United’s President Thinks Low Cost Airlines Can Never Compete Successfully. He’s Wrong.

Prior to deregulation the Civil Aeronautics Board ‘experimented’ with the idea of price competition. That’s the story of how Southwest Airlines became the largest liquor distributor in Texas through fare segmentation. Faced for the first time with fares lower than their own, they segmented customers: matching $13 fares between Dallas and Houston offered by major competitors, while continuing to sell $26 flights to expense account business travelers who would be able to take home a bottle of booze from the flight.

More significantly, in 1977, American Airlines introduced the Super Saver fare. Initially on New York – California routes, it was expanded across their domestic route network in 1978 and the airline introduced ‘Ultimate Super Saver’ in 1985, discounting up to 70% to compete against new lower cost carriers that launched after deregulation.

The American Airlines insight was that they could beat low cost carriers at their own game through revenue management. They could be a high fare business airline and a low fare airline by offering different prices to different customers. Using restrictions such as advance purchase requirements, change penalties, and Saturday night stay requirements they made cheap fares available to price sensitive travelers and still retained their margins on business customers who booked the most convenient flights at the last minute.

This gave American a competitive advantage because they had no marginal cost to run their low fare airline — since they were already running the airline and they had empty seats. Other carriers quickly copied, of course.

In recent times Spirit Airlines, Frontier, and Allegiant have been among the most successful US airlines with the highest margins. None of them is a ‘new airline’ but their low cost business models were launched in the last 20 years.


Copyright: boarding1now / 123RF Stock Photo

The low cost discount carriers eroded the major legacy carriers’ pricing model. They offered last minute cheap tickets. As a result Delta, American and United faced a conundrum: they had to match fares or lose business, but they’d erode their premium margins selling cheap fares to business travelers in the process.

Basic economy fares became the new advance purchase and Saturday stay requirement, segmenting business travelers from the most price sensitive leisure travelers. Many business travelers aren’t even shown basic economy fares through their corporate booking portals. And companies will generally pay for advance seat assignments, and in United’s case for a passenger to be able to bring a carry on bag on board.

The new tool at the disposal of major carriers in the form of segmentation was a strategy of making their inexpensive product worse, hoping customers would spend more money to avoid it. They made their lowest priced ticket closer in experience to what the ultra low cost carriers were offering.

Prior to that, of course, it made sense to buy a Delta, United, or American ticket rather than a Spirit or Frontier ticket at the same price because you got better value for your money. Basic economy erodes the product advantage over ultra low cost carriers, while restoring the ability to segment customers.

United Airlines President Scott Kirby declares that new low cost carriers cannot succeed because United will match their pricing. He says United couldn’t do that before, so new carriers are at a disadvantage and already no new carriers have been successful over the last 15 years.

Virgin America, founded in 2004, was the last startup airline in the United States that actually became a reality.

The low-cost airline model is predicated on the competition not matching prices, Kirby said, and unlike the situation over the last 30 years, United now has the capabilities with segmentation, including basic economy, to go tit-for-tat with the new entrants.

“It’s a business model they are not in control of,” Kirby said, referring to low-cost carriers.

Speaking about so-called segmentation, a slicing and dicing of an aircraft cabin seating for different prices, United can now compete in both levels, which it couldn’t do for decades until now, said Kirby. He argued that gives both price-conscious consumers and passengers who care about product more choice.

Kirby’s view seems extremely misguided.

  • Airlines became successful with their low cost business models exactly in the time period that Kirby says none have succeed. The definitional issue here is that ‘new’ airlines generally came about after their predecessor attempts failed.

    Spirit Airlines began as Charter One and for years was a Detroit-based airline — its transition to a low cost carrier started in 2007. The new Frontier began service in 1994 after Continental Airlines shuttered its Denver hub. It wasn’t until 2014 though that they transitioned to the Spirit low cost carrier model. Similarly, AirTran (acquired by Southwest) can be said to have been a success — but it came out of ValuJet so wasn’t really ‘new’.

  • Segmentation (Basic Economy) isn’t a new tool. Airlines have been successfully segmenting customers since at least the 1985 introduction of American Airlines Ultimate Super Saver fares. Basic economy is just the latest strategy for gaining back the ability to charge different prices to different customers.

