Source: The Amadeus Yearbook of Ancillary Revenue by IdeaWorks 2012)

JET FUEL PRICE GALLON (US$)

Data: US Energy Information Administration - Gulf Coast Spot Fuel

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At the same time, the trend is shifting towards unbundling, that is, meals, entertainment, seat assignments, baggage, and other items that were included in the ticket prices earlier are now being sold as separate services. The expectations in terms

booking over the Internet are becoming very common in the current market.

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Survival for today’s airlines is their ability to carefully make most of the ancillary revenue opportunities. Airlines those are successful in launching relevant additional services for customers have improved their profitability and have generated some loyal customers. In this document, we will summarize ancillary revenue and the way revenue management tactics can influence it.

CHANGES IN CONSUMER BEHAVIOR

The past decade has seen the travel industry change with regards to consumer behavior. Punctuality, good food, and generous luggage conditions, among others, were important competitive offerings when they were sold inclusive of air fare. Flying was a luxury not everyone could afford.

The relaxed entry barriers in air transportation have put a tremendous pressure on fare prices. Availability of cheaper fares has also broadened the market. Where more travelers now prefer to travel by air, the business travel is on a decline because of other developments in the communications area like ELearning, Video Conferencing.

The paying capacity of a leisure passenger is split between transportation, accommodation, and activities at the destination. When it comes to availing low fares, the first thing that travelers are willing to compromise on is service and comfort onboard.

There is a shift towards à la carte systems, where the passengers themselves choose the inclusions in the journey with regards to services and amenities. Reserved seats, extended meals, and baggage handling are among the most popular options selected by passengers. Things such as cancellation and travel insurances, as well as ground transportation and activities at the destination are gaining importance.

CATEGORIES OF ANCILLARY REVENUE

Ancillary revenues can be divided into the following four categories:

1. À la carte: Including onboard sale of food and drinks, baggage handling, reserved and upgraded seating, lounge access, priority check-in, security screening and boarding, onboard entertainment, and internet access. (Source: The Amadeus Yearbook of Ancillary Revenue by IdeaWorks 2012)

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A la Carte Temptations - American AirlinesRoundtrip Economy Class, Portland - DFW - ParisTemptation Ala Carte Price

Double AAdvantage mile accrual - 13,128 total bonus miles $393

2nd Checked bag. roundtrip (1st transatlantic bag is free of charge) $120

Group one boarding zone - purchased at airport kiosk $9 (return)

Prefferred seating with 4 to 6 inches more legroom and located near the front of the main cabin

$44.66 (domestic)

$88 (transatlantic)

Gogo inflight internet flight pass (US domestic flights only)$12.95 (outbound)

$12.95 (return)

Onboard food and beverage such as a Caesar salad and a split of wine (food and alcohol is no charge on transatlantic flights)

$17 (outbound)

$17 (return)

Admirals Club, single visit lounge passes (two at Dallas / Ft. Worth during layovers and one at Paris)

$50 (DFW outbound)

$50 (DFW return)

$50 (Paris)

Trip insurance by Allianz Global Assistance $91.95

Total - if all services listed are purchased (net of airfare) $965.51

Review of American Airlines fees conducted at AA.com during March 2012.

2. Commission based revenues: Hotel bookings, rental cars and other ground transportation, and sale of travel insurances.

3. Frequent flyer: The sale of miles or points to program partners such as hotel chains, car rental companies, co-branding of credit cards, e-commerce stores, chain stores, and telecommunications companies.

4. Advertising – Sale of advertising space in in-flight magazines, boarding ramps, gate areas, and lounges. This category also includes placement of consumer products and distribution of samples.

WHY ANCILLARY REVENUE

Unbundling has brought about a change in the airline industry even though financial crises and technological developments have played a major role.

According to Amadeus estimates, the global turnover related to ancillary revenue for airlines amounts to $32.5 billion in 2011, an increase of 44 percent over previous year. Compared to 2007, the increase is a staggering 775 percent. Another interesting finding is that more than 40 percent of this ancillary revenue is presently generated via the Internet.

The development potential lies in the ability to match with diverse individual requirements and preferences.

• A family traveling during summer often carries golf clubs or other special baggage. While the parents prefer a vegetarian or a regular meal, the children would like to have baby food. When they board, along with various pre-ordered items, they also request

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for movies and headphones during the long journey. In addition, extra legroom for kids’ mobility needs is a common request, which is booked in advance for an additional fee.

• Backpackers want to travel as economically as possible. They can make more trips if the

fares are cheaper. To avoid fees, they perform the check-in and baggage handling on their own and to reduce the price, they are also open to unspecified seating.

Passenger data is a key for airlines, if they need to match the diversity of expectations and offer the best possible travel experience for everyone. This leads to a number of considerations such as follows:

• Seizing ancillary revenue opportunities before, on, and after the flight is crucial to manage the profitability pressures that most airlines face.

