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.

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.

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!

Well, That was Fast...

Just a day after announcing that it planned to buy out Frontier, opening the door for a possible exit from bankruptcy, Republic Airways decided to purchase a second carrier, Midwest, from TPG Group for the princely sum of $31 million. This was down just slightly from the roughly $450 million TPG and its partners (including Northwest) paid for Midwest less than two years ago. And then today, Frontier announced that it will make schedule changes, adding mainline frequencies to several mostly leisure markets, as well as frequencies on Lynx to Salt Lake City, Omaha, and Albuquerque. Service to El Paso and Grand Junction, however, will be discontinued in September. This latter move is welcome, and a possible sign that the market may have bottomed or is coming close to bottoming. For an airline to add new flights during the fall months, let alone in the midst of a recession, is impressive. Obviously, it's anyone's best guess as to whether the new flights will be successful, and the stiff competition they will certainly face from Southwest can't help.

But let's examine the first move more closely. Republic essentially bought what has quickly become an airline in name only. Midwest is rapidly retiring its 717s, and plans to continue to do so even after yesterday's announcement. Instead, Midwest will use E-170s and E-190s operated by a little-known carrier called Republic, an arrangement in place well before yesterday's buyout. So why bother buying Midwest? Aside from being able to exert greater control over their lift, and being able to purchase a well-respected brand for a bargain price, there doesn't seem to be as much point to this move as there did with Frontier. At least Frontier is a well-regarded carrier which has managed to hold its own, if not expand (the announcement above notwithstanding), in the face of Southwest. Although it has adopted a more proactive attitude towards charging for services, Frontier hasn't taken away seat pitch, assigned seating, or onboard television, which are its signature amenities. But Midwest, although it has a well-respected brand, has significantly cut back on its amenities and service as a way to compete, adding more seats to its planes and drastically reducing its onboard food service.

At the end of the day, unfortunately, Midwest simply can't cut it against a strong Delta/Northwest and a nimble carrier with extremely low costs, AirTran. Midwest is bleeding money, unlike Frontier which has reported some small, but significant, profits. Republic's purchasing of Midwest will do little to change the situation at that carrier. Republic has not announced any major operational or strategy changes, and I fear that the end could be near as a result. Service will continue to suffer in the wake of cost cuts, and smaller jets will become uncompetitive in the marketplace since they have higher ASM costs than the larger 717s and 737s which AirTran operates. Many of the routes Midwest services have competing AirTran service, which is cheaper for customers and actually makes money. Midwest should have died long ago, absorbed as part of AirTran. But that opportunity has come and gone, and now it's time to recognize that Midwest, no longer what it once was, will end its days as a small, regional operator before eventually being shut down, with the jets likely going to other airlines Republic contracts with.

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.

Skybus Shutters...

Skybus has become the third LCC this week to fail. The carrier's Board of Directors announced late Friday that due to high fuel costs and a slowing economic environment, the carrier will cease operations effective April 5. The company expects to file for Chapter 11 bankruptcy protection on Monday. While this author isn't surprised at the ultimate fate of Skybus, given that the carrier was predicated on a faulty business model which simply couldn't bring the necessary yields in this type of environment, he is surprised that its collapse happened so soon. Skybus had $160 million in startup capital and burned through much of it rather quickly. However, the carrier still had a fair amount of cash on hand and likely could have continued operating for many months, but its investors probably realized that the company simply couldn't succeed given these market conditions and decided to pull the plug before the losses mounted.

The fact that Skybus decided to stop flying now is a bad sign. The carrier was going to fail, but for it to go under so soon makes me concerned especially about Virgin America, and how willing its investors are to endure the same kinds of initial losses that Skybus, or any new airline for that matter, faced. In this high fuel cost environment, the initial losses any new airline faces will be much greater than under more typical circumstances, and it simply may not be worth it to investors to try and ride out the storm. Virgin America has a much better business plan than Skybus, and is taking the right steps for success, but it's unclear whether the company's yields are sufficient to cover its increasing costs.

What will this mean for customers? Aside from the end of $10 one-way flights, it will mean fewer options to most consumers. The most significant effects may be felt in Skybus's focus city markets, Columbus and Greensboro. These markets will see a reduction in service, and in Greensboro, there is little hope of immediately filling the void. Raleigh and Charlotte have sufficient low-cost service, and the demand simply isn't there for another LCC to step in and replicate Skybus's level of service in Greensboro. It's possible that JetBlue or AirTran could eventually enter the airport, but the service those carriers would offer would be rather limited (service to JFK, Atlanta, and Florida). Columbus, on the other hand, is well-served by Delta and Southwest. While customers may not be able to find the very discounted fares Skybus offered, they will still find cheap fares, relative to other airports in the region, in particular Cincinnati.

