Ancillary Revenue The New Craze for Airlines By Mr. Raphael Kuuchi, Commercial Director, AFRAA

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1 Percentage of Revenue Ancillary Revenue The New Craze for Airlines By Mr. Raphael Kuuchi, Commercial Director, AFRAA As traditional sources of airline revenue dwindle because of lowering yields and reduced travel resulting from the global financial downturn, legacy airlines must now seek ancillary revenue by drawing from the experiences of the low cost carriers suggests Raphael Kuuchi. Over the years competition has forced airlines to improve operations efficiencies and reduce costs significantly, all in effort to boost revenue and attain the often illusive profitability. The advent of the low cost airlines (LCCs) taught legacy carriers how inefficient their operations have been and what can be done to meet the same air travel goals with less resources. But many legacy airlines did not take the LCC lessons seriously. After all, traffic soured in the post 9/11 era and though yields were dropping, there was false hope of prosperity in the offing. This was until the US sub-prime mortgage crisis and the subsequent global financial crisis and accompanying recession. Airline Ancillary Revenue According to IdeaWorks, airline ancillary revenue is revenue beyond the sale of tickets that is generated by direct sales to passengers or indirectly as part of the travel experience. Ancillary revenue is a necessity for all airlines as they struggle to fill the profit gap created by high operating costs and intense competition. Though ancillary revenue has been practiced over time, its wider application is probably attributable to Europe s largest low cost airline, Ryanair. Its CEO, Michael O Leary philosophy of the concept is that while the other airlines are asking how to put up fares; we are asking how we could get rid of them. O Leary envisages an era where passengers will someday fly for free. Ancillary revenue can provide important relief from the economic challenges of today s airline marketplace. In 2007 Ryanair made a profit of 408 million euros and ancillary revenue of 362 million. As the recession bites, United Airlines estimated that its ancillary revenue from baggage fees and add-on charges for meals and seat selection will generate $700 million in A survey of 75 airlines ancillary revenue activities in 2007 revealed that a total of 1.7 billion Euros was generated, with Europe contributing 45%. Africa and Middle East generated the least ancillary revenue 8%. Analysed Financial Statements of 75 airlines Worldwide on Ancillary Revenue Europe & Russia Americas Asia Pacific Africa & Middle East 8

2 There are a host of approaches in the marketplace for generating ancillary revenues including; bundling and unbundling of fares (a la carte), commissions, miles and points. However, the successfully incorporation of these into a carrier's business model requires understanding of the technology requirements of each approach and a clear sense of the direction in which the airline wants to go. David Doctor, Director airline distribution for Amadeus, advises carriers to start by taking baby steps with "easy deliverables" that don't create operational disturbance. A La Carte Pricing A la carting (unbundling) is a prerequisite for generating ancillary revenue from service fees. A la carte pricing and the unbundling of the air travel product is becoming common in the airline industry worldwide and is spreading into other areas of travel such as lodging and car rentals. Product features that lend themselves to unbundling fall into two categories: expense-based and convenience-oriented. Examples include onboard snacks and drinks sale, call-centre booking, checked baggage, priority check-in or boarding, seat preference and added legroom fees. Savvy airlines keep four things in mind about ancillary revenue: Never overburden your consumers with outlandish fees Provide adequate information so that passengers know what to expect. Never surprise and annoy them with unexpected fees Think through changes carefully and make sure your employees and systems can deliver Support ancillary revenue projects with time, cash and corporate attention Early adopters of a la carte pricing have made mistakes from which others can learn. When EasyJet, a pioneer in the unbundling of services, began offering Speedy Boarding for a fee, it worked very well at London Luton and Gatwick. It did not however work at airports where passengers were not accustomed to queuing up or where they were bused to the plane. The carrier pulled the service on return flights from those airports until it could address the problem. Commission-Based Ancillary Revenue Almost all airlines have websites today, but the use to which these sites are put and the benefits derived vary greatly from airline to airline. When one visits the website of a typical low cost carrier, it is apparent that it s no ordinary airline website. The home page typifies a shop window of a supermarket store selling a variety of products from airline tickets, travel insurance, airport lounge access, parking, car rentals, onboard retail, hotel booking, online retail, tour packages, event tickets, etc. The variety of products provided on the website attracts more visitors besides the travel bargain hunters. Adding commission-based products to an airline website represent an excellent ancillary revenue strategy since they are easier to implement and support, do not disrupt the travel booking process, require minimal integration and yet can generate good profits. Through its website, Ryanair realized over 40 million Euros through sale of commission-based products in Besides LCCs, some legacy airlines have also learned the value of selling commission-based goods and services through their websites. Delta Airlines integrated the sale of hotel accommodation, car rental and airport transfers and club access into the process of booking an airline ticket.

