Southwest Announces a Merger With AirTran

Southwest Airlines announced earlier this week that it would acquire AirTran, America's third-largest discount carrier. The deal surprises many industry watchers, including yours truly, because it represents one of the most drastic changes from Southwest's tried-and-true business model which have worked so well for the company for nearly 40 years. Southwest will take on a new aircraft type with this acquisition--the Boeing 717, as well as enter new international routes in the Caribbean. It will add stations with low frequencies, and, it will finally gain access to Atlanta--a crucial hub and business travel market that Southwest has studiously avoided for years.

The deal is a big coup for Southwest, which has extended its dominance in the domestic industry and created a low-fare behemoth that will be hard for any other discounter (JetBlue, Republic, Spirit, or Virgin America) to match. It will also give the company increased pricing power in some markets which, due in part to ferocious low-fare competition between Southwest and AirTran, have very low yields, including Baltimore/Washington, Orlando, and Fort Lauderdale. While passengers are likely to see fare increases from any industry consolidation, these markets are most likely to see fare increases as the consolidated discounter cuts capacity in those oversaturated cities.

The conventional wisdom is that this deal will put enormous pressure on JetBlue, the last remaining sizable discounter, to find a merger partner quickly to achieve the cost synergies of its combined competitors. But as is often the case, I don't think this advice pans out. JetBlue has successfully leveraged its position as the largest carrier at New York's Kennedy Airport to forge codeshare relationships with a large number of international carriers, including Lufthansa, Aer Lingus, El Al, and South African Airways. JetBlue has also started a codeshare relationship with American Airlines, allowing JetBlue customers to access connecting destinations through Kennedy on American that JetBlue does not yet serve. These relationships do very little in terms of costs, in fact, they tend to increase the complexity of JetBlue's operations and likely raise costs. But the revenue benefits far outweigh any cost increases, and that will be the key going forward. JetBlue gains customers who would most likely otherwise fly on a different airline for their domestic segments, helping to fill aircraft in a very competitive market. As JetBlue's CEO has noted, JetBlue is most like Alaska Airlines, in that it has a very strong brand in its core markets (NYC, Boston, and Florida) with loyal customers who swear by the company. Similarly, Alaska has a plethora of codeshare agreements with other carriers which help feed traffic to the company's regional and Alaska routes while maintaining a loyal following in the Pacific Northwest. JetBlue does have relatively high costs, and while the company can make some adjustments to reduce these, it also operates in relatively expensive markets where it receives a price premium for its services, and the company has achieved a scale where further consolidation will have declining marginal returns to the bottom line.

This is not to suggest that JetBlue has no reason to worry. Southwest and AirTran will be an imposing force in the three big East Coast markets that JetBlue intends on growing in--Boston, NYC, and DC. These markets, popular with business travelers, demand high frequencies and service to a wide variety of destinations, which a bigger airline is more able to provide. The growth of Southwest in these markets will make it harder for JetBlue to carve out a niche with business travelers, and may subject the airline to continual price wars on key East Coast routes. But on the whole, JetBlue is an apt competitor and has built a strong following in its core markets. While the merger is not necessarily good for JetBlue, there should be no cause for alarm at JetBlue headquarters.

There are losers in this deal, and the biggest is likely Republic, the owner of the former Frontier and Midwest Airlines. The expanded Southwest will be a very imposing presence in this carrier's two biggest markets, Denver and Milwaukee. Southwest has publicly stated its intention to expand its operations in both markets, and the company has had enormous success in Denver, though mostly at the expense of United and not Frontier. I imagine, however, that as Southwest continues to grow in these markets that it will have a detrimental impact on the viability of Republic's mainline operations. The new Frontier lacks the same codeshare feed that JetBlue has, and although both Frontier and Midwest had a loyal customer base, it will be increasingly difficult to remain loyal to Frontier as it reduces the size of aircraft used on many routes (many of which lack the personal TVs and other amenities passengers are used to) while charging fees for many of the same services (such as checked luggage) that Southwest provides for free. Republic's smaller aircraft also have higher operating costs and are competing with larger, more fuel-efficient planes on many routes. And Frontier is not that well known outside of Denver (and now Milwaukee), and there may be relatively few opportunities for expansion, which would give the company further economies of scale that would enable it to more effectively compete with a combined Southwest/AirTran.

This is not to say that Frontier is doomed, but in that company's case, I think that further consolidation will be necessary to its survival. Possible candidates include JetBlue (which operates both A320 and E190 aircraft that Frontier does, and has LiveTV onboard), or Virgin America (which operates A319s and A320s like Frontier does). The third possibility, though unlikely, is US Airways, also an Airbus and Embraer narrowbody operator. While US Airways has had difficulty with mergers in the not-too-distant past, and is still sorting out some issues related to its deal with America West back in 2005, a merger with Frontier could be a very positive development for US Airways, if it could get the labor situation sorted out. The company would have a stronger presence in the Western U.S., and also potentially enhance its relationship with United, by providing feed to United's international flights from Denver. This is a longshot, admittedly, but it would make US Airways a larger domestic competitor and allow the company to diversify its route structure.

Obviously, the Southwest/AirTran merger is not a done deal yet, but if it goes through, it will clearly have considerable implications for the industry, and in particular the dwindling number of discounters left in the United States.

Mexicana Operations Suspended Indefinitely

Mexicana, Mexico's second-largest carrier, announced late today (Friday) that it will suspend operations indefinitely due to its continued financial quagmire. The company had been close to the brink for a month or so, but after suspending ticket sales and failing to reach agreement with labor unions on wage and benefit reductions, the company had no options which would have allowed operations to continue. Mexicana's sister carriers, Mexicana Click and Mexicana Link will also cease operations. Passengers with ticket reservations should consult the instructions on Mexicana's website for obtaining a refund.

Mexicana's demise is the result of bad management which left the airline with hundreds of millions of dollars in crushing debt which it could not realistically repay. On top of that, both of Mexico's large airlines have labor agreements which have left the carriers with extremely high labor costs. Unfortunately, Aeromexico and Mexicana have seemingly stood idly by while American carriers have trimmed labor costs in recent years and new Mexican low-cost carriers with lower labor costs have sprung up.

It does not appear at this time that Mexico's government will step in and bail out the carrier, a step taken by other governments when their airlines have been in trouble. Letting Mexicana fail is probably the right call. If Mexicana had more intercontinental exposure, then there may be a greater argument for bailing out the carrier, as it's harder to restore lost long-haul air links than short-haul. Mexicana had served London and Madrid, along with four cities in South America prior to its collapse. Aeromexico, on the other hand, serves two Asian destinations, three European destinations, and five South American cities. Mexico has plenty of low-cost competitors who will fill at least some of the holes that Mexicana leaves behind, and carriers such as InterJet and Volaris will likely use Mexicana's collapse to start new routes to the United States. It also may offer an opportunity for some American low-cost carriers, such as JetBlue or AirTran to expand their own offerings to Mexicana's hub in Cancun.

There aren't too many profound lessons which can be drawn from this announcement. Mexicana was a poorly-run company in a shrinking market. It had an uncompetitive cost structure relative to its competitors. All this announcement does is reinforce the trend which has been occurring in the industry globally for several years now. Short-haul travel is being taken over increasingly by low-cost competitors. In most cases, long-haul travel is needed to justify large hubs and Mexicana simply didn't have much long-haul feed. Mexico's lackluster economic performance (driven in part by the global recession, as well as the H1N1 flu) hasn't helped stimulate business travel to help sustain services. Hopefully, Aeromexico's unions will see this announcement as a wake-up call, that their airline, too, could face serious pain if their company's costs are not realigned with what the market is offering. We can only hope that the vacuum left by Mexicana's departure can be filled swiftly and reliably by other carriers, and that other airlines in Latin America will not face the same fate that Mexicana has.

