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)

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)

October 06, 2008

Sun Country Parent Files for Chapter 11

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

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

October 6, 2008 in AirTran Airways, Frontier Airlines, Low Cost Carriers, Northwest Airlines, Southwest Airlines | Permalink | Comments (0)

October 01, 2008

Southwest to Serve Minneapolis-St. Paul from March 2009

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

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

October 1, 2008 in American Airlines, Low Cost Carriers, Northwest Airlines, Southwest Airlines, United Airlines | 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 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)

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)

July 12, 2008

Airline Bulletin is Back; Two (Re)emerging issues in the Airline Business

I have returned from Ecuador (and will try to post a few pictures within the next few days). In the coming days and weeks, I hope to shine a wee bit of light on some of the controversial issues in the airline industry. Upcoming posts may include Why Widespread Panicking is a Bad Idea, Why Most Airline Managers are Idiots, and Why Most Airline Managers are Idiots (Part II). Poor business decisions helped get the industry into this mess, but that doesn't mean ingenuity and the right decisions can get us out of it.

But to begin, I want to examine a couple of key issues that may emerge in the public debate over the next few months. The fuel issue has obviously dominated the press headlines lately, and justifiably so. However, the severity of the fuel crisis will spur ancillary difficulties for carriers, and the nation, as carriers run out of fuel savings, and begin to turn to the government for help.

Subsidies
If airlines continue to hemorrhage cash at current rates, many will run out of cash later this year or sometime next year. As a result, one of the most important issues facing the nation with regard to airlines, is not necessarily how to curb rising oil prices, but how to save the vital airline network that binds our nation together. After 9/11, the airline industry was provided with a government cash infusion to help stave off more trouble, as well as loans to specific carriers to help them survive. Once again, the government may have to intervene, and as cash reserves run lower and lower at many of the nation's top airlines, this issue will become increasingly pressing to politicians, not to mention presidential candidates. Even though corporate subsidies are increasingly unpopular, especially in the wake of the unjustifiable tax breaks that continue to be given to big oil companies, even while reaping record profits, another subsidy infusion may be necessary to the nation's airlines. However, what might be better than a cash infusion, is instead a fuel subsidy that helps limit the exposure airlines have to volatile oil market prices. This could be done by setting a ceiling on prices that carriers pay, and having the government cover the remainder, or by offering a government fuel subsidy per passenger mile. This is far from a perfect solution, as it could disadvantage carriers like Southwest who are less exposed to the volatile oil market, but it would help protect the industry as a whole from its number one enemy at the moment.

Re-regulation
Another issue stemming from high fuel costs is the possibility of some sort of re-regulation. One of the things the airline industry has struggled with since deregulation, unlike many other industries, is the constant struggle of price wars. The airline industry has seen a plethora of new entrants in the past 25 years, and most of them use low fares to draw away customers from the large, network carriers. While competition has its advantages, most notably when Southwest starts service from a new city and lowers fares, it can have very adverse effects when a new entrant enters and relentlessly offers loss-leading fares as a way to drum up new business. Skybus was a prime example of this, using it's lowest fare classes as loss-leaders to help fill planes. Some observers have suggested re-regulation as a way to prevent carriers from offering fares that are simply too low.

Robert Crandall, former CEO of American Airlines, has suggested the idea of a minimum fare threshold on routes, that would help prevent destructive fare wars. Other avenues of re-regulation have the potential to benefit carriers, such as limiting the number of carriers on very high-traffic routes, but in exchange for those carriers operating less popular routes to help appease the demands of airports and the business community. But a full re-regulation of the airline industry is less likely. As Northwest Airlines CEO Doug Steenland said at a recent Merrill Lynch conference "Anybody who looked at re-regulation seriously, I think, has concluded that the genie is out of the bottle, and I don't think it can go back in."

As airlines struggle more and more against the tide of rising oil prices, especially in the fall and winter as the busy summer travel season dies down, more and more discussion will take place about increased government involvement in the industry, either through subsidies or through re-regulation. Aviation is a crucial linkage in our nation's fabric, and the government will do what it takes to preserve it, regardless of which party is in power.

July 12, 2008 in American Airlines, Low Cost Carriers, Northwest Airlines, Skybus Airlines, Southwest Airlines | Permalink | Comments (0)

May 04, 2008

Potential 2008 Merger: United and US Airways

After Continental spurned United, the latter carrier's best hope of a merger is with US Airways. This merger was attempted back in 2002 before United backed out. But, with fuel costs at such high levels, United and US Airways could make a good pairing. Some fleet and service issues would need to be sorted out, but it could be done. And apparently, it is being done, as merger negotiations are said to be in a "very advanced state".

To start off, I don't think this merger would be as good as the United/Continental deal. United and US Airways have fewer commonalities, and a greater amount of overlap in their systems (in terms of redundant hubs and routes, creating difficulties in network integration). That could make it harder for regulators to accept, but easier when it comes to trimming capacity. I think it would be challenging for the labor groups of both airlines to come together, both of which have been abused by management with substantial pay cuts, and in the case of US Airways, botched attempts at seniority integration. The labor force of a combined carrier would likely be one with lowered morale, and I seriously question their ability to deliver the high levels of customer service that customers expect from United.

