United and Continental's Mega-Merger

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

What is likely to happen:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

December 27, 2009

Trends & Predictions for 2010: Part I

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

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

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

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

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

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

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

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

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

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

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

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

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

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

June 24, 2009

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.

June 24, 2009 in AirTran Airways, Delta Air Lines, Midwest Airlines, Regional Lift Providers | Permalink | Comments (0)

September 05, 2008

Using Buses to Transport Passengers Short Distances To/From Hubs

This post discusses an idea I've had for awhile, but been somewhat hesitant to share. After thinking of potential ways for airlines to cut fuel costs, this one struck me as relatively easy with immediate impacts. Throughout our air transport network, dozens of very short routes (less than 150 miles between airports) exist. Most of these routes can be covered by bus with only a modest increase in transport time. While the idea of busing passengers to alternate airports is nothing new, as Ryanair has successfully done at many of its major bases in Europe, busing passengers between destinations in lieu of an aircraft, in order to facilitate connections, it is something untested in the US.

The reason buses are preferable to small aircraft is simple: cost. It's very, very expensive to fuel a small plane traveling such short distances (relative to the amount of revenue generated), in addition to the costs of crewing and maintaining that plane.

There are two different basic types of regional jet contracts that could potentially be affected by a move to buses. One are the contracts, known as at-risk flying, that many companies which operate turboprops on very short routes receive. For a flat fee per flight, the turboprop operator can use the brand of the legacy carrier's regional arm, and the legacy carrier will take care of booking and payment. The company that provides the turboprop takes a risk when providing that flight, and can either make or lose money. Theoretically, if turboprops are not making money with high fuel prices, they would be pulled by operators.

It's unclear whether buses would be effective at replacing turboprops for short flights. Turboprops are designed for use on short routes, and depending on the model, can be significantly more efficient than regional jets. However, because I don't have reliable cost estimates for these aircraft, nor intimate knowledge of the contracts that allow a turboprop provider, like Skywest, to license itself as the affiliate of a legacy carrier, I'm hesitant to say that short turboprop flights should be targeted for replacement by buses. While buses might have advantages over turboprops, particularly for very short flights, buses would arguably provide more advantages over regional jets.

The second kind of contracts, known as fixed-fee flying, typically cover regional jets. The company that provides the regional jet can effectively pass on its cost to its legacy partner. The legacy keeps all the revenue generated from that flight. However, in these difficult times, legacies are eating mountains of red ink, because regional jets are not as fuel efficient per passenger as larger planes, and legacies have faced significantly higher costs in the face of smaller increases in revenues.

As we have seen in the past several months, many legacies, such as Delta, have tried to find any loophole possible in their contracts with regional lift providers in order to cancel them. Delta is simply losing too much money on these deals. Unfortunately for Delta, the company has had difficulty nullifying portions of the agreements. Given these restrictive contracts, the transition to the use of buses on some short services could take awhile, but it is worthwhile from a cost standpoint.

I am not suggesting that buses replace all regional flights. I am not even suggesting that buses replace all flights on a given short route. However, there are flights where it would be far more efficient and cost-effective for carriers if they used buses rather than small aircraft, particularly 50-seat regional jets. The vast majority of passengers on regional aircraft will connect at a hub. Regional aircraft are for getting passengers to and from a hub, not flying passengers point-to-point. Yet regional jets remain a very expensive way to transport passengers to hubs.

Moreover, regional flying, in it of itself, is essential for a legacy carrier, enabling the carrier to differentiate itself from its low-cost competitors, and generate higher yields. In fact, while fuel for regional operations can be rather pricey, labor costs are typically much lower, and this can help offset some of the burden. Airlines are finding that 70-100 seat jets are very efficient for many routes they serve, even to larger cities. Longer regional flights are impractical to target by bus, and 50 and over seat jets will have a place in serving this market.

So hypothetically, if this idea were ever to come to fruition, what would it look like?

The operation:
Ideally, buses would depart from downtowns, or from strategic pickup points in the small city being served, enabling passengers to skip the long drive to the airport. The bus would then travel on the fastest route, nonstop to a gate at the airport terminal. Admittedly, this would require some level of security clearance, and it's unclear whether airlines would be able to obtain this. But ideally passengers could then, at a boarding gate, drop off their luggage into a cart and go through a quick security screening before connecting to their flight. This would require the cooperation of several different parties but if airlines were able to get a bus infrastructure in place, it could enable carriers to make this process very seamless, while preventing passengers from having to wait in long lines at ticket counters.

If the cost savings were not so dramatic, this would not be worth doing, but very loosely estimated costs suggest that if a 55-passenger bus costs $300 an hour to operate and a 50-seat regional jet costs $1500 per hour to operate, the savings generated by using the bus would be very significant. Not only could capacity be added on the route, but at significant savings.

