Four years after its launch, Reno Air's future looks considerably brighter after surviving a shaky start. As the carrier moves into adolescence, the question remains whether the management team that saved it two years ago can adjust to the challenges it now faces as a larger, slower growing airline.
Founded on the premise that Reno was an underserved stepchild to the US gambling capital of Las Vegas, the airline assured the Department of Transportation that it would not repeat the mistake of other new entrants who 'expanded out of their niches.' But as soon as it received its operating licence, Reno Air launched scattered routes that stretched from San Francisco to Kansas City and Minneapolis.
Despite correcting its mistake by retrenching within a year, the carrier then faced withering attacks on regional routes from such low cost rivals as Southwest Airlines, which overlaps more than half of Reno Air's network. Then no sooner had Reno Air opened a second hub in San Jose, than the west coast shootout started between Southwest and Shuttle by United. By the end of its second full year, Reno Air had losses of $21 million.
Perhaps the carrier was simply following the usual pattern of startups, which typically need 18 to 24 months to turn a profit. But the managers who took over during that critical year were unwilling to leave matters to chance. The result has been nine consecutive quarters of financial improvement, the last five of them profitable. Consequently, Reno Air made its first annual profit last year - a modest $1.8 million - and current indicators suggest it could end this year with a net margin of 2.5 to 3.5 per cent and a $7 million profit.
True, this is the year of US airline success stories, thanks to the ticket tax holiday and improved traffic, but the key drivers behind Reno Air's improvement should help it weather future storms.
Foremost are its low seat mile costs. 'Comparing apples to apples, our unit costs are about 7.0 cents contrasted to Southwest's 7.2 when you adjust to equal stage lengths and factor out our first class,' says Paul Tate, Reno's chief financial officer, claiming that Reno Air beats the seat mile costs of all its main rivals. On comparable stage lengths, he estimates United's Shuttle at 8.0 to 8.5 cents, and Alaska Airlines at just under 10 cents. No wonder Reno's president and chief executive Robert Reding can boast: 'With our full service and low unit costs, we could take this airline almost anywhere and be competitive.'
The absence of unions, a young work force with lower base salaries, and some bargain basement deals on aircraft and equipment from the liquidation of Midway Airlines all contribute to these lower costs. At an unadjusted 7.54 cents in mid-1996, Reno Air's unit costs are still falling after adjusting last year's for an extraordinary return of maintenance reserves.
Tate knows he is unlikely to find more deals like Midway's bankruptcy sale, and unions could one day succeed in organising employees, so he must keep pressure on other costs. CRS booking fees are now one of his biggest targets. 'When our average fare is $65, a $3 CRS booking fee is too high.' But rather than complain to Washington, Tate believes competitive pressures will eventually force CRS suppliers to cut their fees. In the meantime, Reno Air offers travel agents an override commission to book directly.
The second reason for Reno Air's success appears to be that, after a helter-skelter start, it has focused on a regional niche. 'Our expertise is in the west,' says Robert Reding, who completed the transition with the management team that he had brought in, after adding the role of chief executive to that of president last year. When Jeffrey Erickson vacated the top post to take over at TWA in April 1994, Reno Air was only just beginning to focus on the western US.
Reno Air has only kept one scheduled route to the midwest (Chicago). Instead its emphasis has been on developing twin bases at Reno and San Jose with 200 daily flights to eight western US states and the Canadian province of British Columbia (see table). Reno Air has maintained a balance in the growth of both its hubs with each accounting for some 40 per cent of all its scheduled departures. Point-to-point services away from the hubs, such as Los Angeles-Albuquerque and Seattle-Alaska, represent the other 20 per cent. For the foreseeable future, Reding plans to keep this 40-40-20 balance (see chart).
Reno, which has an 80 per cent leisure traffic profile, remains the carrier's true hub, with flights timed for both north-south and, increasingly, east-west connections. Reno has become one of the fastest growing US airports, with traffic up 82 per cent in the last five years, thanks largely to Reno Air.
American rescue
Yet the carrier's second hub at San Jose has developed into a much-needed O&D base for Reno Air's higher yield business traffic: some 80 per cent of the San Jose-originating passengers are business travellers plying the California corridor. Ironically, San Jose was not in Reno Air's original business plan, but resulted from a fortuitous commercial alliance with American Airlines that has been a major key in Reno Air's turnaround.
American's decision in 1993 to withdraw from San Jose coincided with Reno Air's need for a business hub where it could make better use of services like its 20-seat first class, advance seat assignments, and full CRS access. The result was what Reding calls 'a win-win situation.'
American was worried about losing west coast frequent flyer members when it downsized San Jose. Since Reno Air had short-haul, full service capability, American proposed to offer its frequent flyer members accrued mileage on Reno Air in return for an undisclosed sum for the enhanced access to those passengers. As part of the deal the carrier subleased most of American's San Jose terminal space.
The link with a frequent flyer programme of a US major gave Reno Air a big boost, both with business travellers in the California Corridor and in new markets where Reno is assured some loyalty from AAdvantage members before it even starts.
The American alliance has brought other benefits. Besides joint marketing and traffic feed where their routes met, American also offered Reno Air a joint fuel purchase agreement, so that both carriers could pool their volumes for lower prices. Under this part of the deal, American also extended Reno Air a $12 million line of credit to free up working capital during the carrier's leaner periods. In the 1993-94 winter season, this may well have saved the carrier from collapse.
Reno Air has outgrown the need for joint fuel purchases, and it stopped paying interest to American when it zeroed out its credit line a year ago. The fuel and credit deals ended in September, but Reno Air uses American for engine overhauls and AMR Services on a bid basis for ground handling.
