Sunday, December 25, 2016

Delta Air Lines, with an eye on revenue and profit, moves quickly to break in its new segments



There’s Coke and Diet Coke, 13 kinds of Cheerios and an endless variety of toothpaste. And now, airplane cabins are being customized, too.

Delta Air Lines is plunging deep into segmentation, industry parlance for dividing an aircraft into multiple fare levels that offer different perks and restrictions.

It’s an attempt by Delta and other major carriers to capture a wider swath of customers with varying priorities and preferences, or win back price-sensitive travelers lost to low-cost and ultra-low-cost carriers like Spirit and Frontier.

While airlines have long offered separate first-class and coach cabins, this trend is about selling experiences. These incremental differences between tiers can add up to more revenue and profit.

“The industry, historically, had been on a one-size-fits-all model,” Delta Chief Executive Ed Bastian said. “So we are trying to tailor specific products unique to the price points people want to pay. They get the same overall quality of service of Delta, but it may not come with a seat assignment or it may come with different [seat space].”

These segments, now bearing branded names like “basic economy” and “premium select” and “Delta One,” have been popping up in recent years. But with 2017 shaping up to be the year segmentation becomes commonplace, customers will need to educate themselves on the sometimes subtle differences before booking a flight. And airlines will have to get better at explaining each tier’s value.

At a meeting with investors and analysts earlier this month, Delta President Glen Hauenstein talked at length about the change. “We think we are in the early innings of this kind of customer segmentation,” he said, “and that this will deliver significant shareholder value over the next three to five years.”

It’s the new business model for the major U.S. airlines, which are still adjusting to this new, and relatively stable, era in the industry. The turn of the century ushered in a time of crisis for airlines — first with the 9/11 terrorist attacks that squelched air travel, then with rising fuel prices and finally with scads of bankruptcies.

While that era left some psychological scars, the airline industry has stabilized and reinvented itself. The consolidation of the largest carriers created opportunity for smaller, ultra-low-cost carriers, which attracted customers who couldn’t afford to frequently travel by plane. These carriers charge a low base fare and get a larger percentage of revenue from add-on fees for baggage, food and roomier seats.

Those fees drew criticism initially, but more people are flying low-cost airlines than ever and many now know to read the fine print.

“We may not like it, but the customer has learned to accept this,” said Henry Harteveldt, travel industry analyst with Atmosphere Research Group. “The larger airlines would rather be known for providing good value to all customers rather than elitist, or an airline for a certain type of customer.”

Bastian said in an interview that Delta’s pricing and marketing has not been terribly sophisticated. But with passengers acclimating to the new pay-as-you-go model, Delta and other large airlines are implementing their own version.

“We have to do more than just win with the business community,” Bastian said. “We have to win with the mass-affluent sector, we have to win in the main cabin and in the basic economy as well.”

At Delta, the addition of basic economy and premium select are the two biggest changes customers will see. Delta was the first of the major U.S. carriers to roll out basic economy, which gives passengers a seat in the main cabin (that cannot be selected in advance) but still comes with complimentary nonalcoholic beverages and snacks. The ticket price is meant to compete with the ultra-low-cost carriers, but Delta believes it has a value proposition those competitors can’t match.

“Basic economy is really designed for people whose primary needs are low fares,” Hauenstein said. “The key to the Delta thesis is when customers are making that selection, and flights are similar or fares are similar … we believe that our basic economy product will stack up better than our competitors’. … We’re a reliable airline, an airline you can track your bags on, an airline that gets you there on time with friendly staff and great technology and an airline that has your back if something goes wrong.”

Basic economy will grow from 38 percent of its domestic market in 2016 to 100 percent in early 2017. It will appear on international flights in 2017 and 2018.

Premium economy — or as Delta calls it, premium select — will roll out next fall on certain international long-haul flights. This new cabin class seeks to bridge the chasm between the main cabin and business class. In addition to bigger seats with greater recline, this tier includes a higher level of in-flight customer service and more luxurious bedding and food service. The top tier, Delta One, includes lie-flat beds and, soon, sleeping pods with a door.

The domestic equivalent to premium select is Delta’s first class. The airline has signaled it is likely it will eventually replace its domestic first class with premium select.

As the airline transitions its reservation systems and airplanes to be compatible with these new segments, the company’s explanations to customers will need to improve.

“We want to make sure our customers understand what they are buying,” Hauenstein said in a meeting with reporters earlier this year. “That is a hurdle you have to get through.”

Analyst Harteveldt said the airlines face “legitimate market challenges” as they try to make customers understand the segments.

“If you try to stand up for everyone, do you run the risk of standing for no one?” Harteveldt asked. “When you have to explain your product using a series of matrices, is that the right thing?”

But, he added, “Consumers are very smart and savvy today and the airlines aren’t the only industry that do this. Think about health care.”

Story and comments:  http://www.startribune.com

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