Baggage Fees a Goldmine for US Carriers - Case Study Example

Why do Airlines charge for baggage? Airline industry has undergone drastic changes since the traumatic incident of 9/11 with many of the companies inthe industry suffering from heavy losses. To sustain their businesses in this competitive environment, airlines have come up with new strategies. The pricing mechanism has changed and customers do not enjoy all the benefits of an airline package in a single ticket. Airlines are now charging separately for different kind of services they provide to their customers. Among them the most evident one is the charges for baggage that customers carry during the flight. Traditionally, Airlines did not charge for the initial two pieces of luggage unless it exceeded the weight limitations imposed by the company. However, in the contemporary environment there is an accelerating trend of charging the customers with baggage fees. American Airline became the first major airline to impose a $15 fee on checked luggage which was soon matched by other companies. United Airlines recently begin charging its passengers $50 to check a second bag. The same policy was adopted by US Airways just after three weeks when United Airlines implemented the policy. Currently, most of the major airlines charge $15 to check one bag, $25 for a second bag and as much as $ 125 for a third bag with only exceptions include Southwest Airlines, JetBlue Airways and Alaska Air Group which allow transporting one bag for free. The baggage-fee frenzy has made many airline passengers wonder: Isnt luggage part of the service you get when you buy a ticket? Customers are astonished that what it actually costs these airlines to fly the 40 pound suitcase. Airlines are cognizant of the negative reactions sparked among the customers due to charges related to baggage fees. The trend has caused great annoyance among the customers but according to government sources these baggage related fees have become a boon for airline industry by saving billions of dollars for these cash deficient airlines. According to the US Department of Transportation, only baggage related fees from the US Airline Industry accounted to $1.15 Billion in year 2008 (Smith, 2009). According to the recent data, the companies in US Airline Industry collected $670 million only in baggage fees in the second quarter of year 2009 which is also a growth of 18.2% from the last quarter. It is estimated that only United Airlines will be able to earn more than $100 million on baggage related fees (CAPA, 2009). US airlines’ baggage fee revenue collection: 1Q2005 to 2Q2009 (USD, ‘000) Source: Centre for Asia Pacific Aviation and Bureau of Transportation Statistics (CAPA, 2009) There are several reasons behind the math of baggage related fees. Firstly, in the light of the recent global economic crisis, companies are trying to make up for their decline in ticket related revenues by increasing the baggage related fees. During the period of economic turbulence, the ticket related revenues fell by a hefty 24% which were somehow compensated by increasing baggage charges (CAPA, 2009). It is important to remember that these baggage related fees were in addition to a host of other fees such as meals, snacks, non-alcoholic drinks and ordering tickets via telephones which initially were within a sphere of free products services. Many of the airlines also claimed that there reason for charging baggage fees is related with higher fuel costs. During 2008, oil prices hit as high as $150 per barrel causing the airline industry to suffer from serious losses. To compensate for these losses, airline industry started to charge for different services provided and the trend toward baggage fees started to emerge in the industry. The claimed reason for charging baggage fees was articulated as to help the airline companies to offset high fuel prices. Currently, some of the US Airlines are covering as much as 38% of their fuel costs from baggage fees (CAPA, 2009). The oil prices have since stabilized and the reason for higher fuel costs does not remain a valid ground. However, airlines assert that baggage related fees yet remain since the revenues from this source are driving up the industry’s crippled financial condition. Furthermore, airlines have devised a new strategy by moving the customers to a “La Carte Pricing”; where customers are supposed to pay for every service they are offered, whether it’s a non-alcoholic drink provided on the board or a checked bag. The above reasons cited by the airlines seem to be justified but they do not explain anything from the theoretical point of view. The concepts pertaining to managerial accounting explain a lot about why airlines are charging for baggage. Activity based costing provides an answer for baggage related fees. As we know that Activity based costing aims to provide a dynamic and realistic means of calculating the true cost of doing business. It precisely allocates direct and indirect costs to particular products or customer segments (CCP, 2009). Hence, we will identify what it actually costs an airline to charge for baggage related fees. Based on the industry estimates and other sources, it has been identified that it actually costs as much as $15 per bag to fly the luggage and hand it over to the passenger in a safe manner (McCartney, 2008). Even most of the airlines such as American and Continental Airlines are charging $15 to check the first bag of the passenger which shows that they are only covering their costs without making any profit on the first checked bag. The baggage handling system is quite cumbersome for airlines to manage and yet after such sophisticated baggage handling systems, yet at least one of the passengers airs grievances about his suitcase not arriving with the plane and many of the others complain about their luggage being damaged and even theft in some