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.

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).

Virgin America-An Innovative Role-Model for the Industry: Part II

This post is continued from yesterday's Part I.

VA has also taken a different approach with its frequent flyer program, eleVAte, which will make the airline very attractive for certain types of customers, and not very attractive for others. VA will award points based on how much you spend with the airline. The more you spend, the more you're rewarded, which makes sense since airlines want to reward their best customers, and their best customers are those who spend the most. Leisure travelers, who are lured by the promise of $39 fares, will be rewarded less, and that may hurt VA's competitiveness over Southwest and JetBlue, both of which offer the same number of frequent flyer credits to customers regardless of ticket purchased (with some new exceptions for customers who purchase Business Select tickets on Southwest).

However, eleVAte's other big shtick will be with redemption. Unlike any other frequent flyer program in the US, there will be no blackout dates for all award tickets, and customers can redeem credits for any unsold seats on a flight. Since the number one complaint of business travelers about frequent flyer programs is the inability to redeem miles, this will provide a significant advantage to VA. But, VA won't have any complicated mileage redemption charts either. Instead, the company will customize the amount of points needed for a ticket based on demand. The amount of miles needed to redeem a seat will be aligned with the price of the ticket. In other words, to prevent many travelers from redeeming miles for flights at the last minute, thereby displacing potential passengers who pay pricey last-minute fares, VA will make redemption of points for higher-demand flights prohibitively expensive for many passengers. A very clever idea, and one I'm surprised legacy carriers haven't adopted yet.

However, part of the reason this idea may not have been adopted is because award tickets are the only seats on the plane where all the customers who are traveling on them pay the same rate (or one of two rates on legacy carriers, depending on ticket flexibility). Business travelers hate knowing that they paid five times as much as the person sitting next to them for their seat, and so since business travelers redeem the majority of award tickets, this is one area in which airlines can show business travelers that they are valued, by charging them what they charge everyone else. Often, business travelers will earn miles on business, and then redeem them for vacations. This tactic will benefit those customers who are able to schedule vacations around less busy times of the year. If you're an employee who receives time off during the holidays, or over busy Spring and Summer travel periods, eleVAte may very well not offer a good value. As a result, VA should consider customizing the number of points necessary for redemption to customers with different travel patterns. Customers who have a history with the airline of purchasing expensive flights should be able to redeem the same seat for less than a customer who purchases discount flights. This customized pricing could help offer benefits to business travelers, especially since eleVAte will not offer an elite system to reward their most frequent travelers.

VA also plans to innovate with its culinary options. VA will offer complementary meals to customers in first class, and meals in coach will be sold for a nominal fee. In early November, the airline quadrupled its menu offerings, offering coach customers a range of pricey (over $10 per item in some cases), but high-quality offerings, including such delicacies as a caprese sandwich with canellini bean and herb salad as well as a steak sandwich. While I can confirm the pricey part, I can't confirm the high-quality part, as I haven't tasted it yet, but it sounds quite delicious, and these offerings could be a big selling point for the carrier. Most business travelers can expense meals, but they can't expense what's not there, and a lack of offerings is increasingly becoming the norm on legacy carriers.

While VA has a great brand and wonderful means of attracting customers, the carrier may face increasing pressure on its yields. With consolidation rumors buzzing in the industry, smaller carriers like VA may get swallowed up, or, what is more likely, the airline will just have difficulty making money. Consolidation will help lower rising costs for those carriers that can participate, and since it's unlikely that VA will be part of that, the company needs to find other ways to cut costs. So far, the company seems to have a cost structure very similar to other large LCCs, like Southwest and JetBlue, and unfortunately, the company's costs will only rise in the future, as workers gain seniority (and the higher wages that come with it) and its planes get older (leading to higher maintenance costs).

As ticket prices rise, demand will still exist, especially on the important business routes that VA services. However, travelers and their companies may be more inclined to book on price, and not on value, given rising ticket costs. VA may be unable to maintain a price premium in the market, which may make it difficult for the company to maintain its extra features and amenities, as well as make a profit. I wish VA all the best in expanding their offerings to make travel more comfortable, just as JetBlue did 7 years ago when that carrier pledged to "bring humanity back to air travel". However, given the current market environment, VA will have to tread carefully with its expansion plans, and ensure that their product is garnering the right price. Without that, VA could be simply another failed startup.

Virgin America-An Innovative Role-Model for the Industry: Part I

Editors' Note: Since the following post turned out to be quite lengthy, I have decided to break it up into two pieces. This first part gives some background information on Virgin America, and offers an analysis of some of the challenges the company faces. Part II will focus on Virgin America's frequent flyer program, their culinary options, and the carriers' position in the ever-shifting market.

Virgin America (VA) has been growing in recent months, and ever since its August launch, the company has added additional transcontinental flights, and plans to commence service to San Diego starting February 2008. And while other carriers are aiming to restrain capacity growth or even cut domestic capacity, Virgin America is growing, though at a slower pace than some other relatively recent airline startups, including Skybus and JetBlue. The airline operates brand new A320 aircraft with leather seats in first class and coach. VA has created an niche for itself using innovative technologies to reduce costs and make travel more convenient and comfortable for passengers. VA is the first airline in the US to essentially put a PC at a customer's seat, offering customers (or "guests" in the company's marketing-speak) the choice of over 25 different movies, 3000 MP3s, and other entertainment. Moreover, VA has the first onboard food-ordering system in the US, offering customers the chance to order food right from their seats, and have it delivered to them in a manner of minutes.

