Fun with Economics: Why Unbundling is a Good Thing

You can probably look back and find plenty of posts that I’ve written about how unbundling in the airline industry is a good thing. So why am I bothering with yet another post on the subject? Well, Chris Elliott is at it again with a misleading article condemning fees this week. And now that USA Today has given him a bigger pedestal to shout from, I feel the need to shout back with a dose of reality. Fees, unbundling, a la carte, ancillaries… whatever you want to call them, they are a good thing. Let’s see if I can make it easy to understand why.

I’ll start with the often quoted “smoking gun” that all people against unbundling use. This is from Elliott’s article:

Some companies, notably airlines, promised customers that unbundling offered the “flexibility” to pay for only what they use — and nothing more.

But there’s no convincing evidence that they lowered their prices when they unbundled, which is what should have happened. Instead, they just added new fees to their rates, undermining their argument that they were helping you.

No, that’s not what should have happened. This makes the assumption that the pricing structure that existed in 2008, when as Elliott puts it, “passengers were beginning to adjust to a new reality,” was somehow sustainable. It wasn’t. Oil spiked higher and higher and airlines were bleeding. Even today, oil is far higher than it has been historically and that’s not something that’s expected to change. With much higher costs, the airlines had two options. They could either raise fares or cut capacity. In the end, they did a little of both. (Though it should be noted that historically, airfare is still incredibly cheap. Domestically, the first quarter 2013 average fare was 19 percent below where it was in 1999, adjusted for inflation.)

At the top end, they pulled a lot of flights and cut capacity. As basic supply and demand tells us, fares go up when supply tightens since there are fewer seats that need to be sold. But since people are particularly sensitive to fare increases, the airlines had to do more to continue to operate a robust network. So they created an alternate pricing structure which allowed people to pick and choose the amenities they wanted above and beyond a basic seat somewhere on the airplane. Below is how Elliott and others dreamed that would work out. (The numbers are just meant to illustrate the point and aren’t actual numbers.)

How Travelers Wish Unbundling Would Work

Elliott and others figured that fares should have dropped because that plus the new fees would have kept total revenue the same. Unfortunately, that dream is just a fantasy for one simple reason:

Why Unbundling Doesn't Work That Way

Airlines were losing a bunch of money at the previous levels, so just introducing unbundling didn’t mean fares were going to go down for those who didn’t want frills. Had that happened, the airlines would still be losing a ton of money. Instead, total revenue had to go up no matter what. With the new unbundled structure, prices went up less for those who didn’t need more amenities than it would have otherwise. Or graphically:

How Unbundling Actually Worked

With the new unbundled structure, those who just wanted basic transportation may not have seen fares go down, but if they went up at all, it’s a lot less than would have happened without unbundling. Yes, they got fewer frills with that fare, but for the first time, they had the choice on whether to pay for everything above and beyond basic transportation. Many people don’t want that, and they pay less today because of it. For those who do want all the frills, however, unbundling has meant they pay more. In other words, without unbundling, the traveler wanting basic transportation would have paid more in order to subsidize the traveler wanting all the frills. That’s why Southwest is often more expensive than other airlines for you today if you aren’t checking bags or making changes. You’re paying for those benefits even if you don’t use them.

Now here’s the kicker. People view fees differently than they do fares. They’re much more price sensitive when it comes to paying base airfare than when it comes to paying fees. So if the old structure still existed, fewer people would have been willing to pay those high fares, and that means airlines would have had to cut capacity even more than they already have. There would be fewer choices for everyone and the fares would be higher.

The False Resort Fee Argument
Of course, just because unbundling is good doesn’t mean that all fees are good or fair. Elliott tries to lump airline fees in with the one fee that I hate the most – resort fees. These are mandatory hotel fees that aren’t included in the cost of the hotel rate, and that should be illegal. In fact, it would be illegal if hotels were regulated the way airlines are. When it comes to airfare, mandatory fees must be included in any fare shown. Period.

Elliott is trying to cast a shadow over all fees by comparing airline optional fees to resort fees, but that’s just silly. They’re very different beasts, and in the airline industry, unfair fees are specifically banned. If only that were the case in other industries as well.

