Airlines Test Strategies: Baggage Fees Vs. Volume

The past two years have been a tough time in the airline industry. After 71 consecutive quarters of profitability, Southwest Airlines has lost money for three straight quarters. Nationally, airline passenger loads are down 13 percent for the industry, compared with last year.

Southwest Chief Executive Officer Gary Kelly says even with the big drop in the price of jet fuel, the airline is having trouble making it work.

"The big problem is that for every dollar that we've seen reduced in fuel expense, we've also lost, ironically, a similar amount in revenue," he says.

Like Wal-Mart, the Dallas-based airline built an empire on low cost. In an effort to stay true to its roots, Southwest is one of the last major carriers to include free checked luggage in the price of the ticket.

It's estimated that competitors like US Airways might generate as much as $400 million a year in revenue by unbundling services previously included in an airline ticket. But Kelly is betting that over the long term, the decision not to do the same will play out to Southwest's benefit.

"Find me one example of somebody who likes paying a baggage fee," Kelly says. "If you look at our customer traffic for 2008, as we were forced to raise prices last year, our numbers fell off."

After the financial collapse, airfare competition has gotten even fiercer. Southwest is banking on market share, filling its planes with hopefully loyal passengers who are happy to have their suitcase and golf clubs flying along for free.

But Southwest's competitors are quietly satisfied with their strategies too. Without baggage fees, losses would almost certainly be worse. Richard Aboulafia, an analyst with the Teal Group, says carriers have stanched the bleeding.

Travel has never been so cheap, he says. As CEOs watch ticket prices fall, they're responding by unbundling the services traditionally included in an airline ticket, like the costs for transporting bags.

Round-trip ticket prices are routinely below $300, even cross-country. But if a family of four checks two bags each, that's up to $320 extra. Originally, these fees were a reaction to fuel prices. Aboulafia says now they are aimed at offsetting collapsing demand.

"If it weren't for falling fuel prices, the airlines would just be hemorrhaging cash," he says. "You've got traffic dropping at record levels because of the recession. And of course you've got yields — the prices paid for a ticket — also still falling. It's like winning the lottery except that if you didn't win the lottery, you'd be in the poorhouse."