But VA hasn't simply been innovative when it comes to technology. The airline announced its frequent flyer program when it launched, eleVAte, which will award points to customers based on the amount of money they spend on tickets, and not on the number of miles traveled. Moreover, the airline offers gourmet food offerings for sale to customers, and plans on making its catering a selling point of the flight. While Virgin America has a lot going for it, it's also facing a very difficult market, like all carriers. The company is competing with some of the toughest carriers around, including United, Southwest, and JetBlue, and facing the same delay-prone, sky-high fuel cost environment as other carriers. I talked with VA spokeswoman Abby Lunardini yesterday about some of the things her company is doing to thrive and survive.

Ultimately, VA faces some of the same constraints as other carriers. VA operates from large airports that are very prone to delays. According to Lunardini, San Francisco will always be the company's home base, and SFO is notorious for weather-related delays. Moreover, New York's JFK Airport, which has several VA flights, is suffering more than its fair share of air traffic control-related delays. As a carrier trying to maximize aircraft utilization, delays can really hurt the bottom line. Unfortunately, since VA plans to target working professionals, serving large, congested airports is a must for the carrier, even if it leads to delays.

Moreover, VA, like all airlines faces challenges with mounting fuel costs. According to Lunardini, the company hasn't yet made any decisions with regard to fuel hedging. Also, the company doesn't plan on changing its growth plan to deal with fuel costs. Many US airlines have been cutting back on transcontinental flights recently because they cost too much money to operate given skyrocketing fuel costs and insufficient yields. VA has several transcontinental routes, and they are an important part of its business. However, VA would be well-advised to slow transcon growth and focus on building a significant presence on the West Coast. There are several additional Western markets that VA could target from San Francisco and Los Angeles, including Vancouver, Seattle/Tacoma, Portland, Phoenix, and Denver. While there is certainly fierce competition on all these routes, they would likely produce better yields for the company, at least in the short term given the fuel environment, than would transcontinental flights.

Check back for Part II tomorrow...

JetBlue Agrees to List Fares on all Major Third-Party Travel Sites

JetBlue announced today that it has agreed to list its fares on Orbitz, Travelocity, and Priceline, (JetBlue has already been listed on Expedia for some time now) enabling the carrier to offer its low fares to customers who prefer to book through third-party sites. While this author disagrees with the rationale behind these customers' decisions, since third-party travel sites typically offer a poor value to customers, especially those who purchase airline tickets only, there is certainly a sizable clientele who use these sites. With the industry becoming increasingly competitive, and tickets becoming more and more expensive, JetBlue has a couple advantages to list on third-party sites.

First, as airline tickets are becoming more expensive, customers are looking for other ways to save on travel, which they perceive they are doing through third-party sites, since customers are able to bundle hotel and car rentals into packages which third-party sites can sell at rates that are sometimes cheaper than if purchased separately. However, actual savings depend on the type of package purchased, and often, customers purchase on these sites even when yielding no savings whatsoever. By bundling airfares with hotels and car rentals, however, it is convenient for customers, since they don't have to make separate purchases.

Second, this decision offers JetBlue a way to keep up with the competition, especially the upstart Virgin America, which is trying to offer more amenities and convenience to customers than JetBlue can. Virgin America is listed on several third-party travel sites, and JetBlue's announcement will allow the carriers to be listed on the same page, letting customers decide which one is preferable.

The risk to listing on third-party sites that use global distribution systems (GDS) is that they can increase costs and remove traffic from the airline's Web site. JetBlue knows that its Web site is not just a place where customers can book the cheapest tickets (for both the customer and the airline) but it's also a place where the carrier can exploit ancillary revenue opportunities. Jetblue.com offers customers plenty of opportunities to rent hotel rooms or cars and book cruises, and JetBlue makes a cut of whatever customers buy on the site. If customers book elsewhere, JetBlue loses ancillary revenue.

Moreover, JetBlue is a premium brand. The airline prides itself on offering superior service and amenities to competitors. But with airfares increasing, customers are becoming more price-sensitive when purchasing airline tickets. While bundling their flights with hotels and car rentals helps them offset some of the increased costs, if JetBlue is listed on third-party sites, then customers will see flights on other airlines, which are frequently cheaper than JetBlue. That could persuade some potential JetBlue customers to book elsewhere.

While I think this move will be a net gain for all parties involved, JetBlue needs to take a careful approach to listing on GDS. There are definitely advantages for the carrier, but drawbacks that must be mitigated as well. The best thing JetBlue can do is to work further on strengthening the awareness of its Web site among its customers so that more people will choose to book there. Ultimately, JetBlue wants the vast majority of its ticket sales coming from its Web site, and it should focus its efforts on convincing customers not to use alternate distribution channels by offering additional discounts or bonus frequent flyer credits to customers who use jetblue.com as well as better-integrating the hotel and car components of the Web site with the airline ticket booking, enabling customers to book their flight, hotel, and car rental with one purchase.