Alaska Takes a Preemptive Strike on Allegiant

Alaska Airlines announced this morning that it will start nonstop service between Bellingham, WA and Honolulu starting January 7, 2011. The flights are aimed at travelers in the northern Seattle suburbs, as well as those on the other side of the border who may be lured by lower fares from Bellingham as opposed to Vancouver. This move is likely in preparation for Allegiant Air, which is preparing to start services to Hawaii next year from a number of West Coast cities. Allegiant, which has a focus city in Bellingham, has grown its operations in the city considerably over the past several years, without much response from Alaska. This is surprising given that Alaska has been very aggressive at responding to new low-fare competition on the West Coast, including with Southwest in the early 1990s, and more recently with Virgin America. As a result of this passivity, Allegiant has most of the market in Bellingham. However, this move could put an end to Allegiant's advantage. Alaska now realizes the considerable demand for flights from Bellingham, and while the airline may be unable to stop Allegiant from launching new services, or take away much of its market share, Alaska can at least make things more challenging for Allegiant going forward. 

But this is an important development not because of the one flight a day that Alaska will be flying on the route. It's important because Allegiant is evolving from the stage of being a mere annoyance to "mainstream" carriers (legacies and LCCs) to being a real competitive threat. This is not to suggest that this is the first time Allegiant has run up against direct competition. Several years ago, Northwest tried to run Allegiant off a number of routes from Midwestern cities to Las Vegas by offering competing non-stop flights, which ended miserably as Northwest lost lots of money and dropped the routes soon after they started. JetBlue and AirTran also fought Allegiant, and won, when all three airlines served Orlando from Newburgh/Stewart Airport north of NYC. Granted, the situation is not like a few years ago when LCCs were adding planes like crazy and had to dump them in lots of different markets, some of which overlapped with Allegiant's. Allegiant has shied away from competition before, but increasingly, they will be unable to do so, and Bellingham may be a case in point. The airport has been a shoe-in for Allegiant's Hawaii service, but Alaska announced first. If Allegiant responds, it could signal a new competitive aggressiveness by the carrier which needs to fight for market share.

And these days, Allegiant is better-positioned to fight, with better brand loyalty from travelers, as well as a reputation for delivering travel value. The truth of the matter is that customers in this recession are looking for excellent value more than ever. And Allegiant has very low costs, operates to airports close to where many people want to travel, and can offer very low prices for vacation bundles. Frequent flyer programs and lots of flights are important for business travelers. But for leisure travelers, being able to travel cheaply is most important. Being able to do so non-stop, and on a mainline jet (far more comfortable for the family than a tiny regional jet), is a bonus. I suspect Allegiant's Hawaii flights will be a success because of this, provided they can keep their costs low and rely on vacation packages, not simply fares for their revenues (which they have done for their other markets). Aloha Airlines, which served Hawaii from many secondary cities around the West Coast, folded a couple years back. Their yields got hit hard while their operating costs were relatively high (operating high seat-mile cost planes), and they didn't have much ancillary revenue through vacation packages and other sources (relative to Allegiant).

It will be interesting to see what destinations will get Hawaii flights when Allegiant makes the announcement. But be warned that their announcement may invite more competition from Alaska and/or United, and that could set up a heated battle on the West Coast. However, unlike several years ago, Allegiant can win these battles if travelers continue to trade down and if it focuses on markets where legacies and LCCs will have a tough time competing against infrequent, bare-bones, and inexpensive service.

Spirit Airlines Pilots Strike

On Saturday, the pilots of Spirit Airlines took to the picket lines to protest inadequate contract offers from management. Though the deal on the table included a 30% raise, a $3000 signing bonus, and 4-day breaks between trips, pilots felt that this was too little. And in fairness to the pilots, they are probably right. Granted, Spirit pilots are not as productive as pilots from other LCCs, and fly fewer hours. As part of the new contract, Spirit's pilots will work more hours, but for only slightly more pay on a per hour basis--hardly a raise from the pilots' perspective. Nevertheless, Spirit's pilots are some of the lowest-paid in the industry (given that they fly larger, mainline aircraft), and the pay increase would only bring them to at or slightly above what pilots at other LCCs make. For instance, first-year captains piloting Spirit's A319 aircraft earn $65 an hour, whereas first year captains for JetBlue who fly slightly larger A320 aircraft earn $138 an hour. Though the pay gap narrows over time, after five years, pilots at JetBlue still make $29 an hour more than the Spirit pilots.

While many airlines have contingency plans in place which enable the carriers to keep operating if lower-skilled workers such as gate agents or flight attendants strike, a pilot strike is a bit different. Managers and other strike-breakers cannot easily be trained to replace the pilots--their jobs require years of training and experience and can't easily be replaced by someone going through a six-week course as with flight attendants. As a result, Spirit has shut down for the time being, and there is no clear sign of when this dispute may end. Moreover, customers are in a bit of a bind because Spirit lacks interline agreements with other carriers, so Spirit's tickets cannot be used for travel on other airlines during this strike. As a result, Spirit customers who need to travel must purchase a new ticket on a different airline.

Spirit has canceled all their flights until at least Wednesday June 16th. If you are a Spirit Airlines customer, the company has information online about how you can get a refund or travel credit. Customers who opt for a credit towards future flights will receive the amount of their ticket purchase plus an additional $100 for their loyalty.

While at this stage, the story is pretty-clear cut, there is a bit of analysis I want to add. The airline industry has been hit by myriad storms in the past decade, and it has only been within the past year or two that airlines appear able to consistently profit again. But as a consequence of industry downsizing and associated salary cuts, airline staff in all job categories have seen their paychecks go down or lost their livelihoods entirely, and unions are fighting back to keep their members happy. Pilots have taken some of the steepest cuts in recent years, which may be justified by the fact that they typically receive the highest non-management salaries at airlines, and a 10% pay cut for a pilot hurts less than a 10% cut for a lower-paid flight attendant or mechanic. Pilots can, and should continue to fight for better pay and work rules that they have sacrificed to help minimize cuts to other employee groups.

But it is important to remember what they are up against. As we saw in 2008, when fuel prices spiked, panicked airlines became even more aggressive with their cost-cutting and revenue-raising measures. Fortunately for the airlines, oil did not stay at $140 a barrel for more than a month or two. But in the not-too-distant future, oil is likely to increase in price. It is an increasingly rare commodity and global production is likely to decrease soon, if it hasn't already. This would especially be the case if the BP disaster discourages other governments from deepwater drilling, which is necessary for accessing many of the latest discoveries. And though oil is already the biggest expense for airlines, price increases are likely to make it an even greater share of airline's budgets. And unfortunately, few technologies seem to be ready and able to reduce these burdens. Airlines are starting to make early investments in biofuels, but these are likely to comprise a very small share of aviation's fuel supplies for a long time. At the same time, the fuel-efficient 787, which is supposed to revolutionize air travel, only reduces fuel costs by an estimated 20%. That isn't a bad reduction, but if fuel prices increase by 50-100%, which would happen if fuel prices returned to mid-2008 levels, the gains from the 787 would be minimal compared to the added cost. And while several of America's legacy carriers have purchased these new aircraft, the bulk of their fleets are going to be composed of conventional aircraft for the time being. And LCCs, including Spirit, are not likely to see any technological miracles on the horizon until the last years of the decade, if not later, Bombardier's smaller C-Series aircraft notwithstanding. But even those aircraft are not expected to reduce fuel burn more than the 787 on a per-seat-mile basis.