• By offering more sales points via the Internet before departure, during the flight, via cell phones, among others can positively influence the revenue per pax.

• Careful monitoring of selection, pricing, and rules and regulations are important as the airline industry is moving towards retailing. Also, payment systems and trade mark guidelines need to be set.

• As the requirements are highly personalized, improper implementation can risk an explosive administrative burden in connection with each flight.

• The workload of the flight attendants is increasing. They are expected to provide personalized service as well as manage their traditional duties.

• Smooth and, in some cases, prioritized check-in procedures and security screening are in popular demand.

• Passenger data and passport information has to be collected in a way that meets local requirements at various destinations.

REDEFINING FUTURE (Source: The Amadeus Yearbook of Ancillary Revenue by IdeaWorks 2012)

Annual Financial Disclosures of Ancillary Revenue

2011 Results posted by 50 Airlines

€ 18.23 billion ($22.64 billion)

2010 Results posted by 47 Airlines

€ 15.11 billion ($21.46 billion)

2009 Results posted by 47 Airlines

€ 10.95 billion ($13.47 billion)

2008 Results posted by 35 Airlines

€ 7.68 billion ($10.25 billion)

2007 Results posted by 23 Airlines

€ 1.72 billion ($2.45 billion)

Annual results are associated with a fiscal period that has ended in the year indicated.

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The first report on ancillary revenue was issued in 2008 with only 23 airlines worldwide disclosing the ancillary revenue activity in financial filings, and the result was a modest €1.72 billion ($2.45 billion). Formerly, largely limited to low-fare airlines, ancillary revenue has now become a financial necessity for airlines all over the globe. Today, 50 airlines disclose ancillary revenue activity of €18.23 billion ($22.64 billion). This represents ancillary revenue growth of 66 percent to €10.95 billion in two years from 2009 .

Table 2: Top 10 Airlines - Ancillary Revenue as a % of Total RevenueAnnual Result - 2011 Primary Source Annual Result - 2010

33.2% Spirit Various 29.2% Allegiant

27.1% Jet2.com Various 22.6% Spirit Air

27.0% Allegiant Various 22.1% Ryanair

20.8% easyJet Various 21.0% Jet2.com

20.5% Ryanair Various 20.5% Tiger Airways

19.1% Tiger Airways Various 19.2% easyJet

17.8% Air Asia Group Various 18.7% Air Asia Group

17.0% Flybe Various 18.1% Air Asia X

16.5% Air Asia X Various 15.7% Flybe

15.3% Jetstar Various 14.7% United Continental

2011 carrier results were based upon recent 12-month financial period disclosures, which may have ended during 2011 or 2012; the equivalent criteria apply for 2010 results.

ANCILLARY REVENUE AND REVENUE MANAGEMENT

Understanding and calculating the relationship and balance between fare revenue and ancillary revenue is the key in the new market environment. This process reveals situations where making slightly cheaper fares available can attract additional passengers, leading to more revenue from ancillary fees. Ticket price being the main driver of demand for many new model carriers, it can be used effectively to stimulate demand and increase the load factor on most flights.

The ancillary revenue impact: a striking example (Source: Balancing ancillary revenue with load to Maximize revenue by PROS authored by David Newell info: http://stratus.pros.com)

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For this example, assume that a new model air carrier charges various fees for checked baggage, seat selection, and early boarding services, and that these fees generate an average of $30 in revenue per passenger.

We examine two revenue management scenarios to illustrate how the process for managing ancillary revenue can affect overall profitability. The first scenario represents the traditional method for managing revenue based on maximizing fares.

Scenario 1Traditional revenue management without an ancillary revenue process. The airline seeks to maximize only fare revenue.

The result:Final booked load factor: 84 percent; Final booked average fare: $130; Fare revenue: $13,130; Ancillary revenue: $3,030; and Total revenue: $16,160

The second scenario illustrates how using revenue management, we can improve overall revenue. Each scenario is based on a flight with a capacity of 120 seats.

Scenario 2Revenue management incorporating an ancillary revenue process. The airline seeks to maximize fare revenue while at the same time attempting to achieve a load factor target of 93 percent.

The result:Final booked load factor: 93 percent; Final booked average fare: $115; Fare revenue: $12,880; Ancillary revenue: $3,360; and Total revenue: $16,240

Low-cost model of managing ancillary revenue

FLYBE ‘THE BACKBONE OF UK TRAVEL’ (Source: A Z of Ancillary Revenues Militsa Pribetich-Gill – Ancillary Revenue Manager, Flybe)

PRINCIPLE OF ANCILLARIES MODEL

Lo-Co’s have pioneered disaggregation of the bundled price

Legacy Model

₤One big price for everyone

No Choice

Base Air Fare + Taxes & Charges (Compulsory)+Credit/Debit card charges + Baggage + Insurance + Food & Drink + Seat Assignment + Car & Hotel(Optional)

= TOTAL PRICE

Be Transparent - nothing to be guilty of

Minimise drop off at each stage of process

Keep in bite size chunks and give freedom to build

Low Cost Model

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GET THE TIMING RIGHT

• Cross sell from the start: Home page is the most important asset to get the timing right. It has to tease the sale

and should not be wasted. Start teasing with the ancillaries from the home page itself. Structure the offers based on relevance and revenue potential. This should be further

directed to an easy link for separate purchase. • Cross sell while purchasing core item: Most of the purchases happen at the first booking instance itself. It has been observed

that less than 3 percent of customers will come back post booking for extras.