Virgin America Announces Launch Date of August 8.

After announcing its final approval from the Department of Transportation last Wednesday, Virgin America announced today that it plans to launch flights starting August 8. Virgin America will initially serve the San Francisco to Los Angeles and New York-JFK markets, but will quickly expand to five cities (including Washington DC and Las Vegas) by mid-fall. Service to the sixth city that Virgin America previously announced they would first commence service to, San Diego, will be added later. Virgin America faces a great deal of competition, as JetBlue currently offers services from San Francisco to JFK, and Southwest Airlines will be restarting services from San Francisco starting August 26, serving Chicago, San Diego, and Las Vegas. United offers extensive service from San Francisco, and has a strong hold on the business travel market there. Virgin America will commence ticket sales at 3:00 pm Pacific Time today, and will be featured on the Galileo global distribution system as well as on Orbitz.

On August 8, Virgin America will start service with two daily flights between San Francisco and New York. One additional flight will be added on August 19 and September 9. Also, five daily flights between San Francisco and Los Angeles will start August 8. Moreover, Los Angeles will be a larger part of the Virgin America network than some have anticipated. Virgin America will launch nonstop service between Los Angeles and New York and Los Angeles and Washington DC starting August 29 and October 24 respectively. Other routes will also be launched this fall, detailed in this Virgin America press release.

Virgin America is going to come out swinging, and the airline is trying to launch service as soon as possible for two reasons. The first is that the summer is the busiest travel season of the year (outside of some brief holiday periods) and Virgin America will be linking major tourist markets with its initial service. Both San Francisco and New York are very popular vacation destinations, and routes to those cities will be very popular throughout the remainder of the summer. I expect Virgin America to have strong sales on these routes through the end of the summer, even though the airline will start to sell tickets today and the summer travel season is an month and a half away from ending. 45 days, maximum, isn't a long lead time to sell tickets on a new route, but given the popular demand of some routes, Virgin America should do reasonably well for a new carrier (although perhaps not well enough to break even). The second reason Virgin America is trying to start service as soon as possible is that it gives the airline a jump on Southwest and a chance to establish itself in the market before Southwest commences service at San Francisco on August 26. However, Virgin America will start two routes which will directly compete with Southwest, San Francisco to Las Vegas and San Diego at a later date than Southwest, hurting its competitive position and increasing Southwest's chances to gain loyalty with business travelers in the markets before Virgin America enters.

It appears that Virgin America will have a very powerful amenity package. The airline will offer personal televisions at each seat, replete with on-demand movies (a feature that's very popular with business class travelers on foreign carriers, but not seen much in this country), television, games, music and online chatting. This will pose a serious competitive challenge to JetBlue, United, and Southwest, and make Virgin America a very attractive carrier to fly for travelers looking for ways to keep themselves entertained (such as business travelers, families, etc.). Virgin America will offer a frequent flyer program, eleVAte, which awards points to travelers. But unlike Southwest's and JetBlue's frequent flyer programs which award credits based on the length or number of flights taken, Virgin America's is based on the amount of money spent on tickets. The more money you spend, the more points you earn, and for business travelers who often purchase pricey tickets at the last minute, that will be very attractive. Also, the program doesn't have any blackout dates or seat restrictions, so as long as there's an unsold seat, a user can buy it with eleVAte points.

But, the program does have some drawbacks. For most heavy business travelers, United's Mileage Plus will provide a better value because it awards miles proportionally to the length of the trip, making it easier to earn a free ticket if the traveler does a lot of transcontinental or other long-distance flying. Moreover, Mileage Plus enables business travelers to use their miles for flights to many more destinations, including Hawaii, the Caribbean, and destinations in Europe, South America, and Asia. Unfortunately, unless eleVAte can offer more extensive redemption options for users through other carriers, it will be hard to generate loyalty from business travelers. Business travelers will be impressed by the low fares and the modern entertainment that Virgin America will offer, but unfortunately, those won't be enough to cement loyalty. Virgin America will need to add a variety of destinations (since business travelers need options to travel to other markets in order to avoid flying another carrier), and that will also help make its frequent flyer program more attractive for redemption as well. However, compared to Southwest and JetBlue, eleVAte will raise the competitiveness bar in the minds of many business travelers.

Virgin America will also need to ensure that it offers great service and low enough fares to attract customers. It's very hard to run an airline with a premium product these days, since consumers expect so much and flying has been made difficult with security hassles and other delays. But Virgin America must deal with those and ensure that it runs a smooth operation with a high standard of customer service. If Virgin America cannot execute its service promises and/or the carrier charges fares that are too high, then the carrier will quickly fail because passengers have plenty of alternatives.

While it's unclear whether Virgin America will survive, airlines that court business travelers in San Francisco and Los Angeles need to beware. Virgin America will be a very tough competitor, and it will market itself as a more comfortable alternative to legacies, as well as low-cost carriers like JetBlue and Southwest. With legacies downgrading their amenities and low-cost carriers not upgrading theirs fast enough, Virgin America will offer a clear alternative to travelers who are looking for something to dull the misery of flying. However, carriers have been preparing for Virgin America's arrival for years now, and they plan a tough response, likely with lower fares, more perks for loyal flyers, and perhaps even upgraded amenities. This fall will be a very exciting one for the airline business in San Francisco...