But in some cases, fewer flight options may mean no flight options. Skybus's departure will be devastating to airports where the carrier was the only commercial airline serving the airport. Punta Gorda, St. Augustine, Gary, and others are unlikely to see any immediate replacement for Skybus's flights. This isn't a huge problem for most consumers, since low-cost carriers serve larger airports near the minor airports listed above, such as Jacksonville, Fort Myers, or Chicago Midway. But for the airports, some of which offered hundreds of thousands of dollars in incentives to Skybus in order to lure the carrier to their facilities, it will be a major blow.

Customers seeking information on how to obtain refunds or about flight cancellations should consult the Skybus Web site.

In a post tomorrow, I'll discuss some of the potential solutions to this oil mess. These airline failures can't keep happening, because while small carriers may get destroyed, over the long-term, even the legacies with large cash cushions could get in trouble. And the last thing Congress wants to do is offer another giant bailout to the airlines...

Low-Cost Carriers Making Cuts To Deal With Record Fuel Prices

Yesterday, you heard about the steps that legacy carriers may take to reduce fuel costs. Low-cost carriers have a business model that's predicated on growth, and so unlike legacy carriers, which are essentially shifting capacity, but not growing, or even slightly shrinking their respective companies, AirTran, Southwest, and JetBlue are all looking to grow, but at reduced rates. Moreover, all seem to be working on additional revenue sources in order to pay for higher fuel costs. Southwest has added its Business Select fares within the past year, offering business travelers increased flexibility and amenities for a price. JetBlue announced yesterday that it would charge $10 to $20 more for seats with greater legroom. But the larger LCCs in the US aren't looking to add some of the charges that LCCs abroad are offering, including charges for all checked luggage, airport check-in, and assigned seating/priority boarding. Unfortunately, many LCCs in the US don't have the ability to do what they really need to do which is to diversify their operations and make themselves into carriers that can serve more types of passengers on higher-yielding routes.

Of all US LCCs, JetBlue is by far the best positioned to do this. The carrier, with a recent investment from Lufthansa, has access to strategic partnerships with foreign carriers that many other LCCs don't, due in part to JetBlue's dominant position at JFK. While the second phase of the Open Skies treaty may dilute this advantage, as foreign carriers may not need to rely as much on JetBlue to offer feeder services, since they'll be able to offer US domestic service themselves, for the time being, this position allows JetBlue to potentially increase its revenue with interline booking arrangements. Moreover, JetBlue is working on expanding its own international routes, especially in Central and South America. The carrier announced yesterday that Orlando would become a focus city, and this will help facilitate JetBlue's expansion to Colombia, as well as additional Caribbean islands. JetBlue will offer serious competition to American and Spirit in the region, and allow the airline to get a greater share of the growing, and profitable Latin American and Caribbean markets. Southwest and AirTran are also examining the possibility of international flights, but these carriers seem to be less positioned to offer extensive international service right now. Both of these carriers will likely offer international service soon, but probably to a lesser extent than JetBlue or Spirit.

Finally, unlike any other US LCC, except perhaps Frontier, JetBlue can command a small price premium for its product, because the carrier has an attractive brand with many amenities and high-quality service, allowing the company a little wiggle room in terms of costs that other carriers lack because they can't sell their product above the market rate. Even a $5 or $10 premium on tickets can make give JetBlue a tremendous financial advantage over competitors in this market.

While JetBlue may be in an advantageous position, Skybus is not. While Skybus will also be reducing its growth rate, that carrier also plans to shift its capacity and growth to routes with shorter flight times, higher load factors, and higher yields. Skybus has had difficulty of late because high fuel prices and low passenger numbers. As a result, the carrier is delaying its expansion, cutting some loss-making routes like Chattanooga, Tennessee, as well as planning to announce its new focus city next year instead of later this year, and focusing on high-traffic markets such as Florida. While this author disagrees with much of Skybus's strategy, the carrier is making some of the right corrections it needs to. However, this may be too little too late, and Skybus could run out of money to fund its operations if it doesn't change its business model to a system that allows the company to charge higher fares. Skybus lacks any sort of pricing power, and must price its fares below those of other low-cost carriers as well as legacy carriers, because the company offers fewer amenities and a higher level of risk to consumers if their flight is canceled or delayed. With rising fuel costs, the cost discrepancies between a carrier like Skybus and a carrier like Frontier are shrinking, as airport, labor, and amenities costs, all of which Skybus has trimmed, become a smaller portion of a typical airline's cost base. Both Skybus and Frontier have to pay roughly the same price for fuel, but rapidly-rising fuel costs make up a greater portion of Skybus's costs than Frontier's, yet the value that customers receive from one carrier is very different from the value they receive from the other. Skybus will need to remedy this by offering additional amenities if it wants to continue to survive.

