With LAX Threatening Rate Increases, Will Airlines Make a Further Push to Reduce Airport Costs?

Due to rising security and maintenance costs, Los Angeles International Airport (LAX) is considering increasing costs for some of its tenants. The new rates would only affect airlines with short-term leases up for renewal soon including Southwest, Alaska, and Frontier. However, these are low-cost carriers who are most sensitive to any rate hikes. With LAX feeling the pinch, will other airports follow with similar proposals and will carriers react by trimming or eliminating flights to certain airports? Let's take the example of Southwest at LAX. Southwest has been at LAX for over 20 years, and has no plans to leave anytime soon. LAX is one of Southwest's ten largest destinations with nearly 120 daily departures. Southwest has made a major commitment to LAX and won't likely leave anytime soon for a variety of reasons, but this potential rate hike demonstrates how vulnerable to cost increases many airlines including Southwest still are, and how increases at other airports could trigger additional losses for still-struggling airlines. But before I go any further, it's important to keep airport costs in perspective. While airlines are trimming all of their costs due to the pressure to lower fares, airport costs make up a relatively small part of an airline's budget and haven't been trimmed as much as labor or amenities. At Southwest, they make up less than 10% of Southwest's total costs, partly because some airport costs are passed onto passengers as taxes through Passenger Facility Charges (PFC) that airports can use for improvements. Different airports charge different amounts, depending on their needs. Airports can charge passengers $0.00, $3.00, or $4.50 per segment, adding up to $18 on a round-trip ticket.

Southwest is in the midst of a transition right now and consequently is vulnerable to any cost increases. For decades, Southwest has had the lowest costs of any airline in the United States, allowing the carrier to charge low fares. Southwest today still has low costs, but it's not because of free-for-all seating, no meals, or the use of alternate airports, it's because of their fuel hedges. Southwest made a brilliant, calculated gamble years ago that fuel prices would increase. They have increased sharply, and Southwest is reaping rewards no other carrier can come close to. But, Southwest's hedges are running out. Southwest has hedged successively less amounts of fuel in the coming years, from well over half of its fuel needs this year to 25% by 2010. This means that Southwest will have to start paying higher fuel bills, and their costs will increase. Southwest's labor costs are also relatively high in the industry since most legacy airlines have used bankruptcy to cut wages in the past few years and carriers that have made those cuts have passed on lower costs to their customers. Southwest is transitioning from 10-15% growth a year to likely 8-10% growth a year, as the airline can't sustain a higher growth rate given their current size. And Southwest is starting to serve airports it once shunned, such as Denver or Washington Dulles, because although they have higher airports costs than most of their other destinations, they command a revenue premium, and Southwest is willing to pay the higher costs if they can generate enough revenue to offset the cost of doing business at a higher-cost facility. But the jump in fees at LAX could increase Southwest's terminal lease cost from $13 million a year to $49 million a year, nearly quadrupling its cost of doing business at the airport.

While it's unlikely that Southwest would jettison LAX because of their longstanding commitments, what would happen if the rate increase forced the airline to leave the airport? Southwest would likely try to replace most of the service at other airports in the LA Basin, including Burbank, Ontario, and Orange County. But Southwest couldn't replace all of its lost service because of the size of replacement airports, and would likely lose considerable market share in the region. There are also runway constraints at Burbank and Orange County, both of which have short runways that prevent Southwest from operating longer flights out of those airports. Southwest might consider entering low-cost Long Beach, but given the battle for the existing slots between JetBlue, American, and Alaska, Southwest likely couldn't commence a sizable operation at the airport without considerable legal action to get the necessary slots. Southwest's airport costs would certainly diminish, but a move out of LAX would cost the airline revenue, market share, and loyal customers and would be more trouble than it's worth. But Southwest did exit another high-cost airport in California six years ago. In 2000, Southwest left San Francisco International and moved all its SFO operations to nearby Oakland. Southwest did this for several reasons, the most important being airport costs. San Francisco costs several times more per passenger to fly from than what Oakland costs, and Southwest wasn't commanding a sufficient revenue premium to stay at the airport. Moreover, San Francisco is a delay-prone airport, and Southwest was having trouble sticking to its schedules when they weren't able to execute 25-minute turnarounds due to frequent fog. Oakland is a large airport, and has worked with Southwest to minimize costs. In the San Francisco Bay Area, there was a real alternative for Southwest that could handle the now 139 daily Southwest flights cheaply and efficiently. In the Los Angeles Basin, there is no sufficient alternative for Southwest. None of the alternate airports in the region can accommodate Southwest's traffic level.