of the cases. Airlines spend a huge amount of money in moving the luggage in a secure and safe manner. Let us analyze the costs involved in managing the baggage throughout the process. Baggage handling is a quite complicated and labor intensive process requiring a lot of workers. Each bag in the process is get checked by on average 10 persons during its journey. Bags are initially tagged, sorted and then are placed on the carts. A driver drives them to the planeside where a labor team loads them into the belly of a jet. The unloading process of the bags is even more labor intensive; Bags are sorted into luggage to be delivered to the carousel for passengers to collect and luggage that needs to be routed to connecting flights and has to be sorted and driven to lots of different planes. The labor team for baggage handling demands proper human resource management therefore the expenses of these workers are beyond the boundaries of only salaries and benefits. Airlines incur millions of dollars annually just for on-the-job injuries related to baggage handling. Hence, training is the fundamental aspect of baggage handling and all the workers need to be trained in hazardous material which adds up enormously to the cost of labor. Furthermore, the cost structure includes the pay of check-in-personnel who tags the bag, workers who maintain the equipment and tools for baggage handling and service workers responsible for helping the customers with lost luggage. Aviation industry considers baggage handling systems as a continuous drain on its resources since mishandled bags drive up the costs considerably. Only in year 2008, the mishandled bags accounted for $3.3 billion which is an exorbitant cost for these airlines. According to the sources from IATA, the amount of mishandled bags in United States and Europe increased three times faster than the growth of passengers between the period from 2005 to 2007 (Kaschdailewitsch, 2009). However, these rates have been slashed since the introduction of technologies such as RFID and other baggage handling systems. Many of the airlines also want to deter the passengers from carrying too much load therefore they are charging heavily on bags other than the first one. United Airlines charges $25 for every second bag the passengers carry during the trip which is yet cheaper than the shipping costs for a 50 pound suitcase. The mishandling rates therefore have fallen because passengers are now days carrying less weight during the flights since airlines are charging for any additional bags the passenger carry during their journey. Customers have become smarter in the way they are packaging their suitcases as weight has become a concern for them. American Airlines had an average of 1.1 to 1.2 checked bags per passenger before it implemented the policy of baggage fees in 2008 (McCartney, 2008). According to the sources it now averages less than 1 bag per passenger. According to the US Airways Chief Executive Douglas Parker, its airlines spends nearly around $250 million only on labor who are assigned the task of baggage handling which is about 11% of the airlines Total payroll and amounts to $9 per bag. Labor expenses are not the only source of cost in the process of baggage handling. Airlines invest millions of dollars in baggage handling technology, equipment, facilities, sorting systems, paying rent to airports for bag rooms, carousels and offices and buying carts, tractors and conveyors (McCartney, 2008). In addition to these expenses, airlines also pay to deliver lost bags and pay claims for any bags not delivered to the customer. Airlines official believe that all these cost estimates are close to one third of the labor cost which amounts to $4 per bag. Finally there is a fuel cost attached with the bag in flight. Generally, it requires around 3 to 5 percent of the weight of an object in fuel to fly it for a period of an hour. Using these rough approximates it implies that it will cost $2 to fly a 40 pound bag on an average 3 hour trip at the current fuel prices. When we add up all these costs $9+$4+$2, it sums up to $15 per bag which is also the baggage fees charged by the major airlines on the first bag. This means that airlines are not making any revenues on their first bag checked for the passengers. Airlines have experienced that these baggage related fees have caused customers to alter their behavior. These fees are deterring the customers to carry any weight as now fewer customers are carrying multiple bags and even there is a large group of customer who is checking any bags. Airlines believe that this reduction has triggered lower rates of lost luggage which was initially a huge cost for them. Also this policy has enhanced the baggage handling reliability and created a greater room for cargo on the plane which has far more lucrative rates than the baggage related fees. Many of the airlines charge a minimum of $80 on a same day cargo service of a small parcel which makes there revenue figures look far more superior than if they had not implemented baggage related fees. References Catalyst Consulting Partners (CCP) 2009, Glossary of Management Terms, Available from the site: http://www.catalystconsultingpartners.com/glossary.html Center for Asia Pacific Aviation (CAPA) 2009. Baggage fees a goldmine for US carriers 2009, Available from the site: http://www.centreforaviation.com/news/2009/10/07/baggage- fees-a-goldmine-for-us-carriers/page1 Kaschdailewitsch, Uwe 2009. Battle of the Scanners, Available from the site: http://www.futureairport.com/articles/022_sept09/022_battle.pdf McCartney, Scott 2008. The Middle Seat: What It Costs An Airline to Fly Your Luggage, Wall Street Journal (Eastern edition). New York, p. D.1 Smith, Aaron 2009. A billion reasons to charge for luggage, Available from the site: http://money.cnn.com/2009/05/12/news/companies/airline_baggage_fees/index.htm Read More