However, Skybus is not the only carrier that will need to make changes. In the coming months, additional LCCs will likely add more ancillary revenue programs in order to help offset fuel costs. LCCs are not in the advantageous position they were a few years ago, in many ways, they are currently at a disadvantage to legacy carriers, and as evidenced by some of the changes Southwest has already made, even the stalwarts are feeling pressure to change in order to survive.

If you enjoyed this post, consider subscribing to our feed. Just enter your email under Get Posts By Email on the right side of the Airline Bulletin home page. And if you're able to, please help support the site by visiting the sponsors on the right side of the page.

How Low-Cost Carriers Should Approach the Impending Consolidation

While much of the attention surrounding the merger frenzy in the industry right now has centered on legacy carriers and their many possible combinations, low-cost carriers are also very much in the fray, and could be important instigators of consolidation. There are several reasons for this. The first is that many LCCs are seeing their costs rise after years of solid cost containment. Older aircraft, more senior employees, as well as rapidly rising fuel costs are challenging LCCs. At the same time, many of these carriers recognize that there is relatively little "fat" to trim. These carriers have minimized staffing, fuel, airport, and other costs, and unfortunately, unless they were to convert to a Skybus-style business model (which, even then, doesn't yield tremendous cost savings), can't pare their costs much more.

Second, many of these carriers are smaller than the legacy carriers they compete with (with the notable exception of Southwest). Smaller carriers often lack the economies of scale that larger carriers have, and the even larger legacy carriers that could be created after a merger frenzy will have economies of scale that LCCs will simply be unable to match.

Third, many of these LCCs recognize that their business model has limited growth opportunities. Point-to-point domestic routes simply don't cut it anymore. To attract travelers and keep expanding, airlines need to offer connectivity with smaller aircraft (such as with Frontier's Lynx operation, or Alaska's longstanding partner Horizon Air), or they need to offer additional international service (as JetBlue and Spirit are doing in the Caribbean). Legacy carriers will continue to expand the diversity of their networks, and low-cost carriers, with their obvious fleet and cost constraints, will struggle to match them.

At a time when international growth, not domestic growth, will lead to higher profits, many low-cost carriers need to seriously think about how to offer more service options to customers. Spirit and JetBlue are looking towards Central and South America, Frontier towards Canada and Mexico, and Southwest towards unnamed international destinations. But even with this expansion, it misses the big prizes of Europe and Asia, which LCCs, in their current form, will be unable to serve.

The question is, though, whether a low-cost carrier would merely get bought out by a legacy carrier, as is quite possible, given that certain legacy carriers could otherwise get left out of the consolidation frenzy (like American and US Airways), or whether two low-cost carriers would merge together. I would suggest that the latter option is less likely, but possible. Since many LCCs have distinctive cultures and brands that they want to maintain, as well as a low cost base, it would be challenging to find a pairing of low-cost carriers that fit together very nicely. While there are certain scenarios that would be possible in this regard, they are limited in scope.

One brief example: I think Aloha Airlines is good takeover bait for Southwest or even Alaska, since both Southwest and Alaska are interested in Hawaii expansion, all three carriers operate 737-700s, and both Southwest and Alaska offer considerable service to the continental US from the smaller West Coast airports that Aloha serves, such as Sacramento, Oakland, and Orange County. However, Aloha is a relatively small carrier, and the acquisition of it by Southwest or Alaska would do very little to reduce either company's costs and instead be more centered about expansion.

A buyout of a low-cost carrier by a legacy carrier, would, however, be a way to add capacity to the network of a legacy carrier, even though it could destroy the brand of the bought carrier. This scenario is imperfect as well, since legacy carriers are focused mainly on improving efficiencies and yields on international routes, not the domestic ones where LCCs chiefly fly. The acquisition of a low-cost carrier would be to a legacy carriers' minimal advantage, unless that low-cost carrier had a certain degree of market share or pricing power in a key market.