The final key to its survival is probably Reno Air's unusual mix of scheduled and charter services. Most US carriers avoid combining scheduled and charter services. 'Charters are a hard way to make money,' admits Tate, who recites the three US all-charter casualties within the last 18 months. 'All-charter airlines are often plagued by surprises,' Tate notes. 'You price out a charter and then discover there were hidden costs.'
This can happen to anyone, but 'charters are a nice adjunct to scheduled service because they round out our seasonality,' Tate adds. Eighty per cent of Reno Air's charters are track (scheduled) flights from Chicago, San Jose, or Michigan to Florida, Mexico, and the Caribbean. The number of aircraft it dedicates to charters varies with the season from one to three.
Tate predicts charters will contribute 6 per cent to Reno's revenue this year, and although this is an increase on last year the figure is unlikely to grow much more. 'We have about the right amount of charter business now,' says Tate.
On a scale of 1 to 10, Tate rated the airline's financial health as a precarious 1.5 when the new management team took over in 1994. Today he pegs it at 7.0 to 7.5. Within 12 months, he thinks it will be 9.
Having survived what is often the roughest period for a startup airline, which key strategies behind Reno Air's success should it retain and which should it change? Adjusting the strategy to fit new realities may be as critical as surviving the startup period.
More ownership
One problem with success is taxes, which in turn can drive aircraft ownership policies, and thus, capital needs. Until now, Reno Air has been a aircraft lessee and has avoided taxes simply by offsetting current profits against earlier net losses.
Since those credits will expire early next year, Tate believes Reno Air needs to boost fleet ownership so it can shelter cash behind depreciation. Currently the airline only owns two MD-80s in a total fleet of 26 MD-80s and 3 MD-90s. The rest are on operating leases, which Tate foresees the airline will always use for operational flexibility. Yet, he is convinced, 'we need to own more.'
Raising capital for aircraft purchases has proven harder than expected. In July, the airline was about to make a fresh public offering of up to 3.5 million shares - the carrier currently has 11 million outstanding. It withdrew that offering at the last minute because of a plunge in airline stocks. Tate attributes that to three causes, none related to Reno Air's own finances.
One was investor uncertainty over when Washington would reimpose its ticket tax, and whether airlines would succeed in passing it on to passengers. The other two reasons might be called 'the ValuJet effect.' This phenomenon breaks down into investor scepticism towards all startup airlines on one side, and the FAA's decision, politically driven in Tate's view, to ground ValuJet, on the other. That decision 'sent the sector into a tailspin' he says, because of Wall Street's 'huge uncertainty over what kind of arbitrary and capricious actions a wounded FAA is capable of taking in the future against other airlines.'
Fortunately, Reno Air can wait until the market improves. It has no working capital needs now and no aircraft acquisition plans until late next spring when traffic typically surges. 'We don't see any reason for anything other than straight equity,' to raise capital, says Tate, who predicts a successful public offering will be followed sometime in the next 12-24 months by a public offering of debt in the form of equipment trust certificates to help finance aircraft.
The other big strategy change planned by Reding is a 'need to slow our rate of growth.' By his own admission the airline's development has been 'aggressive,' a point confirmed in the latest Airline Business 100 which ranks Reno Air as the 13th fastest growing airline in the world. 'Now that we have reached the 30 aircraft size we will grow to meet market conditions,' Reding says. In his planning he is allowing for infrastructure and personnel capable of serving a 50 aircraft fleet by 2000, but insists that is not a goal. 'Whether we will have that many aircraft will depend on the market.'
Reding talks of building east-west traffic at the Reno hub, but it is unclear where the airline will actually fly east of Reno. Aside from Colorado and Chicago, its route network is mostly north-south.
But the threat of increasing competition means not all initiatives are under Reding's control. Shuttle by United is coming to Reno. Reno Air has survived competing in the California corridor, but the prospect of facing this rival at its home hub underscores Reno Air's need to keep costs down and differentiate its product.
Reding promises he will 'be careful to avoid overcapacity,' but shunning competition is not itself part of his strategy. 'We won't compete simply for the sake of competing,' he explains, 'but if our market analysis shows room for us to make money, we're not afraid of competition. We have managed to survive in a low fare market that is the most competitive in the US.'
Despite United's plans, Reding believes the western US market is beginning to stabilise. 'We already have low fares and high frequencies,' he says. 'Carriers are moving capacity to the east coast, where yields are higher. We see Southwest expanding there, ValuJet coming back, and now Delta Express. The pendulum is starting to swing'
Reno Air, however, is not eying the east. Instead, Reding talks about a list of 20 potential western markets, of going back to some California Corridor cities it dropped when it lacked capacity to match Southwest's daily frequencies, of new scheduled authority to Mexico, and of more routes to Canada.
Reding hopes to announce Reno Air's first codeshares 'very soon,' not only on international routes, but also with some 'solid, stable turboprop operator, such as AMR Eagle,' for regional feed. He doesn't believe that American Airlines would be interested in taking a Reno Air stake, but he waxes lyrical about the prospect of a global marketing alliance embracing American, British Airways, and their partners. He foresees Reno Air feeding London traffic to British Airways at Los Angeles, Seattle, or Chicago, delivering European passengers to Canadian in Calgary or Edmonton, and Australian traffic to Qantas in Los Angeles. 'The opportunities are phenomenal,' Reding enthuses. 'Our biggest challenge must be to remain focused.'
Source: Airline Business