On a hypothetical route, if the bus takes two hours to cover the same distance the regional jet can in one that would still produce a cost savings of well over $500 per trip, not bad when added up over time. It would result in some additional time spent traveling for passengers, but this would be minimal if routes were carefully selected. Whether airlines like it or not, oil prices will continue to increase in the coming years, and this cost burdens regional jet operators far more heavily than it does bus operators, making bus travel increasingly advantageous in the future. 

Consider the Delta route between Columbus, GA and its hub in Atlanta. The route, 83 miles by air and just under 100 miles by road, is serviced most days by 4 flights on CRJ-100 regional jets (50-seaters). To fly the route takes about 50 minutes, to drive, about an hour and 45 minutes. If some of the CRJ flights were replaced with bus service, bus passengers would experience a slightly longer trip, but one that is more comfortable and less prone to delays (mechanical, air traffic control, and weather-related).

Admittedly, a bit of timing would be required; sending a bus out in rush hour would nullify any advantages of this scheme. But given the increase in delays that passengers are experiencing, and the increasing strain on our air traffic control system, exacerbated by more flights on smaller jets, bus service could not only offer airlines cost savings, but passengers a better experience by reducing the propensity for delays.

Like a flight, passengers could board the bus from a boarding gate (on the tarmac), and head nonstop to their destination. And with the lower costs of operating the bus service versus a regional jet, Delta could operate additional services, minimizing connections. Unlike a regional jet, which is extremely cramped and offers very little room for passengers to spread out, a bus, while not extremely spacious, offers more room and comfort for most passengers. Moreover, some bus companies have started to outfit buses with Wi-Fi Internet access, enabling business travelers to be more productive on the road. Like planes, most buses have overhead compartments, and there is ample room in large buses for both carry-on and checked baggage.

And though small regional jets would likely be the clearest targets of this scheme, this does not mean that the markets bus services are used in are necessarily small. Regional jets help provide both capacity, but more importantly frequency. On some high-density, inter-city routes that have a lot of traffic, airlines could offer bus service to replace flights for lower-yielding passengers, adding capacity economically.

American currently flies several times daily between Milwaukee and Chicago O'Hare on 44-seat regional jets. If a passenger needs to travel between Milwaukee and Raleigh-Durham, but purchases a very discounted ticket, then American could bus that passenger to O'Hare, about an hour and 45 minutes away, and then fly him or her to Raleigh, saving the airline a considerable amount of money, and enabling the carrier to offer more reliable service during weather and air traffic control delays.

So this begs the question; why wouldn't a customer merely drive the distance themselves instead of putting themselves in a crowded bus with a bunch of other people? Given the rising cost of airport parking, gasoline, and the hassles driving entails, a strong case can be made for taking the bus. Moreover given the convenience of taking the bus (departing and arriving at a boarding gate in the terminal), and the potential comfort benefits (being able to use the Internet or watch movies instead of driving), many customers would readily take the bus instead of their own vehicles. Does this mean that all passengers will be swayed? No, but as long as most are, then offering bus service seems like a reasonable alternative and can help airlines keep valuable business travelers.

Would buses be an ideal solution? Hardly. They will likely be slower in most cases, and some passengers may find them quite frustrating. Time-crunched business travelers (those who provide airlines with their profits) might choose alternative options if the choice was between a bus and a flight on a different airline, and this is something airlines have to be careful with. If business travelers are strongly against the idea of a bus, then this idea may not fly at all. But, if carriers can demonstrate that the bus would not add a significant amount of time to their trip (this means timing buses with key connections), while enabling them to improve productivity, then some could be swayed.

Given the absolute necessity for airlines to cut costs, short regional flights are a place to start. This will hardly be a solution to the airlines' larger problems with fuel, but if carriers are looking for ways to trim excessive fuel usage, bus service should legitimately be considered.

September 5, 2008 in American Airlines, Delta Air Lines, Low Cost Carriers, Regional Lift Providers, Ryanair | Permalink | Comments (1)

August 04, 2008

How Short-Sighted Management has Seriously Damaged the Industry (and some solutions on how to remedy this).

Editor's Note: I've been a bad blogger lately, and I apologize to my loyal readers. I haven't had a substantive post since May, and now we've reached August. How time flies! While I hope to post more often, the nice weather might prevent me from getting more work done on the computer, so posts may be less frequent than desired for the next few weeks. Also, I hope to post selected pictures of my Ecuador trip soon.

The airline industry has problems that no other industry does. For some reason, the airline industry has difficulty adequately matching capacity with demand, and as a result, business cycles and unexpected turns of events seem to hit the airlines much harder than other sectors. There are many reasons for why this may be true. But first and foremost, airlines offer a product that is both essential to the economy, and is one that is constantly in greater demand. Low-fare carriers have succeeded because they have been able to reduce the cost of air travel for those who otherwise couldn't afford it. Ryanair, which has succeeded in reducing fares more than any other carrier, has seen extraordinary growth, because people simply cannot get enough of air travel. After purchasing one car or cell phone, a consumer may have all he or she needs of those products for several years. It's much harder to increase milk sales by lowering prices than it is for airline tickets.