More About Intra-California Competition

Why are so many airlines entering the intra-California market?

There are a few reasons, but the first is that the intra-California market is growing. California is one of the nation's fastest growing states, and the population is expected to balloon in the next several decades. While this population increase may be unsustainable and incredibly damaging for the long-term health of Californian society, it means big bucks for airlines. As the population increases, the demand for intra-state air travel will increase, and it's much easier for an airline that is established with significant market share on a route to expand to meet increasing demand than for an airline with little or no market share to meet that demand. Also, with the improvements made to San Francisco International to make it more cost-competitive with other area facilities, and along with the new competition being brought by Virgin America, other low-cost airlines are taking more of an interest in intra-state air travel. Also, LCCs that have to find places for new planes would rather expand on the West Coast where fares are higher than on the East Coast, where competition is even fiercer and yields are lower. But the final reason intra-state air travel is becoming increasingly attractive for airlines is because their revenues have suffered recently. Airlines can make more money on short hops than on transcon flights, since the airline can charge higher rates per mile flown for a short flight than for a long one (due to fixed costs airlines incur regardless of the length of the flight, such as landing fees, baggage handling costs, and the cost of using gate and check-in agents.) But, airlines can fly more short-haul flights with a single aircraft than long-haul flights, and efficient aircraft utilization is an easy way to increase revenues. Even though airlines have fixed costs, when many of those costs have been trimmed, then airlines are fighting for revenue, and the revenue equation is better for shorter flights where airlines can fly more flights in a given amount of time with the same plane.

How will airlines compete in this market?

What airlines will be competing on in the intra-California market are three things. The first is price. Flying up and down the state, even on a low-fare carrier, can get expensive, and customers want to minimize the cost of their travel. That will mean that a fare war of epic proportions may occur if or when JetBlue and Virgin America expand services. I wouldn't be surprised to routinely see $29 fares to the other end of the state during this fare war. It's also likely to be a prolonged fare war since there aren't any weak competitors in this market. This means that a fare war will give Californians some great bargains for many months, but it will also hurt the financial health of the airlines.

The second is convenience. This is both in terms of flight schedule as well as airport location. Low-cost airlines need to ensure that they offer enough flights to accommodate business travelers, who typically want flights very early or very late so they can work a full day. As a result, airlines like Alaska and Southwest, which are already established in many intra-California markets and offer a convenient menu of flight times, will have an advantage over other LCCs like JetBlue or Virgin America, which may only offer one or two flights at a time a business traveler would find suitable instead of four or five. Airlines will also have to win the convenience war with the airports they serve. Now that San Francisco is becoming more popular with LCCs, low-cost carriers will be a more viable alternative for business travelers to the legacies American and United from the San Francisco area. It will be the job of LCCs to ensure that they offer flights to a sufficient number of destinations on either end of the state. This is true especially in Southern California. Right now, the Ontario Airport is most ripe for expansion of service, though it's likely that LCCs will increase service at all the commercial airports in the region (excluding Palmdale, which will need a little more time before it can be attractive to LCCs.) Travelers heading to or from the LA Basin want to avoid driving as much as possible given the horrific state of traffic in the region. As a result, many travelers, leisure and business alike, will be willing to pay a bit more for service to a more convenient airport. That doesn't always mean LAX; Burbank, Orange County, Long Beach, and Ontario all offer convenience to a segment of intra-state travelers, and LCCs will need to cater to all of them if they want to win the revenue and market share battles.

Finally, as passengers expect more from LCCs, onboard amenities won't be the battleground, but frequent flyer amenities will. Airlines will try to fill seats, and especially try to lure business travelers, by offering bonus miles (or credits) for frequent travelers. Southwest requires eight round-trips for a free ticket. I suspect that if competition gets heated, Southwest will give customers 1.5 or 2 times the normal credits, giving them a free flight after six or even four round trips. JetBlue will need to improve its frequent flyer program the most. Right now, customers have to fly 12.5 round-trips within California to be eligible for a free ticket. That must change if JetBlue wants to lure business travelers. TV is a nice thing to have, but it's much better to have more free flights. Similarly, Virgin America will need to ensure that its frequent flyer program is competitive with its in-state rivals. American and United will certainly retaliate against LCCs, offering similar promotions to retain their hold on business travelers, and if they seriously retaliate, a frequent flyer promotion could be very effective. Business travelers would rather stay loyal to their current carrier than move to another, and if American and United offer the right promotions, those business travelers won't be going anywhere. If the competition gets really heated, then frequent flyer miles will be another major battleground (in addition to fares and convenience) on which airlines fight for customers.

As competition increases on California intra-state routes, airlines will fight harder than ever for passengers, and in six months to a year is when the results will finally start to show. When they do, there will likely be clear winners and losers. Southwest and United are the two airlines best positioned to succeed, and JetBlue, Delta, and Virgin America, are taking the most risks. But given that this is California, anything can happen, and after the first stage of this battle is over, Southwest and United may be in much worse competitive shape than when it began.

