Why Airlines Like Extra Fees So Much

Fees for checking bags, picking your seat, getting something to eat, or in some cases using a live agent to check in. People hate airline fees, yet they continue to grow in both volume and price. Global airlines collect over 20% of their total revenue from fees, called ancillary revenue, according to Ideaworks. Fees represent an important and now standard part of how every airline operates.

There is more here than just adding fees to things to things that, long ago, used to be included in the base fare. The economics of ancillary revenue are very powerful, and it is this reality that best explains why fees have proliferated. President Biden has called some things “junk fees,” but the fees the drive most of industry ancillary revenue are not seriously threatened. Airlines can help themselves by ensuring that they are fully transparent on what is being charged, and when. Here are the compelling reasons that drives most airlines’ thinking:

Lowers The Base Fare

As airlines have collected more ancillary revenue, not only with fees but from many sources, base fares for travelers have dropped. This gives more people the ability to travel by air, even if they must give up a few things to make that happen. What happens most times, though, is people attracted by the low entry price end up buying something else, like a checked bag.

Airline passengers are highly elastic. I don’t mean their bodies, I mean their economic behavior. Small changes in price result in relatively large changes in demand. Low cost airlines see this all the time. They may enter a market that used to carry 350 people every day, and by lowering the base fare a bit the market grows to 500 people a day. So, by building ancillary revenue streams, airlines can grow the base of passengers by making the entry point less expensive.

Better Reflects Consumer Price Elasticity

Back to elasticity, different products react differently to price changes. A family may decide whether to fly at all, or where to go, based on only $5-$10 difference in fare. But once they’ve committed to the trip, a bag charge of $25 or $35 results in almost no difference in the number of bags checked. If you are thirsty and bored, a dollar either way isn’t likely to change how may drinks are sold. The point is that for every part of trip, consumer reactions to price changes based on what and when they are buying.

By unbundling the ticket price, airlines can better reflect the price elasticity of each product and ultimately raise their revenue. This helps them boost the ancillary coffers, in turn lowering the base fare further. It’s a much more efficient way of pricing, and consumers see this in many things we buy. Not many restaurants include drinks or desserts with the main entree. By pricing each product differently, they better reflect both consumer demand and willingness to pay.

Balances Seasonality Somewhat

Airlines are a very seasonal business. There is variability of demand based on time of year, and even by day of week. Weekly airline demand is not evenly spread over seven days, with many more people traveling per day on Thursday-Friday than Monday-Wednesday. Balancing this seasonality is a challenge for airlines, as their capacity is often largely fixed. By doing maintenance earlier than needed, and pushing crew vacations to certain times of the year, airlines can create more capacity for a few busy months.

Base fares often adjust for this seasonality, with higher fares at busy times and incentivizing lower fares at weaker demand times. This results in big variations in monthly and quarterly revenue. Two airline expenses, people and aircraft, are largely fixed through the year. This means earnings vary widely, and ancillary revenues help this. That’s because that while ticket prices may change by hundreds of dollars based on season, baggage and other fees stay largely stable throughout the year. Frontier Airlines now sells over half of their total revenue as ancillaries. This means over half of their revenue has a very different seasonality shape. Even 15% to 20% of revenue from ancillaries, common to most airlines in the world, stabilizes top line revenue against a largely fixed cost base, and this stabilizes quarterly earnings somewhat.

Improves The Cost Structure

Airline fees not only raise airline revenue. They also act as incentives for consumers to behave differently, and these differences often result in lower costs for the airline. When airlines charge for bags rather than bundle these into the base fare like Southwest, customers check fewer bags. This means bag belts last longer, airlines lose fewer bags, and maybe they don’t need as many people to load and unload the bags. RyanAir in Europe, and a few airlines in the U.S., charge a fee to check in with an agent, while checking in on a smartphone is free and easy. As fewer people need a person for check in, airlines can both hire fewer agents over time and lease less space from the airport.

As airport costs decline thanks to consumers choosing new behaviors, this allows an airline to invest more in people and hard assets, and in their consumer product. So, while many people and media complain about airline fees, they like the lower fares and better service that comes from those.

Requires Transparency

As airlines charge for different services provided, it is important they they stress transparency in all of their media. Customers should not be surprised when charged a fee to check in a bag, or to get a bottle of water onboard. This is more easily done on direct media like an airline’s website or app. It becomes harder when selling through third-party sites, as it is difficult for them to be clear about what each airline includes or charges.

Many of the consumer and media frustrations with fees are in this transparency issue. When CEO of Spirit, I used to joke about going into a Chick-fil-A , looking quizzically at the menu and shouting “what, you don’t sell hamburgers here?” I never did this, of course, but expectations are clear when you go into Chick-fil-A that you’re not looking for a hamburger. Airlines have to be just as clear about what is included for what price, and more options means more focus on transparency.