Can We Declare Basic Economy a Success? – A Visual Approach

It has been over a year since Basic Economy made its way onto the industry vocabulary list.  While the impetus was to provide a no-frills fare class to compete with the ULCCs, what excited the airlines (and Wall Street) was the ability to increase fares for those not willing to put up with the Basic Economy level of service.  Delta President, Glen Hauenstein put it succinctly when he explained in a CNBC interview, “Really the success of that product isn’t how many people buy it, in our mind, but how many people don’t buy it and choose another…”  In a nutshell, the idea of Basic Economy is to convince customers to not buy it; rather, to pay for the higher fare.

Did Basic Economy live up to the expectations of producing higher fares while maintaining a competitive offering with the ULCCs?

American, Delta, and United all rolled-out their various forms of Basic Economy in 2017, allowing us the ability to compare traffic and fares in a pre- and post-Basic Economy market.  Did Basic Economy live up to the expectations of producing higher fares while maintaining a competitive offering with the ULCCs?

By looking at the distribution of fares sold well before the roll-out of Basic Economy in Q4 of 2015 and comparing that to Q4 of 2017 when it was in full swing at all three Legacies, we can determine how it was used, and whether it was effective.  As much as we focus on the ability for Basic Economy to increase fares, remember that the main objective was to have a fare offering to compete with the ULCCs.  As such, we will evaluate the basic economy fares based on both objectives:

  1. To provide a competitive offering to challenge the Ultra Low Cost Carriers.
  2. To boost overall fares on those markets by segmenting passengers to the higher fare classes.

 

 

New Techniques to Evaluate Market Performance

Often, when we look at market performance, we tend to focus on average fare and the average number of daily passengers.  While effective for a quick macro view, it would not provide the granularity required to view the true effects something like a new fare class would have.  As a part of several integrated models being developed at Visual Approach, we can look beyond the average fare and traffic, to the total distribution of fares.

In the case of Basic Economy, fares should both decrease and increase as a new fare class is created.  This could have little effect on the average fare, but will have incredible impacts on how competition acts and reacts.  Yet, each of the legacy carriers manage their Basic Economy offering differently.  As a result, we will look at three examples of markets which showcases how American, Delta, and United use this new tool.

Dallas to Las Vegas – American

American has long been competing with Spirit in Dallas.  Ignoring them at first and considering those lowest fare passengers a different demographic, American decided it was time to compete years ago after exiting bankruptcy.  Without a Basic Economy offering, American was forced to lower all fares to provide a competitive offering as can be seen by the large amount of sub-$50 fares offered in 2015.  How American deployed their fares on the DFW-LAS market is one of the best examples of how Basic Economy was supposed to work.  in 2017, a very small bump can be seen at the ultra-low fares, while a much higher peak exists at just over $100.  This is evidence that American really has been able to use Basic Economy fares to limit the number of lowest fares they sell and increase the up-sell to the main cabin offering.  As a result, overall fares increased by almost 10%.

Spirit, on the other hand, were forced to compete with the Basic Economy offering for longer periods of time, forcing more of their fares into the lowest bucket and lowering overall fares by 24%.  Of course, that’s not a 24% hit to their bottom line as ancillary revenues would far exceed that, but the battle between the two airline’s revenue management departments becomes clear.  Spirit also increased capacity in this market by 42% over the two years, bringing the overall non-stop market to 110% of its 2015 size.

Southwest seems unsure how to respond.  Even though they do not compete with American and Spirit directly through their Love Field hub, the effects Basic Economy has had are still apparent.  Without a Basic Economy offering of their own, Southwest has a far higher percentage of their customers at the lowest fares than American, yet they are still able to preserve their higher fares much better than Spirit.  Still, the overall effect to Southwest has been negative, with fares falling an average of 5.7%.

Detroit to Orlando – Delta

Delta’s measured approach to Basic Economy is showcased well in the DTW-MCO market.  Increasing average fares by almost 10% since 2015, Delta has added a significant portion of higher paying customers to their fare distribution.  The peak around $100 in 2015 has been smoothed and increased to approximately $120, while they have seen increases in higher fares almost uniformly.  It should be noted that Delta had a very early version of Basic Economy as a test case in their Detroit to Florida markets in 2015, years before United, and somewhat muting the effect.  However this early version has evolved greatly to what Basic Economy is today, and the comparison is still appropriate.

By Q4 2017 in the DTW-MCO market, Spirit saw the more typical effects of competing with Basic Economy, yet it is Frontier who saw a major shift in their ability to price.

