Air Scoop Article: LCC Contrast: The trend is fuller flights, so why are some carriers flying empty planes or using fake passengers?

I recently authored this article, published in the October 2008 edition of Air Scoop, a European newsletter devoted to the low-cost airline industry. I'll have a post or two out later this week about US carriers, but in the interim, I hope you enjoy this piece.

LCC Contrast: The trend is fuller flights, so why are some carriers flying empty planes or using fake passengers?

As fuel prices rise, LCCs have an even greater incentive to fly fuller planes with passengers paying higher fares. Ryanair and easyJet operate with the highest load factors in the industry (near 90% over the summer), and are increasing yields through higher ticket prices and higher ancillary charges. However, some smaller LCCs have chosen to fly emptier planes with passengers using free tickets. Earlier this year, Flybe was implicated in a scandal when the carrier hired actors to achieve a threshold passenger count on a route, thereby receiving a subsidy from the airport. Some carriers are even operating empty flights. With all the problems LCCs face, why do some companies engage in these behaviors? Two words: airport subsidies.

Arguably, part of the problem lies with the airlines themselves. The airline business has low margins, and airlines are desperate for competitive advantage and additional revenue. In order to survive, carriers want to extract the best possible deals from airports, leading to higher-than-necessary subsidies. However, airports are mostly to blame. Many airports, and the local governments that support them, need LCCs to improve passenger levels and generate tourism. Subsidies are often needed because the barriers to receive airline service, in this era of higher costs, are increasing. However, oftentimes subsidies are handed out without sufficient assessment of a route’s viability. Therefore, airports sometimes dole out large cash amounts for relatively few passengers, especially on routes not specifically focused on generating tourist traffic. Moreover, airports all too frequently cross the line between legal and illegal aid, privately negotiating with one carrier, while refusing to offer comparable aid to other carriers.

This is not to suggest that all LCCs are created equal in terms of their attitudes towards receiving subsidies. Ryanair has been more successful than others in using subsidies to successfully launch new routes from small airports. Often, these facilities lack international service, and Ryanair is a boon for the small communities that receive an influx of valuable tourist dollars. In most situations, Ryanair will typically launch flights to London, and then if those are successful, to other bases. Many of these routes have become commercially successful for Ryanair and the airports, enabling airports to withdraw subsidies over a period of time.

But, there have been occasions when Ryanair has opened a new destination, only to find that its expansion prospects are limited, as few of its other bases outside of London can support its services. Ryanair has withdrawn flights on many routes because of low demand, or because of an unexpected increase in the airport’s costs. This strategy, while somewhat ruthless, has helped the airline minimize losses on new routes. Often, the most successful airlines are those that know when to cut their losses early, and Ryanair has learned this lesson well.

Flybe, on the other hand, has tended to use subsidies from airports not to necessarily foster creation of a long-term, sustainable route, but rather to improve the bottom line. Subsidies are more effective in markets with large potential for traffic increases, such as tourist markets that have not yet been exploited. Markets that have a higher proportion of business traffic generally see slower gains in traffic. Moreover, airports that need to offer subsidies typically lack significant demand from business travelers because they’re typically distant from major trade centers.

Airports can be seen as subsidizing airlines in two ways, through direct subsidies and inefficient slot appropriation. By offering cash to carriers that add new routes or meet specific passenger count totals, airports can spur the creation of new services. Through poorly managed subsidy programs, airports can end up in a very undesirable situation, having to pay a subsidy to a carrier that did not fly passengers benefiting the airport in any way, such as what Flybe did in Norwich. Norwich, like any airport, should consider using subsidies, but should work closely with carriers to develop targets that are meaningful and realistic, on routes that will actually produce tangible gains in passenger totals. This means airports must carefully select routes to subsidize.

Simply because a carrier is able to or interested in serving a route does not mean that it is the best use of airport dollars. If a facility is looking for significant passenger gains, targeting subsidies at carriers like Flybe, which operate smaller planes shorter distances, on routes flown mostly by business travelers, may be less attractive than working with Ryanair or easyJet to bring in more passengers from greater distances to tourist markets.

Unfortunately for airports, given the high fixed costs of the airline business, LCCs will need subsidies to take the risks associated with a new route. Until the EU more stringently regulates this practice, subsidies will continue to exist. However, more careful and conservative route analysis, along with consultation with airlines about ways to increase passenger totals, will help airports ensure their investments.

Moreover, airports can artificially limit passenger counts through antiquated slot arrangements that limit competition. While this is a non-issue at most facilities, larger airports like Heathrow are grappling with carriers such as BMI, which intends to fly empty planes this winter in order to maintain slots. The slot restrictions, which require airlines at Heathrow to use the slots at least 80% of the time in order to keep them, are inhibiting the ability of new carriers who want to fly into Heathrow (with paying passengers) and introduce competition into the market. Since the introduction of Open Skies, Heathrow has become enormously popular for foreign carriers. Few low-cost carriers have been able to obtain slots there, because of high price and scarce availability. Many foreign carriers are willing to pay much more for a slot than LCCs are, since intercontinental flights can generate more revenue with larger planes and longer sector lengths. Regulation will be needed to ensure that slots are distributed more equitably, to carriers who fly paying passengers. Governments need to work with airlines and airports to ensure that the standards for keeping a slot are very high. Not only should airlines be required to use a slot at least 90-95% of the time, but also, there should be a combination of regulations ensuring high load factors, as well as minimum plane size.