For instance, while neither of these scenarios are in any way likely, a buyout of Frontier by United would give United an even greater degree of pricing power in Denver. The same would be true with a Delta buyout of AirTran, again, an unlikely possibility. Moreover, both these scenarios raise certain regulatory issues, since the Department of Justice is active in trying to prevent significant market power by one airline in any given market. However, I would argue that certain markets are large enough such that this wouldn't be a significant issue. Moreover, the unification of both carriers could create benefits for the customers of both companies by expanding route networks and flight schedules.

But if legacy carriers are focused on international growth, why would they want to expand their domestic networks, which would be inevitable with the takeover of an LCC? The main reason is to increase market share, particularly in critical markets of strategic importance to the company, where there are large concentrations of higher-yield travelers. Is there a merger that would do these things? I know of at least one, between United and JetBlue, which is detailed in this post. This is not to suggest that other merger scenarios are unthinkable, for all low-cost carriers are quietly discussing various merger scenarios and how they want to play a role in the upcoming consolidation, but I would suggest that the most attractive merger scenario involving a low-cost carrier is between United and JetBlue.

And if you enjoyed this post, consider subscribing to Airline Bulletin's feed. It's free, and you won't receive any spam or more than one email a day.  To sign up, go to the Airline Bulletin home page and enter your email address under Get Posts By Email on the right side of the page.

JetBlue and AirTran Gear Up for Lucrative, Risky Winter Season

JetBlue announced a significant expansion of its Fort Lauderdale routes today, with three new routes from the city to Richmond, Raleigh, and Charlotte. These routes, to be operated seasonally on a once daily basis, will help expand the attractiveness of JetBlue in these respective markets, where JetBlue has been reticent to expand beyond routes to New York and Boston.

But more importantly, these new routes will help the airline do battle against a key foe, AirTran. AirTran and JetBlue are planning on expanding more conservatively in the next few years, and that means that both carriers will be increasingly competing on similar routes. The carriers would rather avoid competing with each other, because each has much to lose. As a result, these carriers may try to announce routes where they don’t directly compete, though competition will be inevitable. For example, AirTran recently announced seasonal service between Boston and West Palm Beach, a route that JetBlue currently operates.

The Northeast/Mid-Atlantic-Florida market is lucrative for carriers since the yields low but steadily rising, and the demand is incredibly high. AirTran and JetBlue are likely to add more Florida routes in the coming weeks in preparation for the peak winter season, and this was a smart route announcement by JetBlue because AirTran is unlikely to match it. Moreover, there is certainly a need for these three routes for consumers in Richmond, Raleigh, and Charlotte, as one or two carriers currently dominate those routes.

AirTran and JetBlue will continue to stake out their respective routes in the coming week, in time for the biggest winter travel season Florida has experienced. Both carriers should succeed because the market is so large, but both carriers will need to be prudent about the fares they charge because the consumers are more prudent than ever when it comes to finding the best price and ultra low-cost carriers like Spirit will keep yields low. Moreover, customer service is going to be a bigger issue for consumers than it has been in the past.

Even a minor slipup by JetBlue could do serious damage to that airline’s brand. Many customers understood JetBlue’s mistakes the first time, this past February when the airline suffered its now infamous Valentine’s Day meltdown. But they will not be so forgiving if it happens again, and JetBlue could have serious difficulty containing the fallout. But what is more threatening for JetBlue is the possibility that a major customer service gaffe by another low-cost carrier will stain the LCC segment of the industry.

If AirTran has a customer service meltdown sometime this winter, not only will it hurt that carrier, but it will also reflect poorly on all airlines, but especially low-cost carriers such as JetBlue, Southwest, Spirit, and even US Airways. As a result, carriers will have to execute a delicate balance between keeping fares low and ensuring a steady profit, while maintaining enough customer service staff on the ground to handle potential calamities. Otherwise, if customers get the message that flying is likely to be a hassle and a pain, which could happen if a publicized meltdown occurs, then demand on leisure routes could soften in 2008 onward, giving the industry one more problem it doesn’t need.

AirTran's Takeover Bid for Midwest Expires as TPG Group Makes Deal

AirTran’s multi-year long effort to take over Midwest Airlines has ended today as AirTran announced that it has let its tender offer expire. AirTran’s offer, much of which was comprised of AirTran stock, was valued at approximately $15.75 per share of Midwest given AirTran’s closing share price on Friday. TPG Capital, formerly known as Texas Pacific Group, a large private equity firm, which has a long history of investing in the airline industry, made a deal with Midwest to purchase the company for $16.00 a share in cash.

