Alaska Air Group, Inc. (ALK)’s Remarkable Revenue Strategy

Last week, Alaska Air Group, Inc. (NYSE:ALK) announced that it would raise its fees for checked baggage, from $20 to $25 for each of a passenger’s first two checked bags. The announcement had a palpable impact on the company’s stock price: shares rose 7.7% on the day of the news. Along with increasing flight change and cancellation fees, the company estimates that it will increase revenues by $50 million annually.

Alaska Air Group, Inc. (NYSE:ALK) is a leader in ancillary revenue (add-on revenue not included in the basic price of an airline ticket). According to IdeaWorksCompany, an airline revenue consulting company, Alaska Airlines ranked 10th among global airlines in 2012 in the category of Ancillary Revenue Per Passenger. As you may have noticed if you’ve traveled recently, ancillary revenue is increasingly a favored method by which airlines increase their sales, from charging for baggage, to selling merchandise during flights, to issuing co-branded frequent flyer miles credit cards with major banks.

How much of Alaska Air Group, Inc. (NYSE:ALK)’ revenue comes from these ancillary services? The following table shows the relationship between ancillary revenue and total revenue, both for Alaska Airlines, and for four other major U.S. carriers: United Continental Holdings Inc (NYSE:UAL), Delta Air Lines, Inc. (NYSE:DAL), AMR Corp (OTCBB:AAMRQ) — parent of American Airlines, and Southwest Airlines Co. (NYSE:LUV) :

Alaska Air Group, Inc. (NYSE:ALK) is second only to United Continental Holdings Inc (NYSE:UAL) in the percentage of total sales that derive from ancillary revenues. Incidentally, this comparison group is not chosen at random: United, Delta Air Lines, Inc. (NYSE:DAL), American, and Southwest Airlines Co. (NYSE:LUV) rank one through four, respectively, worldwide in terms of total annual ancillary revenues in dollars. It’s interesting that United derives more yearly ancillary revenue, $5.3 billion, than Alaska’s total yearly revenue of $4.6 billion. But, as may be apparent from the table, just having a high percentage of ancillary revenue, or taking home billions of this revenue in a year, doesn’t necessarily make an airline hugely profitable. United, despite its high percentage of sales outside of ticketed fares, still lost money last year. Alaska Air Group, Inc. (NYSE:ALK) has the next highest percentage in the table, but it’s also by far the most profitable of the group. Does Alaska differ in its approach from other airlines in how it gains ancillary revenues?

Turning a hassle into a benefit

I’ve previously written about how Alaska’s management is tuned into its employee base, and how this boosts profit. Management also understands its customer base, and recognizes that the industry’s gleeful rush to tack on “a la carte” fees can backfire — ancillary revenue to an airline is, in many instances, interpreted as an upcharge or hassle by flyers. Ingeniously, over the last five years (since following other airlines and introducing fees for checked baggage), the company has turned the hassle of baggage fees into an incentive for customers, by introducing its “Baggage Service Guarantee” program, or BSG. While the company charges the now-raised fee of $25 for a traveler’s first two checked bags, it also guarantees that the bags will be delivered to the customer within 20 minutes of the flight’s gate check-in. If the airline fails in this promise, flyers can request a voucher that is good for a $25 discount off an Alaskan flight in the future, or 2,500 miles in the company’s “Mileage Plan” frequent flyer program.