Aloft, at lofty prices: How airlines can profit from superpremium service
A higher level of service in first-class cabins, with lie-flat seats and other amenities, has boosted revenues for airlines that have begun offering it on domestic long-haul flights. But as more airlines introduce superpremium service on domestic routes, carriers need clear strategies for maintaining profitability and avoiding the price competition that can squeeze margins.
Aloft, at lofty prices How airlines can profit from superpremium service
Beirut Fadi Majdalani Partner +961-1-985-655 fadi.majdalani @strategyand.pwc.com Chicago Andrew Schmahl Partner +1-312-578-4895 andrew.schmahl @strategyand.pwc.com Andrew Tipping Partner +1-312-578-4633 andrew.tipping @strategyand.pwc.com
Dubai Alessandro Borgogna Partner +971-4-390-0260 alessandro.borgogna @strategyand.pwc.com Frankfurt Volkmar Koch Partner +49-69-97167-412 volkmar.koch @strategyand.pwc.com Stefan Stroh Partner +49-69-97167-423 stefan.stroh @strategyand.pwc.com
Kuala Lumpur Edward Clayton Partner +60-3-2095-2088 edward.clayton @strategyand.pwc.com Los Angeles Jono Anderson Principal +1-424-294-3736 jono.anderson @strategyand.pwc.com
Munich Simon Kuge Principal +49-89-54525-584 simon.kuge @strategyand.pwc.com Sydney Chris Manning Partner +61-2-9321-1924 chris.manning @strategyand.pwc.com
About the authors
Andrew Tipping is a partner with Strategy& based in Chicago. He focuses on large-scale organizational transformation to increase the effectiveness and efficiency with which companies meet customer needs. Andrew Schmahl is a partner with Strategy& based in Chicago. He helps clients respond to disruptions in their markets through designing operating model improvements and exploring new growth strategies. His primary industry focus is on the transportation, industrial, and private equity sectors. Jono Anderson is a principal with Strategy& based in Southern California. He specializes in developing market, product, and technology strategies that help improve competitiveness and business performance. David Schaar is a senior associate with Strategy& based in Florham Park, N.J. He helps clients with new market entry strategy design as well as operating efficiency improvements. He serves both the transportation and aerospace sectors.
In the last few years, on some routes between New York and California, U.S. airlines have upgraded their first-class cabins with lie-flat seats and other amenities. The so-called superpremium airline cabins have been an early success, and have enabled the airlines offering them to increase their average revenue per passenger per mile flown. With superpremium service having passed this important first test, more domestic carriers are entering the fray. If done successfully, superpremium expansion into new routes could generate a 20 to 25 percent increase in yield for the typical premium passenger. The question that carriers face is how to stake out a position in superpremium while avoiding price wars and keeping yields high. The answer starts with an analysis of where the opportunities lie — especially with respect to as-yet-untapped domestic markets for superpremium service. Superpremium service typically makes sense only for domestic flights that traverse much of the country. But there are other nontraditional inputs that should factor into carriers’ calculations, including the business-travel practices of different industries in cities they serve. Finally, in places where carriers decide that superpremium makes sense, they should define the offering broadly and set policies to ensure pricing discipline.
A new area of competition
The profitability of U.S. airlines has bounced back since 2009, helped by consolidation in the industry. The mergers of Delta and Northwest, United and Continental, Southwest and AirTran, and American and US Airways have reduced the number of players in the market, allowing a smaller group of surviving companies to grow in power and compete in new areas. One of the battlegrounds now is in premium service — in effect, catering to passengers for whom money is no object. The front cabins of some domestic flights now offer these passengers a degree of luxury usually associated with international travel. Amenities include lie-flat seats, Wi-Fi, satellite TV, and, sometimes, private suites. By our estimates, the average revenue from seats in these sections — which go by names like Flagship, Mint, and Business Elite — can be as much as three times higher than the revenue from conventional first-class seats. It’s no wonder that so-called superpremium service has gotten the attention of the airline industry. But as often happens with new initiatives in the airline industry, no sooner has the opportunity become apparent than the field has crowded up. In the U.S., superpremium seat capacity has risen sharply, raising questions about whether the first movers will be able to maintain their high prices. Compounding the challenge, airlines face growing criticism over tight quarters in economy class, where “seat wars” have broken out over the right to recline. More square footage for superpremium seating means less legroom in economy. Striking the right balance is critical. In fact, we believe that there will be a shakeout in superpremium, and that there will be some clear losers. The winners, on the other hand, will be those that define the idea of “premium” in a holistic way and use nontraditional analytics to help them figure out what to do.
In the U.S., superpremium seat capacity has risen sharply.
