When you ship a package with United Parcel Service (UPS) or FedEx (FDX), those companies don’t fret terribly about fuel costs. That’s because they assess a fuel surcharge based on market prices so that the customer, not the freight carrier, pays for the gas. Now the chief executive of ultralow-cost carrier Allegiant Travel (ALGT) says he’s ready to try a similar approach on airfares.
Allegiant CEO Maurice Gallagher Jr. would let travelers choose whether to lock in a set, higher fare or pay a lower ticket price in exchange for shouldering any changes in fuel prices before their travel date. Those dice-rolling fliers would, based on fuel prices, pay an additional amount or receive money back if energy costs fell in the period between booking and flying.
“We’ll be the Mikey in this thing,” Gallagher told aviation executives Sept. 17 at a forecasting conference in Dallas, referring to the 1970s Life cereal commercials about a child who would try things that his siblings would not. “We’ll go out and stick our neck out and take on the [Department of Transportation] if this price of fuel continues.”
Unlike the major airlines, Las Vegas-based Allegiant is disproportionately dependent upon leisure travelers, who often plan and book their trips to vacation cities like Las Vegas, Phoenix, and Orlando months in advance. The no-frills airline has virtually no business travelers, the kind of passengers who buy a full-fare ticket a day or less before traveling. That’s one reason Allegiant—which does not hedge any of its fuel purchases—is willing to risk regulatory resistance and consumer confusion with a “variable pricing” mechanism aimed at recovering some of its fuel costs. At Allegiant, 80 percent of an average month’s ticket revenue is sold by the start of that month, Gallagher said. That leaves the discount airline more exposed to fuel price increases than many carriers.
One big wrinkle? In April 2011, two months after Allegiant first floated the idea, the Department of Transportation imposed new rules aimed at enhancing consumer protections in air travel. Among the bevy of requirements was one that prohibits post-purchase price increases except for boosts in government taxes or fees. “They said not only no, but hell no,” Gallagher told conference attendees. “We’re going to work on that.”
Gallagher says Allegiant would need six to 12 months to build the technology into its website and potentially longer than that to persuade regulators about the wisdom of this pricing model. “We as a company are not ready for it mostly because our automation is not ready,” he says in an e-mail.
Department of Transportation rules would allow Allegiant to collect extra money for fuel if the ticket sale is structured as a partial payment, as some tour operators do. “Our rules do not prohibit airlines and ticket agents from selling tickets in which passengers pay part of the fare immediately and the rest later, with the final payment dependent on changes in fuel or other costs,” DOT spokesman Bill Mosley wrote Sept. 24. For Allegiant, the bigger challenge will be to design a sale process on its website—where it sells more than 90 percent of its tickets—that will pass muster with regulators and consumers in terms of clarity and transparency about the transaction.
Still, even if Allegiant gains federal authorities’ permission to dun consumers for jet fuel after a booking, it’s hardly clear that the rest of the industry would rush to emulate the practice, says Vicki Bryan, a senior analyst with Gimme Credit, a bond research firm. For one thing, big airlines typically match fares on competing routes and none of them wants to be in the market priced even a penny above rivals. Second, a post-purchase charge (or refund) could prove to be a logistical burden for airlines that are massively larger than Allegiant, she says. And there’s the difficulty of explaining the optional pricing program so that average buyers can understand it.
Any recovery on rising fuel costs that the airline could achieve would immediately help its bottom line. “Pennies count” for Allegiant’s business, Bryan says. “No one thought that customers would pay for bag fees. And they have. I’m not willing to just say that it’s not going to work but it’s very unique to [Gallagher] and his situation and to his business model.”
Airlines have far different mixes of traffic, depending on day and route, Bryan notes. So it would be unlikely that many would use the fuel surcharge approach across the board. For example, a carrier flying business travelers between Atlanta and Chicago on weekdays would be less likely to assess a post-ticketing fuel surcharge than it might be on leisure traffic to Florida, Hawaii, and California at holidays, times when families usually plan such trips months ahead. “They’ll do it sporadically on specific routes,” Bryan says.
Gallagher, an airline veteran who helped found ValuJet, the precursor of Southwest’s (LUV) AirTran unit, joined Allegiant when he acquired it as part of its 2000 bankruptcy reorganization. The company targets a 90 percent load factor for all of its flights, higher than the industry average, and collects from passengers one of the highest amounts of ancillary revenue per flight in the industry, $33.90 in the latest quarter, for everything from making a reservation on its website ($10) to checking a bag at the airport ($35) to buying an in-flight soda ($2). Allegiant’s average fare—before all the extra fees—is $89.
Gallagher says that separating fuel from the cost of an airline seat is the next logical financial step for low-cost airlines. “If you truly want to build a strong [airline] industry,” he says, “volatility of fuel suggests we have no business being in the fuel business.”