Case study 1:- Flybe generated £20,000 a year from insurance prior to it being a part of the booking

process.- Flybe now generates £1m per year—instant change.

Case study 2:- Driving customers to pre assigned seats- Flybe now generates £5m from seat assignment.- 92 percent of this revenue is made during the booking process.

• Worth targeting the 3 percent segment: If failed to get the bookers when making the main purchase, prompt again, and do not

wait till they come back. This will be the toughest sale, but can generate extra revenue.

DRIVING THE PURCHASE DECISION

• Incentivizing online purchase:- Promoting online purchase as the cheapest and providing price comparisons with

other channels of booking. - Pay for your baggage online at £5 and £10 at the airport or call center.

• Prompt:- Drive every booking through the assign seat page.- Default to one bag induced pre purchase.

• Insurance:- Make customers avoid the sale.- Having customers ‘select’ insurance rather than ‘de-select’ insurance can increase sale

by 25 percent. • Push the purchase decision:

- If customers choose not to buy, question the decision.- Prompt them with the pop up messages about what they have not included in the

trip purchase.

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LEVERAGING THE BRAND AND THE WEBSITE

Need to have brand specific retail products or innovative product line up to capitalize the selling on the brand website. For example:

- Frequent flyer cards- Homepage advertising- Inflight magazines- Packages- New product lines

ANCILLARY REVENUE AND REVENUE MANAGEMENT—‘DO THEY GO IN TANDEM?’

While we talk about the benefits of ancillary revenue and how it has changed the way the airline industry thinks, it is also important to know how it can really impact negatively, if one is not careful, in the form of revenue loss or revenue disadvantage over competitors.

Scenario 1: BOM–DEL with two competitors: XX and YY; XX is the home carrier. Assume that per pax revenue on ancillaries for XX is $70 and for YY is $45. Capacity of aircraft: 100

The schedule looks this way:

1. 0700 XX23 BOM–DEL - 0715 YY12 BOM–DEL For the first customer, scheduling the fare availability or the bundled fare compared to

competition can be as follows:

Home Carrier Competition

Average fare $150 Average fare $150

Ancillary $70 Ancillary $45

Total fare for customer $220 Total fare for customer $195

Assumption: The ancillary products used are the same. And, both the airlines are full service carriers.

Here, we can lose pricing competitiveness as the ancillary pricing is at a higher side. To negate this effect, the fare pricing needs to be altered as it can be dynamically managed.So, it is very important how we price the ancillaries and make sure that it is in sync with the competition.

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Scenario 2: BOM–PNQ (Pune) with 2 competitors: XX and YY; XX is the home carrier. Assume that per pax revenue on ancillaries for XX is $70 and for YY is $25. Capacity of aircraft: 100

2. 1100 XX45 BOM–PNQ - 1500 YY64 BOM–PNQ

Home Carrier (full service) Competition (low cost)

Average fare $130 Average fare $120

Ancillary $70 Ancillary $35

Total fare for customer $200 Total fare for customer $150

Assumption: The ancillary products used are the same. And, both the airlines are full service carriers.

By tweaking the same example, we look at how ancillary pricing can discount us from the buying decision, especially when competing with a low cost. If we look at the pricing of both the carriers without the ancillary, they are comparable with the full service taking a little extra premium over the low cost. However, when the ancillary is a part of the fare, the full service is too expensive and will tend to lose ground in such a competitive market.

Here comes the next question, do we need to have dynamic pricing for ancillaries too? That means should the price of ancillary change depending upon the destination travelled or should it depend on the competition faced or any other parameter. However, it will be difficult to manage when an airline competes with both a low cost and a full service airline in the same market. Here, a clear direction is to be defined at a strategic level. This is a probable question the industry needs to answer as new distribution capabilities come into existence, which promote ancillary revenues.

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Conclusion

generation for the airline industry. Passengers need to be assured that the charges they

customer forever and will become known to many more potential customers. Understanding its customer needs and wants, as well as what its competitors can and will do in response would be of utmost importance for the airlines. The decisions of pricing will depend upon the overall strategy of the airline which is either to stimulate the market or gain market share. Being low cost does not mean low fares or being full service does not mean high fares, but to balance tactfully and remember what has to be done affects cost as well as the revenue. If that is not possible, you have to differentiate and obtain a premium for a higher standard of service.Low-cost airlines are more progressive than traditional airlines, and are seeking to maximize

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