In an attempt to be a cost conscious business student in a long distance relationship, I chose to fly Spirit Airlines for the first time to visit my partner in Miami. The cost of a flight from Boston to Miami? $70.
Like many others, I postulated that this was too good to be true. It wasn’t until after my purchase that I realized how Spirit made this possible. I was not fond of my experience on the airline but to be honest, would certainly fly it again – primarily because my wallet is so grateful.
Spirit Airlines operates on a paradoxical paradigm. In a Consumers Report published survey, Spirit came in dead last out of all carriers rated – yet is the fastest growing and most profitable domestic airline, in terms of operating margin and return on invested capital. What explains this phenomenon for the ‘most hated airline in the world’ and how are they able to pull this off?
Low costs and revealed preferences
The company’s business model is centered on using lower fares to stimulate travel demand among people who are desperate for a cheaper alternative or would otherwise not fly. The lower Spirit pushes its cost, the lower the fare price it can accept while simultaneously earning a robust margin.
Spirit is in many ways the antithesis of the traditional airline by flipping the model of providing comfort and service on its head by stripping the experience of all the amenities consumers are accustomed to. The fare price captures only the value of the seat; other services such as picking a seat, checking-in in person, checked bags and even water among other things carry an additional fee. Traditional airline pricing builds most of these costs into the fare and essentially charges the customer for these amenities regardless of whether or not they use them.
Spirit is able to capture cost savings by charging customers only for what they use. Other airlines claim that their checked bags are free but the reality is that their tickets cost, on average, $60-70 more. Bags add a huge cost to airlines for multiple reasons. In addition to the extra fuel needed due to heavier cargo, airlines need to pay for the labor, the bag belt at the airport, insurance to cover broken bags, etc. Sprit shows their customers that they are valued not through the amenities they are familiar with but rather through the low prices offered.
Given the common complaints voiced by consumers and the plethora of damning survey results, one would assume that Spirit is heading for disaster but that appears to be far from the case. This can be attributed to the gap between stated preferences and revealed preferences. Although customers, myself included, are quick to voice our frustrations about the experience – many of us are quick to book Spirit again if it leads to material cost savings. Spirit is able to target a large portion of the consumer segment that says that they, above all else, want the lowest possible fare.
Spirit, though unconventional in the American landscape, is in many ways seeking to emulate other low-cost bargain airlines such as Ryanair and Air Asia. Despite the exorbitant about of disdain for the firm, it has proven to be a success with profit margins almost double that of many competitors. Spirit’s profit margin is at roughly 11.7% while American Airlines operates at a margin of 6.8% and both Delta and United operate at roughly 3.0%.
A changing landscape
With all that said, it is critical for Spirit to sustain this competitive advantage in an increasingly competitive sector. 2015 has proved to be a challenging year for Spirit with stock prices tumbling by more than 50%. This is attributed in part to American Airlines’ aggressive price matching-strategy that has deeply cut into Spirit’s revenues and profits. However, the caveat here is that American’s significantly higher costs will make it tremendously difficult to sustain this strategy. As a result, well-managed companies with sustainably much lower costs than their competitors tend to do very well over time – just look at Wal-Mart and Costco over the past few decades.
There are many who are willing to put up with various inconveniences and/or minimal service levels to save money. As airfares are rising across the board, due primarily to consolidation, many Americans may decide that saving $100 or more is worth a bit of momentary indignity.