If This is Good, Why Do People Hate It?
Now comes the big question. If unbundling is so good, why do people hate it so much? That is absolutely where the airlines really screwed themselves. As mentioned earlier, when fuel prices skyrocketed in 2008 and airlines began to bleed profusely, they grasped at straws to find a way to right the ship. It was that introduction of first bag fees that really saw unbundling take center stage and ultimately enabled the airlines to get back on firmer ground.

The problem was that the airlines were so desperate to raise revenue, that they failed to really think about the customer experience at the time. It was one of those “shoot first, ask questions later” moments, simply because they were on the brink of financial ruin. Because of that, implementation was clunky and disclosure was poor. So it is indeed true that things didn’t start off very well, but that hardly means the practice of unbundling is a bad one. It’s just that the airlines set the precedent for hatred by doing it wrong in the first place.

Since that time, airlines have become better and better at displaying things properly. If you don’t know that a seat assignment will cost more or that you can pay for things like priority boarding or extra miles, then you just aren’t paying attention. Links to bag fees are made available during the booking process, though that’s an area where further work should be done by the legacy airlines. (The low cost carriers are much better at it.) If there’s any place where the fee structure is misleading, it’s not on airline websites but rather on third party online travel agent sites. But that’s a separate issue, and it’s not the airline’s responsibility to spoon feed them all the details. Online travel agents should be held responsible for providing an accurate display of what’s being offered, not airlines. But I digress.

In the end, the result of unbundling is clear. People pay less in base fare than they otherwise would, and they can pay more if they want more. Not everyone likes this, of course. Those who check a lot of bags, pay for meals, and pay for seats will undoubtedly be sad that others aren’t subsidizing them anymore. But just because they don’t like it doesn’t mean they can’t see that it’s the fair way to do things. If only the reporters writing for big newspapers could see that as well.

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71 Comments on "Fun with Economics: Why Unbundling is a Good Thing"

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BOS Flyer
Guest

Amen, great explanation.

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Trent880
Guest

Chris Elliot is a total fraud. It’s easy to rile up the masses and their pitchforks since airlines are easy targets, but his claims are so unfounded it’s comical. In the oil price run up when airlines were burning the furniture trying to stay alive he penned an article how airlines were using fuel as a convenient cover to raise fares and lauging (crying) all the way to the bank (to beg for another loan). The guy is truly awful.

Evan
Guest
I will agree that un-bundling is good for many people and carriers. I want the cheapest possible seat, and will probably go experience inconvenient layovers/itinerarys/backtracking to get that cheap ticket. However, I was at the Spirit counter last week, where you can avoid the “Passenger Usage Fee” to purchase a ridiculously cheap fare to Dallas to visit my grandparents in October. ($34 r/t! no bags, or seat assignment, of course) While I was standing in line, a couple was in front of me with a purse they weren’t aware that they would have to pay for. Fifty dollars for a… Read more »
David SF eastbay
Member

Sounds like Mr. Elliot is just whoring himself out like so many of these ‘experts’ the media likes to toss out when they need someone to comment on something.

There no truth in jounalism anymore, just say something to cause an uproar in the public to get ratings. Mr Elliot is just the ‘go to’ guy when the media needs someone to be negative on an issue which allows him to promote himself and any books he writes or whatever else he does.

A
Guest
“People view fees differently than they do fares. They?re much more price sensitive when it comes to paying base airfare than when it comes to paying fees.” I know there is consumer psychology in there but the reality is when you get home and open the credit card bill with the base fares + a big charge by the airline for bag fees the consumer gets upset. Granted the airlines are better today at displaying fees and people are more used to the bag fees now but execution in the begining was terrible. Overall I agree with your thesis but… Read more »
PeteyNice
Guest
Unbundling is only a good thing if you care about airlines health as corporations. I could not care less. I want to get from New York to LA. I do not care who gets me there as long as it is not expensive. Whether the plane says “Delta”, “United” or “Virgin America” on the side is irrelevant. If one day “Delta” stopped flying, “Some other airline” would come in and take its place. People hate it because they can see that they are paying more and getting less and no one likes that. Meanwhile airlines book record profits. This also… Read more »
T. Coronado
Guest

Dear David SF eastbay, I understand your frustration, but please don’t paint all journalists with the same brush. Some do a very good job of tweezing out the truth from the hairball of BS.