Unions are seeing black on airline's balance sheets for the first time in years, prompting a desire to go back towards the days before 2001 when airline employees received solid, middle-class wages and benefits. The unions' desire is understandable, but I fear that the inability of airlines to control fuel prices will only put further pressure on airlines' other great cost-driver, wages, which airlines have more control over. The pilots at Spirit and other airlines that have contracts up for renewal in the next year or two may win their battles, but the long-run future for these work groups is not bright. Air travel demand is projected to increase significantly around the world by 2030, but fuel prices are the great unknown that I believe has the power to stifle this demand and further shrink the industry. Time will tell whether I am right or not. But the bottom line is that airlines and aircraft manufacturers cannot be looking for technologies that reduce fuel consumption by 15-20% and expect the industry to flourish. Only technologies that dramatically reduce fuel costs, such as blended-wing-body aircraft, or better yet, airships, are going to be viable in the long-term, and I happen to believe this day will come much sooner (within the next 10-20 years) than optimists expect.

United and Continental's Mega-Merger

Loyal Airline Bulletin readers know that I have been posting very infrequently over the last few months. I was out of the country traveling, but am now back in the States and should be able to post on a more regular basis. And although this is a bit belated, I feel it is somewhat pertinent to add my voice to the chorus of industry-watchers discussing the ramifications of the proposed United-Continental deal. So below is a summary of how I feel the deal is likely to pan out, and what some of the consequences could be.

What is likely to happen:

All hubs stay, bar Cleveland: Between them, United and Continental have eight hubs in the mainland United States: San Francisco, Los Angeles, Denver, Chicago O'Hare, Washington Dulles, Houston, Newark, and Cleveland. The smallest and weakest of these hubs is Cleveland. The city generates little origin and destination traffic, especially from business customers. While the city is not a complete dead zone for businesses, it is a far weaker market than all of the other hubs. Southwest is also present, which helps to keep yields down. Like many industry-watchers, while I don't believe it is a certainty, I seriously question the continued viability of Cleveland as a hubsite. A lot of traffic at Cleveland is on higher-cost regional jets, which are likely to see reductions in usage as fuel prices climb. Moreover, much of Cleveland's traffic can be re-routed through Chicago or DC, and maintaining the hub really provides little benefit to the combined airline.

Moreover, the company also has two hubsites off the US mainland, Continental's Guam mini-hub, and United's Tokyo Narita operations (which are hub-like, but technically not classified as a hub). Both of these are likely to be viable in the near future. Guam is a small operation, and serves as a niche hub functioning primarily to transport Japanese and other Asians to various Pacific island destinations. It has a stable market, and very high yields. Narita helps to funnel very profitable US traffic to various Asian destinations. However, it's continued success is in slightly greater doubt, though for reasons not having to do with the merger. An increasing number of US airlines are being provided traffic rights to overfly Japan and fly nonstop from China and other Asian destinations to the US. And many of these markets where traffic rights were available but not utilized are finally becoming strong enough to support non-stop service to the US. Moreover, as Tokyo opens up its airport at Haneda to more intercontinental flights, some of United's nonstop traffic to Tokyo may get routed through Haneda (though the airline did not gain any slots in the first round of applications, announced recently). This may impact the profitability of flights to Narita, and limit the airport's effectiveness as a connection site. However Delta, which inherited a Narita hub from Northwest when they merged a couple years back, is also likely to face similar challenges in maintaining a hub there.

The merged entity is also likely to be strong in markets where one carrier already has significant, non-hub operations, including Seattle, New York JFK, and Hawaii, creating focus cities with the possibility of further expansion.

Some fleet consolidation: Both United and Continental have done a very good job of trimming capacity on domestic routes, and barring further spikes in jet fuel prices (which are not at all out of the realm of possibility), their fleets are not likely to be radically altered anytime soon. That being said, Continental has a fleet of smaller, high-CASM 737-500s that could be removed from service if further capacity cuts were necessary. Given that United operates a primarily Airbus narrowbody fleet, and Continental, an all-Boeing narrowbody fleet, the cost-saving synergies here are minimal.

The Boeing widebody fleets of these companies is an important synergy, however, that suggests prospects for further Boeing orders. United has ordered 25 A350 planes in addition to 25 787s, and Continental has ordered an additional 25 787s. As a result, the combined carrier may find it more advantageous to scrap United's A350 order and replace them with the larger 787 variant, the 787-9. But given that the A350 is somewhat larger than the 787, giving it a slightly better CASM, and that United probably got a good price from Airbus to order their first Airbus widebody, it is also quite possible that this order will remain intact.

Going forward, both carriers will soon be looking to replace their 757-200 fleets, and given that a new generation high-capacity narrowbody is still years away from delivery, the combined carrier is likely to place an order of existing models. If they can negotiate a good deal, the company may do a split order, with some possibly re-engined A320s or A321s (the latter being a new type), being ordered, along with additional 737-900s, which, seat just two fewer passengers than the older 757 in Continental's configuration.

Leadership in domestic business travel: Both United and Continental have very large and very loyal bases of business customers who fly frequently with these carriers, often at considerable expense. Continental has consistently delivered some of the best customer service in the industry, and United, with its large presence in key business markets like San Francisco, Los Angeles, Chicago, and DC, has been able to win countless corporate travel contracts. A combined United/Continental will be the team to beat, and will be a very strong competitor for business contracts as the combined company draws upon the customer base of both carriers while creating prospects for future growth with an expanded network and additional amenities. While Southwest and other LCCs are vying for this market, the truth of the matter is that many large companies, even in an era of trimmed-back business travel, are likely to choose service providers that offer comprehensive domestic and international service, as well as provide the loyalty and amenity benefits that many companies expect. JetBlue's extra-legroom seating and Southwest's credit-based frequent flyer program simply won't cut it with many businesses.

Bumpy, but not catastrophic labor integration: It appears that while there may be challenges to integrating the two workforces totaling roughly 87,000 employees, the obstacles these present will not alone present a problem. Fortunately for management, both pilots and mechanics at the two airlines share a union. Flight attendant integration may be a difficult issue, but can likely be overcome. This is not my area of expertise, so I suggest looking at this recent article from Reuters about the issue, on the Airwise website.

But perhaps an even more significant question is whether this deal will go through. Many analysts have questioned the prospects for this deal, given that the Obama Administration is likely to take a tougher line on industry consolidation than the Bush Administration did when the Delta-Northwest deal was up for consideration. While the United-Continental deal would create the world's largest airline, it would also provide a key counterweight to Delta, which is now the largest airline in the United States by far.

While the Obama Administration is likely to spend a lot of time examining the ramifications of the deal, I ultimately believe that it will be approved, potentially with some conditions. If this deal went through, I imagine that the combined carrier would be required to give up slots at Newark and/or O'Hare, where low-cost carriers have been eagerly attempting to add more service. It is true that Continental has a minor presence at O'Hare, and United a minor presence at Newark, meaning that the combined airline would not have significantly larger market share than the individual hubbing carrier currently does. However given that the merger will help stifle competition within the industry, opening up slots at these two airports to low-cost competitors would be a nod to critics who worry about the competitive effects of the deal. Such stipulations would further competition in two key business markets but still enable the deal to go ahead because of the important benefits it offers for the industry as a whole.

