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Continental Airlines reported last week that it expects to generate up “in excess of $100 million dollars in net benefits” from their baggage fees over the next year. Following the trend of many U.S. airlines, CAL has put in place a $15 fee for the first checked bag for its domestic economy passengers. You have to wonder if their definition of “net benefits” would show that a customer lost to the competition is a “net benefit” since you won’t incur the cost of servicing that customer. Frontier Airlines demonstrated this week that it really isn’t a whole different animal by following the industry trend and introducing its own checked baggage fee schedule that starts with $15 for the first checked bag, $25 for the 2nd and 3rd checked bags, and $50 for the 4th and higher check bags.

Now, getting back to tort law, Frontier’s checked baggage fees make good fodder for my “damages” example. I.e., a $15 fee could be considered “nominal” meaning that it isn’t that big of a deal and gets the point across that, yes, checking in a bag for a flight is in fact a service that one could reasonably be expected to pay for. The $25 fee being more “compensatory” in nature, meaning that it is really just there to cover the costs of handling the extra baggage. Then, lastly, my favorite. The punitive fee of $50 for the 4th and all subsequent bags. Punitive meaning that it is really more like a fine than a fee. Clearly, such behavior is harmful to society and you need to be made an example of, lest others commit similar atrocities.

As fun as that all is, baggage fees really are, by and large, simply revenue grabs. An appropriate nominal fee would be $1, and a justifiable compensatory fee would be in the $5 - $10 range. I do hold, however, that $50 for any checked bag is really a punitive fee. It makes sense that handling and transporting baggage is a service, and providing that service costs the airline money that it should be able to recoup and, dare I say, profit from. However, what do you think it actually costs an airline to carry a 50lb bag on a flight? Well, if you are a 737-800 flying 1,200 nautical miles, throwing one more 50 lb bag onto an already loaded aircraft would mean that would burn about 1 extra gallon of fuel on the flight. In economic terms, the marginal fuel burn for 50lbs is about 1 gallon. An A321 flying coast-to-coast would need about 2 extra gallons of fuel to take on that extra 50lb bag. Keep in mind, though, that most short haul flying is less than 500 nautical miles. Granted, there is also a ground handling cost involved which I don’t have a good estimate for, but I would guess to be around $1 per bag at the margin.

Now, no one will blame a money losing airline for trying to increase revenues, but in a highly competitive market you have to be suspect of prices that grossly exceed the marginal cost of providing the product/service. They are just not sustainable. In other words, if there is that much margin built in to baggage fees, then you have to expect that they’ll eventually be competed away. Indeed, Southwest is making quite a big deal of the fact that it does not charge such fees. Now, that isn’t to say that baggage fees, in some form, won’t hold. I think “nominal” and “compensatory” level fees, to stick with the analogy, can stand up to competitive pressure, but $50 for a second bag will likely cost United more money in lost customers than it will generate in revenues.

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People who have been in the leasing business for a long time are probably enjoying the irony that it is the lessor who is being dragged down by the parent company this time around.

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Good thing that investment banks don’t have to merge seniority lists…

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Here is the A380 taxiing for takeoff.

As the A380 was taxiing, the Dream Lifter landed.

I thought it was a rare opportunity to capture both an A380 and the Dream Lifter in the same frame. Here the A380 climbs out while the Dream Lifter taxis to parking.

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For those of you not familiar with Germany’s geography, Cologne is less than 40km (about a 30 minute train ride) from Dusseldorf, so the notion of connecting through Heathrow to get there, while adding 6 hours to your trip, is ludicrous. This would be about like flying through Detroit to get from Midway to O’Hare.

Another attempt and things got a little better:

Now we can fly from Dusseldorf to Frankfurt (55 minutes) and take the 74 minute train ride from Frankfurt to Cologne.

This is all amusing enough, but it does make me wonder, though, if any poor souls have been unfortunate enough to unsuspectingly purchase tickets for, and fly on, similar nonsense routings.

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2008 should prove to be an interesting year for leasing companies (and obviously the airline industry in general). On the one hand, $100+ oil will compel carriers with an older, fuel inefficient fleet to update at least a portion of their aircraft. On the other hand, if a recession develops and demand severely tapers off, carriers can just ground those old jets. If times get too hard, and those old jets are on lease, some leases could be cut short or renegotiated. My crystal ball isn’t working properly today, though (I think it is out of compliance with an AD mandated inspection), so I guess I’ll just have to wait and see.

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So, why, exactly, is it that international business class flying is so much more lucrative than “normal” flying? I see two predominant factors at play: restrictive bilateral agreements and “soft” competition on international routes. Typical bilateral agreements between nations put a cap on the number of flights between two sovereigns and the respective governments are typically responsible for awarding routes to airlines. These were effectively government sponsored monopolies on routes. Additionally, I believe competition has been relatively soft on these routes because the major carriers are better at not triggering price wars, which is a lot easier to avoid when you don’t have LCC’s flying the same routes.

The business landscape on this lucrative flying is changing very quickly and the factors that allowed for abnormal profitability are waning. The EU-US Open Skies agreement obviously opens up the trans-Atlantic flying to new market entrants and therefore increased competition. Market entry by the all premium class international carriers such as EOS, SilverJet, L’Avion, and MaxJet (which has already gone out of business) simply prompted the carriers whose business these new entrants intended to steal to react with similar offerings. British Airways (flying an A318 to where?!?!) and American Airlines have responded with increased amenities and offerings for the premium international traveler on trans-Atlantic routes, and Singapore International Airlines has just announced that they intend to the same on the trans-Pacific front. Add to that the desire of Low Cost Carriers to enter the fray, the prime example being Ryan Air’s stated intention of offering bargain fares to cross the pond.

Expect abnormal profitability from international routes and business/premium class customers to be competed away (think “reversion to the mean”, for you statistics-minded people out there). In the end, “lucrative” is great if you are in business, but “sustainable” is probably better. Mark my words, competition for international and business travelers will get vicious, first on the EU-US routes followed next by US-Asia routes. Airlines that are relying on this business to subsidize other pieces of their enterprise need to get in front of this and expect a reversion to normal levels of profit from this component of your business (it’s scary to think what “normal levels of profit” means in the airline industry). It won’t happen over night, but expect it to happen.

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