Yet, when looking at how capacity movements have been made in the market, Frontier’s new fare profile becomes less an impact of Basic Economy, and more a result of the more than doubling of capacity.  Even though the market has only increased by 10%, Frontier has increased their capacity in the DTW-MCO sector by 137%.  Still, this is met with an average base fare less than half of what it was in 2015, and one that is still 22% lower than what their ULCC counter-part was able to obtain.

 

 

Chicago – Dallas:  Contrasting the Approaches of United and American

Although Basic Economy shares the same name across the legacy carriers, how it is deployed can be very different.  While the concept was similar, United was much more aggressive in their roll-out than American and Delta.  This is apparent in the Chicago-Dallas market, a unique market where ULCC competition exists, and both legacy carriers have hubs in each city.

While there has been much discussion on the contrasts in the Basic Economy offering from an operational and customer level (carry-on bags, boarding preference, etc.) the difference in how the airlines revenue manage the new offering is very impactful.  As evidenced between Chicago and Dallas, United was very aggressive with their Basic Economy product, sharply increasing capacity and filling many of those new seats with a large portion of customers paying the lowest fare, presumably Basic Economy.

American, on the other hand, seems to take a much more measured approach by limiting the availability of Basic Economy, and having better success at up-selling to the mainstream fare.  The difference between United and American’s approaches is most apparent in the resultant average fare.  While American saw their fares rise an average of 17% to $151 on that non-stop market, United saw their’s fall 23% to $129.  This was, in part, a direct result of United’s whopping 61% increase in capacity on that market.  However, it should be pointed out that American was still able to find that 17% fare increase even with the large capacity increase from United.

It is important to point out, as well, that we are only looking at non-stop O&D fares for a market, not the total fares on a given flight.  In this case, with ORD being a hub for both United and American, and DFW being a hub for American, there are endless opportunities for the airlines to adjust the percentage of local versus connecting traffic, where fares will likely be higher.  This would not be reflected in the distribution chart, however could be a method by which the airlines managed the available capacity to keep the number of Basic Economy seats offered relatively low.

From the ULCC perspective, Spirit’s fare distribution remained fairly intact, reducing only 6% as they found more direct competition from United.  While anecdotal, this could bring into question whether United was achieving their objectives for Basic Economy on this market.  They added a significant amount of capacity, saw greatly reduced fares while their main competitor was able to substantially increase their’s, all to little effect to the ULCC in the market.

The Big Picture View on Basic Economy

By-in-large, Basic Economy has been beneficial to the legacy airlines.  Both American and Delta have hinted at significant revenue benefits, and while United is undoubtedly seeing benefits is some areas as well, they recently scaled back it’s deployment to what is more similar to the targeted approach by American and Delta.  In fact, in a well-written article by The Motley Fool in September 2017, the entire concept of Basic Economy was considered a failure.  Whether or not it has been a success is yet to be determined, we can judge each of the airline’s approach to Basic Economy by how fares have changed over the two year window.

The real impact of Basic Economy has been felt not by the legacy carriers, but by Frontier and Spirit.

While it is difficult to determine how much of the fare differences have been a result of Basic Economy, other competitive factors, fuel prices, or just inflation, we can get a sense by limiting the data to only non-stop markets and viewing the entire distribution.  Delta saw a decrease in overall domestic non-stop fares of 4.7%, with a barely perceptible sliver of new fares at a very low level reminiscent of a Basic Economy offering.  American, on the other hand, noticeably reduced their lowest fare take rate, and improved their domestic non-stop fares by 1.7%.  United’s aggressive roll-out of Basic Economy seems to have resulted in an obvious bump in their lowest fare class, but also an over-all reduction in non-stop domestic fares of 7.8%.

Which leads us to the ULCCs.  The real impact of Basic Economy has been felt not by the legacy carriers, but by Frontier and Spirit.  While the no-frills carriers are forced to compete with a larger amount of Basic Economy inventory being offered other than their own, the lowest fare buckets are remaining open longer and at lower values.  Spirit saw a 20.4% decline in non-stop domestic fares, and their ability to stretch the curve into higher fares looks severely limited.  Frontier saw a fundamental shift in how revenue management was able to distribute to the higher fares, resulting in a 27.5% drop in non-stop domestic fares.  Again, it should be pointed out that this does not equate directly to revenues, as both Spirit and Frontier approximately double the base fare with ancillary revenues, and both airlines are still profitable.  However cataclysmic the base fare reduction may not be, it is still having a significant impact on the competitive landscape for ULCC carriers.

