There was a recent article in the Wall Street Journal, First Class Fares Get Affordable, reporting the major US airlines have quietly lowered their prices of first class tickets. As is often the case, the airlines are providing some pricing lessons with these moves. I see three main principles we can all take away:
- They have done the math to learn they will gain more revenue and profit from selling more of their first class seats than they will sacrifice from lower prices to customers who have always bought first class tickets
- The competitive risks are manageable and lower first-class fares will not cause a price war
- They have built confidence to make these moves by testing other gradual pricing changes over the past few years
There has always been a distribution of customers who will or won’t buy first-class fares. It is a non-normal distribution, meaning the revenue from selling to more customers at low prices was greater than from selling to fewer customers at high prices. However, most of the customers who would buy first class at lower prices were already going to buy coach seats and just move up from the back. With excess capacity in the plane, the airlines were unlikely to fill those now empty seats in the back, so the incremental profit from selling more first-class seats was actually very low or negative.
Historically we had more airlines than needed with more seats than needed. The cost of flying was relatively fixed for each route, and the incremental cost of adding a passenger was low. Many airlines tried to fill that capacity with low prices, which caused price wars. In an attempt to try to keep their customers loyal, airlines gave free upgrades to their most frequent travelers. With plenty of available capacity and high chances for upgrades, customers were willing to pay the full coach fare in exchange for a high likelihood of an upgrade. Personally, there was a period of years when I was upgraded nearly all the time, and I flew on carriers where I knew I would get upgraded. Like all frequent travelers, I had been trained to expect low prices and upgrades.
Over the past several years, the airlines have consolidated, reduced their aging fleets, and reduced capacity. At the same time, that consolidation has resulted in elite (high-mileage) travelers being consolidated in fewer airlines. So we have more travelers with elite status per flight, lower likelihood of price wars caused by too many empty seats, and the resulting reduced chance of an upgrade. When customers are enticed to pay more for a first-class seat, the seat in the back does not go empty, it is filled by a new full-fare passenger. Now the math works – the incremental profit from selling more first class seats at a lower price is higher than keeping it very restrictive.
Lastly, over the past few years the airlines have been testing a number of pricing concepts that help determine what the price-sensitivity distribution looks like and build confidence that their first-class pricing will be profitable:
- Exit-row seats have always been coveted due to the extra leg room, and airlines have been selling those seats at ever higher premiums. When they first started selling exit rows at a premium, the add-ons were often only $19 per seat. Those seats are now up to $79 or $89 each way.
- Premium economy seats have been sold at premiums of $19 to $29. Those seats are near the front, have 1 or 2 inches of extra room, and allow passengers to deplane first
- Passengers could pay $15 to $30 each way to board the plane early to ensure space in the overhead bin for their luggage
As travelers experience cramped seats, no storage space, and slow disembarking times, they have found more value in purchasing some premium services. As they have adapted to paying for those services, it is a small step to paying a little more for first class which includes all the services.
I have written in the past about airlines trying new pricing strategies. They have avoided the “That’s not how it works” mantra and corrected a market of cutthroat price competition. They have done it by segmenting their customers, identifying areas of value, testing new pricing strategies in logical steps, and doing the math. That approach can work in any industry.
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