Premium economy bungle has cost airlines billions

24
March 15, 2021
Premium Economy
Air New Zealand’s award winning premium economy offers the most legroom. Credit: Supplied The interior of Air New Zealand's new Boeing 787-9 Dreamliner, Monday, July 7, 2014, in Seattle Washington. (Bret Hartman/Air New Zealand)

Premium economy is the airline industry’s greatest missed opportunity of the past 30 years and is now its most profitable product. Billions have been lost because airline chief executives feared a new cabin class between business and economy would result in the high yield business class passengers moving to premium economy.

What so many didn’t understand was that long-suffering economy passengers were clamouring to be liberated from cramped seating and screaming kids, and were prepared to pay for the privilege.

Emirates, one of the last adopters, in February 2021 conceded that it is stunned by the demand for its new premium economy class. President Sir Tim Clark told a Centre for Aviation conference in Sydney Australia that “we at the airline had been absolutely shocked at the level of demand for the seats. People have been clamouring to get into them. They have been paying whatever we’ve asked them to pay to get into the cabin because it is a delightful cabin,” he said.

“For the first couple of months, this cabin has been completely booked, and it’s been a good test for us to see how we can deliver.”

Sir Tim said the demand was all the more incredible because the airline had not been “delivering the full premium economy. We haven’t changed the menus out, we haven’t changed the wines, etcetera … we just provided the seats and goodness me, it’s been very popular.”

“Other carriers that have introduced it, many of our competitors in the European and Asian fields, swear by it.” Mr Clark said.

Emirates
Emirates Premium Economy

And internally, Emirates is cursing that they didn’t introduce the product years ago when industry watchers urged them to do so.

In the 10 years to FY20 Emirates carried 478 million passengers and if just 5 per cent of those had flown PYC and paid just $1,500 extra it would equate to a staggering $35.8 billion in revenue.

Recently, Lufthansa told the FT.com that its premium economy was 6 per cent more profitable than business class and 33 per cent more profitable than economy.

According to a 2015 study The rationale for implementing a premium economy class in the long-haul markets by Cindy Hugon-Duprat and John O’Connell (Hugon-Durat et al.), leisure travellers are willing to pay between 30 and 50 per cent higher fares for premium economy.

In fact, the reality is, according to a study done by Airlineratings.com of the Sydney to London fare since 1990, the economy fare of the year 2000 is the premium economy fare of today.

Hugon-Durat et al. (2015) cited Balcombe et al. (2009) which used a Bayesian method to estimate a mixed logit specification and found that in principle passengers are willing to pay a relatively large amount for enhanced service quality that includes seat comfort, which encompasses enlarged pitch and width.

In the aftermath of the GFC, Cathay Pacific Airways in 2012 reported that an 83 per cent fall in profit was largely attributed to declining yields as a result of tightening of corporate travel policies with business passengers having to travel economy as, at the time, the airline did not have a premium economy cabin.

Industry analysts Counterpoint Market Intelligence told Airlineratings.com that “Premium Economy for airlines allow the opportunity to attain a high yield revenue opportunity for a minimal increase in real estate consumption and service costs.”

But Emirates is certainly not alone in missing the opportunity. Premium economy was first introduced by Virgin Atlantic and EVA Air in 1991, as a super economy service. Industry analysts lobbied both the then Cathay Pacific Airways CEO, the late Peter Sutch and Qantas CEO, the late James Strong, to introduce premium economy in 1996 and went as far as sending a formal presentation of converting one zone of the economy on a 747 to premium economy.

Both airlines rejected the concept with Mr Strong, saying the airline “couldn’t make the business case”.

That was despite Australians being the second tallest passengers who travelled on average the greatest distances. At the time, return business class fares to London were about $8,000, with a big gap in economy fares at $2,500.

British Airways however certainly could make the business case and filled the price gap with its premium economy service, which it called World Traveller Plus, in 2000. In a 2003 interview with the author, then chief executive Rod Eddington said the class was “extremely popular” but not to publicise the fact because he didn’t want his competition to know.

Air New Zealand was on the case with then-chief executive Ralph Norris introducing premium economy with a modest 12 seats on the airline’s 747s in 2004. Quickly that number grew to 54 seats on the airline’s 777-300ERs and 33 on the 787-9.

Qantas finally added premium economy to its A380s, which were first delivered in 2008, and later refitted its 747s. In a 2008 interview with the author, retiring Qantas CEO Geoff Dixon conceded that not putting in premium economy earlier was “a big mistake.” It upgraded the product in 2017 for the Boeing 787-9 which operates the Perth to London non-stop service. Cathay Pacific Airways added the class in 2012 and Singapore Airlines in 2015.

premium economy
Qantas Premium Economy.

Counterpoint Market Intelligence defines PYC as having seats wider than 18 inches and seat pitch greater than 36 inches. It notes that “it is likely that innovations in this sector will require development in new and innovative construction techniques and an understanding on how the airline pricing model for this sector can be flexed to attract full fare YC passengers to pay extra. There are a number of new products showcasing in this sector that give the passenger more comfort/separation.”

However, there are vast differences in the premium economy offering. Air New Zealand, which has the most legroom, serves premium economy passengers using the business class cabin crew and wines, whereas some other airlines service the zone using economy class crew and wines — a noticeable difference.

Counterpoint Market Intelligence says “understanding the market drivers more precisely is the key to innovation in this sector; how can an airline motivate an economy passenger to pay extra without eroding attractive high revenues from business class passengers, who might downgrade to increasingly attractive premium economy.”

It notes that “long haul air travel is still a class experience; in general, the rich at the front and the poor at the back.  As a result, it heightens people’s awareness of their status. They become conscious of their position in the plane, particularly on long haul flights when, as journey length increases, comfort levels decrease.”

It adds that “what people like about premium economy is that it offers an affordable escape out of economy and perhaps, more importantly, an opportunity to improve their status. The psychological effect of being ahead of a YC cabin makes people feel better about flying. This also has a positive effect on the (airline) brand.”

The additional comfort of premium economy is one of the biggest drivers to purchase a more expensive ticket. “Physical comfort is key,” says Counterpoint Market Intelligence. “For flights over 5 hours, passengers felt there was justification in paying a premium for greater levels of comfort.”

Hugon-Durat et al. (2015) found that premium economy cost of production was 1.6 times more expensive than an economy seat, while business class seats were 3.5 times more expensive to produce than economy.

To ascertain the financial viability of the cabin, the study used a Boeing ICAS (Integrated Cost Analysis System) simulation model. “As expected, business class outperforms all the other cabins, but the simulation confirms that premium economy is a close follower, while economy class produces only marginal returns whereas first produced losses, mostly attributed to its low load factor association,” Hugon-Durat et al (2015) said.

“The ICAS model established that premium economy generates the highest revenues per cabin when compared to its cost of production – it generates revenues that are 2.3 times higher than its cost of production. This evaluation further endorses the rationale that underpins the decision to install premium economy and it implies that if airlines scale up the number of available seat miles in premium economy, profits per passenger could be further maximised assuming strong load factors are applied.”

It seems extraordinary that it has taken some of the world’s top airlines almost 30 years to adopt a class, the business case for which, was utterly compelling at the outset.