Who loses from this deal? The biggest loser with this deal is the traveling public. The aim of industry consolidation is to maximize efficiencies and take seats out of the sky that are sold at a heavy discount to keep them filled. This deal will help to raise fares. And with fewer competitors, it also means that the industry has less of an incentive to excel, and service standards may slip since customers have fewer choices if they are dissatisfied with their experience. That being said, while the deal is likely to hurt customers with higher fares, it is also likely to help preserve the long-run health of the industry by increasing fares to a more sustainable level.

One concern I have is that if the industry continues to suffer, it may be the recipient in the not-too-distant future of a government bailout, much as it was after the 9/11 attacks. Not because I think every industry in trouble is going to be bailed-out, but because legacy airlines help provide air service to America's small and mid-size communities, which low-cost carriers for the most part do not do. Without such service, businesses in those communities would be far less competitive, as employees would be forced to drive hours to access a major airport, an expensive hassle for many firms, and an important reason why many firms would opt not to locate in smaller communities. While America could well survive without air service to the couple hundred small airports around the country that depend on regional air service to legacy hubs, some federal legislators, particularly from rural states, could not. As the U.S. Senate illustrates, just a few senators from small states have the capability to hold the nation hostage and demand specific pet projects. Because of the vital national service that it provides, I suspect that the airline industry will be protected from its own failures, as it is currently being protected from foreign ownership or competition on domestic routes. While I think these policies hinder the viability of the supposedly "deregulated" free-market of the commercial airline industry, it seems to be the way this is viewed by those in Washington, for better or worse.

The other big loser in this deal is US Airways, which was courted by United initially to help spur Continental to the bargaining table. While US Airways CEO Doug Parker is disappointed but seemingly unconcerned about the prospect of this merger, he should be worried. US Airways has been pounded by LCC competition along the East Coast. It is the smallest legacy carrier, with some of the highest costs, and lingering labor and organizational issues left over from the America West merger. US Airways probably will not find a merger partner anytime soon, but even if it did, that partner may not want to take on all the baggage attached to the company (no pun intended). Although US Airways is engaging in some international expansion, it is inadequate, and the company still faces LCC competition on most of its routes that helps decimate yields. While its competitors are drastically expanding their route networks and trimming their costs, US Airways has been slow to act.

I have not been positive about this company for a long time, and this merger only reinforces my negative view. However, US does have one advantage in this situation. They, like United and Continental, are partners in Star Alliance. If US Airways chooses to stay in Star, it is still likely to benefit from some of the increased traffic flows and network expansions that will eventually happen due to this merger. But that may be little consolation for the company which, just a few weeks ago, was touted as a potential merger partner of United, and has now been relegated to the status of "ugly girl". Obviously in the months to come, more will come out about this proposed deal, and we will get a better sense of whether it is likely to come to fruition. I will work to update Airline Bulletin more frequently now that I am back in the States, and look forward to your comments and feedback.

May 17, 2010 in Continental Airlines, Delta Air Lines, JetBlue Airways, Low Cost Carriers, Southwest Airlines, United Airlines , US Airways | Permalink | Comments (12)

February 11, 2010

Allegiant vs. AirTran, the Duel for Orlando

Over the past 12 months AirTran has added a number of new cities to its route map.  Many of these cities have not received service to Atlanta, AirTran's primary hub. Instead, AirTran has targeted these flights to Orlando, a fast-growing market for the company, and one that continues to hold up reasonably well despite the recession. But AirTran faces considerable competition in Orlando, not merely from established LCCs on routes to/from major cities, but also  from Allegiant on routes to/from smaller markets, such as Allentown, Knoxville, and most recently, Grand Rapids, where AirTran announced new service from Michigan's second-biggest airport to Florida, stepping on Allegiant's toes. In response to AirTran's advance, Allegiant has added frequencies in markets such as Grand Rapids, and has shifted the destination of many flights from Orlando's Sanford Airport to Orlando McCoy, the more popular and convenient airport in the city (all of AirTran's flights are to/from McCoy).
 
But while AirTran is having to fight for market share, it possesses a number of advantages over Allegiant, the most important being its generally better value for consumers. Unlike Allegiant, AirTran does not charge for charge for online booking (Allegiant charges an astounding $14 for this privilege), seat assignments (on some AirTran fares, seats are not assigned at booking, but all seats are assigned before boarding), or beverages on board. Moreover, Allegiant charges vacation travelers (who are likely to check luggage) more than AirTran if bag fees are paid at check-in. So on Allegiant, to avoid paying excess fees, one must book tickets at the airport, and pay bag fees at the same time. Not an easy proposition for most travelers who don't know how much they'll be taking. Combine Allegiant's arcane and uncompetitive fee structure with AirTran's better brand recognition and frequent flyer program, and it seems that there should be no reason why travelers book with Allegiant.

While I anticipate AirTran to make strong market share gains in the markets it enters, assuming flights are conveniently timed and priced, Allegiant will not be a pushover. By changing hub airports and adding frequencies, they are fighting back. And where they recognize that they can't make money due to depressed yields from AirTran's competition, they will pull out, as they have of other markets that LCCs have invaded, such as Newburgh, NY. But keep in mind that even if Allegiant's flights, with all their extras, are more expensive than AirTran's, Allegiant markets itself as creating value for customers by selling them vacation packages. Allegiant sells only airline tickets to relatively few customers--the company makes much of its money through ancillary revenues. Customers who want the convenience of booking their flight, hotel, car rental, and theme park tickets can do so in one process at Allegiant's website. Moreover, because of the volume of travelers Allegiant handles, the company negotiates significant discounts with hotel operators, and passes the savings on to customers. Thus if AirTran is to succeed in the Orlando market, it will need to ensure its vacation package offerings and pricing, not merely flights, are competitive.

Nevertheless, I imagine that in many of these cities, AirTran will be the victor, and this I see as more positive for consumers than Allegiant. There are a number of reasons for this, including AirTran's more transparent and inclusive pricing structure outlined above, as well as the fact that AirTran is starting to make Orlando into a hub for Caribbean services, and customers who want to fly from Knoxville to San Juan may soon be able to do so via AirTran, something unavailable to Allegiant customers. But perhaps most important of all, if AirTran succeeds in these smaller cities with Orlando service, it may ease the way for the carrier to offer services to more business-oriented destinations, such as New York, Boston, Baltimore, and Atlanta, the latter two allowing customers to connect to additional AirTran cities. Many of these small markets have incredibly high fares (Grand Rapids, for instance, was recorded by the Bureau of Transportation Statistics, as having the second-highest airfares in Q3 2009). While service to Orlando alone isn't likely to lower fares considerably in these markets, since most business travelers need to head elsewhere, it helps to establish the carrier in the community--essential for starting services against fierce legacy competitors. As with many airline duels, this one will be interesting to watch going forward, and if AirTran is the winner, could have implications for how Allegiant will address competitors encroaching on its other bases.

February 11, 2010 in AirTran Airways, Allegiant Air | Permalink | Comments (16)

December 29, 2009

Trends & Predictions for 2010: Part II

As promised, here is the second part of Airline Bulletin's discussion of trends and predictions to examine in the coming year.

Prediction #1: Industry Consolidation, Especially Abroad
While U.S. carriers have made efforts to reduce their capacity and form strategic partnerships with other carriers, it does not appear likely that we will see a full-fledged merger or buyout in the U.S. in the coming year. This is not to say that such consolidation is impossible, rather that it's simply unlikely. There aren't a lot of perennially weak airlines left to consolidate. Frontier (which has recently showed signs of strength) and Midwest have been combined, Sun Country, to my amazement, seems to be hanging on, and small LCCs like Spirit and Allegiant that have defined business models and solid market niches don't appear to be losing buckets of money either. That being said, anyone is a possible takeover target or buyer. Even Southwest, which has historically avoided growth by acquisition (with a few exceptions), has signaled of late that it is open to potential mergers.

