As regional traffic soars, little wonder that major US carriers are paying more attention to this valuable market
Paul Lewis/WASHINGTON DC
The fastest growing segment of US air transportation is the regional airline industry, which is forecast to double the amount of traffic over the next 10 years. Regional operators, fuelled by a massive influx of new regional jets (RJs), are pathfinding markets hitherto deemed either too distant to be served by a turboprop or too small for a large passenger aircraft. Mainline carriers have been quick to recognise the opportunities presented and have adopted different strategies to harness this potential source of traffic and revenue.
Regional traffic last year topped nearly 80 million passengers and this is set to further increase to 153 million by 2012, according to the latest US Federal Aviation Administration (FAA) forecast. Accordingly, major US carriers are paying increasing attention to this valuable market which, in some cases, already generates as much as 15% of overall revenue. This is reflected by the fact that no less than five of the eight US mainline carriers today own either outright or a majority of their regional feeder operations.
Acquisitions include American Airlines' purchase in early 1999 of Business Express (BEX). At the time, BEX was the largest regional operator in the US. This acquisition was followed in quick succession by Delta Air Lines' $2.5 billion purchase of Atlantic Southeast Airlines (ASA) and Comair, one of the country's largest and most successful RJ operator. Smaller deals include Continental Airlines taking a 28% interest in Florida-based Gulfstream International Airlines, while Northwest Airlines is currently in the midst of pitching to take full control of Mesaba Airlines.
Transforming US aviation
"The RJ, in our minds, is transforming the way that the US aviation industry works," says Doug Blissit, Delta vice president network analysis. "We saw a substantial increase in the traffic potential of these aircraft and felt this was going to be one of the fastest growing component of the air transport industry. We wanted to have a piece of that growth opportunity," he adds.
Healthy operating margins of 30% or more have made regional carriers not only an attractive financial proposition but a strategic asset that mainline airlines are keen to protect. In ASA's case, some 90-95% of its traffic feeds directly into its Delta Atlanta-based network, whereas Comair had developed such a large and successful operation in Cincinnati that the very viability of Delta's hub there depends on it.
"A full 15% of load factor performance was driven by Comair feed. We felt there was a reasonable chance that a major carrier might have looked at purchasing Comair out from under use and we couldn't afford to take that chance. We needed to protect our position in Cincinnati, and we saw this as a great growth opportunity. Comair is the best operator in the business," explains Blissit.
American's earlier purchase of BEX has perhaps served as a poignant reminder of the threat posed by a rival takeover, undermining as it did Delta's US Northeast traffic feed. The carrier in the end struck a regional feeder deal with the Atlantic Coast Airlines (ACA) parent company to establish a new Delta Connection operation, ACJet, to operate alongside its existing United Express service and replace BEX in New York and Boston.
American's absorption of BEX as part of its Eagle regional subsidiary was only recently completed with the final surrender of its operating certificate. While Delta was forced to rebuild its northeast operations around a new carrier, American acquired a carrier not only possessing invaluable slots at New York's overcrowded La Guardia Airport, but another almost equally scarce commodity - early RJ delivery positions.
At the time of its takeover, BEX already had orders placed with Embraer for 20 ERJ-135s, plus 40 options. When added to American Eagle's purchases, these contributed to a total orderbook of 229 aircraft. "That was one attractive feature of the transaction. We picked up their order and options and integrated them into out fleet," says Peter Bowler, American Eagle Airlines president.
For the likes of American, Continental and Delta, perhaps the biggest advantage of regional ownership is that it allows them to arrange and plan feeder operations essentially no different from any other division of the company. The airline can schedule its RJ's the same as it would a mainline Boeing 777. It can crossfeed management and make regional operations an integral part of future developments, such as airport terminal planning, rather than it being an after thought.
"The biggest advantage we get is closer co-ordination between American and Eagle as the result of common ownership. We stay more synchronised on strategy, fleet planning and facility requirements. There is also a cultural benefit from the fact that there is less suspicion from the mainline carrier towards the regional. We're able to fine tune a network without taking a lot of time haggling over the nature of the deal," says Bowler.
Weighed against this are the potential downsides of regional ownership by mainline airlines. These can include damping of staff morale, suppression of independent thinking and dynamic decision making and ultimately an erosion of once frugal cost controls - the very same attributes that made regionals attractive.
