Delta takes a risk on premium travel as a hedge against recession

As Delta Air Lines (DAL.N) tries to shore up its defenses against a downturn in the economy, it is doubling down on more profitable premium travel in an effort to boost profits.

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The airline's chief executive, Ed Bastian, told Reuters this summer that premium seating would be available on every plane it flies starting this summer. At the moment, Delta's fleet consists of dozens of 50-seat planes, accounting for only about 2% of the total number of planes in service.

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Overall, the Atlanta-based carrier, which will report its quarterly earnings on Thursday, said it would be able to offer 15,000 more premium seats a day across its network this year as compared to the pre-pandemic period. Further details were not provided by the company.

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According to Bastian, Delta wants to attract travelers who are willing to pay for more than just a seat, thereby contributing to it growing its profits over the long run.

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"In addition, it keeps us from falling into the commodity trap, where we are trying to win this battle based only on price alone," he said in an interview.

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As part of its strategy, it is betting that the spending of affluent leisure customers, who have flocked to premium cabins over the years, will be less impacted by any potential downturn. When corporate bookings were weak last December, President Glen Hauenstein described them as a "great shock absorber" in the face of the weak economy.

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In addition to United Airlines (UAL.O), American Airlines (AAL.O) are also pursuing premium revenue in order to compete with them. By 2026, United Airlines hopes to have 53 premium seats on each flight in North America, which is an increase of 75% over what it had in 2019. It has been announced by American that it plans to increase the number of premium seats on its long-haul flights by 45% by 2026.

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"Travel as a whole, not only in terms of air travel but the entirety of it as a percentage of GDP is holding, if not growing as a percentage of the GDP," Vasu Raja, American's chief commercial officer said in a statement. "The fact that inflation is so high in this world is quite striking, especially in a world like ours."

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United and American Airlines do not report the share of revenue that comes from premium seats in their revenue statements. This share of Delta's passenger revenue has increased to 38%, which is a three percentage point increase from before the pandemic.

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It is expected that the contribution of premium cabins to Delta's revenue will increase by one to two percentage points every year for the next several years, according to Bastian.

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The number of seats they will occupy on Delta's flights is predicted to grow to 30% by next year, up two percentage points from 2019. As the Boeing MAX 737-10 fleets is set to be added to the fleet in the near future, the mix of premium seats in the fleet is expected to increase even further, which will be around 35% when the planes are delivered in 2025.

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The growth of Delta's economy seats has been at the expense of low-fare basic economy seats, which account for less than 5% of Delta's seats at the moment. It opens up the possibility for the carrier to grow revenue through non-ticket sources, such as loyalty credit card fees, checked bags, and extra legroom, in addition to ticket sales.

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It has been reported that Delta is on track to generate more than 60% of its revenue from premium seats and non-ticket sources next year, up from 53% before the pandemic hit.

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There are instances when premium seats, which offer a higher level of comfort and upgraded services at airports and in flight, can be at least twice as expensive as standard economy fares in some cases. Moreover, analysts have calculated that some of these cabins can be up to seven times more profitable for airlines than any other cabin in the sky.

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During the pandemic, Delta's profits and revenue growth from its premium cabins has outpaced its profits and revenue growth from its low-cost seats, according to Bastian. The data indicates that there has also been a sticky demand for premium seats, with over two-thirds of customers indicating they intend to repurchase premium seats in the future.

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Having a reliable on-time operation in terms of arrivals and departures is key to the success of this strategy, according to Robert Mann, a former airline executive who now runs a consulting firm. "This is sort of a litmus test," he explained.

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The summer of last year was a challenging time for Delta and other carriers as they struggled to operate smoothly. After flight cancellations and delays caused chaos for customers throughout the rest of the year, the airline had to limit the number of flights it was offering for the rest of the year.

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Even though Delta had some stumbles during the past year, data from consultants OAG and Cirium showed that it was the most punctual U.S. airline for the year.

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Delta aims to improve its performance in the coming years, said Bastian. According to him, it doesn't matter if you create a product that is a premium one if the customers are going to be late, or if they are going to be canceled on it.

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Changing Travel Patterns

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During the post-pandemic period, travel patterns changed in a drastic way, which in turn has led to the desire for premium revenue.

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Several airline executives have been quoted as saying hybrid work arrangements are allowing people to combine business and leisure trips, allowing them to travel more when they have disposable income available to them.

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Scott Kirby, the CEO of United Airlines, talked about how hybrid work was allowing everyone to have a holiday weekend every weekend.

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Typically, corporate travelers would book high-margin seats for their flights, but it is helping carriers fill those seats, which are high in the margin. Airlines and experts alike see this trend as a long-term one, contributing to a decrease in cyclicality in the airline industry.

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A great deal of American Airlines' revenue comes from customers who combine business and leisure trips when they book an airline ticket. In addition, these travelers tend to spend a higher amount than a typical business traveler, according to the airline.

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Airlines for America, one of the largest trade groups that represent the airline industry, estimates that business travel used to generate as much as 50 percent of passenger revenue for major U.S. carriers prior to the pandemic.

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"Consumer purchasing power is one of the most important factors to consider," said John Grant, senior analyst at OAG. "However, when it comes to travel and holidays, they have just become a necessity."