I am continually baffled by those who attack fees and ignore the context in which they were introduced: spiking oil prices, recession, etc., etc. Well, not really baffled, given the sorts of lobbying campaigns that said players have engaged in previously.

What bothers me most is when lobbyists call themselves journalists. That pisses me off.

longtimeobserver
Member

Well that’s the way it worked out at the legacies — a veiled fare increase — then contrast how it has worked at Spirit — not an endorsement, just a contrast — where they actually did reduce structural fares — and for a while at Air Canada where you could get a refund of USD5-7 per bag not checked (“un-checked”) bag, up to two such, until they saw the result of that — carry-on game playing behavior. It is a game, you know…

sjc user
Guest
Unbundling has had made me choose to travel with one carrier and its partners since if you travel enough you get free bags and along with other perks. Since the airlines don’t provide meals in coach anymore, I make sure I carry enough food to keep from being cranky on board. I can go to the store and get something better than what they served anyway and for as much as I’m willing to spend. I just eat when they serve you drinks. As for a mandatory resort fee, I will never return to a hotel that plays that game.… Read more »
Derek Pugh
Member

I agree that parking fees are incredibly high at hotels. I stayed at the Hilton in Pasadena,CA last weekend and they wanted $18/day for self park and $21 for valet. The train-station park & ride 2 blocks away… $2 per day. Needless to say, I paid $4 and walked for 2 minutes.

Bravenav
Guest

Another benefit of unbundling is that each creature comfort has to sell or fail based on its own quality and perceived value. Take food–when meals were included in the fare, there was no incentive for the airlines or the catering companies to make the food good, after all it ‘sold’ regardless of quality. Now, if the food is bad, no one will buy it. The result is that the buy on board food is actually really good. Or look at wi-fi–only as an a-la-carte option is there any incentive to even offer this.

esw
Member

Right on target, as usual. It’s not necessarily rational, but travelers are, in fact, less price-sensitive to fees than to base fare. Airports (who hate unbundling because fees are not subject to excise taxes from which they benefit) actually tested this theory for airlines by arguing (correctly, it appears) that ever-higher PFCs do not significantly affect passenger demand.

SubwayNut
Guest
I do think that it is balantly unfair to the government that all the various unbundling fees aren’t taxed at at least the excise tax rate that you pay on a base ticket. Fees to the airlines are pure profit that have no sales type taxes, unlike base fares: For example one person who lost money (not including passengers wanting to bring luggage, change tickets ect.) when Spirit lowered fares and unbundled: Uncle Sam, who no longer got to collect the % excise tax and the new extra revenue. This means there is now less money to maintain our airports,… Read more »
Bill Hough
Guest
I am obviously a minority here because I agree with Chris Elliot. The ever increasing growth in fees is misleading, dishonest and annoying. People hate to be quoted a price, only to be nickel-and-dimed when they get to the airport. Airline fees went nuts when fuel prices spiked in 2008. But when fuel prices came down again, did fees go away? Of course not. And I fail to understand the logic of nickel and diming the passenger with extra nuisance fees on top of the airfare. I?ve discussed this with my co-workers, friends, family and business associates, and there is… Read more »
Bravenav
Guest

When did the fuel prices come down? We’re still at over $100 per barrel ($108 as I type), as we have been the last three years. Before the 2008 runup, the price was in the $60’s.

Jim
Guest

Cranky, I’m not saying that I mistrust you, but you appear to have a conflict of interest here. You run a business that helps people interact with airlines. Of course it’s in your interest to 1) have airlines make more money, and 2) make their fees as misleading as possible.

Once again, I’m sure this didn’t affect your opinion, but I’m just pointing it out.

