Delta Air Lines' low-cost, low-fare subsidiary has its detractors; indeed one US magazine recently christened the Florida-based operation 'Delta Distress'. But its supporters say the concept will succeed because it is based on a thoughtfully conceived strategy, focusing on cost, operational and marketing advantages.
The harsh epithet used as a substitute by Business Week to describe Delta Express does find some support among analysts, but for Delta's management the subsidiary is an essential part of its domestic strategy and has drawn on lessons learned from other US majors' attempts to start a low-cost operation. And Express has one overriding goal: to protect Delta's share of the Florida market, which produces one-fifth of the carrier's domestic revenues.
Delta Express started up at the beginning of October with a dedicated fleet of 25 B737-200s operating mainly out of Orlando in 14 point-to-point markets within Florida, and to the Midwest and the northeastern US. Heeding the lessons of the failed Continental Lite and USAir's High Ground operations, and the mistakes made by United when it first aimed its Shuttle at Southwest in late 1994, Delta's management is determined to compete more vigorously against low-cost carriers, such as Southwest and Kiwi, that have begun to invade its Florida turf. And it is equally determined to establish itself in other Florida markets where low-cost competition has not yet appeared.
But before it could fully develop a game-plan to protect its Florida flank, Delta had to cut a pay deal with its pilots to remove a big chunk of labour costs from its low-cost unit. After 18 months of negotiations with the airline's only unionised employees, management reached an agreement with its pilots in April that Wall Street analysts say cut Express pilot salaries by 32 per cent, compared to their counterparts at Delta mainline.
Express copies Southwest's highly successful strategy of using only one aircraft type - the B737 - with one class of service, and rejects Continental's spectacularly unsuccessful deployment of numerous aircraft types in its Lite operation. To this end Delta has segregated 25 of its 67 B737s specifically for Express and configured all of them with 119 coach-class seats. 'It's the most reliable plane we have in our fleet, and it's very easy to ground-handle and to facilitate the turnaround time,' explains 'Skip' Barnette, managing director of Delta Express.
Fine-tuning the logistics of the Express operation since late spring, Delta has increased utilisation of the Express B737s to 12.2 hours per day, compared to 7.4 hours elsewhere in the system. Barnette says the carrier is aiming for a 15 to 30-minute turnaround of these planes, compared to a 40 to 90-minute timeframe for equipment used on other routes. This is one of the main reasons for all Express services bypassing Delta's main Atlanta hub. The other argument for cutting out Atlanta is to protect revenues from high-yielding connecting traffic there.
In addition, boarding procedures for Express passengers have been simplified to cut aircraft downtime and maintenance for the Express fleet has been centralised in Tampa. Steps like these to increase Express' operational efficiency have brought its cost structure down to less than 7.5 cents per available seat mile, according to Barnette. This is appreciably lower than Delta's 8.33 cents per ASM in the quarter ending 30 June and, even more impressively, below Southwest's 7.56 cent unit cost level in the same period.
Equally significant are the marketing decisions made by Delta for the Express operation. Wall Street analysts almost unanimously praise the carrier for sticking to markets in Florida which it already had a presence, albeit some were previously served one-stop. The Express operation flies nonstop from Orlando to 14 cities, including some like Providence, Rhode Island, Louisville, Kentucky and Columbus, Ohio, which it had previously served via Atlanta. Standard & Poor's Philip Baggaley compares routes like these to United's ultimately ill-fated choice to put the shuttle into California markets like Oakland - a Southwest stronghold which the Chicago-based carrier had not served before - and commends Delta for its route strategy, which 'plays to its strengths.' Delta Express will grow from 62 daily flights from startup on 1 October to 128 by 1 January 1997. By this time the carrier will also have added a non-stop Boston-Ft Myers service (from November) and is due to start Boston-Tampa.
