Training Customers To Pay For Extras

Are airline passengers turned off by the unbundled pricing? Especially the baggage fee? Southwest, whose marketing campaigns push  “Bags Fly Free” , says it has data that shows customers do not like paying baggage fee. In one of my previous posts I wrote about the total profit of $536 million   that other airlines brought in the past year from baggage fee. Southwest’s Vice President of Marketing and Sales, Mr.Kevin Krone says, there is more to it than this expected profit from baggage fee.

The Dallas company says it has commissioned several comprehensive market studies that show the public has not accepted baggage fees, even as it pays them. Company officials also believe that passengers are still sorting out the idea that not every airline charges a fee for luggage, and they believe Southwest ultimately will benefit as public awareness spreads. “If [bag fees] were accepted, then I think we’d have to think really hard about it,” Krone says. “But our research shows that people are upset by [fees]. It is emotional. It’s hard to avoid it.”

On the other hand, US Airways wrote in a newsletter to its employees:

“When airlines first introduced charges for checked bags and a la carte-style pricing, customers resisted the change. Now, with the majority of major airlines collecting these fees for more than a year, customers are less likely to complain to the DOT.”

Can both arguments be true? Yes. It depends a lot on the segments they were studying and how the questions were posed. There is also the difference between attitude and behavior.

Customers did not like paying extra for the bags at first because their reference price was $0. If we were to survey customers about their willingness to pay  $15 (or $25) for bags, they are not going to accept the fee. This is what my colleagues and I found in a research. But if we positioned it differently customer’s resistance goes down. So  Southwest is correct in that in general customers will not prefer to pay but there are ways to overcome this. That said, I am not sure if Southwest did conjoint analysis to find customer preference for different factors and found that customers assign  high negative utility values to baggage fee. (We have done this study but we have not published the results.)

US Air’s claim is supported by their passenger data. There is also previous  research that find reference price is not a fixed number. Customers can be trained. Reference price  is malleable  according to Thomas and Menon (Journal of Mkt Research, 2006).  So USAir is correct as well. After an year of paying for bags and after seeing almost all airlines doing it, the reference price customers assign for checking in bags increased as well. Southwest’s goal, with its marketing campaign is to keep the reference price anchored down at $0.

Consumer behavior research shows people tend to discount future costs at a much higher rate than they do future benefits. This is the reason we do not mind eating fatty food and easily put off exercising. When booking a ticket, the customers see only the current price they pay and are oblivious to additional fee they might pay for bags. Even if they do (like some websites help customers see the total price) the mental discounting might push them to pick the option that has lower ticket price.

Questions  come to mind on whether people consider  Southwest as their first choice and whether the fact that bags fly free comes to customers mind when they look at Southwest vs. another airline.  Southwest also spent money on their current Bags Fly Free campaign while other airlines did not have to. Could Southwest have spent the marketing dollars on training customers to accept the fees and turned higher profit than their current profit from the reported  increase in passenger traffic?

Is it Nuts To Charge For Bags?

Southwest is still the only major airline that does not charge for first and second bags checked in. Recently United introduced a subscription plan for bags at $249 a year. I wrote why that is a good move for multiple reasons, strategically and tactically. Southwest’s blog “Nuts About Southwest” has a post on this fee that asks, “Why do they hate your bags?“.  Can South West continue to offer  “Bags Fly Free”? Barrons .com columnist Bob O’Brien writes,

Shares of the average stock in the sector have declined 2% in Thursday’s trading, nothing like the 7% setback that has been inflicted on Southwest shares

Southwest introduced  unbundled pricing, by charging a fee to board first. O’Brien adds that Southwest generated $10 million in revenue from other extra fees but may be hitting the wall on creativity.  Just how big is the opportunity for profits from baggage fees? From my previous calculations, rest of the airlines that charged for the first and second bags, took in a total of about $536 million.

Southwest is trying to generate more profit by cutting capacity in loss making legs. But how long  can it continue to ignore the size of the profit pool, facing declining stock price? They charge for the flexibility to board first, because it adds value to customers who are willing to pay for the flexibility.   If carrying bags adds value to the customers, shouldn’t they be charged for it?

Profits From Airline Baggage Fee

Just when Continental airline decided to extend its baggage fees from US flights to international flights, SouthWest stepped up its campaign against airlines charging extra for bags. Is SouthWest following the right strategy to not only choosing to implement unbundled pricing but also align their messaging around this? How much profits are they leaving un-captured?


In Q2 of 2009, rest of the airlines brought in close to $670 million baggage revenue. Last year it was just $178.  (Data source WSJ print edition, 9/22/2009, page B4). Since there is no significant marginal cost per bag and almost all the costs are fixed and paid for, we can conclude that most of the increase from $178 to $670 is pure profit. There was one study last year (I am unable to find the reference) that put the cost per bag at $15.  This must include fixed allocation and not just marginal cost. This gives a margin of 40%. But since the costs are mostly fixed, we can assume that margin in 2009 is close to 80%. So the decision to charge for bags brought in about $536 million in profit for all the airlines combined.

For SouthWest, leaving its share from that profit  is a better decision only if they captured higher profit from increase in utilization from passengers choosing the airline because of its no-fee policy. Judging from their last earnings statement we can safely say that has not been the case.

Southwest Unbundling Pricing

Southwest ran  marketing campaigns about its “No Hidden Fees” model. They did not charge for baggage, drinks, pillows or like Ryan Air for the toilet. Despite the rest of the airlines charging for baggage etc., Southwest did not gain market share. When every airline was practicing unbundled pricing, everyone assumed Southwest was doing so as well. Their messaging about no fees did not create differentiation they sought. I wrote then how this was not a good move for Southwest and how they were leaving money on the table.

Now Southwest, after seeing their first ever loss, is slowly tipping its toes into unbundled pricing.

The Dallas-based airline, which flies more passengers within the U.S. than any other carrier, said customers can move up the queue at its gates for a $10 fee starting Thursday. Unlike most other airlines, Southwest doesn’t have assigned seating.

I completely support this move. Unbundling is about exposing revenue opportunities, identifying components that are of value to customers and charging for it. In the case of baggage fees, not all customers, especially the business travellers, were not using the service. For those who used the service, it was of considerable value so the airline started charging for it.

Southwest’s Vice President of Marketing, Mr.Kevin Krone said,

“What other folks are doing is charging money for what they used to do for free. What we’re doing is offering new things that we hadn’t done before,”

This is true. Even though the services added value to customers, they were not willing to pay for these because their reference price was $0. Southwest will have an easier task of selling new services because they do not have to surmount the reference price hurdle as long as they are  charging for new services. According to an analyst, baggage fees will bring in $500 a year for Southwest. If they want to go that route  they have to focus on increasing customer reference price (think options).  And about all  those Ads about “Fees Don’t Fly With Us”?  Customers are not going to remember and again reference price improvement will help address that.