My suggestion would be for airlines that fail to achieve an average 70% load factor on a given flight over a three-month period would lose the slot for that flight. Airlines would be required to use aircraft with a minimum of 100 seats. This would force airlines to fill larger planes, more efficiently using the valuable runway space at Heathrow and airports like it. Moreover, to ensure such a high load factor, airlines might be forced to discount some seats, benefiting passengers and encouraging competition.

However, these regulations would need to be implemented in careful consultation with airlines. A 70% load factor on early-morning flights sometimes is not feasible, and some carriers should be allowed exemptions on certain flights, but a target like this would ensure efficient movement of passengers using the least number of aircraft during the vast majority of operating hours. This regulation alone does not mean that many more LCCs will be able to operate from Heathrow, but it will make fares more competitive and ensure greater efficiency.

Most LCCs are guilty of taking excessive subsidies from airports desperate to see new services. During this time of duress for carriers, airlines are under pressure to seek a competitive advantage in any way possible. This does not absolve carriers of their shortcomings, but it will require increased vigilance from governments and airports to ensure airlines don’t exploit public bodies. Airports need to do a better job of holding LCCs accountable for their investments, ensuring that routes are well chosen and are bringing in the desired passengers. Moreover, airports also need to work with governments and airlines to update outdated regulations addressing slot allocation, improving facility utilization and encouraging added competition to crowded airports like Heathrow.

Sun Country Parent Files for Chapter 11

Sun Country Airlines parent company Petters Group filed for Chapter 11 bankruptcy protection amidst an ongoing investigation of fraud by former group chairman Tom Petters. While the airline expects to continue normal operations, at least for now, I have serious concerns about the health of the carrier. Recently, the company (complying with the federal WARN act) announced that it may lay off all of its employees if it is unable to improve its cash flow, and to do this, it may have to trim employee salaries by as much as 50%. These drastic measures signal a carrier in serious trouble.

While Sun Country is a pretty small potato in most of the country, it's an important carrier in Minneapolis, its base of operations, where the carrier not only operates a variety of services to leisure destinations, but also important business destinations such as Seattle, New York, and Los Angeles. There is no reason to believe that Sun Country will manage to survive the next six months. The airline simply has too many things going against it, and unfortunately, Sun Country is unable to command a price premium in most of the markets it serves, as it targets leisure travelers, making profitability ever more allusive. If Sun Country folds, expect Northwest to move quickly to shore up its position as the top dog at MSP, perhaps adding flights to some of the destinations Sun Country currently serves. But more importantly, Sun Country's departure would create an LCC vacuum at the airport, since it would only have minimal coverage by LCCs (mostly on Frontier and AirTran which don't offer many point-to-point flights). Perhaps Southwest will use its impending arrival at MSP in March to offer service on some of the routes Sun Country is abandoning, particularly to Los Angeles, Phoenix, Las Vegas, and Orlando. That would give Southwest a stronger competitive position at the airport, make the carrier attractive to business travelers, and provide Minneapolis flyers a more stable LCC that is unlikely to go bankrupt anytime soon.

Southwest to Serve Minneapolis-St. Paul from March 2009

Southwest Airlines announced its first new destination in more than a year, Minneapolis, from which the airline will begin service to Chicago Midway starting in March 2009. The airline is keeping expectations low, saying that the carrier will begin a "modest" operation at MSP with service only to Midway. This is not in keeping with previous Southwest destination openings, which typically see routes to several cities and at least 10 daily flights. Even a smaller market like Fort Myers, FL received 9-10 daily flights when Southwest first began service to the city. But how the times have changed. Southwest is likely making this a more conservative opening because of the uncertainty over flight demand. Even though Southwest is adopting a bold strategy to attract business customers, who are looking for nonstop flights to a variety of cities, Southwest simply cannot risk too much of Northwest's wrath in this tight market by making a stronger move. Eventually, Southwest will likely add service from MSP to some or all of the following markets, depending on the Chicago route's performance, Detroit, Cleveland, Baltimore, Los Angeles, Phoenix, and Las Vegas, but for now, the company needs to test the waters.

The route to Chicago is a very good test of Southwest's efficacy to attract business travelers with relatively little risk. Northwest, American, and United all operate in the market, and all charge exorbitant fares. AirTran tried to take on these carriers a year or two ago with discount fares, but was forced to withdraw due to lack of demand. Southwest, because of its brand loyalty and reputation in the Chicago market, will likely be more successful than AirTran. Moreover, the carrier is taking a limited risk by flying to a market where the carrier has a strong base of operations, and one which is only a short distance from MSP, allowing Southwest to generate higher yields using less fuel. While Southwest's Minneapolis operations may not become the size of Chicago's (with over 200 daily flights), this is an important announcement in Southwest's push to make itself a more viable option for business travelers by filling in the holes in its network. This could be a signal that Southwest may be getting ready to serve other major markets it does not yet have a presence in, including Atlanta, Cincinnati, Memphis, and most importantly, New York (Regardless of the claims to the contrary, Southwest's Islip operations are not very effective at serving business travelers headed to NYC). Hopefully Southwest will add these destinations in the future in keeping with a more conservative outlook. With $100+ barrel oil, airlines simply cannot add routes willy-nilly, and with today's limited announcement, Southwest's management seems to recognize the necessity to tread carefully.