The next generation of ancillary revenue
Over the last decade the ancillary revenue became a significant and important part of the airline business. It is expected ancillary revenue will surpass US$ 100 billion in 2019, a sevenfold increase from 10 years ago. There are very few airlines out there that do not heavily rely on profits from this new stream. After all, we are talking about an industry that is – on average – achieving single digit profit margins.
Looking at the details of ancillary revenues, there is really just one part where airlines are excelling today – the so called “à-la-carte ticket” portion. Today, this segment represents more than two thirds of all ancillary revenue. We can say that airlines have mastered this part of revenue while leaving a much larger piece on the table for others. We predict that the next decade will be all about airlines discovering new ways to get the other sources of ancillary revenues working well for them. For one, while “à-la-carte ticket” revenue is great and there certainly are opportunities to extract more through better personalization and improved user experience, it is really only possible to get to a certain level. Second, the pressure for increased profitability will not ease up as the core business continues to be commoditized by digital platforms. However, the most important factor is that there is a unique opportunity for airlines to monetize their privileged market position. The opportunity is just too sweet to miss out in a very challenging market. However, exploiting this in the right way means airlines will need to reinvent themselves and embrace a very different competitive landscape called “digital platform economy”.
Let’s start with the basics – why are airlines so good at the à-la-carte ticket and so weak at the rest of ancillary revenues? The answer is very simple if you are a frequent traveller. I can remember 5 occasions last year when I decided to purchase an ancillary revenue product and then gave up because of the poor user experience. Now, there is a big difference between à-la-carte ticket ancillary revenue and others. When I decide not to buy an à-la-carte ticket product, I basically do not have another option. It simply means I have given up on the desired seat upgrade or an additional baggage request. The lack of alternative makes you accept a lot of friction before you decide it’s simply not worth it. On the other hand, when you book a hotel room through the airline e-commerce platform, your patience is limited. Expectations are not set by what is “state of the art” by airline standards but by the digital platform economy at large, meaning companies like Uber, Airbnb, Amazon, etc. And let’s face it – as a rule, airlines are still lagging behind that level of service.
In my discussions with many airlines, I found there are few fundamental mind-shifts that need to happen to set the correct strategic course to exploit digital economy:
- Airlines have a unique unfair advantage because of their privileged position in the travel market. However, in order to monetize this appropriately, they need to decouple themselves from the legacy systems that make them simply too slow to compete in the new economy. And this goes beyond just IT – it really is about a deep cultural change. In other words: the key strength of airlines is also in many ways their key weakness and it is important to restructure the organization and systems in a way to reflect this. The new emerging platform economy is simply too complex to be managed in the same way as the core airline business.
- When going digital, it is no longer about airlines competing with other airlines. It is about creating an open ecosystem in which transactional relationships with an unlimited number of partners bring advantages to all members of the ecosystem. This drives a strong bond that in the end improves the user experience and most importantly – the bottom line. It is imperative to create a very simple structure and business model that captures the maximum value for all players.
- Digital platform economy is an iterative process. You start with an MVP and then improve the product with each iteration. It is all about exploring, learning quickly and then acting accordingly. This is so different to the core business that it simply cannot be understood by people who have worked in a traditional business all their lives. A plane just degrades with time while a well-designed digital platform should benefit from each executed transaction. The system should learn and improve day by day.
Digital economy brings complexity that cannot be managed and controlled with the processes, techniques and metrics used by airlines in the past. This brings about a lot of confusion and missteps. It is simply impossible to succeed by taking only half measures to move towards the digital economy. On the other hand, it is also easy to go too far in the creativity and dream about becoming a company that airlines simply will not become.
So, how do you then make it work in a reality which does not have the patience for the transformation to bring all the possible benefits? There are several important factors, but here are the most important ones:
- Educate the organization about the need to operate a business of different complexity within the same organization. Then, create structures that do not conflict with each other.
- Use a sandbox approach to exploration and innovation – while there is a need to experiment, there is no need to be stupid. Risks can and should be limited.
- Agile does not equal absence of strategy. Agile simply means that the planned part of the business is smaller now and that there is another part which cannot be controlled and measured in the same way and therefore the teams dealing with this will need to have a different culture and much more autonomy. However, there will be fundamentally important pieces that should be carefully designed, planned and prepared for the company to move forward strategically. For example, having strong data-driven foundations which enable airlines to experiment, perform A/B testing, increase personalization, remove friction related to payments, etc. is something that will simply take more than one sprint to solve and will require significant strategic efforts within the involved departments.
The shifts explained here have a broader reach than just the airline industry. The digital economy is evolving and is going deeper. We are moving towards an integrated world where physical and digital will merge into a single seamless experience. This creates a unique opportunity for traditional players (such as airlines) to reclaim some of the value captured by digital start-ups over the past 10 or 15 years. However, in order to do this, airlines will need to make some bold steps and realize their business will no longer be just about moving seats from one airport to another, but more importantly, orchestrating a travel ecosystem to the benefit of their customers and ultimately significantly increased profitability.