Consumers have limitless opportunities to fly, and airlines have succeeded in convincing them that it's a good use of money, partly because it's more convenient and comfortable than other forms of transport. Nevertheless, as costs rise, this myth will be shattered. Americans will still want to fly, but it will require more and more money. What airlines will hopefully realize is that they will be more profitable companies by offering fewer flights, targeting business travelers and those who are willing to pay for it. Capacity reductions are already starting to come into place that would help achieve this, but it could be too little, too late. Fuel prices have reached such stratospheric levels that most major US airlines will likely burn through their cash reserves in the next few years.

As legacies are at a substantial cost disadvantage with the hedging Southwest, instead of targeting their core customer base, their most frequent flyers, and improving their service, legacies have eliminated many of the perks that these travelers have come to expect, in the name of revenue generation. Known as "unbundling" it's a strategy that Ryanair has perfected (to the ire of much of Europe's flying public), by charging for many services that airlines offer, aside from the flight itself. Charging for checked bags, food, pillows and blankets, and anything else that isn't bolted to the cabin, seems to be the trend. In fact US Airways' new policy is to charge for all beverages onboard. This will even keep free water out of the hands of passengers, except in cases of medical emergency; bottled water and sodas onboard now cost $2.

Yet the fact of the matter is, some of these charges are overreaching, offering airlines far more in bad press than new revenues. Airlines need to maintain their reputations, and they need to maintain low fares. This is the dilemma that carriers face. Yet if carriers adopted a better yield management system, I suspect it could generate just as much, if not more than some of these extra charges. That means offering more deals at the last-minute to fill seats (but making them restrictive enough to prevent their usage by business travelers, whom the airlines need to pay full fare). If airlines aggressively move to fill seats on less popular flights, targeting flights individually, and ensuring that the plane will be as full as possible, additional revenues can be created. It also means further reducing frequent flyer award seats on popular flights, to allow more room for paying clientele. Moreover, increased overbooking, when possible, should be practiced to better fill seats. All these moves will likely be bad for passengers, but they won't deliver the continuous negative publicity that these fees seem to generate. They also will not interrupt the onboard service experience that passengers demand. Airlines are already working these angles, but let's face it, filling one additional seat on a plane at $100 could cover 50 $2 soda sales; they can do more.

Some might argue that the "unbundled" strategy airlines are adopting is what customers want. I don't buy that. Skybus' demise proved that the completely unbundled model cannot work in the US, at least with the high fixed costs that airlines currently face. Yet that seems to be the model many legacies are now replicating. There are services many airlines used to offer (and that a few still do) that weren't being effectively utilized by customers, and there was a great deal of waste. Some examples were airline meals and restrictions enabling customers to check two or even three pieces of checked luggage free of charge. Everyone was paying hidden costs in their ticket prices for services that a select group of customers was taking full advantage of. These are services that should be charged for. By most accounts, after US carriers started offering buy-on-board meals, fewer people ate onboard, but the food was of a better quality.

However, other services, including one free checked bag, snacks and drinks onboard, and free booking of award tickets (without some of the surcharges that certain carriers have recently imposed) should be things that all US legacies offer. These are basic comfort and service amenities that airlines need to retain loyal customers. Frequent flyer award tickets are hardly free if customers must pay to redeem the miles. Spirit and Allegiant will always be the deep-discounters in their respective markets, and charge for everything, but those carriers that are shooting for higher yields need to offer more services included within the ticket price.

True, airlines have yet to impose many of these charges on their most loyal customers, with high elite status or those paying full-fare. But it's not merely the charges themselves, but rather the impression they create to customers, that may hurt loyalty, even with customers unaffected by the charges. Continental, for instance, has resisted adding fees for a number of services. This is in part because of the company's concerns that they could disrupt operations, both on the ground, and in the air, as those passengers affected by the fees resist the changes, causing potential delays or turmoil in the cabin, affecting everyone's experience.

The ability of airlines to cut costs in this environment is rather minimal, without shrinking the size of their businesses. Instead, airlines need to focus on better yield generation. That does include some of the charges being proposed, but it also includes fare increases, and a concentrated effort to fill planes during less-traveled periods. The unbundled strategy has gone too far, and the reputation damage has been done. Airlines need to be extremely cautious going forward about adding additional charges, because discretionary air travel will decrease if the experience becomes too painful, and business travelers will be more willing to consider other options of transport (or conducting meetings).

August 4, 2008 in Allegiant Air, Continental Airlines, Delta Air Lines, Low Cost Carriers, Ryanair, Skybus Airlines, Southwest Airlines, Spirit Airlines, US Airways, Virgin America | Permalink | Comments (1)

April 15, 2008

What a United/Continental Merger Would Look Like...