The recent strike by Delta Connection's Comair pilots had caused more than one airline executive to wonder whether crews might have lowered their expectations and tempered their willingness to strike if the carrier had remained independent of Delta Connection. Some observers, by extension, suggest this might prove a turning point away from carrier acquisitions towards more codeshare partnerships along the lines of United Airlines' relationship with its three Express operators: ACA, Air Wisconsin and Skywest Airlines.
"If United Airlines owned these carriers as subsidiaries, they would lose their young and scrappy entrepreneurial energy," suggests Chris Rado, United Express director. "We've got enough control that our network isn't at risk and can always pull the rope back if needed. These guys are independent enough that they can make their own decisions, keep their flair and manage their businesses without an United 800lb gorilla getting in the way," he adds.
Fee for departure
United exercises control through a series of 'fee for departure' or ASM (available seat mile) buy contracts with its three feeder carriers. The carriers, at the same time, are motivated to remain competitive in terms of cost and on-time performance. Ultimately United can play them off one against the other when it comes to allocating new capacity and services.
The recent move away from fair sharing contracts towards fee for departure, by United and other airlines, has provided regional carriers with a more stable revenue stream and insulated them from the volatile effects of traffic and fuel price fluctuations. In return for the promise of a profitable margin, the airlines have ceded a good deal of control to the mainline carriers, including decisions on where and how to deploy aircraft, service scheduling, marketing and revenue management.
"They now have no revenue risk," says Rado. "In exchange we provide a stream of lower margin but steady income. Instead of them focusing on marketing and getting more people on the aircraft, we focus on that. We're really good at that through our yield management. They can then focus on the process of getting the aircraft out and staying low-cost."
United Express has already concluded fee for departure arrangements with ACA and Skywest as part of a new agreement providing for increased RJ opportunities. It is now concluding a similar deal with Air Wisconsin. Delta has forged its own ASM-buy deal with its New York-based start-up ACJet. Delta's other privately-owned Connection partner, Skywest, will also move to a like payment structure as its Denver-base adds more RJs.
The trick for the mainline partners will be to make sure the regional carriers are still sufficiently motivated to keep a tight handle on operating overheads. The inducement being dangled by United is future allocation of what it calls 'RJ operating rights'. These will determine how many jets each operator will be permitted to add to its Express operation.
Under a complicated scope clause deal hammered out last year with its pilots union, United is allowed to increase the number of 50-seat or smaller RJs in the Express system from the old limit of just 65 jets to a projected 358 by 2003. The carrier can add five RJs for every new widebody aircraft introduced into the mainline fleet, and another three per additional narrowbody. United is allowed to add another 150 RJs to the fleet as one-for-one replacements of existing turboprops.
United has so far distributed 243 RJ rights through to 2003, comprising 128 for ACA, 55 for Skywest and 60 for Air Wisconsin. This summer the three Express carriers will be invited to begin bidding on the next tranche of RJs due to be allocated in 2004. The decision will be based on available RJ delivery positions and options as well as performance of each respective carrier. "We're giving them incentives to make sure their on-time completion and bag numbers are what they are supposed to be. If a carrier can't manage 50 RJs, why should we give them another 50?" says Rado.
United is so far the only major carrier to have secured a major scope clause concession from the Air Line Pilots Association (ALPA) during the current round of renewed contract negotiations. The airline's next task will be to integrate US Airway Express operation and deal with its far more restrictive scope clause cap of just 70-jets. If the merger if allowed to proceed, the first step will be for the ownership of US Airways three wholly-owned all-turboprop subsidaries - Allegheny, PSA and Piedmont - to be transferred to ACA.
Delta is still in talks with its ALPA crews, who are demanding tighter restrictions on the use of larger RJs, including the 47 70-seat Bombardier CRJ700s ordered last year for ASA and Comair. American had reached an agreement with the Allied Pilots Association that would have allowed unrestricted growth of Eagle's 50-seat ERJ145 fleet in return for the 25 CRJ700s on order either being flown by higher cost mainline pilots, or being sold off before delivery. The proposed deal was rejected by the union's rank-and-file membership, though.
Scope busting
The airline's old scope clause agreement allows it to operate up to 67 jets between 45-70-seats, of which 59 are already accounted for by ERJ145s. American, as a result, has converted 130 remaining ERJ135/145 orders and options to 44-seat ERJ140s in order to maximise capacity within the current size limitation. The crunch will come with the first scheduled 70-seat delivery this summer.
"The exact numbers of CRJ and ERJ aircraft we end up with will to some extent be a factor of the outcome of talks. If we make no progress, we may have to return some 50-seaters and replace them with additional 44-seaters in order to allow us to take the full order of CRJ700s," warns Bowler. "We believed a large and optimal size fleet is to the benefit of American pilots as its strengthens our hub and increases connect traffic."
