Airline Fees: A Race to the Bottom

February 28, 2010

A recent NYT article touched on the issue of charging airline passengers fees for small components of the service experience.  How close are we to the world that a Southwest commercial famously parodied, where customers have to scrounge for quarters to open up the overhead bins?  Not far, it seems.  Airlines have an emotional hurdle to charging extra for carry-on bags, but virtually everything else is fair game.

The economics of this decision are understandable.  Airlines have been losing money on ticket prices, claiming that the prices the market will bear are not enough to cover their unyielding costs.  The revenue they get from fees drops almost directly to the bottom line.  Fees translate into “pure profit” because there is very little incremental cost in, say, sitting in an aisle seat.

But as airlines chase each other down the fees rabbit hole, customer goodwill is likely to follow.  Customers hate being nickled and dimed in-flight, particularly those who fly regularly.  So why do so many airlines think they’ll prevail by giving their best customers a reason to hate them?  It feels like an entire industry is throwing in the towel.

The game is over when service executives assume that customers don’t value the difference between good and bad service. When this happens, whole industries can get stuck in a competitive death spiral where they try to get a larger and larger piece of a fixed pie they share with their customers.  This is happening with airlines today, but it doesn’t have to be this way.  Competing on service can increase the size of the pie and make everyone better off (customers, employees and owners), even in low-margin businesses.

Why is it so difficult to make this leap?  Because differentiating, by definition, requires doing things differently.  Managers with things to lose (a career in a conservative culture) have powerful incentives to keep doing the same things only harder, to run faster than their competitors rather than create a whole new game.

Most airlines are not just running the same, tired race — they’re now asking their customers and employees to do the running for them.  That’s what the proliferation of fees represents.  Rather than delivering an exceptional experience or innovating on costs, airlines are designing elaborate schemes to charge customers extra without giving them anything in return.  And then they’re throwing their frontline employees out there to deal with customers’ angry response.  My advice is to reroute the creativity from fee schemes to service.  We’re getting close to the point where most airlines have nothing to lose from trying.

Good Government and the Quest for the Palatable Fee

April 13, 2009

A recent NYT article discussed the growing trend among cities to cover revenue shortfalls by charging fees for municipal services.  One fee, in particular — the “cash-for-crash” fee  charged to drivers for the police response to their accidents — is stirring outrage.  Not coincidentally, it also has a limited compliance rate. Only 20% of citizens paid up in the city the article mentioned.

What’s driving these dynamics? And should we care? As the article explains, fees can appeal to our sense of fairness:

Politicians tend to regard fees as more palatable than taxes, and more focused too. If a state needs to finance an infrastructure to oversee fishing, why shouldn’t fishermen foot the bill?

Palatable is exactly the right word here. Fees for new infrastructure may indeed seem reasonable to taxpayers, particularly if it’s a public investment that only a small percentage of citizens will ever use. But fees for services at the core of the contract between citizens and government, fees for things our taxes have been covering for centuries (like police response), are much harder to swallow.

Should cities in crisis waste any time on the search for the palatable fee? A look at IRS compliance rates might give some public servants a reason to pause. The IRS has a very high tax compliance record compared to other countries.  The US is at 85% compliance, for example, while many other countries are in the teens.

This high compliance rate means that the cost of collection is low, and the revenues collected are high. Maintaining high voluntary compliance is essential to making the system work. Voluntary compliance is driven largely by things such as belief in the fairness of the tax system in terms of who pays and how the money is spent.  The perception of corruption, for example, translates into low voluntary compliance rates because citizens don’t trust that their money will be spent on the collective good.

As described by a deputy commissioner of the IRS in a case I wrote several years ago:

When you go down to any country in South or Central America
and you sit down with their commissioner of taxes, they just marvel at our compliance levels, because in their countries they say they can’t even measure, but generally, it’s single digits, 7 or 8%. The rest is enforcement.

The risk of a public revenue strategy that feels unfair is that citizens will eventually stop paying. Even in God-fearing, tax-paying America? I would suggest that the lack of compliance with U.S. cities’ new cash-for-crash fees is a big red flag. When “unpalatable” hits critical mass — as it has in many Latin American economies —  the focus shifts from maintaining high voluntary compliance to investing heavily in enforcement. The economics of the former are far more appealing than the latter. To say nothing of the reelection implications.