With the recent Delta/Northwest merger proposal being made official, it appears that United and Continental may announce a deal within the coming days in order to help the two carriers compete in the changed marketplace. Both United and Continental released statements this morning expressing their desire to be proactive about consolidation opportunities. In other words, they're hard at work coming up with a deal. Like a Delta/Northwest deal, a United/Continental deal would have to target capacity and service, but in different ways than a Delta/Northwest deal.

For instance, looking at capacity, Continental has very been successful in filling planes to Newark and Houston, its two largest hubs. Flights to these cities from many large US markets could be increased in order to increase the number of passengers transferring onto profitable international flights. One beneficial attribute of this merger would be that Continental, which has struggled at times to get the right aircraft for its service requirements, would have access to additional larger, more cost-effective planes to use on services from hubs. For Continental, regional capacity isn't as much of a problem as it has been for other carriers, in that Continental has been able to divest itself of some capacity over the past few years. Continental has had leverage over ExpressJet, its main regional jet provider, to help that company reduce its costs and its capacity. Continental has already trimmed a number of ExpressJet routes and if fuel prices increase further, additional routes could be cut.

But the problem for Continental is that almost all of its regional capacity is on 50-seat or fewer regional jets, which are very expensive to operate in a high-fuel cost environment. While Continental is starting to integrate more fuel efficient turboprops into its regional network, they will make up a very small component of the company's regional services at a time when Continental really needs more cost effective planes. Contrast this to United, which granted, contracts for a lot of 50-seat regional jets. But in addition to this, United has a rapidly-growing fleet of 76-seat regional jets, which United has decided to configure in a 66-seat configuration, allowing United to increase yields on these flights by offering First Class and Economy Plus seating. This has given United a marketing advantage with high-yield travelers on key regional routes, as well as a degree of pricing power. If a merger goes through, expect to see a reshuffling of some regional routes, with a greater emphasis on turboprops, especially in California and Denver. United operates a wealth of short-haul routes from its California and Denver hubs, and many of these could be operated with newer, more fuel efficient turboprops.

Moreover, while domestic flights may not see dramatic additions or reductions, Continental's ability to access United planes may allow the combined carrier to launch key routes from its Newark hub, a long-term strategic asset for the company. Additional routes from Newark to Asia and Africa could be launched with the procurement of additional planes. Continental has struggled to get enough long-haul aircraft, especially 777s for very long routes. However, United has several dozen 777s that will permit the combined carrier to assert itself in the Asia-Pacific, as well as in Europe and the Middle East. If Delta and Northwest get the go-ahead to merge, United and Continental's combined presence will keep pressure on prices on key routes to Japan, China, and other Asian destinations where United and Northwest currently have the only presence by US carriers.

If there's a market in this deal that will be the loser, it's going to be Cleveland. Continental may say, just like Delta did in its press release yesterday, that all hubs will be saved. This is a fallacy that's being perpetuated in order to keep Senators and Congressmen happy until the merger is approved. These secondary hubs are filled with high-cost regional jets, and don't have the origin and destination traffic to keep operating at current flight levels. The economics of these secondary hubs don't work in this market, and Continental will be forced to make tough choices. Regional services will be the first to go, though some regional service is likely to remain for the foreseeable future. Some cities will eventually be axed altogether, and for others, service could just shift to Houston or Newark. Any international service Continental has from Cleveland will also likely be cut. Some domestic routes may be kept, a focus city arrangement that allows Continental to continue serving key business markets from Cleveland. But the bottom line is that Cleveland is going to see fewer destinations. Though the upside of this is that while more passengers may have to make connections, a downsizing by Continental could allow Southwest or other low-cost carriers to start additional flights, lowering fares for area consumers.

Servicewise, this merger is going to be tricky. Both United and Continental have good customer service, though both carriers have been faltering of late to deliver the same quality of service that many customers have come to expect, due in part to increasing pressures on overworked and undercompensated employees. Both United and Continental will have to recommit themselves to delivering high-quality service from all employees if they are to retain the large share of the business travel market that they currently possess.

But, other issues relating to service will have to be resolved. First, United has an Economy Plus section on all of its mainline planes and many of its regional aircraft. Continental does not have such a section, and depending on the structure of a combination, Continental may need to reconfigure much of its fleet. The Economy Plus section has helped United retain higher-yielding customers who often expect a higher level of comfort with a higher ticket price, and it is a concept that should be adopted throughout the combined company's fleet as a way to resurrect the service culture that airlines should be delivering and to retain key customer groups.

