Photographer: Vinh Pham

Travel

How ‘Basic Economy’ Actually Makes You Pay More to Fly

No one ever wants to order the cheapest bottle of wine, right? The airlines are counting on it.

As Americans hop online to book flights for this summer’s weddings and weekend getaways, many will have their first encounter with “basic economy,” a new breed of airfare being offered by the three largest U.S. airlines.

Typically $15 to $30 lower than traditional economy, these tickets are designed to allow American, Delta, and United to better compete with ultra-low-cost carriers such as Frontier Airlines Holdings Inc and Spirit Airlines Inc. They target travelers for whom price is more important than convenience, since they carry a pile of additional restrictions—no advance seat assignments, last to board, no changes or upgrades. (And, on United Continental Holdings Inc., no access to overhead bin space.)

Predictably, basic economy has been condemned as yet another step in the industry’s relentless drive to strip all comfort and grace from steerage class. But there’s a shell game going on here—this consternation overlooks a far more insidious change: While adding these new bargain-basement fares, carriers also raised prices on traditional economy seats. The strategy? If a consumer sees that there’s an even lower class, they’ll pay a little more for the next level up.

In other words, this is where basic retailing goes airborne.

As restaurant wine lists have demonstrated for decades, most people shy away from price extremes. The cheapest bottles are automatically suspect—Is this swill? What will my dining companions think?—while the most expensive vintages are often obscenely unaffordable, obvious cases of extreme markup.

The same thing is now happening with airfares. American Airlines Group Inc. has said that roughly half of buyers in its initial test markets trade up from the lowest basic fare to the more expensive economy counterpart, while United said 60 percent to 70 percent of its buyers choose standard economy over basic. (It’s worth noting that United’s basic fare has more onerous restrictions than those at American and Delta.)

This pricing shift represents a structural change for an industry that’s struggled to make fare increases stick. Network carrier efforts to boost airfares are often undone by a variety of factors: JetBlue Airways Corp. or Southwest Airlines Co. may decline to join in the hike, a growth airline might offer even lower fares, and a market swoon or terrorist attack might dent demand.

Airlines, naturally, are touting the new basic fares as a victory for consumer choice. But it’s more complicated than that.

As they become more savvy merchants, the Big Three carriers consider basic economy fares and increased sales of “premium economy” sections—with more legroom and amenities—to be worth at least $1 billion in additional revenue. “Customer segmentation, to me, is one of the hallmarks of what’s different about the industry this time,” Paul Jacobson, chief financial officer at Delta Air Lines Inc., said Wednesday at a Deutsche Bank AG investor conference.

Delta began studying basic economy fares five years ago, and launched its current version of the fare in 2014. American began its first basic economy markets in February, with only a modest expansion thus far. Its basic economy fares aren’t yet offered in several major markets, including Chicago, New York, Denver, Los Angeles and San Francisco. Over time, however, airlines expect to expand basic economy to their entire networks.

Basic economy fares are often unavailable on corporate-travel booking systems because business travelers require more flexibility. As a result, the new class is “a corporate fare increase by another name” JPMorgan Chase & Co. analyst Jamie Baker said in a December client note. (He’s a fan of the strategy, though.)

United has been particularly aggressive in its embrace of basic economy since launching the fares in February from Minneapolis to its seven U.S. hubs. Late last month, the airline expanded the fare on all flights in the continental U.S. and Alaska and has “been positively inclined with the level of upsell and the customer response to it,” President Scott Kirby said at the investor conference.

United President Scott Kirby. (Laura Segall/ Bloomberg News)
Photographer: Laura Segall

United also sells a basic and an economy fare for every seat on a flight, he said, unlike current practice at American and Delta, which appear to have fewer of the rock-bottom fares available.

The basic economy baggage stricture does carry a bonus for everyone on board, though: It increases the ability to turn airplanes around faster and depart on-time.

“We are really quite excited about basic economy,” Kirby said, noting that the airline has forecast $1 billion in new revenue from its new cabin merchandising efforts. “I’m not going to change the forecast. In fact, we feel really confident that we’re going to make $1 billion in segmentation.”

His confidence may be well placed. When United expanded basic economy to 49 states last month, JPMorgan’s Baker—because of the new fare structure in traditional economy classes—classified the move as a $15 to $25 fare increase.

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