Podcast: The nickel and dime approach — are those new airline fees a smart strategy?

August 27, 2008

As higher fuel costs gobble up airline profits, the carriers are imposing new fees on passengers in an attempt to make up the difference. William A. Verdini, chairman of the supply chain management department of the W.P. Carey School of Business, wonders if this is a smart strategy. 17:23



Knowledge: As higher fuel costs gobble up airline profits the carriers are imposing fees on passengers in an attempt to make up the difference. William A. Verdini, chairman of the supply chain management department of the W.P. Carey School of Business wonders if this is a smart strategy.

Consumers understand that because of higher fuel costs their ticket prices are going up with airlines, but they seem not to be able to understand that, OK we're paying more for our tickets, but then why are you also charging us for drinks, for soft drinks, to get pillows, to get headphones, to check more bags? They kind of feel they're being nickeled and dimed. Is this really the right thing for airlines to be doing right now or should they assume that the consumers are more savvy then they think they are?

William A. Verdini: I think it would be more efficient in a lot of ways to just increase the fares to account for the increased cost of fuel. However, [fares are] published upfront so that when a consumer is searching for a particular flight, that may be enough to put them off. One way is to increase fares a little bit, knowing everyone will increase [at] about the same rate, and then get the extra revenue needed in other ways that wouldn't show up when you book the flight. I mean, it's certainly there, but it's not in that dollar figure. You have to pay these other fees at the airport, so it's not there in your comparison shopping.

What the airlines are failing to recognize is that these fees are not only upsetting customers, who are savvy, but it's putting extra burden on staff and slowing their processes. And actually, that's how this particular issue moves into my realm of supply chain management: considering the entire system and the effects that just these fee changes, or fee additions, add to the process.

Knowledge: The flight attendants union is saying, "Look, we're not cocktail waitresses."

Verdini:  [laughs] Yes.

Knowledge: "Our job is to make sure that the flight goes well. That if anyone is sick, if there are any problems, we've been trained that way. We haven't been trained to make change and to take orders." Do they have a point?

Verdini: Oh, they definitely have a point. On many flights, it's all they can do to get once through the aisle with beverage service. So now, if they have to collect money at every seat -- at one time it was just at a few seats that wanted the fee beverages -- if they have to collect everywhere, I can't imagine them having enough change. In fact, I just saw that they're now going to go to (I think, it was US Airways) hand-held credit card scanners to get around the change problem.

The issue is they needed more money, clearly because their costs are up. So to solve that problem, they added fees. Adding fees creates a change problem, so they're going to go to credit card scanners to make it. Instead of just solving one problem they ought to think about the situation and improve the entire process, take advantage of the situation to improve the entire process.

Let me give you a quick example. Another fee was for a checked bag. Well, that's fine, and in fact that could be related to fuel because of weight and carrying capacity. But, if you think about [the impact of] charging for a checked bag, the first thing a consumer is going to do is see if they can get around that charge. To get around that charge, you would try to bring on more carry-ons. You're only allowed to bring on one carry-on, but now everyone is going to be bringing on a bigger carry-on. And what's the impact? It takes a lot longer to board the plane and to de-board the plane it takes longer.

So, what's happened by charging more for a checked bag? The implication throughout the whole system maybe to have more carry-ons, slow down the boarding process, and make on time performance worse. And possibly even anger customers, because all the bags won't fit in the overhead bins and now they'll have to have them checked on the plane, which is disturbing to people.

I have seen people now getting to the airport earlier. They've changed the seats they prefer, because they now want to get on the plane sooner and make sure they get an overhead bin. The dynamics, the whole system changes, just because of charging fees for a checked bag.

Knowledge: It sounds like a classic example of stepping over dollars to pick up nickels and dimes.

Verdini: Yes. Now, what I don't know, or can't answer is the impact increasing fares would have on demand for a particular airline. Certainly there are fare discrepancies now, in price. But, that would be the alternative, just increase the cost of an airline ticket to cover all those things. It's very up front with everything. It's paid ahead of time so it wouldn't [negatively impact] the process.

And maybe there's a strategy that could be developed to take advantage of that. Fuel is expensive, we have to increase our price, but we are going to be really efficient for you at the airport. You know, come in and boom, right on you go. I don't know how that works?

Knowledge: I'm wondering, Southwest Airlines has done a really good job of telling you what you don't get on the other airlines, why can't airlines say, "OK, maybe, when you do Travelocity, we don't come up first, our prices are higher, but this is what you get in return?"

Verdini: That would be very good, yes. Your mentioning Southwest is an interesting example. A number of years ago, Southwest was one of the first places to eliminate food and just give peanuts. They also were one of the early airlines to not assign seats.

It's a good example of not just solving a problem, but improving a process.

One of the biggest complaints people have on airlines is that the airline food isn't good. Well, think about not only solving that problem, just "OK, we just won't serve food." Now, not only did they solve that problem and [eliminate] complaints about food (there is sort of joking about not having food), but the process inside the plane was so streamlined.

You didn't have to load sandwiches or other meals. The airline attendants didn't have to distribute, pickup … And then seats, people complained because they don't get the seat they want. Well, don't assign seats. You have to come to the airport early to get your seat.

Think about boarding, if getting out on time, boarding a plane is very important. On Southwest, to get a seat, everybody is there early, the whole place. Everybody is lined up, waiting to get in line because they wanted to be first in order to get their seat. They don't have any delays by people walking in a little late and trying to stretch time. It was very insightful.

Knowledge: Do you think the problems too, with these fees for checked bags and for paying for food and you're paying extra for drinks, do you think that's exacerbated by the fact that already, travelers are already having to run the gauntlet through the airport. [They've] already been through security, and now add to that, you can't just sit in your seat and relax, it's like, they're going to be charging you this; they're going to be doing that. "I'm sorry, there's no room for your bag, you're going to have to check it. This is going to cost your extra."

