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Oct 26

Will Southwest Airlines Implement New Bag Fees?

My primary goal with this blog is to provide assistance to those who are novices in the frequent flyer game (or just like a good read). Thus, the “101” moniker. Every so often, though, I find a topic that’s interesting enough that it’s worth taking it up a notch. Today provides one such opportunity.

Has The Time Come for First Or Second Bag Fees at Southwest?

southwest

Photo Source: Creative Commons

Before I start, I want to say something about Southwest Airlines. In terms of corporate culture, ethics and concern for both its employees and customers, there is no airline, and few companies in any industry, that top this one. In one of the most competitive businesses anywhere, Southwest has managed to maintain a corporate culture that is second to none. I know several people who work there and I can attest to the fact that the folksy charm that the airline portrays is 100% genuine. And, for good measure, I met my wife at an event co-sponsored by the airline.

It’s for those very reasons that the airline has resisted calls to implementing baggage fees. Of course, you only get two bags free now, anyway, but that’s more than enough for most people. Fee-free flying represents a competitive advantage for the company, but it still costs them revenue. And luggage revenue is very profitable. There’s almost no incremental cost to charging for bags, so they keep over 90 cents of every dollar that surcharges generate.

So why now, after all those years of free bags, would they finally implement ancillary fees?

Because They Can

Southwest has always had less “ancillary” revenue than its competitors (as a percentage of total sales). For Southwest, about 8% of total revenue falls in the “other” column. For the large network carriers, that number is closer to 12-13%. And for the ultra-low cost carriers, like Spirit, it can exceed 40%. But that number isn’t particularly different than historical trends. Why would they change now?

The answer is a somewhat simple one: because they can. Southwest implemented a new revenue management system this year. Revenue management is just what it sounds like, technology that will help the airline maximize the amount of sales (and, hopefully, profits) that it can generate. The systems will do everything from help them manage supply and demand on ticket prices to determine other ways that the airline can improve its income.

The new system represents an enormous step forward in capabilities for the airline. My suspicion, and this is only my guess, is that the airline’s previous technology did not have the ability to factor in extra fees for bags, particularly at the airport. It’s easy to be the good guy when you don’t have the option to be the bad guy. Let me say this again: It is only my theory that the previous system was unable to manage certain extra fees. Regardless of what it could or couldn’t do, however, it’s almost certain that the new technology does give the airline the ability to manage ancillary revenues, even if they choose not to do so.

Because That’s Where The Money Is

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Photo Credit: Creative Commons

It’s certainly not robbing banks. This is an airline that has always focused on stimulating its own traffic to compete with the legacy carriers, while growing capacity to offset unit costs. Now, there aren’t as many places to grow and they are getting undercut on fares by ultra-low cost carriers. The new revenue management system will help them refine their fare structure more surgically, but Spirit and Frontier aren’t going away.

Over the past several quarters, revenue has been an issue for the company. The company reported its quarterly earnings today and guided revenues for the next quarter lower than expectations. The stock is down 11%. Here are some of the headlines from previous quarters:

Today: “Southwest Tumbles on Bleak Outlook for Airfare Pricing Power” (Bloomberg)

7/27/16: “Southwest Passenger Revenue Falls as Lower Fares Undercut Growth” (Bloomberg)

1/21/16: “Southwest Airlines Co. (LUV) Meets Q4 Earnings, Misses Revenues (Zacks)”

12/8/15: “Southwest Plunges on Lower Unit Revenue Guidance” (TheStreet)

10/15/15: “Southwest Airlines Beat Estimates, Misses on Revenue” (Bloomberg)

True, anyone can cherry pick headlines like I just did, but they do point to a consistent theme. The airline needs to do something about generating revenue, because it is facing difficulties in other areas:

  • It hedged fuel way above market. Fuel hedges will eventually die off, but they will hurt profitability until then.
  • It has competitors who are lower cost than they are. Those other competitors make up the difference on fees.
  • It’s not growing at the same rate that it once did. Fast growth means that your cost per seat mile (how much it costs to fly one seat one mile) are pushed lower.
  • Labor costs are going up.

The argument would be, “Won’t bag fees just suck revenues out of ticket prices? People still know that they are going to have to pay somehow, wouldn’t they account for fees?” The answer seems to be “no.” Consumers tend to “bucket” prices differently. Bag fees are in a different bucket than ticket prices are. Look at Spirit: The airline is growing like a weed and is highly profitable, but charges more fees than anyone else. You can also look at the other end of the spectrum. Basic economics says that bag fees must have some impact on demand, but no airline that I’ve spoken with has said that the demand degradation has gotten even close to what they have generated in fees.

The Bottom Line

Southwest is going to be discussing its fiscal quarter on a conference call in about 45 minutes. I have no doubt that somebody is going to ask about bag fees, nor do I have a doubt that management will deny that additional charges are imminent. They might not be. But they have to at least be on the table as the airline looks to increase its profits. Airlines are publicly traded companies and have a fiduciary duty to their owners (the shareholders). We don’t have to like it, but it’s a fact. If Southwest thinks that it can increase its profits by implementing bag fees, it will. It doesn’t have to be $25 per bag. It could be as simple as a free first bag and $15 for the second.

I like Southwest. I like the people, the brand and the corporate ethics. I’d be proud if my kids went to work there. So I also want to see the company thrive. But even growing companies have to do things that their customers don’t like. I wouldn’t be surprised if a first or second bag fee were one of those.

 

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