There are a lot of people who think they know how to set fares better than the people at American Airlines. This chorus has grown somewhat louder lately as American has aggressively matched ultra low cost carrier (ULCC) pricing. Shouldn’t American be able to get more than those bottom-feeders? Doesn’t it hurt the brand to price so low? People are asking these questions, and on the most recent quarterly earnings call, President Scott Kirby gave an in-depth look at how the airline views pricing. There is absolutely a method to American’s madness.
It’s true that American has been aggressively matching ULCC pricing where it has nonstop overlap. As I write this, I can buy a ticket two hours from now from LAX to Dallas for only $88.10. It’s really cheap. My in-laws bought a roundtrip from Chicago to LAX a couple months in advance for about $80 each. (They were just here last week.) It’s incredible how fares have fallen in markets where there is nonstop ULCC competition.
But does American really need to be that low? Many would say no, but Scott Kirby would say yes.
The statistic that Scott trotted out that stopped people in their tracks was this.
87 percent of our unique customers fly us one time per year or less, and they represent over 50 percent of our revenue.
Yes, that means that 13 percent of the travelers account for a whole lot more revenue. Those are the elites, the road warriors. Those are people that American caters to in a variety of ways. But those 87 percent of other customers? American needs those people to make sure it can offer the depth and breadth of schedule that the road warriors need to stay loyal. It’s an important segment, and it’s a segment that is much more price sensitive.
The True Measure of Competition
But isn’t this overkill, you might wonder? The ULCCs all talk about how they’re pulling people off the roads. They don’t fly frequently in these markets. They just want to help a few people who can’t afford to fly. Of course, the impact is much greater than that. Here are some more interesting stats from Scott.
If you measure our overlap as our domestic [available seat miles] that have nonstop competition from someone, 28 percent of our domestic ASMs have nonstop competition with Spirit. That is much larger than our domestic overlap with Delta and United. Frontier, similar. Frontier, before American filed bankruptcy, had 1 percent overlap with the American Airlines network, and they’ve grown that by 1,000 percent. They now have 11 percent overlap.
And this brings up a good point. It’s not all that common for the legacy carriers to overlap on nonstop routes. Sure you have United and American in Chicago, more in New York in LA too, but other than that, competition is going to involve connections. With the ULCCs, that’s not the case. Spirit in particular has been aggressive at going into markets that are already served by legacy carriers. But it gets even more involved than that.
American’s nonstop flights are nearly always touching a hub on one end. That means these flights have a big mix of local and connecting passengers on them. For the ULCCs, it’s different. They tend to be almost entirely full of local, nonstop passengers. So while Spirit might only have one flight a day in a market like say, Dallas to Kansas City, it’s carrying as many local Dallas to Kansas City passengers as three American flights on average, says Scott. It’s just that American has a bunch of connecting passengers to fill the rest of the seats.
All of this means American is not going to mess around and let the ULCCs gain any more than they already have. When it comes to nonstop markets, American is going to match on price. Wall Street has been freaking out about this, but this isn’t just about having cheap fares on every single flight out there. This is where revenue management comes into play.
American files these super low fares in its lowest fare buckets. And it only allows the fares to be sold on flights that aren’t expected to be filled with higher fare passengers. So, people who are truly price sensitive will be pushed to off-peak flights. (My in-laws, by the way, left to go home at the ungodly hour of 5am on Saturday.) That means those off-peak flights will have higher load factors. Yes, the fares are lower, but American thinks its managing this appropriately. As Scott notes, its unit revenue performance in these competitive markets has been similar to what it’s done in the rest of the system.
Bring on the Product Differentiation
All this being said, American isn’t happy with the status quo. It wants to cater to those truly price-sensitive people with a product that matches their interests. Or as Scott puts it:
…doing more to further disaggregate the product, and really move to a world where we can offer fares that compete with low-cost carriers, and have a suite of attributes that are appropriate for those prices, and then fares that have a greater suite of attributes, and give our customers choice. It’s all about giving our customers choice.
Does this sound familiar? It should, because it’s the idea behind Delta’s Basic Economy. We don’t know anything about how American wants to implement this, but hopefully it’s better than the way Delta does it. I don’t see a problem at all with offering a fully stripped down fare that doesn’t include a carry on, a seat assignment, etc. But the operational implementation is the biggest issue with that.
Now that the US Airways code is gone and American is selling to the public as one airline, the airline can start to make these kinds of changes. Travelers can expect to continue to see these aggressively low fares, especially at off-peak times, but in the future, these fares will be tied to a truly unbundled offering. As far as American’s concerned, that’s the right way to price. And it’s likely to deter ultra low cost carriers from expanding in American’s way when there’s lower hanging fruit elsewhere.