So here is a video of Southwest Airlines CEO Gary Kelly talking about their recent financial performance.
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Long story short, they had a good quarter. What is interesting to me is that Kelly credits Southwest’s bags fly free policy for a significantly bolstering their results — particularly for the rebound in leisure travelers. That makes me want to ask why does Southwest let bags fly free?
A little background. Since starting this blog, Gady and I have been taken with claims of Michael O’Leary, the CEO of Ryanair. O’Leary has claimed that Ryanair has imposed baggage fees not for the revenue but for the cost savings. (See this and that post.) That is, he views these fees not as an opportunity to segment the market and extract more revenue (like beer at the ballpark) but as a way to shape customer behavior to help control the firm’s costs. Here is how one of his lackeys put it in the New York Times (Less Baggage, Big Savings to Airlines, Apr 6):
“Bringing a big bag and expecting it to travel for free, it’s too much to ask,” said Stephen McNamara, director of communications for Ryanair. “It’s expensive to ship something heavy in an airplane when fuel prices are very high.” Mr. McNamara said the airline had as a goal nothing less than changing passenger behavior. “People are packing way too much; women bringing four pairs of shoes, hair dryers, that sort of thing.”
Could anyone that sexist be right? Suppose that he is. (The same article reports that the number of lost or mishandled bags has dropped dramatically as has workers comp claims.) Why isn’t Southwest trying to get its share of savings as well?
As I said, Gady and I have been taken by these assertions. Enough so that we have roped a colleague Achal Bassamboo into writing a paper about it. That has led us to some conclusions about what these fees can do and why Southwest may be just fine without them.
- Competition. This seems like an obvious point. Southwest with its aggressive bags fly free ad campaign has carved out a unique positions with customers. However, it is pretty easy to write out a “standard” model of competition in which firms compete in offering an expected cost of travel and then split that cost between the regular airfare and baggage cost to minimize their operating costs. If that were the case, one would expect Southwest to either have baggage fees or have higher base fairs. It seems that they don’t on both accounts. I just checked flying from Chicago to Manchester, NH. There are only two firms offering direct flights between these cities (and, yes, I am aware that it calling Manchester a “city” is being rather generous). Southwest doesn’t charge for bags but United does. They charge, however, essentially the same ticket price. Actually, Southwest is about three bucks less.
- Segmentation. The standard model I referenced above assumes that customers are risk neutral and have homogeneous costs in reducing their need to check bags. That ain’t necessarily so. Some consumers may be risk averse and not want to chance getting tagged with baggage fees. A recent report by the Consumer Travel Alliance noted that baggage fees can easily add 30% or more to the cost of travel. Note that that number is going to be higher for short-haul travel since the base fee is generally lower on those routes while baggage fees are not distance sensitive. Given the relative costs involved, risk aversion could play a real role. Similarly, if Southwest attracts more leisure travelers going on extended stays (as opposed to business travelers who have just one day of meetings), their customer base may find it costly to reduce the need to check bags and whether a firm (in our model) imposes a baggage fee depends on the balance between the customer’s marginal cost to reduce the need for a bag and the firm’s marginal cost of providing the service.
- Firm cost. So we need to value the firm’s and the customer’s costs. Maybe Southwest simply has lower costs to handling bags. Two points support. First, Southwest has long been lauded for its more productive and flexible workforce. Second, they do more point-to-point flying as opposed to sending passengers through a hub. Hubs mean connections and transferring bags. Southwest would then have less work to do for the average checked bag while United might prefer that customers schlep their luggage across O’Hare themselves. Finally, there is another cost consideration. Effectively encouraging customers to check bags keeps them from piling excessive amounts in overhead bins and slowing down boarding. Longer boarding times may be tolerable at a hub when planes are forced to sit waiting for a connection. They would not be so easy for Southwest to absorb. Spirit caught a lot of flack for proposing a fee for carrying on bags but they claimed that this would shorten the average boarding time by five minutes. Going the other way, Southwest may not believe they will get enough from baggage fees to justify stretching out boarding times.
In looking at this list, I don’t see how any of these are going to change soon. I don’t see how Southwest’s cost structure is going to blow up and if anything their marketing is reinforcing their appeal to segments that are risk averse or have a high cost to not checking bags. It seems that bags will fly free for a long time.