Tuesday, October 15, 2013

Business Math + Banker's Math III: Flying High

Airlines are having a tough time these days.  For example, the recent merger between United and Continental apparently didn't go as smoothly as hoped and the company lost $723 million last year.  Poor Jeff Smisek, United's CEO, suffered from his mistakes in handling the merger -- his total compensation for the year dropped a whopping 41% leaving him with a mere $7.9 million, down from $13 million the year before.  Barely enough to make ends meet, I'm sure. Though Jeff's compensation is still extravagant (IMHO) at least this is one case where it appears to have been influenced by the company's financial performance.  This is rare, however -- industry-wide studies of the connection between CEO income and company profits have repeatedly shown that overall there is very little correlation between the two.

As airlines have struggled to cut costs and increase revenue it has more often been the passengers, not the CEO's who have borne the brunt -- more crowded planes, charges for food, baggage fees, extra fees for booking over the phone, no blankets or pillows or snacks, charges for reserving seats in advance, higher change fees, greatly diminished rewards for miles flown (see my blog, "Flying the (Un)Friendly Skies"), etc., etc.

These are the obvious ways of raising income, but there are a number of costs that are hidden in the price of the ticket itself.  One I came across for the first time recently was a KLM ticket my wife and I purchased online for a European trip. When it came time to pay for the ticket we were stuck with a 15 euro fee (about $20) for paying with a credit card.  The only way to avoid the extra charge was to purchase the ticket via a direct debit transfer from our bank. The 15 euros is a flat fee, the same regardless of the cost of the ticket.  In our specific case it amounted to a rather stiff 5% of the total that goes to KLM, not to the credit card company.  I'm sure U.S. carriers are watching public reaction to this very carefully and would love to do the same thing if they can get away with it.

Extra charges and fees can add up to a substantial portion of the total cost of a ticket.  In the case of our KLM ticket (Amsterdam to Nice, France) these add-ons comprised a stunning 61% of the total!  Don't think this is just true of European carriers, either -- for our ticket on United Airlines from the U.S to Amsterdam the extra charges were less, but still a hefty 44% of the total price. Note, both of these are international tickets but differ in two ways:  KLM is a European carrier and the flight is within Europe. United is a U.S. carrier and the flight is from the U.S. to Europe.

So what are these add-ons, exactly and are they different for the two tickets?  A close look at the ticket cost breakdowns suggests the following categories, along with the %  for each category in the case of the two tickets described above:
  • Extra Airline Charges: booking fees, international surcharges, credit card fee (26% KLM, 33% United)
  • Airport Fees: airport service charges, airport international airport service charges (16% KLM, 2.3% United)
  • Security Fees: "Security Charge" (8.4% KLM), "September 11th Security Fee" (3.4%United)
  • Taxes and Government Fees:  "French Aiport Tax, Soilidarity Tax, Netherlands Noise Isolation Charge" (11% KLM),  "U.S Customs User Fee, U.S. Immigration Fee, U.S. APHIS Fee, U.S. Federal Transportation Tax, U.S. Flight Segment Tax" (5% United)
There are a few things I find interesting about the breakdown.  First, most of the extras don't go to the airlines themselves but to other entities.  Second, the KLM add-ons are greater in every category except for the portion going to the airline itself.  Perhaps we shouldn't blame KLM for the credit card fee -- they're just trying to bring their portion of the ticket to the same level as other major carriers based in the U.S.

Third, it is interesting to note that the biggest difference by far is the portion going to the airports (16%% for KLM versus 2.3% for United). I don't know if this is true of other countries and carriers, but at least in this case it seems that some the funds for building and maintaining airports are coming from the users of those facilities.   We have found a general superiority around the world in foreign airports compared to those in the U.S.  -- perhaps this might be a good idea for us to consider as a way to upgrade U.S. facilities.

Fourth, the next biggest difference is that our concern with security in the U.S. isn't reflected in the portion of our tickets that supports security efforts -- KLM adds more than twice as much to a ticket as United does, 8.4% versus 3.4%.  Of course, this might be due to the way security is funded -- in the U.S. it is through general income taxes to fund the TSA's budget ($7.6 billion in 2012), whereas in Europe it may again be supported more by user fees assessed through ticket charges.

Finally, the amount added specifically for government taxes and fees is greater for the progressive European countries of Holland and France than for the U.S., but the absolute levels (11%, 5%) don't seem to me to give much support to the "damn taxes for big guvment!" folks.

Now for some disclaimers.  My analysis is not very general and different results might be obtained using different airlines and different countries.  I invite you to do your own research.  Also, my analysis is limited to international travel in which a sizable portion of the add-ons were those assessed because of this.  Indeed, when I did a quick check using domestic travel the add-ons dropped to 48% for KLM and just 12% for United.

The lesson I got from this analysis is that increases in airfare are not necessarily under the control of the airlines.  To maintain profitability and competitiveness they have turned to those things they can control, like baggage fees, configuration of seating, charging for food, etc. I can't blame them for that, though it has made air travel particularly unpleasant these days.

However I'd feel a whole lot better if airlines would show frugality in another area they can control -- CEO compensation.  Or, if you are still going to pay someone like Jeff Smisek nearly $8 million in a year the company lost $723 million, at least make him fly to Europe in the middle seat of the last row of the plane, with the video of him breathlessly touting all the wonderful changes coming to United looping over and over on the screen.

1 comment:

Anonymous said...

I especially liked your last paragraph!