EasyJet's results from a few weeks probably passed you by. As a set of numbers they were actually more than half decent with many in the City applauding the improved cash flow and the ‘in-line’ pre- tax loss.
But lurking beneath the half year numbers was a tale of two stories – the first is an exemplary tale that offers genuine insight into how to think about large companies in a strategic way. The second is rather less flattering and centres on that all important subject of ancillary revenues.
The positive narrative is that easyJet under Carolyn McCall seems to be displaying exemplary strategic focus.
Last November’s strategy to ‘Turn Europe Orange’ (TEO) is a great template for any growth orientated travel company looking to add a bit of rigour to its cost reduction and revenue maximisiation plans.
In the latest set of numbers easyJet carefully spins through every part of its strategy, ticking off progress as it goes along, giving analysts and investors alike a better understanding of the business context.
In particular the TEO strategy is forcing directors to think long and hard about how they intend to use capital within the business moving forward – an important discipline in an industry that has frankly frittered away billions of shareholders money on wasteful capex projects resulting in excess capacity.
According to easyJet the new long-term incentive plan for the executive directors ‘has been re-aligned to return on capital employed’ (ROCE) with payments kicking in at a rather lowly 7% and maxing out at 13%.
That focus on return on capital employed is especially welcome as it presumably includes debt used within the business and aligns the director’s interests to the publicly stated goal of delivering 12% ROCE ‘through the cycle’. My only observation is that a target of 12% whilst commendable (if achieved) is hardly earth shattering.
So, full marks for strategic focus – not that we’d expect anything else of Ms McCall – but that listing of progress made so far did contain one fascinating anomaly, namely ancillary revenues.
In sum, everything is not quite going to plan. According to easyJet ‘after three quarters of decline, ancillary revenues have seen improvement in the second quarter taking the six month revenue to £10.20 per seat, in line with the first six months of last year’.
Checked baggage pricing has been ‘optimised’ and revenue now ‘stabilised’. There’s a hint of progress too in dynamic packaging with ‘improvements in on-line merchandising of accommodation, driving 30% improvement in booked margin’.
Just for good measure in the second half of the year there’ll be ‘continued optimisation of fees and charges’, a refresh of the in flight range and a renegotiation of car rental partnerships.
Lots of activity but one can’t quite shake off the sense that Easyjet is beginning to run out of steam when it comes to maximising revenue per customer and ancillary income.
What Next For Ancillary Revenues?
Whatever happened to the brave new world of ancillary revenues powering profits growth? It seems only a short while ago that we were all talking breathlessly about picking up free tickets as a matter of course and then paying for every aspect of the subsequent journey.
Easyjet’s arch enemy Ryanair has mooted all sorts of ideas about charging for everything from using the airplane toilets through to breathing in oxygen (all right the last one was made up!). The ancillary revenues story really does matter because it tells us why we should buy shares in lowcost airlines.
In truth flying is a volatile, choppy business and subject to the whims of geo politics, oil prices and the business cycle in other words it’s a volatile, low margin business prone to overcapacity. Ancillary revenues is a game changer – it boosts profit margins, forces a focus on return on capital employed, and stimulates overall demand by making headline fares seem affordable.
Yet easyJet, and to a lesser extent Ryanair, seem to be beginning to run out of steam. EasyJet’s recent push to increase credit card charges has clearly gone down like a lead balloon and one wonders whether asking ever more money for either fuel surcharges (BAs favoured tactic) or checked in baggage will really yield much more in the way of extra revenue.
Clearly the airlines have to start thinking long and hard about the new frontier for extra revenues. The good news is that according to the experts, there’s a bevy of new ideas that might just help to re-energise the corporate bottom line of outfits like easyJet.
The easy win is to get customers to pay more money for particular seats – talk to experts such as Dr John O’Connell at Cranfield University and he’ll excitedly tell you about the US airlines that are now charging extra for those prized front row seats and seats by the emergency exit.
Some outfits stateside are also charging for picking a particular seat whilst ClickAir is offering customers (presumably of the more overweight variety) the chance to buy the seat next to them at a discounted price.
The next big area of growth according to Dr O’Connell is dynamic packaging. The really clever stuff consists of working out where in the purchase process airlines should offer the ‘extras’ - hit rates for packaging offers at the end of the booking process rarely exceed 3% to 5%.
Given that the mark up on holiday insurance is close to 75% in some cases, that low hit rate is an obvious target for improvement. According to Dr O’Connell the solution is a simple behavioural fix, with packaging offered at the very start of the process. Take-up rates increase tenfold when done properly.
Yet some US airlines are moving beyond these systems based fixes, and thinking a little more adventurously – Hawaiian Airlines for instance is already offering a veritable smorgasbord of activities during the booking process - ’buy your air ticket and go on a submarine for a day’.
According to Dr O’Connell the real game changer is using data mining to personalise offers during the booking process. The targets for this still nascent process is the travel agent on the high street – in effect the data miner programmes will build a personalised offer that replicates much of the hard work done by living, breathing travel agents, all in a matter of milliseconds using clever algorithms.
The last potential growth area would seem to be food. Airlines don’t tend to have a great reputation for providing delicious in-flight grub (with a few, expensive exceptions) and the low cost airlines in particular excel at offering sandwiches that would shame even the average railway trolley service.
But again progress is being made stateside with the likes of Virgin America offering customers the opportunity to order their food at the time they want. Other airlines are offering a la carte business class meals for anything between $16 and $100.
If Little Chef can successfully use Heston B to reinvigorate its range, why can’t easyJet do something similar for its business customers or travellers on medium haul routes to places like Jordan or Morocco?
Obviously there are risks inherent in all of these new approaches. US airline JetBlue ran into trouble when it started charging for pillows. Equally many American customers have kicked up after being asked to pay for food on longer haul international flights.
But the potential for growth still seems huge – allowing every lowcost customer the opportunity to feel a little bit more special and unique for a not inconsiderable fee. Most importantly the smart stuff coming to an airline near you might make you feel better about travelling – as opposed to the sense that we’re all being ripped off for something we can’t avoid (like using credit cards to make a booking).
But there is one last revolutionary idea for ancilliary revenues – do without them, and insist that all those extra add-ons should be included in the price. Who among the low cost airlines will be brave enough to copy SouthWest’s proud declaration that bags fly free.
Maybe they could even offer great customer service, and personalised attention as a freebie – all part of the price.
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