When just looking at the routes on which the carriers compete with Spirit and Frontier, the airline’s differing approach to Basic Economy becomes even more apparent.  Delta is enjoying the increased traffic on those competitive routes through their Basic Economy option, and they have largely been able to balance the lower fares sold with some higher fare segmentation, leaving them at only a 1% lower average fare.

American is clearly doing what they said they would do with Basic Economy, and have increased average fares on those competitive ULCC markets by 5%.  This is substantial, and I believe a model for how Basic Economy will evolve across all legacies in the future.  It should be pointed out as well, that while American’s benefit to Basic Economy has been stronger, the impact to the ULCCs has also been somewhat muted.  American is using Basic Economy to help American, rather than as a way to hurt their competition.

Basic Economy has been a success… So far.  The threat that it could ultimately back-fire is still present.

United, on the other hand, seems to be wielding Basic Economy as a weapon.  With deep competition at their large hub in Denver with Frontier, United has more exposure to the ULCCs, and are using Basic Economy as a tool to fight back and reclaim lost market share.  While it is working, and their traffic in those markets has increased substantially, it has come at a cost of 15% average fares in a domestic market where United already found themselves lagging their legacy competitors.  Some are even concerned of a fare war.  But this was planned for and expected.  United’s approach is best summed up in a quote from UA President, Scott Kirby during a CNN Money interview:  “The best way to compete with a low-cost carrier is match their prices…”  And match prices they did, driving traffic (and lower fares) into their aircraft.  The challenge for United is that, during the same period they are working on improving domestic yields;  a case of burning the candle from both ends.

Southwest seems to be along for the ride.  Not a criticism by any stretch, Southwest has done what Southwest does and managed their fares without the Basic Economy option.  Fares have dropped and traffic risen on those markets competitive with ULCCs, however Southwest has largely been able to stay above the fray, particularly with their somewhat protected presence in alternative markets such as DAL, MDW, and BWI.

Basic Economy has highlighted the striking contrast in capabilities of legacy airline revenue management systems versus those at the ULCCs

Spirit and Frontier, however, are taking the full brunt of Basic Economy.  Even though it was marketed as a way for the legacy carriers to ultimately increase fares, the origins of Basic Economy are still rooted in the need to compete with the ULCCs.  Fares have taken a nose-dive on those markets with a direct Basic Economy offering, and Spirit and Frontier are already looking elsewhere to deploy their capacity.

How Can the ULCCs Respond to Basic Economy?

Basic Economy has highlighted the striking contrast in capabilities of legacy airline revenue management systems versus those at the ULCCs.  In fact, it has been said that Basic Economy essentially takes advantage of a glitch in ULCC revenue management systems in that they can’t respond without being drastically changed.  As a result, the direct response to Basic Economy by the ULCCs has been limited.    The impact was felt fairly early on, and without being able to match the heavy revenue management firepower at the legacies, both Spirit and Frontier have accelerated their move into non-competitive markets.   Frontier created new focus markets like Trenton and Austin, while Spirit continued its highly profitable growth in Latin America, as well as finding new markets such as Asheville and Greensboro (just announced this week).

When fares are searched through corporate booking tools, Basic Economy fares are not shown, and this is the brilliance of Basic Economy.

How the ULCCs respond to Basic Economy on the routes where it is unavoidable has yet to be determined.  These markets all have their unique challenges, as well.  Depending on who is offering the Basic Economy fare, the deployment could be very different.  For instance, when first rolled out, Basic Economy seemed to be a $15 discount on all United flights, a $50 difference from the lowest economy fare offered at Delta, and a more openly managed fare bucket on American.  The airlines have all evolved their offerings since then, however the philosophy seems to be similar.

This difference in philosophy suggests how American is doing so well with their Basic Economy offerings, and potentially how the ULCCs could respond.  Take this personal example, for instance:

In February, I was booking business travel between DFW and FLL.  American offered a Basic Economy fare of $99 for the round trip fare, a very good fare.  Yet it was the jump to main cabin economy that caught my attention.  At almost ten times the basic economy fare, American was charging what could be considered by any measure, a premium fare for a low cost market.  When I search for fares through my corporate booking tool, Basic Economy fares are not shown, and this is the brilliance of Basic Economy.  Through cooperation with the GDSs, the legacy carriers are able to hide Basic Economy fares from business travelers ensuring segmentation.  It’s a perfect use of an advantage the ULCCs don’t have.

