AARON KARP / WASHINGTON DC
In North America, the term 'low-cost' no longer means 'no frills' and majors are launching their own budget airlines in a bid to compete
As recently as four years ago, a look at low-cost carriers (LCCs) in North America would have focused almost exclusively on Southwest Airlines - Texas businessman Herb Kelleher's no-frills, point-to-point brainchild that has earned steady profits while catering to the "everyman" passenger. In the late 1990s, with the internet boom in full swing, Southwest plugged along as a low-fares, low-amenities alternative to North American majors, which raked in money from business passengers willing to pay high fares to travel the continent and the world in relative luxury.
But now, with majors bleeding money and facing bankruptcy, LCCs are taking centre stage in the world's largest aviation market. While the majors lose billions of dollars (American Airlines lost $3.5 billion in 2001 and 2002 combined), LCCs continue to earn profits. US LCCs AirTran Airways, JetBlue Airways and Southwest, and Canada's WestJet all made money in 2002.
Southwest, while still consistently profitable, has faded to the background as start-ups such as JetBlue fly passengers across the USA in new Airbus A320s with satellite television at every seat. Even some of the majors are attempting to launch low-fares subsidiaries.
No North American market is more demonstrative of the surge in high-stakes, low- fares competition than Calgary, the western Canadian city where WestJet and Air Canada's newly launched low-cost subsidiary Zip are based. The two carriers are battling for passengers who, no longer interested in even the simplest of amenities, are looking only for the cheapest ticket possible.
Market shift
"There's a worldwide phenomenon in the industry where the business travellers that full-service carriers focused on in the 1960s, 70s, 80s and 90s are no longer the dominant market," says Zip chief executive Steve Smith. "The visiting Aunt Molly crowd is now the dominant market and they want far different things than do business travellers - the overwhelming, most important thing for these passengers is price. After that, everything else pales. Time of day, service - doesn't matter much anymore," he says.
Others, such as WestJet chief executive Clive Beddoe, say the business traveller is still a big part of the airline passenger market - but is content to join the Aunt Molly crowd in paying low fares and foregoing in-flight meals and other amenities. "It's utter nonsense that the business market is dead," says Beddoe. "The businessman is flying; he's just not willing to pay."
Major North American network carriers and LCCs are quickly realising that exactly who the passengers are is largely irrelevant in the post-economic boom, post-11 September reality. Whether they are visiting friends and relatives, hopping on a flight for a weekend getaway, or heading to a business appointment, the passengers all appear to want the same thing above all else - low fares. To survive, North American airlines are scrambling to work out how to make money while having no pricing power.
Entrenched LCCs such as Southwest and WestJet are doing what they have done for years - using assets as efficiently as possible, keeping costs low and compensating for a lack of amenities with friendly, reliable customer service that aims to secure repeat passengers. Southwest - with its legendary 31-year profit streak - and WestJet - riding a six-year profit run - have continued to make money during the industry's largest-ever downturn.
New LCCs, such as JetBlue, offer a more high-end low-fare service that aims to go above and beyond the bus-in-the-sky Southwest model while still employing the same basic principles devised by Kelleher. "We're Southwest with seat assignments, leather seats and television," JetBlue chief executive David Neeleman is fond of saying. JetBlue, launched in February 2000, has been successful despite the flagging economy.
The majors, meanwhile, are attempting to launch low-fare subsidiaries and/or restructure mainline services into much lower cost operations. In the most high profile and ambitious of these moves, Delta Air Lines is starting up Song - a high service, low fares subsidiary designed to compete directly with JetBlue.
Following the lead
The LCC concept was born in 1971 when Kelleher founded Southwest. His novel concept, which Southwest says it follows to this day, is that the carrier's competitors are not other airlines; rather Southwest views its primary competition as automobiles and buses. "We haven't changed in 31 years," says Southwest director of revenue management Keven Michalenko. "You know what to expect from Southwest. You pay a nice, low fare and you know you're going to get there on time."
Southwest keeps costs low by operating one aircraft type - the Boeing 737 - on point-to-point, mostly short-haul routes. The carrier focuses obsessively on turning aircraft around quickly. Because it is not a hub-and-spoke operator, "connections are not our primary concern", says Michalenko.