See the post JetBlue Considers Bolstering Intra-California Service for more information on the topic.

JetBlue Considers Bolstering Intra-California Service

In light of recent announcements that competition may be heating up on intra-California routes, JetBlue CEO David Neeleman announced at the company's annual shareholder meeting today that JetBlue is considering adding additional flights on routes within California. While Frontier has announced its intention to withdraw from the San Francisco-Los Angeles market, Delta announced additional flights from its Los Angeles focus city today to Oakland, Sacramento, San Francisco, and San Jose. The new Delta flights will be operated with regional jets by a feeder carrier, ExpressJet. Moreover, Virgin America is also set to enter the intra-state market within a few months with new flights between San Francisco and Los Angeles as well as San Diego. Southwest, Alaska, American, and United are also major players in the intra-California market.

As the competition in California heats up, JetBlue is making a choice whether to size up its operations or whether to withdraw from the intra-state market. In a competitive environment like this, customers must know which airlines carry passengers within the state. Even though JetBlue is a well-known brand, many Californians don't know that JetBlue currently offers intra-state service. With increasing numbers of flights on more and more airlines, passengers are increasingly less likely to choose JetBlue unless the airline offers more flights and attempts to grab a larger slice of the market. JetBlue currently flies between Long Beach and Oakland as well as Sacramento. JetBlue is considering starting intra-California flights between other airports, and will need to do so in order to survive in the competitive market. JetBlue has an advantage over some of its competitors, since its Embraer 190s, which might be used if the airline expands in California, enable the carrier to offer greater frequencies on many routes, making JetBlue more attractive to time-sensitive travelers. But if JetBlue can't expand on routes within California, it needs to withdraw from the intra-state market entirely, because otherwise JetBlue will end up like Frontier, with a solid brand, but with little awareness among customers that it flies intra-state.

But this convenience must be carefully thought out. JetBlue is also entertaining the possibility of starting intra-state flights at Los Angeles International. While this would help JetBlue attract some business travelers, it would also put JetBlue into direct competition with Southwest, which is something JetBlue has tried to avoid during its expansion. Southwest already has a very large operation at LAX, and it might be difficult for JetBlue to gain a foothold at the airport. Competition, combined with the difficulties some airlines have had with the airport authority about significantly higher terminal rental costs, may keep JetBlue away from LAX, at least for now.

However, if JetBlue does expand intra-California service, the airline will inevitably face competition from Southwest, due to Southwest's massive presence in the state. JetBlue can compete with Southwest, since JetBlue offers more amenities and comparable fares, but given the convenience Southwest offers customers (flights on many intra-California routes are often every hour), and the fact that on a one hour flight, amenities aren't too important, customers may stick with the established carrier. It's not just JetBlue that will have trouble breaking into the intra-California market, Virgin America, even with its amenities and flashy brand, will have difficulty attracting customers.

As a result, JetBlue will have its hands full if it decides to expand into more intra-California routes. However, the rewards for success will be lasting, since the market has a lot of long-term potential. JetBlue needs to be careful if it expands in California, but the airline has the potential for success if it exploits its strengths (like its Embraer 190s), and minimizes its weaknesses (like its frequent flyer program, which needs to be improved to be made more attractive to business travelers). There is no reason why Southwest should dominate the low-fare market in California, and JetBlue may exploit the opportunity it has to change that.

See the post More About Intra-California Competition for more information about this topic.

The Limits of Future Low-Cost Airline Capacity Increases

This first full week in March is important for many reasons. It's the last week before daylight savings time resumes, yesterday was the most beautiful day the Pacific Northwest has seen all year (with temperatures exceeding 60 degrees), and airlines are reporting their monthly traffic figures. And the trend on traffic reports this month has been lower load factors, particularly at low-cost carriers. LCCs are adding capacity wildly, even though many markets cannot support additional service. LCCs still have hundreds of planes on order, but with many markets having been satiated in terms of the level of capacity received, LCCs are being forced to serve markets that aren't as attractive, or to add service on routes that already have sufficient capacity, thereby providing more options for customers, but higher costs and lower load factors for the airline. Southwest Airlines yesterday indicated a slowdown in air travel demand is ahead. Many markets simply have sufficient capacity, and demand cannot be spurred much more with additional low-cost airline service. However, that hasn't stopped LCCs from trying to gain a foothold in some of these markets. Load factors at Southwest, AirTran, Frontier, and Alaska were all down in February. JetBlue hasn't reported traffic results yet, but they too will likely see decreases in load factors. As a consequence of this, low-cost airlines that do have new capacity coming on line soon are struggling to deploy it, and many are changing their tactics in order to fill seats and get a competitive edge. Those that aren't changing with the times face a growing threat of red ink.

