Southwest Airlines at LaGuardia Airport?

Southwest Airlines announced today that it has bid for 14 takeoff and landing slots (permitting seven daily round-trip flights) at New York's LaGuardia airport from bankrupt ATA Airlines, though the carrier has yet to formally acquire the slots. Southwest has long avoided serving the New York market directly, instead preferring to use the less expensive and less congested Islip airport on Long Island. But how times have changed. Southwest is eager to get revenues from business travelers as noted before on this blog, and few are willing to make the trek out to Islip, particularly when other low-fare options abound, such as JetBlue at JFK.

Hence, a move into LaGuardia was not completely unexpected. But it does raise some important questions about Southwest's ability to maintain its cost advantages. The carrier is known for its 25-minute turnarounds, which could be difficult to maintain at LaGuardia due to lots of ground traffic during peak periods and other obstacles. Moreover, flights at LaGuardia (as well as JFK and Newark) have some of the worst on-time ratings in the country. Most of JetBlue's flights go to/from New York City, and it has the worst on-time record of any airline in the country. Southwest will need to be prepared for this, but even with delays and potential longer turnarounds, the additional revenues could make up for it.

A limited Southwest operation at LaGuardia will not hurt too many carriers. Many of the flights will likely be to Chicago (or possibility feeders to Baltimore), and so American and United may face some competition, but with Southwest offering only a few flights a day in the market, it will be relatively minor, at least for the time being. American and United will lower fares to compete with Southwest, and probably offer tons of bonus frequent flyer miles to loyal travelers, but Southwest cannot do much harm with only seven daily flights.

The real question is how Southwest will manage to acquire additional slots in the future, if it so chooses. Nobody seems willing to give up their slots, and the government appears to be ready to auction some of them off (a really stupid idea that's going to hurt already-suffering airlines). However, the auction, if it occurs, could give Southwest an opportunity to acquire more slots, but it remains to be seen whether prices will be satisfactory. It's possible Southwest could be negotiating with other carriers for slots. AirTran or Spirit might be willing to part with some of theirs, and if US Airways continues to encounter more financial troubles, that carrier could sell off some of its slots to raise cash. But unfortunately for Southwest, LaGuardia is a popular airport, and its competitors know that once Southwest has a foothold, the company will do all it can to expand, causing significant erosion of yields and pricing power on key routes. Thus, most of Southwest's competitors will not make life easy for Southwest as it seeks to acquire slots.

Perhaps the bigger question is what to do about LaGuardia and other NYC airports in the long-term. Clearly a new generation of air traffic control will help pack more flights into the airspace. But the government needs to be more aggressive at encouraging airlines to upsize their flights. Too many carriers serve very busy airports like LaGuardia with 37- or 50-seat regional jets, which take about as much time to take off and land as a mainline aircraft, thereby clogging up airspace that could be filled with larger jets. It's one thing to suggest that regional jets are necessary at large hubs, and understandably, some small jets should be feeding into Newark and JFK to allow passengers to make international connections. But LaGuardia is not a hub airport, and ideally, jets seating 50 or less should be banned from the airport. New ATC will help more planes get through a given airspace. But if airlines continue to use that airspace for regional jets, it will lead to LaGuardia being underutilized and more passengers having to make longer treks into Manhattan from JFK or Newark. More competition is needed at LaGuardia, and Southwest is right to try and provide it. But until the system is fixed, it will be difficult for the carrier to make significant inroads because of the poor utilization of airspace.

The Worst is Yet to Come

Is the title overdoing it? After all, legacies have suffered through the rise of their low-cost competitors, the 9/11 attacks, and skyrocketing oil prices, not to mention record low customer satisfaction. Could the next crisis really be worse? Many say the answer is yes, and I'm inclined to agree.

Due to the recent financial meltdown that has plagued the world, corporate travel managers are ordering emergency travel cutbacks at unprecedented rates. According to one survey, 25% of firms have issued cutbacks, and this number is only likely to increase as the crisis gets worse. If companies are cutting back, airlines are being deprived of some of their most profitable clients at a time when they are desperately needed.