3 The standard ancillary revenue model for websites sales has partners paying a commission on every completed sale but Ryanair has gone a step further by requesting vendors to pay a fee for each passenger carried. Besides generating money per boarded passenger, Ryanair offloads the burden and risk of sale to the vendor. A customer survey of air travelers shows that 87% of direct consumers believe airlines have the best deals on their websites. With this believe, well developed airlines websites attract a lot of traffic. Vendors are encouraged by airlines to take advantage of the online traffic and offer hotels, car rentals, destination activities and trip insurance. Miles or Point-Based Ancillary Revenue Gone are the days when airlines frequent flyer programmes were solely used to accumulate points and or miles and dispense loyalty benefits to customers. In addition to this traditional function, airlines are now gaining revenue from selling miles/points to partners. From being cost centres in the past, frequent flyer programmes are fast becoming profit centres for many airlines. The miles/points-based category of ancillary revenue largely consists of the sale of miles or points to programme partners such as; hotel chains, car rental companies, online malls/retailers and communication service providers. This is an outcome where everyone; airline, customer, partners and investors, all benefit. Early frequent flier programme history did not include significant partner activity. Hotels and car rental companies were originally added as inducements to boost participation and make the programme more relevant to frequent travelers. The progammes now operated by major airlines rely upon partner activities in a wide array of categories as a method to create revenue. Customers enjoy the added savings and perks, while airlines appreciate the millions of dollars in revenue produced by partner relationships. Alaska Airlines generated $194.2 million revenue through its Mileage Plan frequent flyer programme in Bundled-Service Packages While some airlines are unbundling their products, others are opting for bundled-service packages rather than a la carte pricing. Air Canada introduced "AirFairs" with three levels: The stripped-down, no-frills Economy fare; Classic, which includes access to DirecTV, two checked bags, advance seat assignment and lower change fees, and Classic Plus, which also provides priority boarding, full refundability and inflight snack and beverage. Depending on a passenger's needs for a particular trip, the Classic fare package could be a better buy. A family traveling with two small children, for example, is almost certain to check at least two bags, and it will want the certainty that the family can sit together. It is also likely to want DirecTV to keep the kids occupied. In many cases, buying those services separately, is an option for Economy passengers but would cost more than the $20 differential between the Economy and Classic fares. Within the first few hours of Air Canada announcing the launch of these fare types, 30% of passengers were opting for either the Classic or Classic Plus fare. Air Canada has developed a set of products that allow it to up-sell and still promote and entice end users to buy more. It even offers customers the option to reduce their fare by opting out of certain elements, which is unheard of, but this contributes to customer loyalty. Air Canada's unit

4 revenue has risen 22% since it launched its branded fares in 2003 and 48% of customers buy up at some point during the process. Airlines are E-Commerce Businesses Airlines that are not selling ancillary products on their websites are missing their chance at making good money from non-ticket sales. In the view of Raphael Bejar of Airsavings, a Parisbased firm, "Airlines should consider themselves as e-commerce companies." Online booking engines are great in as far as helping a passenger to check an itinerary or book a fare is concerned. For a passenger looking simply to go from Point A to Point B on the cheap fare, online booking service is sufficient and user friendly. But why should passengers stop at that when they can avail themselves of so many more bargains? Airlines should avail to passengers the opportunities to supplement their vacation with competitively priced hotel or hostel booking, automobile rental or city tour pass. While passengers are online, airlines should entice them to buy concert or football tickets, arrange for car insurance or indulge in a bit of online gambling. New technology enables airlines to integrate fully branded multisource inventory and sell competitively. The options have little if anything at all, to do with commercial air travel, yet they are just a mouse click away for the millions of people who visit airline websites each month, many of whom end up buying more than just an airline ticket. Younger internet-savvy passengers, who are unfamiliar with the good old days of air travel luxuries, are happy to embrace low fares and the ability to create customized travel through a-lacarte pricing. Increasingly there is a greater willingness on the part of consumers to pay up for an ancillary offering than to absorb a base fare increase, which is particularly relevant in light of the industry's current challenges. Technology to Support Ancillary Revenue Exist Fortunately, airlines do not have to look far for the right technology. Custom-made e-commerce suites exist and can be used in isolation or integrated into the existing airline IT infrastructure. Once carriers implement the technology required to charge for trip-related perks like checked baggage, onboard catering or extra legroom, they can put just about anything else up for sale. Amadeus for example, have produced platforms enabling airlines to restructure and unbundle their fares or market and take commissions on products from third-party vendors. The Amadeus e-commerce Airline Suite is used by more than 75 airlines to power over 250 websites in approximately 80 markets. Half of the world's top 50 airlines have selected Amadeus to provide their e-commerce solutions, with 80% of those outsourcing their user interface as well as their booking and shopping engines to the technology giant. Legacy Airlines Must Generate Ancillary Revenue Admittedly traditional network airlines may find it more difficult to abandon the full-service model that has served them well in the past. But there is no excuse for not embracing the modern trends of business considering the current difficult operating environment. There are airlines all over the world (and especially in Africa) that often ignore economic opportunities by hanging on

5 to excuses. To such airlines, the sand is shifting under their feet and their future can no longer be assured if they cling-on to traditional business practices and fail to innovate. It is instructive to note that ancillary revenue opportunities are largely driven by the extent to which carriers directly control the customer booking process through its own website. In this new ancillary revenue era, it is incumbent on airlines to make their websites the first destination for any potential traveler. Airlines should strive to have the appropriate internet tools or else they will be lacking the right business model. Although integration of mobile phones into the reservations, booking and boarding process has been slower to come online (although it has picked up steam in Japan and China), web-based applications are advancing and soon will be limited only by an airline's imagination. As we go through these unfavorable economic times, it is the opportune time for airlines to broaden the use of their websites to incorporate tools that support ancillary revenue generation. The outcome of such efforts could thrill airlines that do this well.