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.

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 29, 2009

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!

December 29, 2009 in AirTran Airways, Allegiant Air, American Airlines, EasyJet, Environmental Issues, European Carriers, Frontier Airlines, JetBlue Airways, Low Cost Carriers, Midwest Airlines, Ryanair, Southwest Airlines, Spirit Airlines, United Airlines , US Airways | Permalink | Comments (24)

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)

April 23, 2009

Three Carriers Report Results--And A Note About Checked Luggage Policies

Alaska Air, US Airways, and JetBlue all reported first quarter earnings today. Alaska and US Airways reported quarterly losses, whereas JetBlue reported a profit, albeit a small one. The results were hampered by fuel hedge losses recorded in the quarter, though most carriers have detached themselves from most of their fuel hedge obligations, so in future quarters these losses will diminish (assuming the price of oil stays low). The results were a bit better than expected, and a promising sign for the upcoming summer months.

I wouldn't post about these earnings, because I don't have too much insight into them, except for one thing I found interesting in the results of both Alaska and US Airways. Both carriers used the date of their earnings releases to announce revisions to their baggage policies, and both policies will ultimately result in greater revenue for each carrier. US Airways will offer the option of online payment for checked baggage fees. If a passenger chooses not to pay online, there will be an additional $5 fee at the airport. Alaska will add a $15 fee for a first checked bag, bringing it in line with legacy carriers, though distancing itself from Southwest, which currently permits passengers to check two free checked bags. However, the nature of these moves differed.

US Airways added an additional restriction in their policy without adding any value to it whatsoever. Customers that had checked bags before for $15 or $25 will now have to pay more if they don't pay online. Not only is there no value added, but ostensibly, there is no reason why US Airways needs to add this charge now. The summer travel season is coming, meaning higher revenues, and fuel prices are at low levels. The economic crisis has been hurting airlines for the past several months, and though it's not clear things will get much better anytime soon, the business travel environment doesn't seem to be getting significantly worse. A more reasonable policy that would have added some value might have been to add the charge, but then offer customers who pay online a discount on the bag fee or bonus frequent flyer miles for the first few months. That way, US Airways could have seen whether the charge would be added by other carriers and either retreat from it if they were at a competitive disadvantage, or get rid of the discount after other carriers had added it.

What this new policy indicates is US Airways' aggressiveness to nickel and dime its passengers. In a similar move to add a new fee without adding any benefit, US Airways added fees for onboard soft drinks several months ago. The carrier was forced to retreat from this policy after the charge wasn't adopted by other carriers and frequent flyers complained. Nevertheless, US Airways is basing its survival on being able to charge customers for added services, and will continue to try and take the lead in adding new fees and charges in order to raise ancillary revenues without giving customers anything in return.

Contrast this with Alaska's new policy that will charge customers $15 for a first checked bag. What is interesting is that, although Alaska may be putting itself at a competitive disadvantage against Southwest, the carrier is offering their customers something for that extra fee--namely, a $25 discount off future travel or bonus frequent flyer miles if a customer checks in a bag and it arrives at the carousel more than 25 minutes late. Yes, customers are paying for a first checked bag, but at least the carrier has made an attempt to save face, to offer a perception of value even though the value of discounted travel certificates and frequent flyer miles awarded under this policy will be far far less than the new bag revenues collected.

Adding ancillary fees does not mean that airlines cannot do it in a customer-friendly manner, where customers feel that they received something extra for a service that was previously free, even if that something extra is only a nominal cost to the airline. This is something Southwest might want to take note of. Southwest could still maintain a consumer-friendly image even while moving to make itself competitive with other carriers. They are the ones that are putting themselves at a disadvantage, by having to match the fares of their competitors without the lucrative ancillary revenue streams their competitors use. I wouldn't be surprised if in the not-so-distant future, Southwest adds some limited new fees, though not necessarily for checked bags. Perhaps when they report Q2 earnings, airlines seem to like to appease their investors that way...

April 23, 2009 in Alaska Airlines, JetBlue Airways, Low Cost Carriers, Southwest Airlines, US Airways | Permalink | Comments (0)

August 05, 2008

Decommoditization as a Solution to the Airlines' Problems

The recent push to "unbundle" services airlines has hid the more fundamental problems facing the industry, regarding airline business models, and how these businesses treat their customers. All airlines need to do a better job of presenting themselves to travelers. If a consumer is going to pay, say $500 for a flight, even if most of that cost is out of the airline's direct control, the airline still needs to deliver a service that the customer values at that level. Most customers in this country will gladly pay $510 or $520 for the same flight, but with a superior experience attached. As ticket prices rise, so will consumers' expectations. Wealthier customers typically expect more of the services they purchase, and airlines must live up to that. That carrier will lose some business, but the tradeoff is worthwhile, and with capacity cuts, many seats at higher prices will inevitably be filled. Unbundling is the wrong way to retain customers who value airline travel most, and who have already contributed more than their fare share to the airline's bottom line.