The combination of routes and hubs of the two carriers would be a big mess. US Airways has large hubs in Phoenix and Las Vegas, near United's Los Angeles hub, though admittedly, the traffic flows are somewhat different, Los Angeles serving as a jumping off point for a lot of Asian and Latin American services, unlike the mostly domestic focus of Phoenix and Las Vegas. These hubs would have to be consolidated somehow, as it makes no sense for this carrier to operate three separate hubs within a very small radius. What will probably happen is that Las Vegas will receive the bulk of the flight cuts. Any regional/international service, as well as many of its lower-yielding domestic routes could be cut. Las Vegas would be retained mostly as a point-to-point destination, and the combined carrier's operations there would compete mainly against Southwest's point-to-point service to/from the city. Some of the capacity cut from Vegas could get shifted to Los Angeles or Phoenix.

The other primary US Airways hubs are Philadelphia and Charlotte. US Airways has strong market positions in both these cities, and I expect that these would be tougher to consolidate. Because of the functioning of international traffic flows, some regional service in the South could get shifted from Charlotte to United's Washington Dulles hub, and longer-distance domestic routes (such as to the West Coast) from Charlotte could be cut in the face of high fuel costs, with much of that traffic getting rerouted through another hub like Chicago O'Hare. Philadelphia will probably keep most of its current assortment of flights in a merger because of its scale and advantageous position for European flights.

There are some narrowbody fleet synergies, as both United and US Airways operate A319s and A320s, as well as some older variant 737-300s. But, these advantages are mitigated by the fact that United has committed to a Boeing widebody fleet, and US Airways to an Airbus fleet. While this is certainly not a show stopper, it could be a problem, especially if the carrier focuses on international growth. Things could be complicated by the fact that US Airways has orders for Airbus A350s, Airbus's answer to the 787, but the combined carrier will not see those planes for several years, and by that time, the company may have decided that although the A350 is economically beneficial, it's not worthwhile keeping the relatively small subfleet of Airbus widebodies in the overall fleet.

The key is that this merger needs to exploit United's advantages on high-yielding Asia-Pacific and European routes and combine that with US Airways' presence in some key small markets. There are travelers willing to pay $2500 to get from Scranton to Kuwait City, and the combined carrier can make a lot of money off of them. Of course, the combined carrier will need to be prudent about which regional routes it keeps, since much of US Airways' regional network is operated by 50-seat or less jets, which are very uneconomical at current fuel prices. But if the combined carrier can get the right balance of connectivity to an array of smaller destinations with nonstop international flights to destinations few other carriers serve from the US, this carrier will have a winning formula. Hub-and-spoke carriers will survive because they can fill so many different roles. They can't be all things to all people, and US Airways may find that Southwest will continue to gain more market share on Philly to Fort Lauderdale routes. But hub-and-spoke carriers can be in places where there are strong yields, and provided the cost to obtain those yields isn't too high (like it very well may be with some small cities served with 50-seat aircraft or below), hub-and-spoke carriers can be very profitable.

In addition to making sure that capacity is in the right place, and that there is an attractive network for customers, balanced between small, regional, national, and international destinations, the new carrier must also institute systemwide capacity reductions. The combined carrier will have planes that it can easily remove from its fleet (older 737-300s, -400s, and -500s), but whether the company will have the courage to make the necessary decisions is another matter altogether.

United needs to reduce flights to and from its hubs and consolidate its remaining capacity. Because United is merging with US Airways, a legacy carrier billing itself as "low-cost" that offers relatively few amenities compared to its legacy or low-cost competitors, United may decide that it's best to downgrade its own operations and brand. This may not be a smart strategic decision, as business travelers who appreciate comfort and service are likely to be the biggest profit generators for the company, but they may have to begrudgingly accept the financial realities that United faces and put up with a diminished product. By eliminating its Economy Plus section, United could add several rows of coach seating to its narrowbody aircraft, enabling the company to reduce CASMs and consolidate its existing capacity. Seven flights a day between two major cities could be made into five. Overall capacity will decrease, though it will be mitigated by adding additional seats onto each aircraft. It doesn't sound sexy or exciting, but it has the potential to save the company a tremendous amount of money in the long run.

A merger between any two carriers must be used to consolidate the tremendous amount of capacity in the domestic market. Serious cuts will need to be made. The ridiculous proposal that Delta and Northwest made several weeks ago doesn't do this, instead, it tries to keep everyone happy by promising that all hubs will remain intact (the validity of this promise is yet to be determined). All that will do will make investment banks happy, executives rich, and leave our air transportation system in even deeper excrement. While United and Continental had the potential to create a world-class airline, with high standards of service focused on business travelers, the combination would likely have had minimal capacity cuts. US Airways and United have real overlap. Cuts can and should be made. Cuts, made strategically and with an eye towards customer needs, will result in fewer flights, but higher yields, and in the long run, more profits. If it's going to cost hundreds of millions of dollars to put these carriers together, there better be a tangible plan for long-term savings. Getting those hundreds of millions of dollars in savings doesn't result from combining management, it results from company-wide modifications. In a world of $120 oil, no amount of hedging, seat pitch tightening, or aircraft modifications will be sufficient to generate the savings that investors are looking for. Capacity must be cut on mainline domestic routes, as well as on small regional routes (particularly with 50-seat jets). That is the only path to profitability. 

Creating a brand attractive to business travelers, with high levels of service, an expansion of international routes (particularly in the Asia-Pacific region, where United is currently dominant), and frequent flight schedules is also critical. The combined carrier won't survive without loyal customers and those customers won't be loyal without the benefits to keep them there. The combined carrier needs to take seriously its frequent flyer benefits, onboard amenities, and service standards, and make these things a priority in a merger deal. But the airline won't thrive without actively managing its capacity, and that's the key to any merger, not just to a potential United/US Airways deal.

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May 4, 2008 in Continental Airlines, Low Cost Carriers, Southwest Airlines, United Airlines , US Airways | Permalink | Comments (0)