What has not been announced is whether regulators will accept the deal. There is another investor partnering with TPG on this deal, Northwest Airlines, and that may raise some antitrust issues with the federal government. However, Northwest claims that the company is only providing financing for the deal, and will not participate in the management or control of Midwest if the deal is successful.

TPG is a very experienced and savvy firm. And they will do what is necessary to help Midwest survive. However, it remains to be seen how Northwest’s involvement in the deal will affect Midwest. Like AirTran, TPG and Northwest may have big plans for Midwest, including restructuring its product, route system, fleet, and competitive strategy in order to more effectively compete with low-fare competitors in Milwaukee and Kansas City. And Northwest’s involvement will certainly raise antitrust concerns, as it could give Midwest and Northwest a disproportional amount of market share in Milwaukee and possibly in Kansas City and Omaha.

Northwest made a serious attempt to compete with Midwest a few years ago by opening up a focus city base in Milwaukee. However, Northwest was forced to pull out of many point-to-point markets from Milwaukee after a protracted battle with Midwest. Now, Northwest may finally have won the war.

From what Northwest has said, it appears that Midwest will not be turning into Northwest anytime soon. However, Northwest’s vague claim makes it very unclear how detached Northwest will be from operating Midwest. Should Midwest merge with Northwest, it would be worse for the airline than merging with AirTran. While Midwest’s customers would have access to a larger route system, spanning across the United States as well as three continents, they would also get some of the airline industry’s worst customer service and an on-time performance record that needs definite improvement.

But what is more likely is that TPG will help Midwest maintain its respected brand and keep its niche as a service-oriented carrier. But the big question is whether TPG can keep Midwest’s service standards high and its costs low while being attacked by low-fare competitors such as AirTran.

AirTran has likely been seriously damaged by this deal going through for Northwest and TPG. The airline was counting on Midwest to help propel its growth Westward and into new markets. Unfortunately for AirTran, the company must find ways to grow organically, which the airline has been struggling to do.

However, even though this presents a challenge for AirTran, it also presents an opportunity. AirTran must now focus on what has helped it in recent months, which are fare cuts. AirTran has some of the lowest costs in the industry, and the airline can pass those savings onto customers. AirTran can focus its growth on older markets. While the airline should certainly use some of its new planes to link focus cities on the East Coast with destinations out West, some of AirTran’s new capacity should also be put into tried and tested markets.

The best markets are along the Eastern Seaboard, between the Northeast and Florida. With JetBlue facing substantial difficulties in the next few years, now is the time for AirTran to nibble at the carrier’s market share. While JetBlue will continue to dominate the low-fare market in NYC for some time to come, AirTran has room to grow and steal passengers from JetBlue in Washington DC and Boston. Moreover, AirTran has growing operations in Baltimore and Philadelphia that have also been resisting competitive pressure from Southwest. All these markets are ripe for increased service to Florida.

AirTran has a decent enough product that it should be able to retain a fair number of the customers it attracts with its low fares. While customers may not flock to AirTran as they do JetBlue, there’s no major reason why AirTran cannot gain at least some brand loyalty in these markets. That loyalty will enable AirTran to charge higher fares once the carrier’s costs begin to rise in the coming years.

AirTran made an attempt to deal with future growth by making an acquisition. While it was a noble and reasonable effort on the part of management, sticking to what has been proven to work may be the best option for the airline at this stage. One of AirTran’s more recent expansion announcements was additional service from Las Vegas to several smaller markets in the Midwest. This is much riskier than Eastern Seaboard service and carries relatively low yields. Short-haul travel is still a growing market on the East Coast, and it’s the one that AirTran has been most successful in thus far in its operating history.

 

AirTran’s competitors, legacy and low-cost rightly feel that they need to change in order to ensure their future success. But AirTran doesn’t have as many of the cost imperatives and thorny expansion and labor issues that some of its competitors are dealing with. AirTran certainly has issues that it needs to work out, but perhaps those issues are best worked out in markets the airline is more experienced operating in, rather than in brand new markets.

Finally, if you like what you read on Airline Bulletin, don’t forget to subscribe to our feed. It’s free, you won’t be spammed, and it won’t come into your inbox more than once a day. Just enter your email under Get Posts By Email on the right side of the page.