It seems it's becoming so incredibly stressful, I can't imagine being a parent with small children and having to fly across the country to see somebody. I just could not imagine doing that.

Verdini: Yes. And actually, that's another interesting thing I saw recently, that they're increasing the fees for unaccompanied minors. But, I agree -- traveling with children, there's so much going on now that interferes with the actual process.

So, the issue is, what is the customer looking for when they get on the plane, and what don't they want to deal with? And I don't know that the … I think that this fee increase is very short term, thinking in dealing with the customer's experience.

Knowledge:  We touched on how these fee increases are related to supply chain management -- would you like to elaborate on that?

Verdini: The relation to supply chain is, supply chain management really deals with what it takes to procure materials and services needed to manufacture or deliver your product or service to a customer. At one time there were very distinct areas where that happened.

So, procurement went off and bought stuff, bought materials for example, for a manufacturing process, and their measure of success was: how little did they have to pay? Or, what was the quality of the product? So that they would, if the occasion presented itself, buy twice as much as might be needed, because the cost savings were so great, in their measurement.

But, [that] fails to consider what impact that has on the manufacturing operation. So now, you have twice as much material coming in than you really needed over a period of time -- what do you do with all that? So, there's a space issue. It's cluttering, and in fact, if a production process or a product specification changes before you get to use it, you may end up throwing it away.

Thinking about an entire system is a very important concept that supply chain management deals with. It's the same here. You may think, "I need more money now, cash flow. Costs for fuel are way up, so let's charge for baggage -- that's an expense we've never charged for." But, you need to think about is how that charge cascades throughout the system. And not just customers are perturbed, but what do the employees think. What happens to the process?

And you mentioned earlier regarding the attendants -- they're not trained to do that, it diverts them from other, perhaps more important issues that have to be going on. It slows down the processes totally, and if on-time performance is what's really important, and the satisfaction of the customer, this might be a very short term view, myopic view, of balancing your costs and revenues.

Knowledge: What are some of the repercussions that these airlines could be facing in terms of how consumers react? We're looking at a short term solution, what are going to be the long term problems of this?

Verdini: Well, I think most folks are suspicious that if fuel prices go down, and I don't know how likely that is, but if they were to go down, these fees wouldn't go down, because they're actually not tied to fuel costs directly. They are ways of charging for services that were rendered as a part of the entire experience of flying on the airline; and now, in the name of fuel, they are adding those costs.

So, longer term, I don't know that those costs will go away. There's almost no way they can put in to pay upfront, so you're almost going to change the airport experience into a supermarket, a grocery, a cafeteria -- you walk in and you say, "I want one of these, these, these, these, these," and go check out. It changes the whole process.

And as you said, it's already, with our security at airports, it's already uncomfortable. It's not the pleasant experience it used to be. I don't know that we have other alternatives at this point, except to not travel as much.

Knowledge: What are the responsibilities of the flying public in terms of -- if they want prices to go down, what are some of the things that they also have to be cognizant of, of their behaviors that could be causing prices to go up, or to understand why things are being done the way they are?

Verdini: That's a very interesting question. What could I as a consumer do? I could make sure that I don't cancel my flights, or not show up for my flights. Because if you think about it, the primary way that the airline has to increase its revenue, given a set of costs, is to make sure every plane is full. And unfortunately, an empty seat at take-off is lost. It's lost revenue. It's like stolen product off of a shelf. They cannot recoup that.

So, if customers were sensitive to that, and didn't mind having full planes all the time … I mean, one of the things you hear people talking about most often is "I take a window," or "I take an aisle," or two friends traveling together will take a window and an aisle, hoping that the middle seat stays open and they have more room on the flight.

Well, that's not going to happen much, if at all, in order to take advantage of the capacity of the plane. And the only way that happens now, it seems to me, is when people don't show up. That's why we have overbooking on flights, to make sure that those seats get full. That's why we have these cheap seats showing up right at the end of a flight; if the plane is empty or has some extra seats, you need to fill it up.

Knowledge: And I guess, they also have to recognize their own behavior, what the airlines point to, and it makes sense, that if you're going on those Travelocity sites, on those Cheaptickets.com, and that's the only thing you're basing your flying experience on, and you're a company who has decided: "OK, we're going to treat the consumers as clever consumers, and raise our prices because they'll understand we're not charging this, that, and the other," but the consumers fall back on the old habits of just looking at that one number.

Verdini: Yes. Well, you know, the one way that the airlines have of keeping customer loyalty are their frequent flyer plans, and even they're starting to nickel and dime even on those -- charging for a ticket on their increased price, or adding a fuel charge to those tickets, which may be sensible, but, you're going to irritate those people that came to you and to your site to get those tickets.

It might be that the frequent flyer programs should be for those who book just through their site. Or just through the airline itself. And that may be a way to [say] "You're loyal, and we're going to reward you for that, but if you get your ticket somewhere else, you don't participate in this particular program."

I mean, that may be better than getting another $25 or whatever they happen to be, for booking the ticket. That certainly doesn't pay for the seat [laughs].

Knowledge: Is there anything else that you would like to add on this issue?

Verdini: Well, I haven't stopped flying personally, with these tickets with these new fees, but I have tried to not bring two checked bags. This summer I took a quick fly-fishing trip, and I had a checked bag and a fishing rod, and I thought, "I am not going to check my bag and check a fishing rod for $25 each way ($50) when I could buy a fishing rod at the place I'm going and just leave it."

So, it changed my thinking about it, and I think, longer term the airlines will need to worry about that.