Breaking The Yield Barrier


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A discussion of how airlines can break out of the commodity ticket price trap and capture more their customers wallet.

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Breaking The Yield Barrier

  1. 1. This piece was published before the May 2007 rebranding of Mercer Management Consulting, Mercer Oliver Wyman, and Mercer Delta Consulting as Oliver Wyman. Oliver Wyman Oliver Wyman is building the leading global management consultancy, combining deep industry knowledge with specialized expertise in strategy, operations, risk management, organizational transformation, and leadership development. The firm works with clients across a range of industries to deliver sustained shareholder value growth. We help managers to anticipate changes in customer priorities and the competitive environment, and then design their businesses, improve their operations and risk profile, and accelerate their organizational performance to seize the most attractive opportunities.
  2. 2. Breaking the Yield Barrier How airlines can create new revenue streams by merchandising ancillary goods and services By Andrew Watterson and Raj Lalsare Airline passengers represent a huge potential market for food, insurance, package tours, and other products that are adjacent to the core product of a seat in an aircraft. Carriers in search of high-margin growth can cultivate this market by building awareness, generating traffic, closing transactions, and fill- ing the “shopping basket”––in short, by learning how to think like a retailer. D espite recent successes in raising fares, the airline industry continues to experi- ence long-term price deflation on its primary and some customers seem willing to pay a bit more for that. For most other airlines, how- ever, yield and the profitability of a ticket will product: a seat on an airplane. It has proved continue to decline. difficult for airlines to break through this Over the past five years, airlines have “yield barrier” to increase revenues (Exhibit 1). aggressively reduced costs only to see soaring The problem is that for most customers air fuel prices eat away much of their savings. travel has become a commodity based prima- Even Southwest Airlines, which has one of the rily on ticket price and a convenient flight. lowest cost structures in the business, realizes Some airlines, such as Virgin Atlantic, have that revenues have to grow and raised its top tried to offer a different travel experience, fares in March and July of 2006. This is a sure sign that cost reduction, while imperative, is Exhibit 1 The long-term decline of airline yields not sufficient to achieve financial stability. All industries face the threat of commoditi- Index: 190 zation of their core products at one point or 1985=100 another. Demand curves shift and drive inno- CPI vation for better products and services. 170 Pharmaceutical firms, for example, confront the challenge by developing derivatives of existing drugs or drugs for adjacent disease 150 areas. The good news is that, as in other indus- tries, airlines can achieve new levels of growth 130 by addressing customer demand that is adja- cent to the core product of an airplane seat. When purchasing their tickets, Internet- 110 enabled passengers are notoriously adept at Real yield finding the lowest price. But once travel has 100 begun, passengers may be far more willing to 90 1985 '87 '89 '91 '93 ‘95 '97 '99 '01 '03 ‘05 trade price for convenience, just as people Source: Air Transport Association who buy a 2-liter bottle of soda at a discount Note: Yield is defined as the average revenue from sold seat-miles; real yield adjusted to 1985 dollars. retailer for 99 cents will pay the same price Andrew Watterson is a Dallas-based director and Raj Lalsare is a Dallas-based senior associate of Mercer Management Consulting. They can be reached at, and 52 Breaking the Yield Barrier Mercer Management Journal
  3. 3. for a .35-liter can at a vending machine. forecast projects that passenger revenues per Several industries have been particularly seat will grow between 3% and 4%, driven adept at capitalizing on customers’ different largely by ancillary revenues, which are pro- demand elasticities for different purchase jected to grow 30%. occasions. Gas stations are a well-known European low-cost carriers have developed example. In a perpetual price war for their three types of non-transport revenue models: basic product of fuel, they looked for new sources of revenue and profits and began Partnership deals, in which co-branded offering food, beverages, tobacco, and other partners market their services and prod- items that didn’t warrant a trip to the super- ucts across the carriers’ travel chain as if market and could easily be combined with a it were a real estate property or a mar- fill-up. Hence the term “convenience store.” A keting channel. These carriers have culti- decade ago, non-fuel sales contributed less vated strong brands in order to draw than one-fifth of the gross margin at gas sta- customers directly to their websites, and tions, whereas today almost half of the gross partners have been willing to pay for the margin comes from non-fuel sales, according brand association and channel leverage. to the National Association of Convenience Ryanair markets packages for events such Stores. British Petroleum, after merging with as the Grand Prix and wine-tasting tours. Amoco in 1998, embarked on a major mar- EasyJet markets car rentals for Europcar, keting campaign to re-brand itself and ski packages for several resorts, lodging remodel its gas stations into a welcoming for many hotel chains, and has even co- place under the slogan “beyond petroleum.” branded air sickness bags on board with In the movie theater business, over 90% of photo developer Klick Photopoint. profits now come from concession stands and advertising. The average movie ticket in the Retail sales, where the carriers sell add-ons U.S. costs about $6.50, while in most theaters, such