US Airways Deals?
One carrier that still mystifies me is US Airways. The airline has been very aggressive in implementing ancillary revenue-generating programs and cutting costs/capacity. CEO Doug Parker seems to know what he's doing in this regard. But, US Airways may not be very poised for future business travel growth. It operates by far the smallest international route network of any of the 5 legacy carriers in the States, and has actually cut some of its European routes recently due to poor loads. Growth in Asia has taken something of a hiatus, as US Airways let its Philadelphia-Beijing route authority expire after the airline wanted to avoid opening the route due to the recession. And the carrier's position in Star Alliance has been weakened due to Continental's recent entry, and due to the announcement of a strengthening of reciprocity between United and Continental frequent flyer programs. The conventional wisdom has been that American would make a bid for US Airways, since American has avoided much of the consolidation activity within the past 7-8 years, and as a result, has watched its market share decline, while US Airways needs an available suitor. But American and US Airways have almost no fleet compatibility--American is mostly Boeing, US Airways is mostly Airbus. And another merger would only further complicate the labor troubles that have hampered US Airways recently, particularly with its pilots union having trouble integrating seniority between old US Airways pilots and former America West pilots. On the plus side, the route networks of American and US Airways would align somewhat, with US Airways having hubs in the Southwest, Southeast, and Northeast, all regions where American lacks hubs (American's Miami hub, mostly geared towards traffic to/from Florida or Latin America notwithstanding). However, both carriers are relatively weak in Asia and the Middle East, areas where they will need to ramp up capacity if they hope to compete in these increasingly important business markets.

What seems to be a more plausible idea, actually, is a buyout of Spirit by US Airways. US Airways as noted above has been very aggressive, perhaps the most aggressive of any legacy carrier in seeking out new ancillary revenue opportunities, and transforming itself into an LCC which can effectively compete against the likes of Southwest, JetBlue, and AirTran on the ultra-competitive routes along the eastern seaboard. A buyout of Spirit would have very strong fleet complementarities--both carriers fly A319 and A321 aircraft, as well as strong route network complementarities. US Airways tried a few years ago to open a mini-hub in Fort Lauderdale--Spirit's biggest base, with routes to Caribbean destinations, but was fended off in part due to Spirit's competition. There is clearly money to be made on these routes, but US Airways lacked the cost structure several years back to adequately compete. Now the carrier has realigned its costs, and a buyout of Spirit would make accessing such routes much easier.

It would also do something else which is pretty important. The two slot swap deals announced earlier this year, which (if approved) will strengthen legacy carriers at slot congested airports while helping to keep out low-cost competitors. US Airways, even though they are starting to act like a low-cost carrier, is not a low-fare carrier, unless it is forced to be through competition. US Airways would rather stifle demand with higher fares (and higher profits) than lower fares which stimulates demand but reduces yields, which is what Southwest tends to do. Keeping slots in the legacy carrier "family" prevents potential low-cost competition at slot-congested airports (see also Prediction #2). Spirit is one of the few LCCs to have slots at both LaGuardia and Washington National (even though it has relatively few slots in both). A buyout of Spirit would help diminish low-fare competition at these airports, and allow legacies to charge higher fares to business customers. However, I still think that this deal is somewhat improbable, only because Spirit is presumably a money-making carrier with a good market niche, while US Airways is a money-losing carrier with lots of problems that could make a merger tricky. It could be an easy buyout, or it could just be an obstacle to US Airways doing what it needs to do to revamp itself to compete against LCCs while expanding its international network.

European Consolidation
In Europe, the picture is much simpler. I don't anticipate many state carriers to go out of business, however I do imagine that governments will work even harder in the next year to privatize or revamp the following state carriers, named yesterday in Part I:
CSA Czech Airlines
Croatia Airlines
LOT Polish Airways
MALEV Hungarian Airlines
TAROM Romanian Airlines

After additional research, I also want to add the following carriers' names to this watch list:
Aer Lingus¹
Air Malta²
Bulgaria Air

Given the obligation of these governments to maintain positive images, it appears extremely unlikely that they will suddenly pull the plug on these carriers' operations, stranding passengers (voters) and angering the public, a la the recent FlyGlobespan fiasco. However, such airlines are definitely at risk of being purchased by larger airline conglomerates or of being privatized. 

Notes:
1. Aer Lingus may be at risk for another Ryanair takeover attempt in the new year. The carrier has struggled to compete against Ryanair, and has gotten push-back from its unions as management tries to contain costs. Efforts have been made to diversify the carrier away from Ireland, opening new routes from London Gatwick. While the carrier may avoid a Ryanair takeover, serious reforms are needed to make the company profitable once again, and these do not appear forthcoming.
2. Air Malta may also be in need of further reform due to the recent arrival of LCCs in Malta after the airport lowered passenger charges. Air Malta had effectively been protected from LCC competition due to these high charges, but this is no longer the case. As a result, the carrier must find ways to diversify and compete. But since the vast majority of Malta traffic is holiday-oriented, and thus, price-sensitive, it appears unlikely that unless Air Malta can turn itself into a bare-bones LCC, the carrier could face extinction. Another possibility would be a buyout, perhaps by another LCC like easyJet, which would reform the carrier, much as it did with GB Airways, while maintaining most of the its routes.

In terms of LCCs, there are simply too many out there, and too few of them have such well-defended market niches that they can't be attacked by market leaders easyJet, Ryanair, Wizz Air, and Norwegian. I believe that the following carriers are in trouble, and are at risk of potential sudden shutdown. As a traveler, I would do some research before booking with them, and then only with a credit card:
bmiBaby_³
Cimber Sterling⁴
Niki
SmartWings
Vueling⁵
Windjet⁶

3. bmiBaby is unlikely to engage in a sudden shutdown, now that the carrier is owned by Lufthansa. If bmiBaby is closed, it will likely be in a controlled fashion, or if it is sudden, passengers should anticipate far fewer inconveniences than when FlyGlobespan shut down (ie. Lufthansa will likely offer alternate flights, etc.). However, bmiBaby is under heavy competition from easyJet and Ryanair. And while the carrier is growing--it recently expanded at East Midlands which easyJet vacated due to poor yields--it is unclear whether the airline, with relatively old, inefficient planes and infrequent service on many of its international routes, will thrive in the coming years. Lufthansa may use its recent acquisition of British Midland mostly for its aircraft and slots at Heathrow, taking the airline's good routes and using British Midland to help feed into Lufthansa's long-haul routes, while scrapping much of the rest of the company. As British Midland's low-cost subsidiary, bmiBaby doesn't have very much to offer Lufthansa, and a sale or suspension of services appears likely.
4. Who knows what's going on with Cimber Sterling? The carrier seems bereft of a coherent strategy, flying both business and leisure routes with a bizarre mixture of aircraft. Most of Sterling's core routes were taken over by Norwegian and Transavia immediately after that carrier's demise, and Sterling's new namesake has been left with relatively thin routes and little room to grow. I see Cimber as extremely vulnerable to shutdown.
5. Vueling is probably not going to shut down immediately, but will be increasingly vulnerable to competition from easyJet and Ryanair in Barcelona and Madrid. It is unclear whether the combination of Vueling and Clickair has really made the company more financially stable, and due to this lack of information, I am concerned about the carrier's future. However, Vueling has potential to thrive and grow within the coming years. It has a large fleet, a relatively low cost structure, and by operating from primary airports, including Heathrow, can attract higher-yielding business travelers. Thus, it is less vulnerable than most of the other carriers named on this list, but is vulnerable nevertheless.
6. Same issue as with Cimber. It's hard to know what's going on with this carrier. It's privately owned, not discussed much in the press, and it seems hard to believe that they have a real competitive advantage in the marketplace. Now maybe they're like Spirit Air in the U.S., and have a relatively undisturbed market niche on thin routes to/from Sicily. And given Ryanair's recent announcement that it may close domestic routes within Italy, WindJet may benefit through expansion of services. But without clear evidence that WindJet is a profitable LCC with competent management, I have to place them in the same category as Cimber--extremely vulnerable to shutdown.