In this rather extreme instance, the lowest fare I would see on American was $980, yet Spirit’s essentially-Basic-Economy fares showed up at $110.  The problem is, Spirit is a pain to fly on for business.  Any ancillary fees need to be expensed separately in a laborious process those of us in the corporate world love to hate, and there is a serious risk of those expenses being refused.  For instance, some company’s will reimburse for checked baggage, but not seat selection.  If I were to choose a higher economy fare which included some of those options, with better times and frequencies, it becomes an easy decision. In this case, a $110 fare bundled with a $25 checked bag on each flight and throw in a $25 seat selection would have resulted in a $210 fare which matched American’s offering of $980.  Yet it is difficult to deal with the requisite corporate travel agency to book the ticket, then to find the ticket in the Spirit website to enter new credit card information to add ancillary items at rates that were higher than if I were a able to add them at booking.

If the ability to segment into higher fares was the offset to the lower fares of Basic Economy for the legacy carriers, then the ULCCs are left without that offset;  something they should just take.

Yet, this large fare difference by American is a good thing and a sign of a thriving revenue management department.  They should get the highest fare they can charge, especially at the close-in dates for which I was searching.  Even though there were still cheaper connecting options on competing legacy airlines, if schedule is critical for a business traveler in this instance, American would have just extracted $881 more as a direct result of Basic Economy.  This is exactly how segmentation should work.  (As a post script, I did manually choose the Spirit option, and while it took an extra hour to get the ancillaries ironed out, all expenses were reimbursed.  Nice flights, too).

While the legacy carriers are un-bundling their offering to allow the Basic Economy fare to preserve their higher paying customers, the opportunity for the ULCCs may be exactly the opposite:  to bundle offerings for higher paying customers.  This could offset some of the necessary lower fares required to compete for the lowest fares, while enjoying the very advantages that the legacy carriers are able to gain through segmentation.  If the ability to segment into higher fares was the offset to the lower fares of Basic Economy for the legacy carriers, then the ULCCs are left without that balance;  something they should take.  I would have gladly paid a bundled $250 through a GDS for what was an ala carte $210 ticket on Spirit to avoid the extra hour, and the uncertainty.  If nothing else, this could dampen the benefits of Basic Economy to the legacy carriers who may not be so willing to take such deep cuts on the lowest fares if the higher fares are going to the ULCCs as well.  Perhaps the ULCCs should focus on the stick, not the carrot.

Has Basic Economy Been a Success?

So far, yes.  Basic Economy has been a success… So far.

Basic Economy has mostly achieved the two objectives.  Clearly, the legacy airlines are competing at the lowest fare class and putting pressure on the ULCC carriers.  Whether or not it is enabling higher fares is more a function of the airline, ranging from fantastic results at American to highly competitive fares at United.  Yet, we have not witnessed the final evolution of Basic Economy, and in particular, how the ULCCs will respond in the long term.  And the threat that it could ultimately back-fire is still present.

Considering that the ULCCs have yet to fully respond to Basic Economy in the markets for which it was designed, it could be some time yet before we ultimately declare it a success or failure.

While the legacy carriers pat themselves on the back for putting the hurt on the ULCCs, what they have done is to force the ULCCs into other markets;  markets which, on a smaller scale, are much more profitable for the legacy carriers.  Consider Greensboro, NC, a market where Spirit just announced they will begin operations with service to three Florida markets.  There is currently no non-stop service to those cities (aside from Allegiant to alternative markets).  The higher fares enjoyed by the legacy carriers on these smaller markets will continue to be eaten away as the ULCCs are forced to find homes for their coming capacity.  Basic Economy may have accelerated the spread of ULCCs into smaller markets where higher margins are being used to offset the lower fares in the larger, more competitive markets.  Whether those moves will be successful for the ULCCs remains an open question, however they will clearly put additional pressure on the legacy carriers.

One very handy aspect to Basic Economy is the visibility it allows legacy carriers to claim it a success.  It is very easy to measure up-sell based on what you were offering in Basic Economy, and what a passenger paid for the main cabin product.  This creates good sound-bytes and investor presentations as they show massive fare benefits to the offering, yet I would caution against using those numbers for analysis.  The true benefit of basic economy is the difference between the fares they achieved, and what they could have achieved by a simple fare increase (which at the foundation, is what Basic Economy is designed to achieve).  Setting a low Basic Economy fare, then counting everyone who did want it is not an accurate way of quantifying its benefit.  Also considering that the ULCCs have yet to fully respond to Basic Economy and “fix the glitch” in their revenue management systems, it could be some time yet before we ultimately declare it a success or failure.

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Courtney Miller

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