The Economics Of Discount Airlines

By Amy Fontinelle | January 11, 2012 AAA
The Economics Of Discount Airlines

Operating an airline is both capital- and labor-intensive. The airplanes, maintenance, fuel, regulatory fees, pilots, crew, agents, baggage handlers and other key components of airline operations aren't cheap. With such high expenses, airlines typically earn profit margins of just 1 to 2%. (To learn more, check out Is That Airline Ready For Lift-Off?)



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Keeping costs down is essential to maintaining those profits and staying afloat in a bankruptcy-ridden industry. Here are some ways that discount airlines are able to make a profit while charging airfares consumers can afford.

Airport Selection
Airlines must pay fees to each airport they operate out of, but different airports charge different fees. By operating out of less popular airports, airlines can save money on these fees. Less-busy airports can also save airlines money by wasting less time at the gate. The more flights an airline can operate, the more tickets and extras it can sell and the more money it can make. To remain competitive, discount airlines also operate out of the most popular airports.

Oil Price Hedging
Fuel represents a major expense for any airline. Fuel prices change unpredictably and sometimes significantly. With the amount of fuel airlines use, even a small uptick in fuel prices can have a major impact on an airline's profit margin.

To protect against these price changes, airlines can engage in oil price hedging. Hedging is an investment strategy for reducing the risk of price movements. Southwest has been a leader among airlines in using hedging to lock in its fuel prices, sometimes for years in advance. It isn't the only airline to use this strategy, but it has been the most successful at it.

This strategy is not without risk, however. If an airline locks in its fuel prices when crude oil costs $100 a barrel and the price later drops to $90, the airline would have been better off without the hedge. (For more on airlines, read 4 Reasons Why Airlines Are Always Struggling.)

Aircraft Options
By only operating a single type of aircraft, airlines can cut their operating costs in several ways. They can negotiate discounts on the purchase price of numerous identical aircraft purchased at once. They can also save money on maintenance because they only need tools and parts for one type of airplane, and they only need technicians who know how to fix one kind of airplane. Southwest, for example, uses Boeing 737s exclusively.

Putting as many seats as possible into a plane is another way to make aircraft operations more profitable. The new ultrathin seats that Lufthansa rolled out last October make it possible for airlines to improve both per-flight profits and passenger legroom. They also save money by allowing airlines to renovate their existing planes instead of buying new ones.

Miscellaneous Fees
We're all familiar with the fees airlines charge on services that used to be free, but most discount airlines manage to turn a profit while charging fees that are often lower than those of legacy carriers.

Legacy carrier American, for example, charges $25 for the first checked bag, $35 for the second and $150 for any additional pieces, and baggage that weighs more than 50 pounds is subject to hefty overweight baggage fees that start at $100. Southwest, on the other hand, allows two checked bags for free and only charges $50 for oversized or overweight bags, while JetBlue allows one checked bag free with the second costing $35 and the third $75. Alaska Airlines charges just $20 a bag for the first three checked bags. However, discount carrier Spirit Airlines charges even for carry-on luggage. (For other things to watch out for, read 5 Changes To Airline Rules You Need To Know.)

United charges higher prices for its Economy Plus seats that have more legroom than regular economy seats. These fees vary by flight, or frequent flyers can purchase a year's worth of economy plus seating for $499. US Airways charges extra for seats near the front of the plane or in an exit row. Southwest lets passengers sit wherever they want at no charge, but charges a fee of $10 each way to passengers who want to check in early and secure a spot near the front of the boarding line. Spirit charges customers to choose their own seats no matter where they want to sit.

When it comes to in-flight meals and entertainment, the legacy and discount carriers have comparable offerings and charges. While Southwest and Delta offer modest free snacks like peanuts and crackers, Virgin America charges for meals, sandwiches and snacks. Spirit sells snacks ranging from $1 to $10 and drinks ranging from $1 to $15. Jet Blue's meal boxes cost $5.99, and Alaska's in-flight meals and snack boxes cost $6 to $7. Delta also sells meals and snacks that range from $3 to $8.50. United charges for snacks and meals, too.

In-flight entertainment presents another opportunity for airlines to make or save money. Jet Blue charges $5.99 per movie on domestic flights. Delta also charges $6 per movie or per television bundle. Southwest's money-saving plan appears to be to not offer any entertainment features other than its spunky flight crew, though it has started to offer $5 in-flight WiFi on some of its planes. Alaska's in-flight WiFi costs $4.95 to $12.95.

The Bottom Line
The economics of discount airlines are more complex than they seem. Turning a profit in a competitive industry with high fixed costs isn't about gouging consumers on baggage fees. Rather, it's about paying careful attention to numerous behind-the-scenes expenses, and looking for opportunities to charge passengers for optional extras while keeping ticket prices low. (To read how other airlines were less successful, see Dead Airlines And What Killed Them.)

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