Prediction #2: Continued LCC Growth
As the economy continues to suffer, expect more businesses to shop around for travel, and send employees on LCCs when necessary. LCCs will try to respond to this growing demand. In the U.S. in particular, LCCs will likely make more efforts to enter or expand services at airports that are dominated by legacy carriers and which are the few remaining bastions of high fares in the U.S. While virtually every large metro area in the U.S. has low-fare airline service, many large, primary airports in these metro areas lack much low-fare service. Examples include Dallas Fort-Worth, Miami, Chicago O'Hare, Newark, Washington National, Cincinnati, Charlotte, Houston Intercontinental, and Atlanta (obviously, AirTran has a large hub here, which keeps fares lower than they otherwise would be, nevertheless, the lack of Southwest, JetBlue, or other LCCs in the Atlanta area at all is problematic and allows a Delta/AirTran duopoly to set prices). Although some of these airports are more congested and delay-prone, they are often preferable for business travelers, as they are easier to access, are located closer to where companies are situated, have better facilities and connections to other airlines, etc. In the coming year, expect expanded service from AirTran, Southwest, and JetBlue to the airports above. While new leisure-focused service will be added, particularly to/from the Caribbean, don't count out future expansions at these key airports for business travelers. Leisure demand has actually held up better than business demand, and so while LCCs will do well in leisure markets, because they are already strong in California, Florida, and the Caribbean, less of the growth in their operations is likely to be concentrated in those regions, since little added LCC capacity is needed to handle this traffic.

In Europe, while it may seem like business routes would also see expansions in service, this does not seem to be the case. Ryanair has announced minimal service of late that will be attractive to business travelers, mostly because it is concentrated in very distant and inconvenient airports. EasyJet, which has aimed to take business customers away from BA and other full-service carriers, has instead recently announced that it will add new service to a host of leisure destinations next summer, mostly in Turkey. Such moves seem to place easyJet and Ryanair in closer competition with European charter carriers such as Monarch than legacy carriers like BA. It will be interesting to see whether carriers like Wizz Air, Norwegian, and Air Berlin follow suit and concentrate growth mostly on leisure routes, but that would be somewhat counterintuitive, given the growing demand of businesses to trim travel costs.

Prediction #3: Increasing Focus on the Environment
While there are other interesting predictions to be discussed, it's getting a bit late and I need to get this out. So I'll conclude with my third prediction, which is something that will be of increasing importance not just in 2010 but in the coming decade. Expect more airlines to highlight their "green" credentials whenever possible, through marketing campaigns, press releases highlighting environmental initiatives (such as this recent announcement highlighting airline participation in a jet biofuel scheme), and programs to offset emissions. Such efforts will be reinforced as Boeing delivers the fuel-efficient 787 Dreamliner to its first customers next year, and as the U.S. Senate debates a cap-and-trade bill to combat climate change. Although we're in a recession and customers are price-sensitive, more and more consumers are going to make what they perceive to be environmentally-friendly choices, given growing awareness of environmental concerns. While airline efforts to address the issue are mostly greenwashing, since the benefits of getting customers to recycle soda cans on the plane or powering one engine with 50% biofuels aren't diddly squat compared to the effects of contrails fully-loaded commercial jets spew out at high altitudes, such efforts will likely succeed at winning customers over since most people don't know any better. What we won't see, however, are serious efforts to make the industry more environmentally-friendly through new technologies. V-shaped aircraft ("flying wings") or better yet, high-altitude airships would radically alter the airline industry as we know it, but they would also make a substantial dent in the industry's pollution levels. But because such technologies aren't compatible with current air transport infrastructure, are not seen by consumers or regulators as safe, and in some cases are slower than conventional aircraft, don't expect Boeing to announce production of such aircraft anytime in the near future. This is not to say that such technology won't be commercialized, but significant steps aren't likely to be taken within the next year due to the recent air travel slowdown and manufacturers' focus on the latest generation of fuel-efficient planes.

In 2010, as the airline industry globally continues to struggle, it will likely once again continue to make headlines as it tends to do, and Airline Bulletin will be here, whenever possible, to offer commentary on these events. Until then, have a wonderful new year!

December 29, 2009 in AirTran Airways, Allegiant Air, American Airlines, EasyJet, Environmental Issues, European Carriers, Frontier Airlines, JetBlue Airways, Low Cost Carriers, Midwest Airlines, Ryanair, Southwest Airlines, Spirit Airlines, United Airlines , US Airways | Permalink | Comments (24)

December 27, 2009

Trends & Predictions for 2010: Part I

After the recent hiatus which was a bit longer than anticipated, Airline Bulletin is back, albeit briefly. Believe it or not, I have a life outside of Airline Bulletin, and it has prevented me from doing much on the blog of late. I will be doing some traveling over the next few months to Africa, and so once again, posting may be a bit spotty. My apologies in advance. I am using this post and the following one to highlight some trends and make predictions regarding air travel in the coming year. Part I focuses on some of the trends shaping the industry, and discusses some of the potential problems facing airlines in the coming year. Part II will make more specific predictions regarding industry consolidation, expansion, and other significant changes.

Trend #1: Continued Economic Weakness
The economy is not poised to make a significant rebound next year, and the unemployment rate may not fall below 7-8% for several years. This means that air travel demand will be commensurately affected, perhaps even more so since travel is one of the first things businesses have cut back on during this recession. However, airlines are aware of this, and have taken proactive steps to cut capacity. U.S. carriers appear to be doing better now that they've taken these steps, and are likely to fare better in the coming year. That being said, expect profits to remain relatively low, and if oil creeps up (see Trend #3), then airlines could once again wind up with buckets of red ink.

It should be noted that this crisis is hitting the traditional developed economies hardest. Europe in general is facing a severe economic situation, and the continent's demographics do not bode well for future economic recovery. The U.S. and Japan will also continue to suffer, but possibly to a lesser degree than Europe. But carriers who serve China and the Middle East are still finding relatively robust air travel demand, especially from business travelers (Dubai's debt crisis notwithstanding). These new developing markets will be increasingly important for the airline industry globally, including for U.S. carriers, and airlines like Emirates stand to benefit from relatively strong economic growth in many newly industrializing countries. Carriers that concentrate service in these markets may be a bright spot during another difficult year.

Trend #2: Capacity Cuts, Especially in Small Markets
To go along with Trend #1, airlines will continue to make capacity reductions where they appear appropriate. These reductions are likely to hit small communities in the United States the hardest, because they rely on high ASM-cost regional aircraft, which are not very attractive for carriers at $80 oil. Airlines, particularly in the U.S. will continue to press for reductions in their regional jet capacity, and especially with 50 or fewer seat planes. In Europe, small airports that rely on the business of low-cost carriers such as Ryanair will be increasingly pressured for subsidies. While these airports face a different dilemma than their counterparts in the U.S., because they can be served with mainline jets, they will be increasingly played off each other, as Ryanair and other LCCs vie for lower landing fees. 