Nick Barnard
Member

One could argue that less profitable airlines are better for CrankyConcierge. A less profitable airline would have less ability to properly handle irregular operations, which IMHO is one of the major values of CrankyConcierge.

Jason Steele
Guest
You know I love your site and respect your opinion, but Elliot’s rant is just a reflection of public sentiment. The public now hates the airline industry which isn’t good for anyone. Some of the fees for checked bags, food, or entertainment make a little sense, but many of them are bizarrely unhinged from reality. $200 change fees that cost more than some tickets? $1,000 international lap child fees? Families forced to pay seat fees just to sit next to young children? These practices invite regulation. I was at an event this year where Bob Crandall summed it by saying… Read more »
DesertGhost
Guest

Fees or no fees, air fares are a bargain.

sundevils
Member

When USAir began the unbundling the CEO sent an email to all members of the frequent flier program and basically said EXACTLY what the USA Today writer wrote. And USAir fares didn’t go down for those of us who didn’t want frills.

Derek Pugh
Member

Did you read the entire article above (with the nice graphs)? Unbundling is what has kept the prices at their current rate. If not for unbundling, prices would be MUCH higher. Unbundling wasn’t meant to make fares lower, rather to keep them from skyrocketing…

George
Guest
Some great comments. I agree with Cranky for the basic logic of the argument-if I’m not checking a bag, eating a meal, etc, why should I pay for it. I also agree that $200 change fee is just pure greed, and shows somewhat the airlines think of their customers. I think we all agree the basic job of an airline is to carry you, and me from Point A to Point B. This is where the problem lies. Last quarter UA made a good profit-but it was provided by the fees-they had a loss in operations. If they are not… Read more »
Olamide Iledare
Guest

Hey is it illegal for airlines to charge a fuel surcharge. Other modes of transportation do it why don’t airlines?

Hillrider
Guest
1) the core of the argument is that the “alternate pricing structure” of fees is a good thing because oil prices spiked. it follows then that if airline costs go down then the “alternate pricing structure” does not hold. right — please hold your breath. 2) the corollary of the argument is that unbundling is universally a good thing, because “the traveler wanting basic transportation would have paid more in order to subsidize the traveler wanting all the frills”. apparently you haven’t had a wireless phone for long — until the 90s unbundling in wireless was all the rage, with… Read more »
Nick Barnard
Member
Hillrider – The thing with 2) is many of those telephone system services don’t cost anything, its a matter of making a simple setting change. I remember at one point reading about setting up your own telephone company that would simply re-sell the Baby Bell’s services, the rate that the resellers paid was approved by regulators and call waiting had a $0.00 cost. In many ways its cheaper for telephone companies to just provide the bundle since then customers don’t call to add/remove services, which is where the real cost is. Back to airlines, yes the baggage systems are paid… Read more »
Hillrider
Guest

5) pretty graphs, but there are no data sources. it seems that you made up the data.

Olamide Iledare
Guest

I think the difference pricing points are good for the industry as a whole it really boils down to like cranky stated how these fees are presented as an option and for the airlines to find away of not coming off as nickel and diming the consumer.

TomSFO
Guest

Cranky, sorry but you are TOTALLY WRONG! All companies have found out that ?unbundling? and charging fees is a GREAT way to make lots of money! Companies charge a base price then slowly add 100?s of fees knowing that a customer can?t keep up with it all and just pay them. In the end the average customer pays MORE!

Examples: Banking Industry, Cruise Industry, Hotel Industry, Cell Phone Industry, Utility Industry, Rental Car Industry, the list goes on and on.