Southwest, for example, is facing higher costs and tougher competition, especially in some of its most established markets including Las Vegas, Phoenix, Chicago, Baltimore, and Oakland. While Southwest is growing from these markets, adding new routes and additional flights, much of Southwest's growth is being targeted at newer, large markets Southwest has only recently started to serve. Four out of Southwest's five latest new markets are large (within the top 40 airports nationwide). Southwest's last relatively small market addition was Fort Myers back in 2005. Washington Dulles and Denver are the two most recent examples of this. Southwest's Denver operations started out with little more than a dozen or so flights to a few different cities. Now Southwest serves 11 markets from Denver, and plans on expanding their operations even further. Moreover, Southwest plans on soon expanding to another large market: San Francisco, where the carrier will likely build a strong presence in the city rapidly with dozens of daily flights. As Southwest expands to new markets, it will inevitably have to enter smaller cities, but for now, the airline still has certain large markets that it can enter cost-effectively. I predict that Southwest's next new city may be smaller than Denver or San Francisco, but of Southwest's next three new city announcements, I predict that one or two will be larger markets. The prime target may be Boston. Even though the airport is still expensive, gate vacancies (particularly with a recent Delta pullback in service) may be forcing the airport to lower its rates and work more cooperatively with airlines, opening the door for both Southwest and Frontier. Larger markets like Boston are likely where Southwest will deploy some of its new capacity (in addition to connecting the dots between select cities) in the short-term.

Frontier has also changed its strategy to adapt to changing market realities. It is developing a strong regional operation with 70-seat aircraft that will allow it to generate a more diverse feed of passengers through its Denver hub, allowing the airline to expand its mainline operations methodically without adding too many additional routes. Frontier knows that it serves most of the markets it can from Denver with their A318 and A319 aircraft, so the primary source of its expansion will come from routes outside of Denver, or from additional frequencies on already established routes from Denver. But in order to support those additional frequencies, Frontier needs additional traffic flows, hence the expansion into regional services. This strategy should work, provided Frontier's regional operations target the right markets, and that they have sufficient yields to make them profitable to serve with 70-seat aircraft.

Alaska is also changing its strategy, but more slowly than other low-cost carriers. Alaska is expanding primarily through expansion of point-to-point routes to cities East of the Rocky Mountains, as well as new services to Mexico. However, Alaska's challenge isn't as significant as Southwest's or Frontier's because they aren't growing as quickly, and their growth is more conservative. Alaska already has strong customer bases along the West Coast, so opening new routes to major markets on the East Coast isn't too dangerous for Alaska, provided there are sufficient traffic flows on the routes. While Alaska's market share on transcon routes is less than on West Coast routes, it is still significant in part because they have competitive fares and can draw on such a strong customer base. This strategy should work well for the time being, provided they aren't forced to add too much new capacity on lower-yield California routes.

The two airlines that will have the most difficulty adding capacity are JetBlue and AirTran. JetBlue has struggled to find new markets that it can serve competitively, and has been forced to slow growth in the past year to grow profits. JetBlue has delayed delivery of some aircraft, although they still have plenty on order, enough to promote strong growth. But, JetBlue has had difficulty establishing itself outside of its New York and Boston strongholds. Its Long Beach operation is sizable, but its future growth is limited due to slot restrictions at the Long Beach Airport. Oakland operations have increased considerably, however, JetBlue has been hesitant to add too much capacity to lower-yield routes along the West Coast where capacity could be deployed more efficiently than on transcon routes. JetBlue has avoided these routes because they would directly compete with Southwest, and JetBlue has tried to avoid direct competition with Southwest throughout its history. If JetBlue wants to succeed, it will need to find outlets for its new capacity outside of New York and Boston, because those markets are seeing lower fares and on many routes, JetBlue has sufficient capacity. JetBlue should not add too many new flights to Florida because the yields there are very low. JetBlue will need to find new focus cities with high enough yields for both its A320 and E190 aircraft, and unless they move with some dispatch, other carriers with new capacity coming on line soon may get a jump on JetBlue.

But even though JetBlue has significant problems deploying its new capacity, at least they have been able to maintain relatively high load factors throughout its capacity reshuffling, in the high 70s. AirTran filled a pathetic 69.5% of seats in February, and has filled only 65.7% of their seats in the first two months of the year. These difficulties are partly why Midwest Airlines has been opposed to AirTran's buyout. AirTran's business seems to be sinking, while Midwest's is growing. However, while that is an important factor, the main reason Midwest is opposed to the buyout is because AirTran isn't offering enough for the company. Like JetBlue, AirTran has a sizable amount of capacity coming on line in the next few years, but what's more alarming in AirTran's case, is that the airline is heavily committed in very low-yield markets, most notably Florida. AirTran is also committed in many smaller markets, some of which cannot support AirTran's mainline flights very well, but which AirTran serves in order to create a competitive hub in Atlanta. As a result, AirTran is receiving less for these seats than they would if they were focused on larger markets with higher fares, such as New York or San Francisco. Many low-cost airlines that operate in low-yield markets must fill a lot of seats to be profitable. Spirit has done this quite well with flights to the Caribbean. But unfortunately for AirTran, they are good at charging low fares in an attempt to fill seats, creating low yields, but they aren't good enough at actually filling seats. As a result, AirTran has been hesitant to add a lot of new capacity on point-to-point routes, because most of them are served sufficiently through Atlanta, even though there may be demand for a nonstop flight. Just look at AirTran's latest route announcement. AirTran will only add new nonstop flights between San Diego and Orlando two days a week (Friday and Sunday, the busiest travel days of the week), because the airline believes that it cannot sustain too much additional capacity when passengers will have the option to travel through Atlanta. The five days of the week the plane isn't flying, it will be sitting on the ground overnight, which will likely prevent AirTran from losing money if that plane flew across the country. AirTran has already delayed some aircraft deliveries and they may have to delay additional ones if they cannot find profitable routes. Unfortunately, AirTran seems to be grasping at straws with their two latest transcon routes. Even though their new routes between Seattle and Baltimore as well as San Diego to Orlando might be the start of a larger capacity shift, it will only occur if AirTran can fill planes on point-to-point transcon routes in addition to transcon routes from Atlanta. Right now, AirTran isn't capable of doing that without additional marketing and lower fares, both of which should spur demand. If AirTran cannot find additional transcon routes to easily serve, they may have to push additional capacity into intra-East routes from select focus cities. This could help AirTran in certain markets like Chicago, Philadelphia, Boston, Raleigh-Durham, and Charlotte where AirTran has unmet demand, and yields are higher. Those markets seem to be the best places for AirTran to add their new capacity. These markets have sufficient yields, and insufficient service to many other important AirTran markets. If AirTran doesn't add their new capacity in markets which have higher yields then AirTran is taking a much greater risk that it will be able to spur enough demand to compensate, which they would want to avoid doing at this time given their poor track record. If AirTran chooses to deploy its new 137-seat 737-700s on low-yield transcon routes or low-yield Florida routes then AirTran will likely lose money and only gain a marginal amount of market share.