  • The latest version of segmentation erodes United’s advantages. United and other airlines were already matching fares of low cost carriers. This did not begin with the introduction of Basic Economy, which hasn’t meant lower fares for customers but rather new restrictions on the existing lowest fares.

    Basic economy fares mean giving customers less than before, eroding the product advantage that major airlines had over low cost rivals. It used to make all the sense in the world to choose a legacy airline over Frontier or Spirit at the same price because of the mileage program or advance seat assignments. Reduced mileage-earning, limitations on use of elite benefits, and at best only allowing customers to pay for seat assignments close to departure shrink that difference in product.

  • Ultra low cost carriers have their own competitive advantages. One of the best deals in travel is Spirit’s Big Front Seat, a domestic first class seat without perks like boarding or bags. It can be as little as tens of dollars more than a standard coach ticket. Meanwhile Frontier Airlines has aggressively rolled out elite benefits that allow their top flyers to make all tickets refundable, and they’ve aggressively integrated their credit card product into the program so that every dollar spent earns an elite qualifying model.

    Meanwhile both Frontier and Spirit have improved their products. Both participate in PreCheck. Spirit has even been installing inflight internet, and delivering a reliable flight operation.

The Super Saver model was a realization that airlines flying routes anyway had excess capacity and could sell those seats to price-sensitive travelers at little to no marginal cost without cannibalizing high yield sales.

The basic economy model is effectively the same thing, though in a world with less excess capacity the ability to match pricing at no cost is limited.

United can certainly declare an intention to match price, but that will begin to hurt their yields. They are the most aggressive major carrier restricting the basic economy product — only they forbid full-sized carry-on bags completely on these fares — so at the same price United not only has to compete with the product of Spirit, Frontier, or new low cost entrants they also have to compete with American, Delta, JetBlue and especially Southwest which are offering more to the customer.

Ultimately a high cost carrier needs to win by attracting premium fare traffic. United realizes this with its introduction of a new business class (despite Kirby’s attempts to erode Polaris) and premium-heavy aircraft configurations. The idea, though, that customers will always choose United over a competitor at the same price — and that United can now win the war on price because of ‘new’ tools they’ve never had before — seems entirely off base.

About Gary Leff

Gary Leff is one of the foremost experts in the field of miles, points, and frequent business travel - a topic he has covered since 2002. Co-founder of frequent flyer community InsideFlyer.com, emcee of the Freddie Awards, and named one of the "World's Top Travel Experts" by Conde' Nast Traveler (2010-Present) Gary has been a guest on most major news media, profiled in several top print publications, and published broadly on the topic of consumer loyalty. More About Gary »

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Comments

  1. I guess I just don’t know which airline industry United’s President has been working in if he thinks that (1) segmentation is new, or (2) that low cost carriers haven’t been successful.

  2. Great article, Gary. For me, from DFW, I’m left with just two reasons to fly AA to a destination served by Spirit: better IRROPS recovery and a wider choice of daily flight times.

    If I can make the flight times work, in other words, I’m flying Spirit since their fares are still significantly cheaper than even AA’s “basic economy” and they’re more likely to be on time. (Ever waited for a gate at DFW?) Plus, Spirit fares are always $40 cheaper than what the website says if you buy your ticket at the airport.

  3. Very well written and informative. Well done! I wish you would do more articles like this. But I guess it’s the tabloid trash that gets the clicks.

  4. I remain amazed by the unenforced error expressed by UA’s Kirby (who came from AA), which parallels AA’s thinking in the tank. Surprising that with such a group of PR folks, and a sensitized executive management team and Board, that such blissful ignorance expressed in the public would have been allowed at UA.

    Obviously, Kirby never read the superb Harvard Business Review analysis of how Southwest pushed its way into the market while avoiding DFW and IAH, competed head-on with, and beat Braniff! As well, Kirby remains oblivious to the fact that given the choice of flying Lufthansa and the airlines under its wings, or, Singapore/Cathay Pacific/Qantas, Air New Zealand, nobody who has flown UA over the oceans would ever do so again, in the face of such superior competitors as named here. It’s bad enough flying a legacy carrier domestically, but who would not elect to go, for example, from Chicago to Toronto and fly Air Canada to Tel Aviv, in lieu of connecting on UA at Newark to Tel Aviv?

