MIAMI — Passengers flying on Delta Air Lines may notice a new feature available on select routes: an intriguing “Basic Economy” fare. After testing the viability of a new fare class for a few years, Delta formally revealed “Basic Economy” on October 8, 2014 for bookings after February 1, 2015. “Basic Economy” features lower ticket prices, but also a pallet of notable restrictions, including an inability to change the reservation, refund the reservation, or pre-select seats.

Delta’s introduction of its “Basic Economy” class largely represents a competitive response to pricing pressure exerted by a string of ultra-low-cost carriers (ULCC’s), which attempt to undercut mainline carriers such as Delta by stripping out most elements commonly associated with a ticket but the right to a seat itself on the plane. This practice, commonly known as “unbundling,” allows ULCC’s to offer lower base fares, with other complements to a ticket accompanied by an additional charge. By unveiling “Basic Economy,” Delta demonstrates a sensitivity to ULCC’s, which have recently encroached more heavily within its primary markets.

In particular, Delta seeks to fend off an invasion on its Atlanta hub. Both Spirit and Frontier – two notable ULCC’s – have intensified their service to Hartsfield-Jackson Atlanta International Airport, adding a number of new routes from the airport. Spirit represents an especially formidable threat with which Delta must combat. ULCC’s primarily target a leisure-minded audience, ferrying passengers predominantly to vacation-oriented destinations. Not surprisingly, Delta’s “Basic Economy” fares apply only to leisure-dominated routes, most of which harboring competition with Spirit. It opened the new fare class for booking to thirty-three destinations from four of its hubs, reflecting a very narrow response to routes under fire.

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While adding a variety of new routes conflicting with Delta, Spirit most often comes nowhere near matching the frequency Delta offers on each route, usually only supporting one or two daily flights. Delta’s response suggests that even small amounts of direct competition may negatively impact its profitability and warrant retaliation.

Delta hopes that fares competitive with those boasted by ULCC’s will re-capture some passenger traffic. According to economic theory, more price discrimination should appeal to a broader audience by maximizing overall consumer surplus. Delta must believe that it can persuade some passengers away from the arms of Spirit with a fare class matching its low “Bare Fares.”

The amount of success surrounding “Basic Economy,” hardly three months old, remains a bit ambiguous. If Delta accomplishes its goal at luring some passengers away from ULCC competitors, an uptick in load factors or an upswing in passenger traffic, adjusted for seasonal variation, along routes of interest might point (albeit not conclusively) in this direction. We currently lack data for the relevant time period, with “Basic Economy” initiated in February and Department of Transportation (DOT) data currently reaching only until January. But the extension of “Basic Economy” beyond Detroit, where Delta tested the concept, suggests the airline found a promising result internally with the concept.

“Basic Economy” reflects another trend overtaking the airline industry in recent years: a blurring distinction between full-service (FSC’s) and discount carriers. On the cost side of the equation, airlines have grown more similar than ever, fueled by economies of scale created by consolidation. A wave of mergers benefits FSC’s by reducing the cost assigned to each passenger. As shown in the graph from CAPA, the American region exhibits the smallest cost gap between FSC’s and discount carriers. On the product side, Delta’s new fare class only further diminishes the distinction traditionally separating FSC’s and their counterparts.

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However, while theoretically allowing the airline to widen its audience, Delta must also balance the desire for additional revenue with the need to maintain a consistent product image. Segmentation of the cabin increases the risk that passengers will experience the same flight differently. If fliers book “Basic Economy” tickets without a grounded understanding of the associated restrictions, this could lead to customer dissatisfaction, which may hinder Delta in the long-term.

Its “Basic Economy” rhetoric points to an overall experience consistent with traditional economy class, sporting only slight differences. But a customer anticipating the ability to change his/her reservation, or perhaps pre-select a seat for a fee, would likely view the airline very differently if these expectations do not materialize. While the responsibility ultimately rests with the consumer to understand the product being purchased, Delta must clearly communicate the nuances between fare classes if it chooses to pursue further segmenting the cabi

The challenge of misguided expectations poses a particular problem when customers book through independent sites, such as Priceline, Orbitz, and Expedia. Often, such agencies post the lowest available fare without sufficiently explaining the conditions underlying the price. Even if Delta handles the situation well internally, it runs the risk that misinformation will bleed through external sources.

Additionally, Delta’s strategy seemingly runs counter to that adopted by its rival, American Airlines. While Delta tries to further engage with “unbundling,” American has adopted a position centered around offering a list of fare packages that sandwich together multiple amenities for a reduced price. It aims to upsell customers, potentially convincing travelers to opt for more features when served together than when offered individually, leading to more revenue. After all, customers only realize the “savings” advertised with a bundle under the assumption that they previously intended to buy all elements of the package separately. While Delta has followed this path to a degree, American has done so most aggressively. The chart to the left illustrates Delta’s decision not to fuse key add-ons, such as a free checked bag, with its fare classes.

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American has publicly acknowledged pricing pressures exerted by ULCC’s as well, especially resulting from the expansion of Spirit in the Dallas market. However, American’s strategy may reflect less concern for the impacts imposed by these carriers, or just a dominant focus on generating more revenue. We should monitor American’s response in the coming years as it completes its integration with US Airways, which may tempt it to raise fares on formerly overlapping routes between the two – holes an ULCC might attempt to exploit. Delta instituted its “Basic Economy” class several years after it finished combining its operations with Northwest’s, so how American acts after it begins to fully realize the effects of its merger will be of particular interest.

“Basic Economy” evidences a new dynamic within the airline industry, one in which legacy airlines interact responsively with the ULCC’s rapidly gaining power in the market. Ultimately, Delta’s decision to establish “Basic Economy” as a permanent feature on selected routes brings it a notch closer to its ULCC competitors on the basis of price, an effect it obviously desires in the war to win passengers. But Delta must ensure that, with this move, its customer perception doesn’t slide downward with the price.

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