As low-cost carriers add capacity, they are faced with bleaker choices about how, where, and when to deploy it. Some carriers have recognized that they need to change their tactics while others have been slower to adapt to the demand slowdown. However, as the air travel business gets even more competitive later this year, with the likely entry of two new airlines into the US market, Virgin America and Skybus, established LCCs will need to adapt to industry changes even quicker, because their new competitors with lower costs could easily take market share if they aren't prepared. LCCs will likely add fewer new routes this year, and will focus on larger, more established markets with higher yields in order to steer themselves towards profitability, but this may not be enough to protect themselves from the new competitive realities that low-cost airlines are faced with.

Southwest Announces Resumption of San Francisco Service

After a six year absence from San Francisco International Airport, Southwest Airlines announced on Friday that it is in discussions with the Airport Authority in San Francisco to resume service from San Francisco International Airport, presumably starting in early fall. This announcement is another blow to Virgin America, which has yet to receive final approval for its operations, and has already come under assault from low-cost competitors. Two of Virgin America's largest potential low-cost competitors in San Francisco are Southwest and JetBlue, and neither airline made public its intentions to serve San Francisco until less than a month ago when JetBlue announced new flights to New York and Boston. Southwest's announcement is only a signal that they have an intention of commencing service at San Francisco sometime in the fall, the precise date of when that new service will start and what cities Southwest will serve from San Francisco, are still a mystery. When Southwest vacated San Francisco in 2000, it left behind an airport with extremely high costs, long delays, and stiff competition from entrenched airlines, primarily United. But the San Francisco Airport has changed since then. User fees have been reduced, strategies to control delays have been implemented, and low-cost competition at San Francisco, and nearby Oakland (particularly from Southwest) has forced United, San Francisco International Airport's largest tenant, to reduce fares. But nevertheless, Southwest still faces a very challenging competitive environment at San Francisco. In many ways, they have adapted to the new realities of San Francisco International Airport slowly, and unfortunately, it will likely lead to Southwest finding itself at a competitive disadvantage in terms of routes and amenities when it starts flights from the airport.

San Francisco will become the new battleground in the ever evolving competition between airlines to offer superior amenities. Virgin America will offer the best entertainment in the skies, with TV, music, movies, games, interactive chat networks between passengers, and more. JetBlue will have a hard time keeping up with all these features, given that their entertainment system was designed in 1999, not 2006. Frontier, which is building a small focus city operation in San Francisco, also has JetBlue's LiveTV, and they too will have trouble staying competitive with Virgin America when it comes to offering the most attractive amenities to customers. Virgin America will also offer seat pitch, snacks, and service standards competitive to JetBlue, which will make it difficult for customers to distinguish between the two carriers, something neither wants. However, there is one important distinction business travelers will notice: Virgin America will offer a first class section for passengers willing to pay extra, a feature JetBlue lacks. JetBlue has struggled to cope without a first class section by offering customers who purchase more expensive tickets choices of more comfortable seats. Southwest will be unable to compete with these carriers, unless it makes some changes between now and when it commences San Francisco service. Southwest doesn't have any in-flight entertainment, and doesn't offer seat assignments, a feature all other US low-cost carriers offer, and a service that passengers have come to cherish. Because Southwest can't compete for passengers with its amenities, it must compete on price.