Another concern for small airports in the U.S. is how they will address the increasing penetration of low-cost carriers into small markets, a la Ryanair. Allegiant has successfully entered many small cities and siphoned off many leisure passengers who formerly flew regional jets on legacy carriers or drove to larger cities for low-fare service, in addition to creating new demand for vacation travel. While Allegiant has been a boon for many small communities, the airline's ability to offer much lower fares than legacy carriers has put pressure on legacies that use regional jets to serve these airports. Small airports will need to work hard to keep both kinds of service, because both offer travelers in their communities a range of travel options. However, make no mistake that Allegiant is hurting legacy carriers, and by siphoning off passengers, it reduces load factors on the very 50-seat jets that need to be kept full if airlines want to avoid junking that capacity.

But there is another issue to consider here. How does the introduction of low-fare carrier service into one small regional airport affect legacy service to others? One case to examine next year: Southwest's recent announcement that it will serve the Northwest Florida International Airport starting next May, albeit with subsidies from the St. Joe Company. Such service is likely to bring lower fares to one of the nation's most expensive air travel regions. How will the airlines and airports serving Pensacola, Tallahassee, Fort Walton Beach, and Dothan respond? This remains to be seen. New low-fare service in one airport has the potential to drive away traffic in others, or it could stimulate traffic, by forcing legacy carriers to reduce fares. As U.S. low-cost carriers look for room to expand domestically, entering small markets may become increasingly attractive, but this likely means picking and choosing certain small airports in a given region to stage their operations, since LCCs need larger catchment areas to fill mainline planes as compared to legacies that need smaller catchment areas to fill 50-seat regional jets. However, if regional jets are increasingly cost-ineffective for some small markets against larger LCC aircraft, legacies could be forced to offer fewer frequencies on larger planes, or to exit these markets, which is not a desirable outcome, given that a key competitive advantage of legacies over LCCs is their wide range of destinations. LCCs have the potential to spur competition, or to squelch it, and I worry it could be the latter.

Trend #3: Problematic, But Not Devastating Oil Prices
For airlines which are relatively unhedged, the challenge of high, volatile oil prices could be a challenge in 2010. However, (and I knock on wood when I say this), I doubt that there will be major oil price spikes or falls within the next year (however, such events are quite likely to occur in future years). Here is why: oil prices are tightly connected to overall economic strength since our economy runs on oil. We are currently dependent on it for most economic activities. As the economy grows, so does demand for petroleum products. But supply is being constrained, mainly because we're running out of oil (or at least the stuff that's easy and inexpensive to access). Thus, when the economy is doing poorly, we don't use as much oil, and it isn't as expensive. But as soon as the economy starts to show signs of life, then the oil price could go much higher, because the lack of new supply is likely to result in little new oil in the market, but lots of new demand. But if there isn't oil to supply this demand, then the demand goes away and economic contraction results. Since the economy isn't showing many signs of life right now, this won't be a concern. But in the future, when the economy does rebound, then all industries, including the airline industry, will have to learn to live with less oil if economic growth will occur. And airlines will have to contend with price spikes that affect how they do business because the economy is likely to go through fits and starts. Oil prices will be something to keep an eye on, but given weak demand, it won't be as significant problem for 2010 as it was in 2008.

Trend #4: In Europe, Serious Short-haul Weakness
European LCCs are kicking butt. They are rapidly taking market share away from legacy carriers. This has resulted in a hyper-competitive intra-EU market where legacies are at a distinct disadvantage. While European carriers are looking to mergers and consolidation in order to adapt, they will nevertheless encounter resistance to doing so (see for instance, British Airways' recent difficulties with their cabin crew who nearly went on strike over Christmas due to proposed wage and personnel reductions). But unlike Ryanair and easyJet, British Airways has a long-haul operation, and when the economy picks up, this is likely to make them lots of money, since there is less competition, and such routes can command high yields in premium classes. But not all European legacy carriers have such operations--a point missed by many analysts of this market. Legacy carriers without significant long-haul operations will be strained by more efficient, cheaper, and oftentimes, more comfortable LCCs. While some of these carriers are still owned by state governments, as these companies lose money, there will be increasing pressure to privatize and get taxpayers out of this loss-making business. Whether such privatizations will be successful or not, given the competitive disadvantage of these carriers, remains to be seen. Some of these carriers could get bought out by bigger legacy carriers, and become part of European Airline conglomerates, such as Austrian Airways, which got bought out by Lufthansa. However, without such deals, carriers such as LOT, CSA Czech Airlines, Croatia Airlines, Malev, and TAROM, are likely to suffer from the likes of Wizz Air and Ryanair, the latter of which has recently signaled its intent to open new bases in Eastern Europe. All legacy European carriers will encounter problems as they battle LCCs, but those without long-haul operations that bring less competition, higher yields, and opportunities to support feeder flights to other cities will be in serious trouble.

Trend #5: Pressure for Foreign Integration
As the recent battle between American and Delta for a partnership with struggling Japanese carrier JAL illustrates, U.S. carriers will increasingly look abroad to find ways to boost their route networks. While U.S. carriers are unlikely to become owners of many carriers abroad, they may continue to deepen their partnerships with alliance partners. As business travel increasingly entails international flights to countries poorly served by American carriers, such as China, India, or Gulf states, U.S. carriers can capitalize on the route networks of their partners. Additional deals such as the loans proposed to JAL from potential U.S. suitors are likely to occur as foreign carriers, especially those in Europe and Japan, struggle with weak economies and strong competition from LCCs.

But integration will also come in other forms. U.S. carriers already have the privilege of serving intra-EU routes, and come 2010, Open Skies II should take effect, such that EU carriers can serve intra-U.S. routes. While it remains to be seen whether this provision of the treaty will be enacted by U.S. authorities (failure to do so could result in the initial phase of the deal being nullified), it will be a boon to European carriers who could enter and cooperate with their alliance partners on U.S. routes, siphoning business travelers off from carriers like JetBlue and Virgin America with the perks many foreign carriers offer, and which U.S. carriers have removed.

Finally, integration could take place through foreign carriers purchasing controlling stakes in U.S. carriers. Right now, foreign entities are prohibited from owning more than 25% of U.S. carriers. Some, such as airline consultant Mike Boyd seem to think this is a grand idea and that such restrictions ought to be maintained. As he notes in his Dec 21 "Hot Flash", "Regardless of what the deals may represent to shareholders, foreign control of US airlines means foreign strategic planning." He then proceeds to spew out some jingoistic nonsense about how such foreign ownership is anti-constitutional, and how Democrats don't give a damn about U.S. independence from dangerous dictators. Please. Foreign ownership is not necessarily a bad thing (the key word here being necessarily). It's one thing to have Richard Branson's Virgin Group take a controlling stake in Virgin America, or for Lufthansa to increase its stake in JetBlue to 51%. These companies run profitable, world-class airlines, and would bring new capital and new insights into one of the world's most dynamic aviation markets. Such connections would also help support the expansion of carriers like Lufthansa, which with its evil, anti-American strategic planning, could better time JetBlue flights at JFK to coincide with arrivals from Europe, offering Lufthansa's European passengers a convenient option when they travel to the States. A controlling stake would lead to more complete integration, and likely provide customers with a more seamless travel experience, while preventing the conflicts that sometimes occur between alliance partners. While many of the benefits of ownership can be obtained in alliances, the different interests of shareholders and managers of the partners can result in conflicts between the companies and hassles for passengers if flights aren't adequately timed and ticketing/baggage systems properly integrated. Common ownership is likely to over time alleviate such problems, increasing efficiencies and minimizing the conflicts passengers encounter when they travel between carriers.