Brad
Guest

Bravo! One of your better articles and the best explanation I have seen so far to explain fares and fees. I agree that most articles written by others shows a lack of understanding of the economics of the issue. You hit it right on the head. I am still bewildered when educated travelers fail to grasp the concept. The way it was done is over, there is just a new business model and it is keeping our airlines healthy and in business. Thanks for the excellent article

MeanMeosh
Guest
I’m late to the party, but had to get a lick or two in. First off, I wouldn’t even bother trying to argue with Chris Elliott on this issue. The only thing you’ll get in return is a notation on his blog that you’re an “airline apologist”, usually followed up with some kind of snarky attack. I learned that the hard way a couple of months ago, and have stopped reading his site since. Second, you touch on this in your piece, but IMHO one of the biggest failures of the unbundling concept was the failure of the airlines and… Read more »
longtimeobserver
Member

Unbundling was raised with and resoundlingly rejected by at last one airline luminary CEO as early as 1993.

kelty
Member
Unbundling depends on two factors, i.e. what do you personally want, and what are the added costs to the airline for some amenities. In the first category, I do not want to be charged for crumby movies and would like this removed from my fare. I’d rather see the Grand Canyon, but I do not have that option. On the other hand there are amenities that don’t cost more than pennies. When US Airways absorbed Allegheny there was a problem with giving the customers a full soda, or just pouring from the can. This was stupid since the cost savings… Read more »
Scott
Member
High fees are completely caused by the internet. Follow my logic; a person (without a lot of knowledge) goes to website, plunks in where they want to fly and then “SORT BY PRICE”. In order to get to the top of that list airlines/hotels/whatever will do anything, including ‘unbundling’ things they know the person will need to purchase. In the past a travel agent would be able to add the value add of “but that airline give you a better meal/more free luggage and way more legroom” but that’s a thing of the past. As for the comparison with “resort… Read more »
Paul Ferdinand
Member
Many readers here may be too young to remember World Airways and $99 transcontinental flights. The fact that I can now buy a ticket for $149 on a transcontinental flight some thirty years later, from pricey Philadelphia no less, really speaks to the case for airlines charging fees. Without them it simply wouldn’t be possible. Look at price increases at the grocery store, cable bills, heating and cooling at your house. I dare say those increases have been greater. But an article on the rise in groceries prices isn’t really going to grab your attention when you open a paper,… Read more »
KH
Guest
I’m not too old! I worked at World Airways then. I think we were the first ‘alternate sales model’ as well, When we first started operations (April 11, 1979) we did not have a standard TPF reservation system. Instead, we sold our tickets through Ticketron, absolutely unheard of at the time. Passengers mailed in their names to our central office, and my ‘reservations’ office would take the paper forms and send out teletypes to the stations with the passenger lists each night. I guess we were the first ‘unbundling’ sort of as well. We had 4 fares when we first… Read more »
David SF eastbay
Member
The big issue was people felt cheated since the airlines could have handled it better. Before a ticket costing say $100.00 people got the seat assignment, checked bags, got the soda/coffee and a meal on a longer flight. If the airlines had said ok now your price is $60.00 and if you want this other stuff it will cost you, but if the traveler paid what they wanted and the ticket still cost about $100.00 they would have been good with that since they would have understood it all more. The traveling public doesn’t know air fares are way lower… Read more »
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Eric
Guest
Where the bundled fares made sense for me as a business traveler. In 2008, I worked for a Fortune 500 company with travel policies. I had to purchase within $100 of the cheapest fare on the days I was traveling. Because I flew enough on 2 airlines, I could usually get a decent seat. Once the fares were unbundled, I had another expense to deal with. Paying to check a bag is often done at the airport and some of the auditors wouldn’t approve it. We eventually were given a policy that said we could only check a bag if… Read more »
Come on Man
Guest

Very good post.

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[…] week, I put together a post showing the merits of an unbundled fare structure. In my mind, unbundling was actually just the first step. Now it’s time to re-bundle. Oh, and […]

Rohan
Member

I wrote a blog post in response to Elliott’s piece which I published last week. Here is the link:

http://upgrd.com/aerospace/dear-chris-elliott-there-is-nothing-insidious-about-fee-unbundling.html

I did receive a response from him, via Twitter, which read:

“a thoughtful rebuttal. well done.”

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[…] The Cranky Flier defends the unbundled airline structure one week, then proposes how we should rebundle the […]

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[…] agree with most of what he says about the industry, but recently I took issue with this post, Fun with Economics: Why Unbundling is a Good Thing. In it, he makes the argument that airline passengers are paying lower base fares when other […]

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