Northwest Airlines, like United, has been able to use the allocation of RJ's to pressure its Airlink operators on cost and, ultimately, ownership. The carrier to date has allocated the first 42 of its 54 CRJ200s on order to its wholly owned subsidiary Express I. Minneapolis-based Mesaba Airlines is pushing to get the final 12 jets and as many of North-west's next anticipated purchase of up to 100 37/50-seat RJs as possible.
Never committed
"Express has not been guaranteed all the CRJs going forward. The plan in all our announcements is for 42 jets," says Jim Cron, Northwest Airline vice president market planning and airlinks. At the same time he adds, "we've never made a commitment to Mesaba on the CRJs." The airline's current scope clause agreement limits it to 54 RJs of 45-seats or larger, with the exception of Mesaba's 36 69-seat BAE Systems Avro RJ85s.
RJ growth beyond 54 jets is currently contingent on expansion of the mainline's narrowbody fleet. Northwest recently ordered 18 additional Boeing 757s and is now evaluating a replacement for its large fleet of McDonnell Douglas DC-9s, which range in configuration size from 79/125-seats. The need for sub-100-seat replacement jets raises the interesting prospect of Northwest's mainline fleet also operating RJs, acknowledges Cron.
The final disposition of new RJs is almost certainly tied into Northwest's push to buy out Mesaba's remaining shareholders and take full control of the carrier. A further consideration is moves to restructure the two Northwest Airlink operations along capacity lines, rather than using more commonly accepted geographical lines of demarcation.
Express I is now expanding with its new fleet of 50-seats into markets that were formerly Mesaba's preserve, starting with Detroit and to be followed, this summer, by the launch of operations from Minneapolis. Mesaba already operates the RJ85 from all three of Northwest's hubs including Express homebase of Memphis, as well as the Saab 340 for routes unsuitable for turboprops.
Breaking down traditional hub barriers between regional carriers also serves to further strengthen mainline leverage over its feeders. United Express has constructed an interlocking network that allows it to assert pressure over Skywest at Denver through the presence of Air Wisconsin, while the latter in turn is forced to share both Chicago and Washington Dulles with Skywest and ACA respectively
The presence of more than one regional feeder also gives mainline carriers the flexibility to better optimise capacity at slot-constrained airports such as La Guardia, where Delta is represented by no less than three carriers: ASA, Comair and ACJet. The presence of the latter has helped defray the impact of the recent lottery on future slots at La Guardia, with ACJet transferring to its sister ACA/United Express operation the 20 CRJ200s previously earmarked for New York.
"At La Guardia we could keep only 30 out of the 100 or so slots we wanted. That limited our jet opportunities and took a big bite out of someone's fleet plan. We preferred it was ACJet rather our own Comair or ASA," says Blissit. Delta, conversely, has been able to reallocate to ACJet other routes better suited to its 32-seat Fairchild Dornier 328JETs, freeing up larger Comair and ASA equipment to be more profitably used elsewhere in the Connection network.
For carriers with a more homogeneous regional structure, such as American Eagle, the task of optimising hub operations is a lot more straight forward. This enables the carrier to simplify hub aircraft types, reducing crew and maintenance costs. Despite the influx of large numbers of ERJs, the carrier has no plans to dispose of its entire turboprop fleet soon.
"We'll be a predominantly jet operation, but there will still be a number of markets we operate to that will be better suited to turboprops for long period to come," says Bowler. This includes the Caribbean, where airport facilities and the large amount of baggage carrying tourist traffic makes the jet unsuitable. While major hubs such as Boston, Chicago and New York La Guardia and JFK transition to an all-jet operation, American Eagle plans to concentrate its ATR 42/72 fleet at San Juan and Miami and maintain an all-turboprop operation.
Turboprop role
While most US carriers are in the process of downsizing their turboprop fleet, very few are rushing to emulate Continental Express' headlong rush towards an all-jet fleet. There is widespread recognition that, in spite of an over- whelming public preference for jets, there are some shorthaul routes of 150nm or less where the current generation of RJs simply cannot compete with the better economics of a turboprop.
"We're going to deploy capacity that makes the most economic sense. There is an obvious customer bias to a jet product and in every evaluation we do there is a revenue demand associated with having a jet versus a turboprop. But there are places in the short-haul market where a jet will never be able to compete with turboprop economics," concludes Blissit.
Source: Flight International