However, that hasn't stopped Southwest from trying to reduce airport costs in another key market. A year and a half ago, Southwest created a plan to leave Seattle/Tacoma International Airport and start commercial service from Boeing Field near downtown Seattle, an airport with no commercial service. Southwest was upset at a massive expansion at Sea-Tac that included an unnecessary new runway and a modern, new terminal that went over-budget numerous times. Instead of paying for that project, Southwest pledged to spend hundreds of millions of dollars to build a brand new terminal at Boeing Field. Alaska Airlines immediately responded with a similar plan, and both were later rejected a year ago by King County, which owns the airport. Part of the reason was that many residents were worried about increased noise, however, that was a fallacious argument, as cargo carriers routinely fly into Boeing Field with aircraft that are several times louder than Southwest's. Nevertheless, residents jumped on the anti-noise bandwagon forcing the county to table Southwest's and Alaska's plans to expand commercial service to Boeing Field. But, Southwest is still committed to the issue, and will continue to fight for the right to build a terminal at Boeing Field, although it now lacks much of the political capital to do so given the current public opposition to the plan.

But Seattle isn't the only city where airlines may change airports to find lower costs. St. Louis' Lambert Field will cost considerably more to operate from in the next several years, as American Airlines downsizes and other airlines are having to pay a higher share of American's costs. Southwest has the second-largest operation at the airport and will find itself with a substantial cost increase in the coming years. But, a plausible alternative does exist in the MidAmerica Airport across the river in Illinois. Currently, the only scheduled service at MidAmerica are Allegiant's flights to Las Vegas and Orlando. But if Southwest entered, they would have a lot of leverage with the airport about costs and charges. Any entry into MidAmerica might have to come with a new terminal, financed by Southwest, but if the airline made a commitment to the facility, it could save Southwest millions of dollars a year. The airport is only 30-45 minutes from downtown St. Louis, not ideal for travelers, but certainly manageable. However, like the LAX scenario, this one's unlikely, but it's plausible, and if St. Louis continues to hike fees, then Southwest might seriously consider a move to MidAmerica.

But even at airports that Southwest won't leave from anytime soon, Southwest still has leverage and an incentive to reduce costs. One example is in San Jose. The airport is undergoing an expansion to create a new Terminal B and a new North Concourse that will force the airport to raise fees significantly. Southwest, one of the airport's largest tenants along with American, has encouraged the airport to scale back its plans to make the terminal more economical. A year ago, the airport announced that it would proceed with a scaled-back plan after Southwest's protests. Unfortunately for Southwest, unlike in San Jose, they voted to approve Sea-Tac's expansion plan without much question, raising Southwest's fees considerably. If Southwest wants to stop more of these massive expansion projects, they need to look well into the future and make the assumption that the project will go over-budget. That doesn't mean Southwest should try to block any airport improvements, but they should be economical, specific, and appropriate for the airport and the airlines that serve it. Oakland doesn't need the same kinds of improvements that a larger San Francisco needs because of the two types of airlines that serve each airport. Overall, low-cost airlines like Southwest and JetBlue serve Oakland, and legacies and international carriers serve San Francisco, and the latter carriers might not feel the pinch of airport costs as much as Southwest does.

Many cities want their airports to become museums, with plenty of open space, artwork, and class. Airports want to project a classy image to woo businesses to the airport. After all, when a new businessperson comes to town, the first thing he or she sees is the airport, it can make a great first impression, or a sour one. But airports need to radically reconsider how they are expanding, and passengers need to reconsider what an airport terminal should look like. Airports aren't shopping malls, and they aren't luxury hotels, and if passengers continue to demand low fares, then airlines will try to force rate cuts on airports. In Europe, the balance between cost and class has shifted at some airports. One example is a low-cost terminal opening in Marseille to the likes of Ryanair and EasyJet. The terminal costs airlines about 1.30 Euro per passenger instead of 6 Euro for the main terminal. The terminal was constructed out of an old freight warehouse and offers no jetbridges and few amenities to passengers. This is similar to Amsterdam's low-cost Pier H where the gates are a 10-15 minute walk from the restrooms. While this won't happen immediately in the States, some airports may begin to reconsider what an airport terminal looks like, and passengers may need to understand that in order to keep costs low, airport terminals may need to have more retail space, fewer seats, fewer restrooms, and no jetbridges. If airlines in the United States really want to lower airport costs, they need to start pressuring airports to completely redesign terminals in order to maximize the number of passengers that the terminal can accommodate while minimizing the cost to airlines.