To make matters worse, many legacy carriers announced a wave of capacity cuts over the summer in response to rising fuel prices. While fuel prices have (thankfully) fallen, overcapacity continues because airlines were not anticipating economic collapse when the announcements were made. Leisure travel has suffered due to the latest stock market falls. Even with fares higher than they have been in some time and fuel relatively low, that doesn't make for a good recipe.

While the Delta/Northwest merger will help alleviate some overcapacity, the two carriers have very few overlapping routes which can see trimming. Instead, most of the cuts will come from significant capacity cuts at certain hubs (eg. Memphis and Cincinnati) or downsizing to smaller aircraft. But the fact still remains that there is an excess of capacity in the market, and unless legacy carriers take more and more of their mainline aircraft out of service, lots of empty seats will exist. But airlines can remove capacity. DC-9s and MD-80s probably should head to the scrapyard; they're old. The reason further downsizing is a problem to airlines is not so much their inability to do so, or even their reluctance to lose market share (heck, even the prolific grower Southwest is trimming capacity this winter). Rather, it could be resistance by labor.

In 2009, a plethora of new labor negotiations will come to the fore, and with a pro-union Obama administration in the White House, airline workers could have the upper hand. Labor tensions could run high at virtually all major US carriers this year, and that could create further angst for passengers. Employees are going to resist further job cuts, especially given the limited job prospects at other carriers. In the Delta/Northwest situation, Delta's mostly non-union employees will need to decide whether to join the unions of their Northwest brethren. Employees at all legacies have made significant sacrifices to help keep their companies afloat since 9/11 and they deserve better. While major airline CEOs are not as lavishly paid as some of their banking counterparts, they have received remarkable salaries for lackluster performance in recent years. Employees are feeling pressed, and if airlines refuse to given on wages, it could get ugly.

If the industry continues to weaken, and mainline employees fail to receive wage increases, the employees most likely to benefit are those at some airlines' regional affiliates, who could see increased job security. Because of falling demand, more and more flying duties are being passed onto the regional carriers that operate 50-100 seat planes for legacy carriers. Many 70-seat jets are currently flying between major hubs and large cities, such as Chicago and Philadelphia. These regional lift contractors have lower payscales and are often exempt from some of the more onerous work rules that legacies are subject to. Unfortunately, if the demand isn't there, more and more flying will be outsourced. This means less comfort for passengers, lower wages for workers, and an overall downsizing of the industry.

So this brings me to the all-important question. Can the industry weather this crisis? Of course. Most legacies, with the possible exception of US Airways, are too big to fail (just like AIG), and the Federal Government will not let them collapse. One legacy could fall victim to this mess, and be bought out or partially liquidated, but I don't see any one of the four key legacies (American, United, Delta/Northwest, and Continental) failing entirely. Too many jobs would be lost, and the market couldn't handle that seismic loss in capacity.

Whether profitability comes soon is a different question. Southwest is facing its own set of problems including risky fuel hedges, which will turn out to lose the airline money if oil stays put for the next few years (possible if there's an extended downturn, but not likely), and industry-leading labor costs, which suggest that the carrier may feel pressure to raise fares, triggering fare increases from competitors. If this happens, airlines will have a better shot at achieving profitability.

However, while legacies are likely to survive, even if they are not profitable for awhile, some LCCs are in a more precarious state, most notably Frontier. The carrier seems to be without a viable business plan, and is getting hammered by Southwest in Denver. The company is trying to stay afloat by appealing to its local loyal customers, and launching its Lynx turboprop service, but it could be too little too late. Frontier is hemorrhaging cash (the company just lost $30 million in its fiscal second quarter) and seems to be on the defensive as Southwest takes more and more of its market share. Frontier is not yet a lost cause, but unless the company is able to post better numbers, it will soon run out of cash. In this liquidity environment, the company cannot count on getting more financing to operate, without which, it could fail.

Some argue that Sun Country, if it can make it to the winter season (their most popular time of the year), may be able to survive. I disagree. I don't see this company as having a viable business plan even if they make it through the winter, and I am skeptical that they will survive the next six months. I have been wrong before, and I may be wrong again, but with demand for leisure travel falling precipitously as families worry about their 401(k)s and new potential competition from Southwest on some domestic routes (albeit with a connection in Chicago), I simply do not see Sun Country surviving as a scheduled carrier. However, the company may be able to survive if it reverts to mostly charter operations, but that will depend partly on the demand for package tours.