He adds: "We're more concerned about getting the aircraft back up in the air. Our aircraft spend very little time on the ground. The airline isn't generating revenue if the aircraft isn't in the air. "We don't have to have as many jet bridges and gate areas and a lot of space that's underutilised. We use the heck out of our inventory," he says.
For the full year 2002, Southwest recorded a net profit of $241 million, less than half of its 2001 net profit. Revenues for the year declined 0.6% to $5.5 billion. It operates a fleet of more than 350 aircraft serving 58 destinations. The carrier has no plans to add new destinations in 2003.
Kelleher, whose freewheeling, whiskey-drinking persona was often seen as a metaphor for Southwest's one-time maverick status in the industry, plays down the perception that his LCC business model was ever a radical concept.
"In many ways we are the most conservative company in our industry," says Kelleher, now the airline's chairman but no longer its chief executive. "We have always maintained a strong balance sheet, watched our costs, and paid as much attention to our financial fitness in good times as in bad."
With LCCs now carrying 20% of the US domestic passenger market - a figure expected to continue rising - the Kelleher strategy has become mainstream. "We've been sitting on the sidelines more lately," says Michalenko. "The focus has now shifted to JetBlue and some other carriers who are taking our philosophy and adding a few twists to it."
JetBlue's Neeleman, who sold Morris Air to Southwest in 1993 and was a consultant to Beddoe during the 1996 founding of WestJet, decided in 2000 to start a new kind of LCC. The carrier, based at New York Kennedy airport, focuses on long-haul, high-density routes, and emphasises comfort and modern amenities while still keeping fares and costs down.
"We achieve low costs through an industry-leading use of our aircraft - nearly 14h a day, and an unprecedented use of technology," says Neeleman, who raised $130 million in venture capital to launch the carrier. This technology includes a fully electronic US Federal Aviation Administration flight manual system, which enables pilots to use standard-issue laptops to access the most up-to-date FAA information before every flight. JetBlue says the technology maximises flight efficiency.
In-flight entertainment
JetBlue offers passengers 20 channels of live, free DirecTV satellite television via the LiveTV platform for viewing in flight. JetBlue last year acquired 100% of the ownership interests in LiveTV for $41 million in cash and the retirement of about $40 million of LiveTV debt.
Based at Kennedy, JetBlue also has a West Coast hub at southern California's Long Beach Airport, near Los Angeles Airport, and touts the efficiency and hassle-free environment at Long Beach as compared to Los Angeles. It operates a fleet of 40 A320s serving 20 destinations, including Fort Lauderdale, Florida; Buffalo, New York; and Oakland, California. The carrier aims to have 50 A320s in service by the end of the year.
For the full year 2002, JetBlue saw its net profit increase to almost $55 million from $38.5 million the previous year. Revenues for the year totalled $635 million, a growth of 98.2% over revenues of $320 million for 2001. Its traffic soared 108% to 11 billion revenue passenger kilometres on an increase in capacity of 95.8% to 12 billion available seat kilometres. As a result, the carrier's passenger loads improved 5% year-on-year to 83%.
On 15 April Delta will launch Song with flights between New York Kennedy and Palm Beach, Florida. It will operate Boeing 757-200s taken from Delta's mainline and reconfigured for JetBlue-like service.
Song will begin operations with just one aircraft and plans to add one 757-200 a week until November to reach 36 total aircraft serving eight destinations, mostly competing head-to-head with JetBlue on New York Kennedy-Florida routes. The carrier will also operate New York Kennedy-Atlanta service, a direct shot at Delta LCC rival AirTran, which offers several daily flights from New York's LaGuardia and Newark airports to its Atlanta hub.
A losing formula?
AirTran chief executive Joe Leonard dismisses Song as a credible threat. "We think that this is a new verse of the old tune of Delta Express, which was a failure. It's the latest in a series of high-cost, low-fare airlines and we don't think that formula works."