What Boyd worries about, and rightly so, is a scenario where a Chinese conglomerate turns Delta Air Lines into The Pearl River Delta Air Line, which would not only result in minimal alliance benefits for customers (since Delta's most Western hub is in Salt Lake City which isn't really convenient for many trans-Pacific connections), but would place America's largest carrier in the hands of a country we don't really trust. Ownership rules are ostensibly in place to provide aircraft for the military in the event of a national emergency. It's implausible to me that Richard Branson would suddenly divert Virgin America's planes to help Hugo Chavez, but Chinese control of hundreds of U.S. commercial planes could leave the U.S. in a difficult situation if there ever were such a crisis. The days of restrictions on foreign ownership of U.S. carriers should not end. But their days may be numbered. Such policies need to be changed not with a bang but a whimper. Steps should be implemented to allow investors from nations trusted by the U.S. (eg. the EU, Canada, Japan, Australia, etc) to control U.S. carriers. This may require changes to bilateral or regional trade agreements that have restrictions on foreign investment, but the process should be started. Integration will result in some "foreign strategic planning", but in a world where business is increasingly global, one where airlines need to be able to transport passengers seamlessly between distant markets, big and small, such common ownership may be increasingly important to building strong, dependable transport networks.

2010 will most certainly be an interesting year for the industry, and I'll offer some more specific predictions of all the interesting things we'll see in my follow-up post.

December 27, 2009 in Delta Air Lines, EasyJet, JetBlue Airways, Ryanair, Virgin America | Permalink | Comments (14)

September 01, 2009

SkyEurope Folds...Finally

SkyEurope, an LCC with hubs in Prague and Vienna, filed for bankruptcy late Monday and officially suspended services today (Tuesday). As has been noted here previously, SkyEurope did not compete effectively against larger LCC rivals, including Ryanair, easyJet, and Wizz Air. The move, which strands thousands of passengers all over Europe, will sadly not be the last failure of an airline in Europe in the coming year. Not only are there too many airlines for each nation to have their own state carrier, but so many LCCs have sprang up that the market has been saturated. Whoever thought that starting an LCC in Europe was a good way to make money must have been quite short on business ideas, for European low-cost airlines seem to be the the best way of destroying financial capital known to mankind, second only to subprime mortgages.

As for the future of the European aviation market, pay close attention to whether BA and Iberia are able to merge, as this would allow those carriers to more effectively compete against KLM/Air France and Lufthansa. But an even more crucial development appears to lie in flag carriers, particularly in Central and Eastern Europe. Many of these carriers, particularly ones which offer little or no intercontinental service, such as CSA Czech Airlines, MALEV Hungarian Airlines, LOT Polish Airlines, and Olympic Airways, are extremely vulnerable to low-cost competition. Some are so vulnerable that they have already been taken over, such as Austrian Airlines by Lufthansa. Because these carriers operate few long-haul services, most of their business comes in the form of short-haul travel, which is trending increasingly towards LCCs, particularly in this economy. And carriers such as easyJet are fighting aggressively in the hub airports of these carriers. While these carriers continue to offer amenities to upmarket travelers, the recession is tamping down their travel spending.

What will be interesting is to see whether alliance partners make acquisitions in order to protect their feeds in different regions. For instance, Austrian Airlines is part of Lufthansa's alliance, Star Alliance, and without a takeover by Lufthansa, that carrier risked Austrian failing due to low-cost competition and then not having sufficient feed from the Austrian market to flow to long-haul flights. Lufthansa's buyout not only helps give Austrian the resources it needs to market itself and streamline its operations, but it also preserves this precious feed for long-haul flights.

Aside from buyouts of smaller state carriers, the other major development in the market will simply be the falloff of LCCs. I don't want to sound like a cheerleader for Ryanair or easyJet, but unfortunately, many of Europe's smaller LCCs simply lack the management expertise, the low cost base, and the extensive route networks to succeed. Airlines such as bmiBaby, WindJet, and even Jet2 may be vulnerable to shutting down (or in the case of bmiBaby, having some of its operations absorbed into its parent British Midland). I foresee a market with only a half dozen or so sizable LCCs, Ryanair, easyJet, Air Berlin, Wizz, Norwegian, Transavia, and Clickair/Vueling. There are still some smaller carriers that appear to be thriving, Smartwings comes to mind as one, but it simply does not seem like their business models can work unless they grow extremely rapidly and choose whether to try and compete on price with Ryanair, or aim for higher yields while still minimizing costs (such as easyJet's model). There are still too many carriers with too many seats chasing a dwindling market. Fortunately, a free market has the power to reach equilibrium one way or another. Let us hope that the next airline failures are at least a bit more civil than SkyEurope's was.

September 1, 2009 | Permalink | Comments (5)

August 13, 2009

Republic Airways Wins Frontier Auction

In a surprising turn of events, Republic Airways, which submitted a significantly lower bid for Frontier, won the Bankruptcy Court auction today for the carrier. Republic, which submitted a bid of $108.75 million, far less than Southwest's $170 million, appeared to win the auction because of Southwest's refusal to remove a clause in its bid requiring its Pilot Union to come to agreement with Frontier's Pilot Union regarding seniority list integration. Without such integration, Frontier's pilots would have likely been at the bottom of the pecking order, should they have been kept on by Southwest, getting the lowest pay and least desirable routes. This could have resulted in labor tensions at the worker-friendly Southwest, and the carrier didn't want to risk labor strife over the issue, even at the cost of being able to purchase Frontier.

In the short term, this changes nothing. While Southwest may try and lure Frontier's pilots union back to the bargaining table (and lure Frontier's creditors into rejecting an agreement which gives them far less than what Southwest is offering), this is rather unlikely. Southwest will probably continue to expand methodically in Denver and do its best to compete with Frontier.

And Republic's purchase of Frontier gives the carrier a reprieve. Although Frontier has suffered since Southwest's entry into Denver, the carrier has responded well, reporting many months of consecutive profits. Even as Southwest expands further into Denver, if Frontier plays up its hometown roots and amenities such as LiveTV, it should have a chance. Remember, Frontier serves many routes to a variety of airports (eg. LaGuardia, Washington National, Anchorage, Mexico, and Lynx regional cities) that Southwest does not serve from Denver. These give the airline pricing power, and they make the airline more attractive to flyers who need to go to a variety of destinations.

Then again, Southwest operates dozens of nonstop routes from Denver, plenty for many travelers, and has lots of cash, which it could use to reduce fares and hurt Frontier's (and United's) competitiveness. Southwest will develop its own loyal following in Denve over time, and both Frontier and United could suffer as a result. The future of Frontier and Southwest in Denver will depend in part on the economy, as well as how aggressive Southwest chooses to be in terms of adding frequencies, offering frequent flyer promotions, and most importantly, lowering fares. If Southwest chooses to focus its competitive energies (for lack of a better term) on other markets, such as Milwaukee, Minneapolis, and LaGuardia, Frontier could benefit. But if Southwest chooses to come down hard in Denver, the carrier has the potential to weaken Frontier and United, and that could make for a messy situation a year from now.

August 13, 2009 | Permalink | Comments (12)