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Airfare add-ons can beat the budget

Date

Tony Webber

On Tuesday night, I booked a return flight from Sydney to Melbourne on Jetstar. I've travelled on numerous low cost carriers all over the world, so I am quite familiar with the seemingly endless array of add-ons that one can purchase, but even I was surprised by the extent of the extras available at Jetstar.

I counted up to 20 add-on services, including those that have been a part of air travel for a number of years such as the purchase of a more flexible ticket, upgrades and the purchase of extra checked-in baggage.

There were also more exotic services such as hot meals, entertainment units and comfort packs, earning frequent flyer points, on-line check-in of baggage, itinerary sent by SMS, seat selection, seats with extra leg room, seats closer to the front of the aircraft, travel insurance, car hire, tourism activities, purchase of carbon offsets and donating to charity.

Fairer pricing

In some instances, the default option is to consume these add-on services and so one must uncheck the option to avoid payment. Consumers have to be on the ball during this purchase process, otherwise they could be paying for services that are either not needed or unwanted.

Despite this caveat, unbundled pricing is a much fairer system because it allows consumers to avoid paying for services that they don't consume, thereby stopping one set of passengers cross-subsidising others.

This issue of cross-subsidy is a greater issue with full service airlines where passengers pay for the full service regardless of whether they consume it or not. For example, passengers that say no to the air meal are paying for a service that they are not consuming, as are passengers that only take carry-on baggage on a full-service flight.

Ancillary revenue

The proliferation of add-on services has been a boon for airline revenue. Over the year to September 2012, the low cost carrier Air Asia earned between 15 per cent and 17 per cent of total passenger revenue via ancillaries.

Tiger Airways Holdings earned 19 per cent of its revenue as ancillary, while the European low cost carriers Ryanair and Norwegian airlines earned 21 per cent and 12 per cent respectively.

Credit card add-on

The add-on service that surprised me the most because of the magnitude of the fee relative to the base airfare, however, was that for payment by credit card. For the Sydney to Melbourne trip that I booked, paying by credit card cost $8.50. The same fee applies to all domestic travel, with a higher $12.50 fee for some longer international sectors.

The airfare itself between Sydney and Melbourne was $55 each way, so the credit card surcharge component was 15.5 per cent of the base airfare. On the basis of the average merchant service fee that is paid for credit cards in Australia, which according to the Reserve Bank of Australia was 0.86 per cent in 2012, one could draw the conclusion that Jetstar was charging excessively for credit card usage.

And it's not just Jetstar. Qantas and Virgin charge $7.70 for domestic sectors and $30 for longer international sectors.

Surcharge fees

But it's not as simple as examining the credit card surcharge relative to a single internet fare. The law of averages is important here.

For starters, the fare that I paid was in the cheapest fare class. As I booked a few weeks in advance of departure the fare I actually paid is what aviation analysts call a lead-in or enticer fare. I therefore paid the cheapest ticket in the lowest fare class.

The cheapest fare within the lowest fare class is not representative of the average airfare that is earned by a carrier. Dividing the credit card surcharge of $8.50 by this cheap internet fare is not a reasonable assessment of the burden of the credit card surcharge.

A much more reasonable assessment requires dividing the surcharge by the average airfare. This can be up to two times the lead-in airfare in the lowest fare class.

Distance-invariant

Secondly, the domestic credit card surcharges of Jetstar, Virgin and Qantas are invariant to the distance flown – you pay the same charge for Sydney-Canberra as you do for Sydney-Perth. While the $8.50 charge for Sydney-Canberra may look high for that route, it looks relatively small for Sydney-Perth because fares are greater for Sydney-Perth.

This distance-invariant surcharging approach appears to be adopted by airlines to reduce pricing complexity. The problem with this, however, is that it creates a dislocation between price and unit cost – the cost to the airlines of accepting credit cards for payment is a function of the value of the airfare, and thus the distance travelled, but the surcharge they set is not.

This generates two sets of problems. The first is that they cannot be sure that they are recovering costs, which may pose problems for the airlines with the Australian Competition and Consumer Commission because the ACCC generally requires cost recovery if the price component of a bundled product is advertised as a surcharge.