as trip insurance and in-flight food, a medium-size drink and bag of popcorn cost beverages, and merchandise. Here again, $7.50. Two major theater chains, AMC and easyJet has been aggressive, co-marketing Regal Cinemas, report that they barely break lounges on a per-use basis with Servisair even on movies; it is the ancillary products operators at select airports. Via easyJet’s that contribute to the movie experience and website, customers can purchase entry to keep them in business. use in conjunction with their trips. Many hotels, casinos, and theme parks have also dealt with the commoditization of their Service fees and penalties related to luggage, core product by cultivating adjacent demand. seat assignment, and other aspects of Host Hotels and Resorts, for instance, reported travel. Flybe, which has a rapidly that 38% of its revenue for the first quarter of expanding network of European and 2006 came from non-room sources. In Las domestic flights from regional U.K. airports, Vegas, casinos have added 3 million square has been charging customers £4 a bag per feet of new retail space over the past five one-way flight for checked-in luggage since years, with many of these shops, restaurants, February, 2006. The fee drops to £2 if cus- and spas becoming some of the most prof- tomers pay via the website up to two itable retail real estate in the country. hours before the flight departs. Other U.K. airlines are charging extra for an exit row The European Experience seating assignment. To be sure, there is an Among airlines, it is the innovative carriers implicit risk in charging customers for in Europe that are leading the way in cap- something they may perceive as part of turing high-margin revenue from adjacent their travel purchase; nonetheless, service demand. For instance, easyJet’s 2006 earnings fees are a new source of revenue. Mercer Management Journal Breaking the Yield Barrier 53
  4. 4. North American airlines, particularly the few products that do exist, such as buy-on- legacy hub-and-spoke carriers, have been board food, and they lack robust transaction slower to harvest adjacent demand. Most of systems at the point of sale. As a result, cus- U.S. carriers’ non-ticket revenue comes from tomers still perceive the travel experience as loyalty-program-related partnerships, and is one, all-inclusive product, which remains a stagnating, while most of the European low- hurdle to selling add-ons. cost carriers’ non-ticket revenue is generated As managers at legacy carriers and other air- via retail sales and brand partnerships, and is lines start to experiment with developing ancil- growing rapidly (Exhibit 2 ). lary revenues, they can benefit by studying The U.S. carriers’ experience in this area has some powerful principles from the retail sector. emerged primarily through frequent flyer pro- As we have seen, well-run retailers are adept at grams, which they have monetized through developing products and services around their partnership deals and consumer product core offerings. selections. In 2005, Air Canada raised $200 mil- lion by selling 12.5% of its loyalty program, Think Like a Retailer Aeroplan, into an income trust; this implied a A retailer’s management of the shopper’s total valuation of $1.6 billion for Aeroplan. experience and the firm’s method of cap- The top three North American airlines turing value can be simplified into five steps derived 8% to 10% of their 2005 revenue from (Exhibit 3): non-transport sources, mostly business part- nerships. They have also turned to penalty- Build awareness. Retailers spend enormous based sources of revenue, charging for ticket resources to build a brand and secure con- changes, excessive baggage weight, or talking sumers’ attention. Wal-Mart’s entry into gro- with a reservation agent. However, such ceries and fresh produce is a great example. service fees may undermine customer loyalty, Just a few years ago, Wal-Mart was a discount no matter how clear the fine print. store. Wal-Mart ran a steady campaign to At the same time, these carriers have been create awareness of its Supercenter grocery slow to cultivate other non-ticket revenues. concept. Awareness grew in just a few years They have not made customers aware of the as Wal-Mart effectively expanded its “always Exhibit 2 European low-cost carriers are aggressively growing non-ticket revenues CAGR $15 United 3% Ryanair 11% Non-ticket 10 revenue, $ per Delta 2% passenger easyJet 15% 5 0 2000 ‘01 ‘02 ‘03 ‘04 ‘05 Source: Company annual reports, The Airline Monitor 54 Breaking the Yield Barrier Mercer Management Journal
  5. 5. low prices” guarantee to groceries. In many to pay a premium for certain products. Some regions, it has become the preferred destina- airlines have realized that this dynamic tion for grocery and fresh produce shopping. exists, and their agents ask at the end of the In selling a seat on an aircraft, airlines pro- reservation process whether a rental car or mote their brands, prices, and sometimes hotel booking is needed. The propensity and their products, so that customer awareness of capability to sell ancillary products and serv- travel choices is generally high. Awareness of ices needs to be embedded in airlines’ entire new purchase opportunities could be created value chain. for far less money, as the target segment has been reduced to those already planning and Create a transaction. Many retailers try to get buying travel. consumers to make a purchase through “loss leader” products or everyday low prices. In Generate traffic. Based on a perceived need selling seats, airlines and travel resellers have and brand awareness, consumers come to the put a lot of effort into improving the “look to retailer’s store or website to assess the prod- book” ratio, and like retailers, their tactics ucts’ attributes and value. While the Internet often center on price. For ancillary products may have reinforced the commoditization of and services, there are several points in the many products, including the aircraft seat, it customer