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United: It's in the Bag Fees

United's charging for a second bag underscores its persistent search for new revenue.



) -- It hardly seemed epochal when top managers at


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came up with a new idea near the end of 2007: Why not charge passengers $25 to check a second bag?

For United, the fee represented a small piece in a far-larger effort, as fuel prices soared, to more closely align airline costs and revenue. It seemed unlikely to impact many passengers, because just one in four checked a second bag, and some of those would be exempt due to having elite status in United's frequent flier program. Additionally, the idea was not unprecedented: while no major carriers had bag fees, low-cost carrier


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and some international carriers did.

Announced in February 2008, United's fee triggered some passenger protest, but most competitors gradually matched. Eventually,



went further, adding a first bag fee in June 2008. And this year, each of the three largest carriers will collect more than $1 billion in new revenue from fees, with bag fees as a major component.

FTN Equity Capital Markets analyst Mike Derchin says United not only pioneered bag fees, but also has had success marketing seat upgrades through Economy Plus, extra-legroom seating, starting in 2006. "In the past few years, they've definitely been thinking outside the box," he said.

In imposing the second bag fee, United's focus was that "transportation is the core product, point A to point B," said Jeff Foland, senior vice president for sales and marketing. Extras, such as food, better seats and faster airport experiences should cost extra: In particular, checking bags involves additional costs such as increased fuel burn and maintenance of a costly baggage handling infrastructure.

The "core product" concept was developed within a group of five to 10 top United managers, headed by President John Tague, who meet weekly, Foland said. He could not recall who originally suggested a bag fee, but United was already making money by charging for better seats as well as for snack boxes. "We talked about the concept for awhile," he said. "We (envisioned) a different way of selling (because) the industry has been unable to extract value from the travel experience."

Foland noted that


, United's Star Alliance partner, sells products such as enhanced airport lounges, from which passengers are driven to their flights. Other possibilities could emanate from the frequent traffic on United's Web site, which gets about 3 million hits each day. After all,


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has found a lot of ways to sell products beyond hamburgers, and hotels sell products beyond rooms. "We're not the first industry to do this," he said.

So far, United shares have not derived much benefit from the innovation. Following Monday's close, shares were down about 30% year to date. While not pretty, the number puts United in the middle of the pack among its peers.


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is down 21%;


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is down 28%; American is down 43% and

US Airways


is down 52%.

John Gebo, managing director of investor relations, notes that United has been hurt more than its competitors by two trends: travel declines in the Pacific, where United is the second largest player, and a decline in business travel. Now, both areas are showing signs of recovery.

Overall, United has fallen back from the time it was the world's largest carrier. Between 2000 and 2008, the fleet shrank by a third, the workforce shrank by half and the passenger count shrank by 38%. United's competitors also shrunk, as they too turned over flying to lower-cost regional partners, but they also expanded through acquisitions. While reducing unprofitable flying has boosted results, it has chipped away at employee morale.

Derchin said Wall Street has been giving United a second look. "Wall Street felt that in bankruptcy United could have gotten more cost out, but since they exited (in 2006) they've continued the process," he said. "I think in recent years they've felt United was doing a good job, given the tough hand they've been dealt."

-- Written by Ted Reed in Charlotte, N.C.