Midwest is not as important a player as it once was. The TPG/Northwest buyout has helped reduce the company's route network and transform its culture into another LCC. Midwest plans on subcontracting much of its flying out to Republic Airways on smaller regional jets, making the company much more dependent on short-haul routes in the Midwest. Even during this downturn, AirTran has made a concerted expansion effort in Milwaukee, and I expect that, if things stay bad in the industry, Midwest will be increasingly marginalized.

While Southwest, JetBlue, and AirTran have all had major challenges, these three "core" LCCs should survive the downturn relatively unscathed. Each of these companies has a solid business model, and all three are working to diversify themselves, adding international routes (or in the case of Southwest, international codeshares), as well as working to improve ancillary revenue streams. Although the days of rapid growth and $200 transcon fares are over, these three carriers will continue to be important. There will also be a continued role for LCCs that operate mainly in one region. Alaska, Hawaiian, and Spirit should all survive. Even Virgin America looks like it can make it (although this cannot be independently verified, as the company has refused to release traffic and financial data, citing competitive concerns).

With one or two exceptions, most US airlines have viable business plans and are adequately prepared to handle potential setbacks in the near future. Passengers continue to demand low fares more than anything else, and carriers are working diligently to provide. However, to do this, airlines will continue to make changes that will likely irk passengers such as increasing ancillary charges or replacing mainline aircraft with regional jets, all in the name of saving money. As the industry shrinks still further, one hopes that airlines will gain the necessary pricing power to provide a better product to customers, a living wage to employees, and fair returns to investors. It's possible, just don't count on it.

Air Scoop Article: O’Leary’s Transatlantic Vision: Can it succeed?

The following article appeared in the November edition of the European low-cost carrier newsletter Air Scoop. I hope to have a new post up by the end of the week or, at the latest, the beginning of next. I promise!

Ryanair CEO Michael O’Leary has said over past two years that he intends to form a new transatlantic long-haul carrier if he can locate sufficient aircraft at a low price. However, past iterations of this business model (such as Oasis Hong Kong, Zoom, and XL) have failed, primarily due to escalating fuel prices. O’Leary has made promising announcements like these before. Given the environment and its constraints (such as a competitive transatlantic market and shortage of available long-haul aircraft), will he succeed?

Unfortunately, long-haul low-cost carriers lack the same operating efficiencies as short-haul low-cost carriers. Why? Because the cost base on long-haul flights differs from short-haul, and the costs are more difficult to avoid. Fuel and labor (for cabin crew and pilots) are the two biggest chunks, as well as the extraordinary cost of acquiring and maintaining twin-aisle long-haul aircraft. Food and beverage, baggage handling, and airport costs make up a smaller percentage of the total costs than on short-haul routes. Low-cost carriers have a greater degree of control in determining efficiencies on short-haul routes. 25-minute turnarounds, for instance, are critical in this. A long-haul carrier has less flexibility in its turnarounds, due to provisioning and security requirements. Moreover, a 25-minute turnaround versus a 50-minute turnaround will enable a carrier to complete additional short-haul legs, but this time savings is negligible on long-haul routes, since a long-haul aircraft may only complete one or two legs a day. Finally, ancillary revenue opportunities, while available on long-haul flights, are more limited. Since a given long-haul plane will only serve about 600 customers a day, whereas one of Ryanair’s 737s could see well over twice that number in a given day, the number of customers who contribute to ancillary revenues is more limited.

O’Leary promises a two-class configuration, with tight seat pitch and bare-bones service in economy, while offering “beds and blow jobs” in business class. It has been reported that the carrier plans to fly between secondary airports in the US and Europe. The carrier may use facilities like Islip Long Island (a popular facility for Southwest Airlines) as a substitute for New York’s overcrowded airports, as well as some of Ryanair’s European hubs such as London Stansted and Frankfurt Hahn. With these efficiencies, O’Leary hopes to sell seats in economy for as low as $12 each way. But, unlike some other low-cost, long haul carriers, which sell the majority of their seats in advance through package tour operators, there have been no signs that O’Leary is planning this for his new carrier. Therefore, the airline will have greater control over its yield management, but at the risk of having greater difficulty filling its seats.