    But, opportunity awaits Kirby at Amtrak, where they have an executive team that thinks similar to his narrow vision, by not serving the premium traveler market outside of their narrow “Acela” focus. That translates into no first class product (seating, food/beverage, service) on Amtrak’s other corridor operations, including: “Northeast Regionals;” Midwest Corridors; California’s “Pacific Surfliners,” “San Joaquins;” “Capitol Corridor;” or Pacific Northwest “Cascades.” Just like Kirby’s mindset, at Amtrak they willingly “leave coin on the street.”

  5. Excellent longer article, Gary. Ever think of pitching this topic to a book publisher? I’d buy it.
    Your line re airlines’ ” strategy of making their inexpensive product worse, hoping customers would spend more money to avoid it,” made me think- how would that go over if hotel chains took that approach? Badly, I’d think.

  6. Read the reviews if UA & AA on airlinequality.com. Both come in worse than Delta & Southwest. Arguably these negative reviews are written by mostly infrequent flyers but they are the ones buying basic economy. They all hate UA & AA. Legacy carriers are not doing well with their cheap product.

  7. In Europe the LCC have much lower administrative costs in the „back office“ etc. Is this not the case in the US?

  8. @ralf of course it is. low cost carriers have a huge cost advantage. united can’t win as the low price leader, with their costs they need to earn a revenue premium

  9. @Gary: Kirby is essentially correct. The Chapter 11 Three (C11-3) have created airlines within airlines that replicate the ULCC experience. Basic economy is not just an evolution of earlier discount tickets, it is a perfectly ring-fenced discount carrier within a C11-3 carrier. The ring-fencing is so precise, and so tight that there is no erosion of C11-3 advantages. They will still sell you exemptions, on a slice-by-slice basis ($X for reserved seats, $Y for changeability, $Z for an extra bag, etc.).

    Some economic nonsense:

    “Airlines became successful with their low cost business models exactly in the time period that Kirby says none have succeed. ” (sic).
    Because of an (unprecedented) economic boom over the last 10 years. Everyone who has studied airline economics knows that is is one of the most cyclical sectors in the economy. To see what a downturn will do, look at Europe where the ULCCs have fallen like flies unless they were old-established (e.g. Ryanair, EasyJet).

    “The latest version of segmentation…did not begin with the introduction of Basic Economy, which hasn’t meant lower fares for customers…”.
    It certainly has. They offer less. If they tried to sell it at the same price as a regular fare nobody would buy it (unless capacity-constrained)! Right now, you are postulating upward-sloping demand curves. Duh! Time to talk to Kim Kardashian about string theory….

  10. @L3 – There’s no disagreement that this is a highly cyclical sector. Kirby postulates there’s been only one successful new airline in the last two decades, and that’s not a fair read since the business models of Spirit and Frontier and Allegiant are all new since then. And the idea that Basic Economy lets United segment customers for the first time is silly. It’s a new tool they came up with after the old tools stopped working.

    Nowhere am I suggesting upward sloping demand curves, or that all airlines succeed (???).

  11. Never flying United again after traveling with miles on Business from Seattle to London with Lufthansa and on the return flight from DC to SEATAC had to pay for a seat that WAS NOT premium economy class to avoid sitting in the rear of the plane. Left my computer onboard in Frankfurt. Anyone ever tried to get a left item from Lufthansa? No phone number, no service at lost and found in Frankfurt airport, rude customer service on the phone. I experienced all of it.

    Changing to Alaska.and Air Canada.

  12. You are really something else Gary. You know very little about running an airline compared to Scott having never wanna in this industry. You lose credibility with posts such as this one.

  13. @Josh G – welcome back! As usual you attack me, but never actually say what you think I’ve gotten wrong. If you’re going to disagree you sort of have some burden to explain where I am substantively mistaken I think? “I think Scott Kirby is smart” isn’t an argument. By the way I agree, and I have written the same – he is a smart guy and one of the most interesting in the industry to listen to. He also has, I think, some real analytical blind spots (such as when he suggests airfares should be double merely because of the level of airfares relative to GDP https://viewfromthewing.com/2018/09/14/the-president-of-united-airlines-thinks-airfares-should-double/).

  14. Scott Kirby says stupid things. What else is new? Oscar Munoz and the board needs to get rid of him already.

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