The second major service-related issue that the combined carrier will have to deal with concerns onboard food and beverages. On many longer domestic flights, Continental offers complementary meals to customers, something not matched by any legacy carrier. This is something that the combined carrier will need to think carefully about. Providing meals is a good selling point, but it's also expensive. If the company is focused on cutting costs, then for consistency of operations, meals should be cut on domestic flights. But, if the company is serious about attracting business travelers, then it will offer improved food service on additional flights, offering all travelers food service at a standard similar to what most airlines offer for buy-on-board meals. This won't be inexpensive, but it's a cost worth having if customers value the meals. Airlines can serve decent onboard food (many of the buy-on-board selections carriers offer are of a much higher quality than the "free" meals they gave out several years ago), and while it's a cost, with the hassles travelers are facing at the airport, having food available onboard the aircraft may be a selling point to a lot of travelers.

If this merger is completed, the combined carrier will have a larger base of business customers than Delta/Northwest, and a critical advantage over that carrier in key business markets including Washington DC, Chicago, Houston, Denver, San Francisco, Seattle, Los Angeles, and others. It won't be a perfect match, no combination between two legacy carriers will be, but they do have compatibility, more so than Delta and Northwest, and while it will take time, I have more hope for this deal being a long-term success than the Delta/Northwest agreement.

For more details about the United/Continental deal, check out this earlier (speculative) post, or this post for information about the Delta/Northwest deal. If you haven't subscribed to our free feed, please do so by going to the Airline Bulletin home page and entering your email on the right side of the page, under Get Posts By Email. And if you haven't had a chance to support the sponsors on the site, please do so next time you book a trip. By doing so, you're helping to ensure that Airline Bulletin can keep operating.

April 15, 2008 in Continental Airlines, Delta Air Lines, Midwest Airlines, Southwest Airlines, United Airlines | Permalink | Comments (0)

April 13, 2008

What Delta and Northwest Need to Change in Order to Thrive

Recently, Delta and Northwest got back to merger negotiations, after having broken off talks due to difficulties concerning the combination of seniority lists if a merger were to take place. The Wall Street Journal reported today that a deal could be announced within a couple days. With airlines suffering from record fuel costs, as well as ongoing maintenance issues, a merger is appearing more attractive to airline executives. Unfortunately, the savings they desire may be elusive. The easiest way to combine carriers would be a holding company combination, where management activities, as well as some airport operations, would be combined, but pilots and flight attendants would operate under separate contracts and probably on separate fleets, at least in the near term. A combination is fine because it allows Delta and Northwest to resolve the two issues that are most important, controlling and adjusting capacity to the realities of $100 a barrel oil, as well as improving the company's customer service.

One of the reasons many managers were looking to merge legacy carriers was in order to consolidate domestic capacity. But a merger wouldn't necessarily allow Delta and Northwest to consolidate a significant amount of capacity in terms of seats. Both Delta and Northwest are in the process of removing capacity from their fleets and there isn't a tremendous amount of overlap on their domestic routes. Internationally, both carriers are expanding, and capacity would increase. However, a combination would allow the carriers to better manage their existing capacity, consolidate some flights, as well as reevaluate service to small markets, that with $100+ oil, may not be profitable. With a combination and a restructuring of the combined carrier's route network, the company could have the opportunity to rearrange its agreements with regional jet contractors, such as Mesa or SkyWest, in order to help the companies reduce costs and capacity to unprofitable markets. Even though the number of seats reduced in the carrier's overall system would be small by the trimming of some regional routes, it could save the carrier a great deal of money.

As the US Airways/America West merger has demonstrated, forcing two sides to a labor agreement that neither particularly likes is a bad recipe for employee morale and customer service. The pilots have still not satisfactorily resolved their longstanding disagreements over seniority agreements. Therefore, instead of a complete merger, a combination of the operations side of the business while keeping Delta and Northwest as essentially separate carriers under one parent company might be a preferable arrangement. Unfortunately, this wouldn't lead to as many cost savings as managers would desire, since larger labor groups, such as pilots, would be covered under separate contracts. But what is critical in this deal, even more than cost savings, is that management cannot force the pilots unions to accept an agreement that one side sees as unfair. Airlines will have to deal with large groups of employees for the indefinite future, and they need to do their best to keep them happy. What legacy carriers especially cannot forget is that with the flying experience becoming increasingly unbearable for travelers in the US, airlines need to ensure that their employees deliver top-notch service. And one of the best ways they can do that is by making them feel valued and treating them with the respect they deserve. This is partly why Southwest is known for its service. Even though the company has more leeway than other carriers in its hiring, because it can select from a broader range of candidates, the airline successfully retains and motivates their employees by keeping them in a work environment that lets their voices be heard. If Delta and Northwest cannot improve their customer service, they will seriously threaten their future viability as businesses.