Like in most of Southwest's other new markets, San Francisco has high fares, especially on short-haul routes. Frontier has lowered fares on a couple of important routes, from San Francisco to Los Angeles and Las Vegas, and Virgin America will likely lower fares when it starts flights to Los Angeles, Las Vegas, and San Diego. But Southwest will be able to lower fares considerably from San Francisco to additional, smaller markets, or simply ones that lack a lot of competition from the Bay Area. The Pacific Northwest is a perfect example. Only Alaska and United serve Seattle and Portland from San Francisco; although Southwest offers nonstop service to both cities from Oakland and San Jose. Southwest could start new service from San Francisco to cities in the Pacific Northwest and end the duopoly that has kept fares between the two areas artificially high for some time. But that's not where Southwest could make its biggest impact. Markets like Albuquerque, which are relatively small and only served nonstop from San Francisco by United could see fares come way down. Even though Frontier offers competitive fares on connecting service, United still charges high fares on nonstop flights, upwards of $300 round-trip even on advance purchase tickets.

This means that Southwest will have to expand carefully in San Francisco. When it left in 2000, Southwest was still serving San Diego and Phoenix nonstop, but Southwest may want to modify which routes it focuses its San Francisco expansion on. Southwest's best bet is to focus on what they do best, short-haul flights, since transcon flights will see very low fares with JetBlue and Virgin America's new service. Moreover, Southwest would have difficulty competing profitably on routes to many major markets on the East Coast, since Southwest uses secondary airports in the big three East Coast markets (Boston, New York, and Washington DC) that are unpopular with business travelers. However, the one exception to that is Southwest's operations at Washington Dulles, but the number of flights Southwest currently offers at Dulles pales in comparison to Southwest's focus city in Baltimore, making it difficult for Southwest to contemplate transcon expansion from Dulles because they haven't built up the market at that airport yet. If Southwest focuses on short-haul routes from San Francisco, flights to the Pacific Northwest are a distinct possibility, but beyond that, service to a series of markets in the Midwest and Southwest could lower fares for consumers, offer more nonstop service to cities underserved from San Francisco, and draw reluctant passengers to Southwest instead of Frontier or other LCCs. Some potential markets where Southwest could considerably lower fares include St. Louis, Kansas City, Omaha, Tucson, El Paso, Albuquerque, Oklahoma City, Tulsa, Austin, and San Antonio. All of the markets listed above are markets Southwest currently serves, and all have disproportionately high fares from San Francisco. It's cheaper to fly to New York City than to many of these cities, and some even lack nonstop service from San Francisco. Southwest will likely start San Francisco service with service to major Southwest focus cities including Los Angeles, San Diego, Las Vegas, and Phoenix. In the next wave of expansion, Southwest will likely expand to add more intra-state service, but hopefully after that wave, the airline will add more lucrative service to underserved cities in the Southwest and Midwest regions. Southwest could build a very strong market in San Francisco if it put strong downward pressure on fares to select markets that the airline is already strong in.

But, what Southwest has to be careful about, is usurping its strong Oakland focus city. Oakland is Southwest's fifth largest market with 142 daily departures, as of November 3, 2006. Southwest has grown quickly in Oakland in the past several years, and the airline has added a variety of flights on short-haul and medium-haul routes across the country. Southwest already serves many of the destinations listed above nonstop from Oakland, and Oakland service has failed to put downward pressure on fares from San Francisco. But if Southwest augmented or even replaced some of its Oakland flights with services from San Francisco, it would provide convenience to more customers, since many customers are crossing the Bay to fly cheaply from Oakland, and it would put strong competitive pressure on United, particularly since United is weaker with short-haul service than it is with transcon service. Southwest needs to find the right balance between Oakland and San Francisco service, but it will all depend on what customers are willing to pay for. Oakland flights will likely be cheaper, because it's cheaper for Southwest to operate from Oakland, and Southwest already has an established presence in Oakland where it exercises considerable leverage over fares in the market. Due to San Francisco's higher costs and the very high fares from San Francisco currently offered by United, Southwest could likely get away with not lowering fares from San Francisco as much as it typically does in other new markets, particularly on less competitive routes, such as to Kansas City or Austin. Consequently, Southwest will probably charge more for equivalent flights from San Francisco than from Oakland, although the difference will probably be relatively small, my guess is that it would be no more than $20 per round-trip ticket.

Southwest will have a difficult task when it commences service from San Francisco this fall. They will need to overcome their lack of amenities, particularly their archaic seat assignment system, and compete in a very difficult environment with every other major US LCC. Southwest would be wise to focus on short-haul nonstop service from San Francisco to underserved cities that Southwest already has a strong presence in. Southwest's success in San Francisco will depend on whether the airline can lower fares enough to make their no-frills flights attractive for customers used to flying with airlines such as United that offer more amenities. Otherwise, the hip San Francisco crowd would rather fly with JetBlue, Virgin America, Frontier, or United than Southwest. The competition from San Francisco this coming summer will be a good indication of which airlines will be able to compete successfully with Southwest in such a difficult market. By the end of the summer, it will be clear which airlines are in an advantageous position in the market, and which ones could be forced to reduce service or exit if locked into direct competition from Southwest. One thing is for certain, Southwest's successful reentry into the San Francisco market will be a very different task than Southwest's relatively recent entry into other new markets, such as Washington Dulles and Ft. Myers because of the level of competition from most major US LCCs and one of America's strongest legacy carriers, United, as well as the immense downward fare pressure that Southwest and other low-cost airlines must put on shorter and longer routes alike in order to fill seats.