After the Open Skies agreement, fares have gone down slightly, but not significantly, especially in economy class. Why? Because fares were already quite low. In fact, on some deeply discounted tickets, taxes and fees make up more than half the cost of the ticket. While some carriers like Zoom saw an opening to offer lower fares, the company was unable to sustain enough traffic at higher fares to compensate for loss-making lower fares. The economy sections of many legacy carriers are relatively inexpensive on the heavily-traveled routes that O’Leary seems ready to compete on.
However, it is true that passengers can often end up paying a significant amount for transatlantic fares if they require a nonstop flight, or are flying from a market that lacks a lot of competition. For instance, there is a monopoly on nonstop flights between Dallas and Paris (held by American Airlines). A traveler needing a nonstop flight between those two cities will pay an enormous amount. In this instance, any type of competition will help. But O’Leary’s low-cost carrier does not plan to target business travelers who need nonstop flights in underserved markets. Instead, he seems interested in leisure travelers who, lacking his carrier, would either not fly or would change planes in order to do so. 

This is the fatal flaw of O’Leary’s model. He’s targeting a market which is already enjoying low fares. Meanwhile, business travelers, those whom O’Leary hopes to charge higher fares to, are unlikely to want to fly on his carrier. Many business travelers do not fly on business class due to corporate travel policies, and instead fly economy. These travelers who need to be ready for work the next day are not likely to enjoy being woken up at 3 am for another trolley run through the aisle, selling food and duty-free items. Provided that fares on other carriers were reasonable, they would likely pay a bit more to enjoy a much higher standard of comfort. Moreover, those travelers who do fly in business class are unlikely to put up with other aspects of the airline. O’Leary promises extensive comforts, but other carriers set the bar very high in business class. It’s likely that O’Leary’s business class product, although potentially cheaper than rival products, will be inferior to the competition. O’Leary admitted in a press conference that a certain percentage of the traveling public doesn’t really care what it costs to travel. Which is why they’d choose other carriers, ones that have more frequent flights, use primary airports, and offer connections to other destinations. In other words, carriers with which they have loyalty.

I am concerned that O’Leary’s new carrier will not only offer an insufficient product to those who want to pay for it, but it will also offer unreliable service. One problem that plagues many long-haul low-cost operations are frequent and lengthy delays. Business travelers will simply not put up with 6-12 hour delays, which were common on Zoom, and are also usual on other long-haul, low-cost operations like FlyGlobespan. If O’Leary’s carrier is strapped for planes, then passengers could face agonizing delays, and this could hurt his carrier’s reputation quite quickly. In order to lower costs, O’Leary may try and operate planes as long as 18 hours a day, which will not leave much room for recovery if delays occur.

The primary problem with any long haul, low-cost operation is that the lowest cost tickets have to be subsidized by passengers who pay more. Even premium class operators such as Eos or Silverjet failed to get enough travelers to pay more expensive fares which inhibited the carriers from achieving profitability. Moreover, their products and amenities were not sufficient to convince passengers to switch their business. Ryanair can find passengers who will pay more at the last minute because many people want weekend breaks at the spur-of-the-moment (something that’s less common with trips over longer distances). Moreover, the company has a well-established system of ancillary revenues and charges that enable the carrier to make significant amounts of money off of lots of passengers. If O’Leary wants to succeed with this model, he should follow what he did with Ryanair and not target the biggest markets with the fiercest competition. Instead, he should look for offering nonstop routes between city-pairs where there currently is little or none. Then, he would have a more persuasive product to potential passengers.

Ryanair already serves the primary airports in a number of key cities that lack significant nonstop service from the US, such as Madrid, Dublin, Manchester, and Marseilles. These could be attractive airports from which to offer long-haul service. Or, if O’Leary chooses to serve primary airports with his transatlantic carrier, then he could more effectively target business travelers, and enter routes that currently have monopolies or duopolies on nonstop flights, drastically lowering fares and profiting. This is the best way to tackle the market. More flights between New York and London aren’t likely to generate terrific yields, whereas flights that bring competition into markets burdened by astronomical fares will be more successful.