A carrier modeled under the Air France/KLM combo where the carriers operate separately under a holding company that controls scheduling and pricing for both carriers, would allow Delta and Northwest to adjust their route network to make it more efficient as well as adjust pricing to make the carrier more profitable. Unfortunately, restructuring flights will not do enough for the combined carrier. What airlines in the United States are suffering from is a media deluge of negative publicity. Customers are growing more antagonistic towards the airlines. The recent airline quality survey that came out last week was a typical example of this. Nationwide coverage of increased delays, increased rates of lost bags, and so forth, didn't do much to help the airlines. And Congress has caught onto the act, with front-page hearings criticizing airline executives about safety. To put it bluntly, consumers in this country hate airlines. And with rising prices, customers are getting increasingly irritated with putting up with substandard service that they feel they don't deserve given the exorbitant cost of their ticket.

As a result, the merged carrier needs to re-brand itself, with the Delta name, as a carrier that genuinely cares about service. What we don't know in this market with rising prices is whether there will be sustained demand for leisure travel. Business travel (specifically unmanaged business travel), while perhaps decreasing slightly in demand, is going to be a more important target market for the carrier in the coming years. Moreover, Delta has a very strong presence in large business markets, including Boston, New York, and Washington DC, and by making sure that it offers industry-leading service, comparable with carriers abroad, will help the carrier maintain yields and market share in this turbulent market. Business travelers will otherwise look to LCCs such as Southwest and JetBlue, which are pulling out all the stops by offering business travelers more amenities, better service, higher punctuality, and lower fares. With air travel becoming increasingly burdensome for business travelers, airlines that make the experience as pleasant as possible will be those that will see growth in market share and profits.

This company, if it is positioning itself for a future of more competition, especially from overseas, as well as from LCCs on key domestic routes, and a future of high oil prices, needs to discipline itself on capacity and service. The carrier will likely get Delta and Northwest's route networks integrated into a larger whole, and the company will find way to combine operational redundancies to reduce some costs. But, this carrier will not make money if it has too much excess capacity in the market, as well as too little capacity in growing markets. Moreover, it will not make money if it has poor service, because as has been shown in Europe and Asia, customers, and especially business travelers, are willing to pay more for good service if airlines actually deliver it. Now to get good service, management needs to, for lack of a better term, "be nice" to its employees, especially its pilots and flight attendants. That means these labor issues need to get resolved, or at least get to a point where they won't boil over after a combination. If the combined company can focus on these two areas, capacity and service, not only will it be the largest carrier in the world, it will be one of the best positioned for an uncertain future.

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April 13, 2008 in America West, Delta Air Lines, JetBlue Airways, Low Cost Carriers, Northwest Airlines, Southwest Airlines, US Airways | Permalink | Comments (0)

April 04, 2008

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...

April 4, 2008 in AirTran Airways, Delta Air Lines, JetBlue Airways, Low Cost Carriers, Skybus Airlines, Southwest Airlines | Permalink | Comments (0)

March 19, 2008

Legacy Airlines Making Cuts To Deal With Record Fuel Prices

As evidenced by yesterday's Delta announcement that the carrier will trim 2,000 jobs and reduce its domestic flying, many airlines are feeling pressure to shrink in the face of high fuel prices. Moreover United and Northwest have issued warnings that legacy carriers may need to shrink in order to survive by trimming routes that simply aren't profitable with such high fuel prices, especially those on higher-cost regional jet aircraft. Carriers are starting to feel the pinch. The question is, will these cuts be enough?

Perhaps the greater uncertainty that carriers face is not what the price of crude oil will be tomorrow, but rather what demand will be for air travel, particularly from business travelers, in the coming months and years, given a slowing economy. While the rise in oil prices hasn't helped the economy, most of the reasons for the recent economic slowdown are independent of oil prices, and so airlines are feeling a double-whammy from the economic slowdown and the recent rise in oil prices. What airlines have been able to count on in recent years is that demand is still strong, both from business and leisure travelers. But with a slowing economy, many businesses may try to reduce travel expenditures. Many travelers who work for small businesses or others who have unmanaged travel accounts provide lucrative yields to carriers. But their employers could be hit hardest by an economic downturn, and may have less of an ability to keep funding pricey travel. This would challenge airlines, especially because business travelers have a greater ability than leisure travelers to deal with the fare increases that airlines have had to impose due to rising fuel prices. As a result, many legacy carriers, are looking to expand abroad, where they feel demand will pick up more in the near future. Whether this is true or not is unclear, but there are two key drawbacks that carriers need to be aware of with regard to this expansion.