Superpremium service to date
Up until recently, superpremium service within the continental United States has been offered by only two carriers — American and United — and has been limited to two routes: New York (JFK) to Los Angeles (LAX), and JFK to San Francisco (SFO). These routes have been the locus of superpremium service because of the long travel times, the high volumes of passengers, and the concentration of wealth in the origin and destination cities. But the supply side of the equation is changing. Delta and JetBlue are both in the process of introducing superpremium service for the same routes as American and United, and American’s use of the new A321T aircraft for these routes — intended to enhance the passenger experience — will also have the effect of adding superpremium seat capacity. On the JFK–LAX route alone, the number of daily superpremium seats has gone up 29 percent in the last year (see Exhibit 1, next page). The net effect of this increased capacity will be to shift the supply–demand balance and put pressure on ticket prices. At that point, some of the yield benefit that carriers have gotten from offering superpremium service will be in jeopardy. Superpremium is also being introduced on some completely new routes. For instance, Delta will have superpremium service between JFK and Seattle, and JetBlue is adding Washington, D.C., as a departure point for its service to California. Along these routes, the impact on yields may well be positive, since the new superpremium service is replacing conventional (lower-priced) first-class seating.
Exhibit 1 Superpremium yields are high, but capacity is growing
Example: American Airlines long-haul domestic yields (US$/rpm)1
Superpremium ﬁrst/business capacity: JFK–LAX2
800 600 400
618 613 591 612
$0.27 $0.11 $0.11
95th percentile passenger
Conventional long-haul JFK–LAX
JetBlue Mint Delta Business United Airlines Business and First American Airlines Business and First
1. Nonstop itineraries; Q3 2013; extreme values above $1.60 eliminated; excludes Hawaii; rpm = revenue passenger miles. 2. Number of daily seats in August of each year. Source: Diio Mi; Bureau of Transportation Statistics; Strategy& analysis
The profitability question
Just how much revenue is superpremium service bringing to the airlines that offer it? This is not information that carriers divulge, but publicly available data offers some clues. Of particular note is the yield differential that American is getting on its JFK–LAX flights (all of which have superpremium service) versus its long-haul flights using conventional aircraft (with firstclass and economy cabins). The yields on passengers paying for the most expensive seats on American’s superpremium flights are three times as high as they are for passengers paying for seats in one of American’s conventional first-class cabins, according to a Strategy& analysis. Our analysis also shows that superpremium yields on American’s JFK–LAX flights have increased 12 percent annually since 2009. In addition, transportation industry statistics for the third quarter of 2013 show that the routes where superpremium service is already in place — JFK–LAX and JFK–SFO — have some of the highest average yields in the industry (see Exhibit 2, next page). A portion of that may reflect the high prices being paid by passengers for superpremium service. And if there’s a correlation between high yields and receptiveness to superpremium service, the scatter chart also shows some other origin and destination points that are ripe for superpremium service. Revenue isn’t the only relevant factor, of course; cost matters too. Superpremium service is more expensive to deliver. The actual cost of providing superpremium service will be different for each carrier, and will depend on factors such as the level of investment needed to do cabin upgrades,1 the quality of in-flight service and catering, and any costs related to introducing premium ground service. There are also opportunity costs. Superpremium cabins devote more space to each seat than conventional first-class cabins. United, for instance, has 16 seats in the front-most cabin of its p.s. (premium
Revenue isn’t the only relevant factor; cost matters too.
Exhibit 2 Yields for the busiest U.S. domestic routes
95th percentile passenger yield (US$/rpm)
$0.55 $0.50 $0.45 $0.40 $0.35 $0.30 $0.25 $0.20
DEN-IAD ATL-SLC LAX-MSP MSP-SFO DEN-LGA ATL-PHX DFW-SFO LAS-ORD BOS-DFW DFW-SEA ORD-SAN ORD-SFO ATL-LAS LAX-MIA IAD-LAX ATL-LAX LAX-ORD ATL-SFO ATL-SEA JFK-LAS IAD-SFO LAX-OGG BOS-LAX HNL-SFO HNL-LAX BOS-SFO IAH-SFO JFK-LAX JFK-SFO
Candidates for superpremium service
EWR-LAX ATL-SAN DTW-LAX
Stage $0.15 length 1,300 1,400 1,500 1,600 1,700 1,800 1,900 2,000 2,100 2,200 2,300 2,400 2,500 2,600 2,700 2,800 (miles)
Routes with conventional service Superpremium routes Bubble size indicates relative total passenger volume
Yield on nonstop itineraries; only stage lengths > 1,400 miles; Q3 2013 Source: Bureau of Transportation Statistics; Strategy& analysis
service) aircraft, versus 24 seats in the first-class section of its conventional aircraft — both using the same amount of cabin square footage. In order for a strategy of superpremium service to make sense, airlines need to figure out a way to make a smaller number of higherpriced seats pay off consistently.