There is a proverbial race to the bottom in the airline industry, and this is only magnified when the industry faces difficulty. Airline tickets have, for the most part (excepting first and business class seats) become commoditized. If a product (or service) is a commodity, the business offering that must either adjust to that reality and reduce costs as much as possible, embracing low fares in order to lure customers, or it must create a brand. Airline managers are certainly at fault for failing to create enough of a customer experience that retains customers and allows the companies to generate higher yields. Branding isn't easy, and is risky. Publicized mistakes can seriously damage good airline brands, as shown with the JetBlue Valentine's Day fiasco last year. But brands have been the most successful companies in this country, including in the airline industry. It's why Proctor and Gamble products, while being virtually identical to store brand products, but at a far higher price (and in my experience, a lower quality than store brand goods), generate more sales. Customers believe that P&G offers a better product, even if that's not really true. To accomplish this, the company carefully targets its customer base, and responds to their needs by constantly innovating and improving the product.

Marketing, and market research, is something sorely lacking in aviation. In the airline industry, companies will have to work a bit harder than P&G, because seeing is believing when one is trapped in a flying tube for seemingly endless hours. Southwest, JetBlue, Virgin America, and to some extent, Continental, have all built strong brands and generated marginally higher yields as a result. They're also the carriers doing the most innovation with their products, responding to the increasing needs of customers. While they struggle, as all US airlines do today, their problems are less severe because they have loyal customers that will pay higher fares.

Industries often suffer reputation damage in times of financial insecurity. Companies that don't work quickly enough to turnaround their downward spiral of bad press lose even more market share (aka, US automakers). At a time when the airlines need the public on their side, to help fight oil speculation and push for a better air traffic control system, they're alienating their clientele. Charging for snacks and beverages on planes is incredibly short-sided, and will deliver minimal cost savings, while delivering long-term reputation damage. With Southwest working to lure more and more business travelers, this is exactly the wrong approach to keeping the highest-yielding travelers flying with legacies.

US carriers are starting to recognize that foreign carriers may soon enter the domestic market, and have far more innovative products and services. Already, US carriers are losing ground to foreign carriers on international routes, the very routes that US airlines need to succeed on to make money, even as foreign carriers charge higher average fares than US carriers. Customers notice that most foreign carriers offer a far superior experience with free food, alcohol, pillows/blankets, and extensive entertainment. Perhaps most importantly for many travelers, foreign carriers more frequently offer nonstop flights to the destinations business travelers need to visit.

Some limited spurts of product improvement have occurred on domestic routes. United's premium service routes (offering international standards of service on domestic flights between NYC and Los Angeles/San Francisco) are some of its most profitable, attracting a large portion of the carrier's business travelers. Neither JetBlue nor Virgin America can top United in terms of passenger comfort on these routes. Sadly however, on most other domestic routes, United, nor any of its legacy competitors, offer similar service standards.

Creating brands, ones that customers will pay for, must be the goal of every airline manager. Service standards need to be improved, both in terms of amenities and employee helpfulness to customers. Managers create company cultures, and cultures turn into brands. At many legacy carriers, company culture is all but dead, and management needs to make a good faith effort to improve it. How the company treats its employees, and the kinds of tools it gives them to improve customers' experiences, determine a brand. Management needs to start innovating and create better cultures that create unique airlines. In turn, they will create more profitable companies.

August 5, 2008 in Continental Airlines, JetBlue Airways, Low Cost Carriers, Southwest Airlines, United Airlines , Virgin America | 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 20, 2008

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.

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March 20, 2008 in AirTran Airways, JetBlue Airways, Low Cost Carriers, Skybus Airlines, Southwest Airlines, Spirit Airlines | Permalink | Comments (0)

January 27, 2008

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.

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January 27, 2008 in AirTran Airways, Alaska Airlines, Aloha Airlines , Frontier Airlines, JetBlue Airways, Low Cost Carriers, Skybus Airlines, Southwest Airlines, Spirit Airlines, United Airlines | Permalink | Comments (0)