The first is that many of these long-haul flights, while offering higher yields, also have higher fuel bills to go along with them. Many of the new destinations that carriers are adding, in East Asia for instance, have 12+ hour flight times, which burn a tremendous amount of fuel. Moreover, many legacy carriers are operating these routes with older 767-variant aircraft, which are less fuel-efficient than the newer 777s. And with only 2 US carriers placing orders thus far for the fuel-efficient 787 aircraft, it may be awhile before US carriers can significantly reduce their international fuel needs. While legacy carriers can afford these fuel bills for the time being, because the yields are higher, many of these routes could be cut too. Many legacy carriers are expanding to new markets, markets that have little nonstop service to the US. Adding service to a market that has little nonstop service to the US offers greater risks and rewards than would a flight on an already-established route. With the heavy demand on fuel resources that international flights require, many carriers may not allocate a sufficient amount of time to let their new flights gain enough demand to a point where they can be profitable, because the initial losses will simply too severe due to high fuel costs. Any route takes time to gain demand and become profitable, but in this environment, airlines may be more risk-adverse. This may have good short-term implications for airline balance sheets, but if the new international markets airlines tout really do warrant service to the US, then other carriers, foreign carriers, may make the leap to start service and get a valuable head start on US carriers in terms of gaining market share.

The second drawback is this expansion of service by foreign carriers in US markets. In many cases, these foreign carriers have higher product and service standards than their US counterparts, especially in first and business class, allowing them to gain additional high-yield passengers, even if they start service on a route after a US carrier starts service. Moreover, foreign carriers often offer nonstop service where US carriers offer hub-and-spoke connections (though this works both ways, depending on the routes, since passengers can connect in the US on American carriers or abroad if flying on foreign carriers). Many passengers would prefer to spend five hours in Frankfurt than five hours in Chicago. US carriers have tried in recent years to upgrade their cabins to compete with foreign carriers, but sadly, they have fallen behind in many areas, and this could impact their ability to make international routes as profitable as they desire.

Legacy carriers have done nearly all they can to reduce costs. There are no major cost cuts they can make, and any further cost cuts will either shrink the size of the carriers, or trim operations that shouldn't be trimmed for the long-term benefit of the company. What will need to happen now is that these carriers will need to look into the future and see how they can best position themselves towards these new realities. As much as legacies would like to believe that fuel prices will dramatically decrease, oil over $80 is a new reality that carriers need to adapt to. This means that carriers need to rethink their expansion as well as their new aircraft purchases and timing. Expect increased pressure from airlines around the world on aircraft manufacturers to create an aircraft that can deliver dramatic fuel efficiency gains. Moreover, airlines may exert continuing pressure on government to offer better solutions to energy policy. This isn't a problem we can drill our way out of, but rather one where established alternative energy solutions need to be implemented (such as electric vehicles) so oil can be used for industries where serious alternatives do not yet exist (such as aviation). By reducing the pressure on oil prices from automobile drivers and other oil users, airlines will see lower crude prices. But that will only come when airlines and other large companies lobby for a comprehensive national energy policy that takes renewables seriously. If the airline industry is to thrive, oil prices will have to come down, and the only way to do this is to reduce demand. Ultimately, this is where the solution lies.

March 19, 2008 in Delta Air Lines, European Carriers, International Carriers, Northwest Airlines, United Airlines | Permalink | Comments (0)

March 02, 2008

Potential 2008 Merger: American and Continental

This is a merger deal that has been mentioned less often than a potential United/Continental deal, and it's in part because quite frankly, the match between them wouldn't contain as many synergies as the latter deal, due primarily to too much overlap in terms of both carriers' route networks, though there would be important fleet synergies that could offer cost savings. Of any two legacy carriers, American and Continental are most similar in terms of route structure. Both have very large hubs in Texas, as well as sizable operations in the Midwest (American having hubs at St. Louis and Chicago O'Hare and Continental having one in nearby Cleveland). Furthermore, both carriers have strong operations in the NYC metropolitan area, with a wide array of international flights, and neither carrier has a very diverse set of operations in the US west of Texas.

Moreover, while Continental has used its Newark hub to expand to destinations in Europe and Africa, a very large proportion of both carriers' international capacity is concentrated in Latin America, especially between hubs in the Southern US and Latin America. For many smaller destinations in Mexico and Central America, many of which are served by regional jets, a merger by American and Continental would leave very little additional service from US carriers, potentially raising prices for consumers. That would be beneficial from a competitive standpoint, but it could threaten the viability of the merger.

In an American/Continental merger, Cleveland has a very high probability of being sacked as a hub. The same is true in a United/Continental scenario. Cleveland simply doesn't have the yields and the origin and destination traffic levels to sustain the levels of service Continental has there right now. Continental's operation there could be downgraded to a focus city, with regional service being trimmed or eliminated altogether, and service maintained mainly to hubs and large business centers. This could open up the opportunity for Southwest to gain market share in Cleveland, where it already has a presence, by offering competing nonstop service to woo business travelers. Southwest could help lower fares for area travelers, but a reduction in Continental service will almost certainly mean a loss in the number of destinations served from the airport, forcing many travelers to make connections to reach many smaller markets. Moreover, any international flights Continental flies from Cleveland would very likely be eliminated in a merger. As a result of consolidation in Cleveland, most of that hub's traffic would get diverted to American's O'Hare hub. It's unclear how this deal might affect American's operations in St. Louis. Because Continental has no hub within several hundred miles of St. Louis, my guess is that it's operations will likely remain relatively intact, though St. Louis could feel the effects of a further reduction in regional jet usage if fuel prices continue to remain at such high levels, since regional jet flights are increasingly unprofitable due to high fuel costs. Many of American's flights at St. Louis are operated by regional jet contractors.