How to profit from superpremium
The challenges of superpremium service are such that not every carrier should attempt it. A basic decision tree can be used to assess the suitability of the strategy. “Does superpremium fit with our way to play?” is really the one critical question. For carriers that pursue a low-cost strategy, the answer may well be no. For full-service carriers, the answer may be yes, and there are three mechanisms they can use to strengthen their hands. Take a holistic approach to the idea of superpremium service. The experience of being in a luxurious cabin, without the crowding and discomfort that often characterize economy seating, is certainly the main differentiator once a person who is holding a superpremium ticket is aboard an aircraft. But are there ways to make superpremium service feel like something more than just a fancy seat? No matter how creative the food menu is or how many first-run movies are shown, a travel experience won’t feel premium if the lead-up to the flight and what comes after it are full of the usual inconveniences. At a minimum, airlines offering superpremium service need to find ways to speed these high-value passengers through the reservation process, security screening, and baggage claim. They may want to offer premium-seat passengers the option of a concierge service that would transport them to connecting flights without so much as a glance at the flight board. There should be an option for ground or even air (helicopter) transport to and from airports, instead of treating embarkation and disembarkation as the starting and end points of the transaction. Alliances with other premium travel providers, such as high-end hotel chains, and dedicated ground facilities for superpremium passengers should all be a part of the offering. The components of a holistic premium flight experience will be easier to identify when airlines start thinking about the passenger’s trip as something that may begin on Park Avenue in New York and end at the Transamerica Pyramid in San Francisco, as opposed to starting at JFK and ending at SFO.
Maintain your pricing discipline and focus on profitability. Airlines see themselves as world-class in coming up with price-elasticity models and in understanding yields, but superpremium service requires them to add a level of pricing discipline on top of that. This means superpremium tickets should never be given as upgrades to loyal customers when lie-flat seats or private suites haven’t been sold. The tickets should be provided only to people who have paid for them in full, or who are redeeming a tremendous number of frequent-flyer miles in order to experience something unique in the sphere of air travel. This is different from the way airlines handle their inventory of first-class seats, but it is an essential policy to put in place if the aura of exclusivity is to be protected and price erosion prevented. At the same time that carriers are maintaining their pricing discipline, of course, they must look for ways to limit the costs of delivering superpremium service. The high cost-to-serve in this area means airlines must learn what premium passengers don’t particularly value, and look for ways to economize in those areas. They should also look into their allocation of aircraft “real estate.” For instance, it may be more economical (from a capacity- and yield-management perspective) to operate a smaller superpremium section rather than a larger one. It might also be possible to work with suppliers to develop seats that maximize the use of the available space. The bottom-line goal is to build a true premium experience. Having built it, airlines need to have faith that the market will come. Look for additional routes on which to offer superpremium service. Identifying new routes with superpremium potential may require some nontraditional inputs. An example of such an input is the number of passengers who are traveling on business and therefore (in effect) using someone else’s money. In certain industries, it’s common to allow executives to fly first-class if the trip they’re taking exceeds a certain number of hours. If an airline could access data like that, and map that data geographically to its existing routes, it would have at least a proxy for willingness to pay for superpremium service. With their large numbers of wealthy people in the finance, entertainment, and technology industries, New York and California are already sweet spots in many U.S. airlines’ superpremium strategies. But they aren’t the only origin and destination points where large numbers of business travelers take long-haul or medium-length domestic flights. Houston, with its petroleum wealth, is another location that might work for superpremium service. (In fact, we know of one airline executive who banked on the oil industry’s expense-account generosity to persuade his company to begin service from Houston (IAH) to the Asian country where his airline is based. This isn’t the
Houston, with its petroleum wealth, might also work for superpremium service.
exact same situation as the rollout of superpremium service, but it’s analogous — and it worked.) Newark (EWR), because of its proximity to Manhattan, may also have potential as a superpremium origin/ destination point. Indeed, as shown in Exhibit 2, IAH to the New York area and IAH–SFO routes already have some of the highest yields among all routes. This suggests they may be good places to roll out superpremium service. The expense-account data point also raises the possibility of some sort of direct marketing of superpremium service into the executive suites of large U.S. corporations. One area of particular potential for the long term might be companies that make private jets available to their top executives.
Airlines often copy one another’s strategies and moves when they sense a chance for profit, and in an industry that faces such unforgiving economics and sees so few genuinely new revenue opportunities, it’s hard to criticize this tactic. But “me too” isn’t going to work with superpremium service. Instead, companies need approaches that customers recognize as genuinely distinctive. The three ideas we’ve laid out in this article are good places to start. Carriers may also want to look for analogs in other industries — cases in which companies successfully went up the quality ladder, getting their customers to pay for something better — and deconstruct why those efforts worked. Strategies that are based on expansive definitions of what constitutes premium services, or that incorporate atypical analytics, are particularly worth investigating.
1. United attributed a US$550 million capital investment it made a few years ago partly to the cost of adding flat-bed seats to 62 additional aircraft: ir.unitedcontinentalholdings.com/phoenix.zhtml?c=83680&p =irol-newsArticle&ID=1598567.
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