Song's 199-seat, one-class-configured 757-200s will be used 13.2h a day, up from Delta mainline aircraft's 11.5h per day utilisation. Passengers will sit in leather seats and be offered in-flight entertainment (IFE) similar to that of JetBlue.
Matsushita Avionics Systems has been tapped to install its new eFX IFE system for narrowbodies on Song's Boeing 757s by October. Passengers will be offered EchoStar Communications' DISH Network satellite television service broadcast over the eFX platform. Also available at each seat will be a lengthy music playlist and pay-per-view movies.
JetBlue's Neeleman has warned he will keep a close watch on the Delta-Matsushita project to ensure it does not infringe on JetBlue subsidiary LiveTV's patents. Although Matsushita must receive supplemental type certification for the eFX system on the 757 and meet various other components regulations, it expects to begin installations by late summer or early autumn.
Song passengers will also be offered a wide food menu, but will have to pay for any items ordered from it.
"We are actually going to change the low-fares expectation," says Song. "We are really upping the low-fares ante. Delta customers have higher expectations and we'll provide service to meet those expectations."
It is precisely the higher expectations of full-service carrier passengers that makes Southwest, among others, sceptical of Song's ability to succeed. Says Southwest's Michalenko: "If I were buying a ticket on Delta Air Lines and I got to the airport and I'm flying Song, I'd be confused. I don't know how Delta's customers will react."
He adds that Song, operating within a major airline, will be saddled with its parent's higher cost structure and will not truly be low cost even if it offers low fares. But Song says that "costs will be kept down", in part because "we have the power of Delta's technology infrastructure behind us".
Neeleman says JetBlue will compete against Song by continuing to add frequencies in New York-Florida markets. He says the carrier "will have 16 flights a day to Fort Lauderdale by the peak winter season".
Bankrupt United Airlines is also looking to launch a low-fares carrier. In a document given to its creditors' committee explaining a planned restructuring, United describes a no-frills unit positioned as a distinctive, low-cost brand, with independent management and labour costs. United says the LCC would compete directly against Southwest and JetBlue.
"United's value proposition to price-sensitive/value-conscious customers is uncompetitive," says the United document. "The low-cost carrier threat is real and growing."
According to the plan, United's low-cost carrier would operate a fleet of 134 narrowbodies, serve 37 cities and offer mostly short-haul flights of 1,450km (785nm) or less. The 134 aircraft presumably would come from United's fleet of A320s and 737s. Aircraft utilisation would be pushed up to 11.25h a day versus United mainline's current 10.22h. United's target cities for its LCC span across the USA and almost exactly mirror Southwest's network.
Even majors not planning low-fares spin-offs are aiming to retool their cost structures to compete with LCCs, which have thrown a considerable scare into the once dominant network airlines. "We're in a period of particularly intense competition," American Airlines chief executive Don Carty recently told employees. "When you see $19 fares on the West Coast, you have to wonder if someone turned the clock back to 1965 when you weren't looking. It's true madness."
Carty notes that American competes "with Southwest or other low-cost carriers in 70% of our markets", adding: "Though they offer low-frills, simple service, they are capturing our prize customer - the business traveller - in bigger numbers than ever. We have no choice but to match their fares in many of these markets, even though we offer a much more attractive product. And that's not a sustainable situation."
The bottom line
American is looking to trim $4 billion in annual costs, including $1.8 billion in concessions from unions. AirTran director of planning John Kirby says watching the bottom line is now the key to airlines' survival. "Cash and costs really were king in the industry in 2002," he says. "People are competing very aggressively. It's as cut-throat as it's ever been."
Kirby adds: "It is no surprise or coincidence that the three [US] carriers that made money last year were the three lowest costing airlines in the industry" - Southwest, JetBlue and AirTran. The latter reported net income of $10.7 million for 2002, down from a profit of $21.7 million for 2001. Total revenue for 2002 increased 10.3% to $733.4 million compared to $665.2 million in 2001. Kirby says LCCs' stature has risen considerably in the eyes of the travelling pubic: "For a long time there had been a stigma about low-fares carriers. People associated low cost with low quality. But I think that's changing now with Southwest's growth, JetBlue's emergence and our continued presence."
Source: Flight International