Of course the real wild card in any American/Continental consolidation is what would happen to the two carriers' Texas hubs, which are very close. It's likely that both hubs will probably remain intact in a form similar to the present, because American and Continental simply have too much to lose by giving up their position in either market, the yields are too good, and the market share is too significant. However, what could get shifted around are the routings of some international flights. Depending on which city has less competition, or has better yields for a given international route, certain international flights could get shuffled between Dallas and Houston. Moreover, flights between Dallas and Houston could be consolidated with larger aircraft and more frequent service, giving a combined American/Continental leverage against Southwest by lowering ASM costs and potentially boosting market share.

American Airlines has a very simplified fleet structure for an airline of its size. After 9/11, the company reduced the number of aircraft types in its fleet from 14 to 6, and this has produced tremendous operational efficiencies for the carrier. Continental, which has a range of 737, 757, and 767 variants, will complicate American's fleet. However, these aircraft, even those variants which would be new to American's fleet, would bring efficiencies in maintenance and training. But what's even more important, is that increasingly, US carriers have resorted to regional jets and smaller aircraft to fill the roles larger aircraft used to play, in order to increase load factors and revenues per available seat mile. Because of its relatively uniform domestic fleet, American cannot easily tailor capacity to certain markets at certain times. The company has a large capacity gap between its MD-80s, which seat over 140 passengers, and some of the 70-seat regional jets its American Eagle subsidiary operates. Continental, while not an ideal carrier to help fill this capacity gap, helps give American some flexibility. Continental operates a large amount of smaller 737s, including some that seat around 120 passengers, and Continental recently started contracting to use 78-seat turboprops on certain routes out of its Newark hub, that have allowed the carrier to better time capacity to meet the needs of business travelers, as well as reduce unit costs. With a more diverse fleet of 737s, the combined carrier will be better able to time capacity to certain times of the day in certain markets, giving it leverage over Southwest which only operates 122- or 137-seat planes.

Like a potential merger with United, a merger with American would help Continental realize its international potential. Continental is constrained due to its lack of 777 planes, but American has 47 which will help the combined carrier add new lucrative long-haul international routes in the coming years. With the exception of American's A300s, which are very useful aircraft for carrying large amounts of cargo on Caribbean routes, both carriers' long haul fleets are Boeing 767s and 777s, allowing the combined carrier to reap additional cost savings.

Strategically, the argument can be made either for or against a merger. On the one hand, because American and Continental are such similar carriers, with similar fleets and route networks, relative to other legacy carriers, then a merged carrier would not be a diversified one, but instead one with many more eggs in fewer baskets, than a Delta/United merger. Strategically, this could work out, but it will focus the carrier on hub-and-spoke domestic routes, international travel in certain regions, and certain products and service standards, all of these being much less varied than those of other carriers. If the carrier is focused on the right markets with the right levels of capacity and the right product, then it will have a tremendous advantage over the competition. It's a gamble, and one that I think will not pay off well for the combined carrier in the long-term because the market is changing too quickly to have a narrower strategy. A diversified carrier, like a combined Delta/United, has strength in virtually every location US carriers serve, as well as the ability to attract key groups of corporate flyers and leisure travelers. A combined American/Continental might be very, very strong in Texas and elsewhere, but its service frequencies to key business markets such as San Francisco, Los Angeles, Boston, and Washington DC might pale in comparison to a Delta/United combo, making the carrier less attractive for high-yield business flyers.

This merger is less likely to be approved by lawyers at the Department of Justice than a United/Continental deal. American and Continental would simply have too much market power in Texas, especially between Dallas and Houston which is one of the busiest air travel routes in the country. Moreover, American and Continental are the only two carriers for many smaller communities in Texas, Oklahoma, and the surrounding states. If these two carriers merged, higher fares and less frequent service would likely result for communities that have struggled to maintain precious flights. The last major regulatory conflict concerns whether the DOJ would examine how American/Continental consolidation would affect fares to certain international destinations, that the two carriers dominate from the US, particularly in Latin America. These are all hurdles that can be overcome, but they may be tougher ones to climb than what a combined United/Continental would have to face.

While some of the recent difficulties in securing the Delta/Northwest merger have made an American/Continental deal even less likely, it's still a scenario that should be considered. Even if legacies aren't able to spark consolidation this year, this deal may be one to watch for in future years.

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March 2, 2008 in American Airlines, Continental Airlines, Delta Air Lines, Low Cost Carriers, Northwest Airlines, Southwest Airlines, United Airlines | Permalink | Comments (0)