Secondly, the airline is in the business of making a profit. If it is setting a price component that bears no resemblance to cost, then it is almost impossible to know if it is going to be able to meet its profit objectives.

Tony Webber was Qantas Group chief economist between 2004 and 2011. He is now managing director of Webber Quantitative Consulting http://www.webqc.com.au/ and associate professor at the University of Sydney Business School

11 comments

  • Imagine he screaming if woolworths or Coles charged $8.50 every time you put fifty bucks worth of groceries on the credit card. This is an outrageous gouge, probably bordering on fraud. I don't know how they get away with it, underlines again the toothless tigers that are Australia's corporate regulars

    Commenter
    Rhm
    Date and time
    February 15, 2013, 3:25PM
    • Of course it is NOT compulsory to pay by credit card - I have just booked both Jetstar and Virgin flights and paid directly from my bank account with no fees.

      Commenter
      MrDog
      Date and time
      February 15, 2013, 4:58PM
  • I was booked on a direct Melbourne to Denpasar flight in May and recently got moved to a flight via Sydney with a 4 hour stop over extending the travel time by 6.5 hours! I was told it was for 'safety reasons'. I booked the ticket over a month ago and the direct flight is still operating - business class seats are still for sale.

    Whilst the terms and conditions state that Jetstar does not guarantee a particular flight - it is because the ticket was purchased on sale and they can sell more expensive seats on the original flight? Or because they overbooked the original flight and therefore move people who purchased sale flights?

    Commenter
    moved
    Date and time
    February 15, 2013, 4:00PM
    • I find Jetstar to be the worst domestic airline. I booked a late afternoon flight from Melbourne to Sydney - there were constant differing excuses as to why it was delayed . . . . later flights kept taking off but I was not allowed to take one of them. Finally I got to travel at 8.30pm. Imagine how unhappy I was to discover that passengers that had booked for that flight paid around 50% of what I did. No compensation or offer of a free drink or meal. I would have to be really desperate to book with them again.

      Commenter
      MST
      Date and time
      February 15, 2013, 4:31PM
  • And we all know that the airlines - like everyone else - will be compelled to stop overcharging CC fees March 18, don't we?

    Commenter
    DC
    Location
    Melbourne
    Date and time
    February 15, 2013, 4:08PM
    • I find the surcharge to be a real rip off - as it is charged for each seat - so if I am booking for 6 people it is multiplied - however the airline is not entering into 6 credit card transactions with the bank - but only one. As for the plethora of other charges - the word "robbery" comes to mind.

      Commenter
      MST
      Date and time
      February 15, 2013, 4:16PM
      • Airlines gouging their customers?
        Shirley that cant be right??

        Commenter
        Damian
        Location
        Bundoora
        Date and time
        February 15, 2013, 4:20PM
        • I have found on many occasions that Qantas can be very close to and sometimes even cheaper than Jetstar to the same destination on the same day and a very similar time. EG Sydney to Melbourne or Sydney to Brisbane or Perth. Why would you pay for Jetstar for less room and service?

          Commenter
          Frequent flyer
          Location
          In the Qantas lounge
          Date and time
          February 15, 2013, 4:42PM
          • I have a concern regarding the scaled they use at Hamilton Island Airport. When I left Melbourne my bag weighed 16 kilo including 2 full bottles of bourbon. I only bought a pair of snorkeling goggles as my strap broke on my pair.

            When I checked in at the airport, the woman said my bag weighed 27 Kilo's, she gave me the excess baggage charge and I almost died of shock, I did not buy anything, the bourbon was consumed, the bag would have weighed less.

            I said to her this is not right, I demanded she try the bag on a different scale, she did and it was 22 Kilo, I demanded she try another scale and it was 21 Kilo, I reluctantly paid the rip off fee, as the line was getting longer.

            What concerns me is the difference of the scales. I thought they would have had to be calibrated etc.

            Commenter
            Bob
            Location
            Melbourne
            Date and time
            February 15, 2013, 4:47PM
            • Customers buy based on price alone, and that is usually the base price. So they pull every trick to make their tickets cheaper. If we stop buying this way they would stop selling that way.

              Commenter
              Flingebunt
              Location
              Brisbane
              Date and time
              February 15, 2013, 4:57PM

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