Broken model

Are cheap airfares coming to an end?

Robert Kokonis,

In the traditional airline model, premium-class travellers in First and Business Class cabins are the profit drivers. They account for just 10%-20% of passengers on long-haul flights, but generate up to 50% of revenues.

In other words, the folks sipping champagne up front are subsidizing the el Cheapo fares for us saps back in Steerage Class. But what happens when the premium passengers stop showing up? Who will do the heavy lifting?

It looks like we’re about to find out. The global economic meltdown has resulted in a sharp drop in traffic, especially on the premium side. Despite aggressive capacity reductions by the airlines, they have been unable to keep pace with the accelerating fall in demand.

Will airline travel return to an era when it was accessible only by the well-heeled and privileged? That’s doubtful — the rise of the low cost carrier will see to that. And full service carriers will continue efforts to improve competitiveness by further trimming costs. But like it or not, the cost of travel for many of us will inescapably be on the rise.

The depths of the present economic morass demonstrate the frailty of the current airline model. Lose a substantial portion of your premium fare traffic and it doesn’t matter how many Economy seats you fill with cheap fares – you’ll still lose money. Low cost and leisure charter carriers aside, something has to give to ensure mainline carriers live to see another day.

After the early 1990’s recession, many carriers downsized their First cabins or eliminated them in favour of a Business Class alternative. The price was better and the stigma of corporate waste not as visible. In time though, the “new” Business service encroached on traditional First Class standards which, coupled with booming economies, drove the re-emergence of an ultra-luxurious, status driven “new” breed of First Class.

So what will airlines do this time around? In some parts of the world there will continue to be a demand for some level of premium product. For example, of 86 scheduled passenger airlines recently surveyed by AirTrav Inc., 36 (42%) had a long-haul First Class product. Tellingly, 27 of those airlines were based in Asia-Pacific or the Mideast.

For the rest of the world, it’s likely that some carriers will again scale back or eliminate First Class cabins. Business Class cabins will either remain the same size if First Class is eliminated, or be downsized on airlines that had no First cabin.

What will airlines do with the surplus space? They will increase seats in the Economy cabin and an many will roll out a “Premium Economy” service that typically features a separate cabin with upgraded seats and space yet which provides regular Economy meals.

Premium Economy panders to the legions of corporate types and better-off individuals who can afford a little more luxury, but can’t justify Business Class prices due to corporate travel policies and/or budgets.

The introduction of a Premium cabin is an intelligent move for airlines because the incremental revenue earned from passengers who would otherwise sit in Economy should exceed the revenue lost (“yield erosion”) from passengers trading down from Business to Premium Economy.

The bottom line is that a flight must generate a minimum level of revenue to be profitable. The changes described above will not address the total scope of the demand-driven revenue dilemma. Ultimately, back-of-the-bus passengers will have to pay more to offset what may be a longer-term pullback from premium air travel.

Compounding this trend is the prospect of rising fuel surcharges. It is not a question of if oil prices will climb again, but when and how high.

With higher Economy fares and fuel surcharges looming, if you want to fly to London for $199 you’d better book a ticket, because by this time next year you’ll likely be paying a lot more.

By: Robert Kokonis, President & Managing Director, AirTrav Inc.

Photo Credits: Dr. Flash, Raymond Truelove Photography