experience where transactions can has also generated a lot of traffic to the vir- be created: tual store window. At, throughout the book browsing and buying At the time of booking, suitable for travel process, customers are informed of related “add-on” and partner sales, which do not titles and authors, which increases Amazon’s drive up costs by adding a complex chance of making an add-on sale. delivery chain For airlines, sales of the aircraft seat gen- erate traffic for the ancillary store. Not all At the airport, when price sensitivities passengers will buy, of course, but as each generally decline, suitable for product passenger goes through the travel experi- enhancements such as club entry, exit ence, he or she is progressively more willing row seating, and cabin upselling Exhibit 3 Thinking like a retailer Increase the Build awareness Generate Create a value of Build loyalty traffic transaction transaction What it • Make customers • Invite and channel • Develop the organiza- • Develop product and • Make the retail means aware of value-added customers to try the tional and technical service extensions, to experience into products and services products and services. capability to convert capture incremental a proposition that across their travel traffic into transac- share of wallet. customers would experience. tions. consider again. Examples • EasyJet’s website • At Lufthansa boarding • In its buy-on-board • Ryanair’s average fare offers an airport gates, marketing reps • Carriers such as Air offering, Hapag-Lloyd is $53 and it has a parking space reserva- typically offer an hour Europa and easyJet Express has “virtual” cult-like following tion service to address of free onboard have been success- combo deals, which of customers who the growing shortage Internet access on fully selling food on are assembled from repeatedly spend an of parking spaces; international flights; board, but U.S. the à la carte choices. average of $10 per customers get a beyond the hour, airlines have strug- This increases the trip on Ryanair’s car discount for reserving customers pay for gled because they value of the transac- rental, hotel, and early––an attractive continued access. lacked point-of-sale tion, without the apartment finder, proposition for time- transaction need for pre-assem- on-board food, car and cost-conscious capabilities. bled boxes. insurance, and even customers. an online lender. Mercer Management Journal Breaking the Yield Barrier 55
  6. 6. On board the aircraft, where products are on a website, at an airport, or on an aircraft, it often consumables such as food, a pur- is critical to maximize cash margin per unit chase point akin to a convenience store of space. The second area for development, opera- Increase the value of the transaction. Once tions, addresses the fact that even the best the consumer has put an item in the basket, products with the best placement don’t sell there is enormous leverage to be gained from themselves. Airlines need to deploy the right filling the basket with other products. point-of-sale devices and give front-line staff Retailers are becoming increasingly sophisti- the right type of training for high-volume and cated at using in-store advertising and dis- non-routine transactions. plays to expand their share of wallet at each Just as airlines have been evaluating which touchpoint. Supermarkets place impulse-buy aviation activities should be outsourced and products with high margins at the checkout. which kept in-house, airlines may not want Here, airlines must walk a fine line of pro- to develop all the skills needed to create moting additional products and services ancillary revenues. Even retailers do not per- without bombarding the customer with too form all these activities in-house, as evi- many offers. At each transaction point, the denced by the famous collaboration between messaging and mechanisms should match P&G and Wal-Mart, where the supplier man- the type of sale—“meal deal” pricing on board ages levels, stocking, and product selection the aircraft and product images at the airport. within certain categories. A similar partner- ship can be arranged with airline suppliers. Build loyalty. Just as there is leverage in filling the basket, it is also valuable to know the prof- *** itability of each existing customer and, for Airlines cannot count on the current tem- them, skip the awareness and traffic steps. porary firmness in ticket prices to lead them Instead, reinforce their loyalty via targeted to sustainable profitability and revenue promotions, an activity that airlines know growth; the commoditization of travel will well. Once customers grow accustomed to continue. Capturing adjacent demand buying additional products and services through ancillary products and services is the around the seat purchase, airlines can use loy- most feasible alternative. North American alty programs’ offer and reward systems to network carriers started the process with deepen the relationship and increase mar- their loyalty programs, but European low-cost keting ROI. carriers have taken the lead in this area. Non-ticket revenues can create new rev- Learning How to Merchandise enue streams at attractive margins, while To effectively execute on this approach, air- addressing customers’ needs and improving lines need to develop capabilities in two areas their flying experience. To do so, airlines must of retailing, among both headquarters execu- adopt a merchandising mindset. This doesn’t tives and the front-line staff. necessarily mean investing large sums in new The first area, merchandising, is the analyt- capabilities or departments. Rather, it involves ical approach that retailers use to help them incorporating a retail element into the gain insights into customer behavior and strategy, selectively building capabilities, and decide which products to stock and how to above all understanding what passengers array them. Given the expensive real estate want and are willing to pay for. 56 Breaking the Yield Barrier Mercer Management Journal