The carrier has not tinkered much with the existing deeply discounted fare structure in Express markets, but instead has simplified its own tariffs, which it believes passengers, particularly leisure travellers, will find more appealing. Express routes now have three fare levels - a 21-day advance purchase tariff; a seven-day advance purchase tariff; and a 'walk-up' fare. Unlike Southwest - but significantly like ValuJet - Delta has made the walk-up fare non-refundable, and requires payment at time of purchase. Although this should help Delta control overbooking better, one competitor suggests it could make Express less attractive to business travellers, which Delta says will account for 40 per cent of Express traffic.
Indeed, others suggest Express may alienate business traffic further by offering only a single-class product. Both Gordon Bethune, who on becoming president of Continental Airlines dismantled the disastrous Lite operation, and Brian Harris, airline analyst for Lehman Brothers, criticise Delta for not offering a first class on Express flights. The seemingly successful Shuttle by United offers just such a two-class product (see separate feature).
But Delta is counting on the strength of its frequent flyer programme, and the use of advance seating allocation, to make these Express services more attractive to both business and leisure travellers over those of its competitors.
Any competitive response to Delta Express appeared rather tempered at presstime in late September. The lack of any action in the market can be attributed to the attitude of Dave Ridley, Southwest's vice president of marketing and sales. 'It's clearly not an overt threat. We're competing directly only on six routes. It's not the kind of frontal assault and threat with capacity that we faced with the Shuttle by United on the west coast,' he notes.
From startup in October, Express, in fact, faces competition from over a dozen airlines (see table). USAir and USAir Express pose the strongest head-to-head threat with 42 daily departures, followed by Southwest with 24, and Continental with 16.
USAir's reaction to the Express expansion has been to increase flights in two of its key markets, the Boston-Orlando route, where it is increasing its daily frequencies from three to five, and the Philadelphia-Orlando route, a hub market that will jump from eight to 11 flights daily.
Southwest has adopted a 'wait and see' attitude about Delta Express, of which it is 'respectfully wary,' Ridley says. Asked about the possibility of cutting fares in Express markets, Ridley says, somewhat portentously, that he does not anticipate 'any whiz-bang reaction, at least at this point.'
Aggressive price-cutting, especially by Southwest, is, in fact, a distinct possibility, should Delta start treading too heavily on Southwest's gradually expanding Florida turf. Witness the Dallas-based airline's fare reductions in west coast markets the past 24 months, meant as a warning to both United and Alaska Airlines. Southwest began flying to Florida last January and now offers over 80 daily flights to or within the state. According to Ridley, load factors on these routes are exceeding the carrier's system average, which in August was 71.2 per cent.
Sam Buttrick at investment bankers PaineWebber believes the Express operation is indeed 'aimed squarely at Southwest. Almost all the new nonstop markets are markets Southwest has entered in the last 12 months.' Harris at Lehman's goes further and questions the wisdom of Delta battling it out with Southwest. 'I'm firmly sceptical because historically - with the Lite and Shuttle by United operations - there's been no indication that a large hub-and-spoke carrier can beat Southwest at its own game with a point-to-point operation,' he says.
More fundamentally, several Wall Street analysts fear the Express route system will cannibalise traffic from Delta's Atlanta hub, a claim Barnette wholeheartedly disputes. 'Advance bookings are strong on the mainline [airline] and on Delta Express. In markets where we fly to feed the hubs, we don't see any reduction in demand for service, even after you take out Delta Express traffic,' he maintains.
Sceptics are also concerned that the Express operation is an unwise allocation of Delta's resources, especially if ValuJet returns to its previous size. 'We are not crazy about a strategy that entails pulling planes from high-yield markets and putting them into perennially low-yield markets while leaving your flank exposed in your most important hub to low-fare competition (i.e., ValuJet's [return]),' wrote PaineWebber's Buttrick in a recent report on Delta Express. 'Common sense dictates that defending fortress Atlanta from revenue erosion must take precedence over defending Florida. But we're not in charge, and to be sure, the cannibalisation of Atlanta connecting flows will free up more seats to sell at competitive local fares.'
Delta's supporters reject this criticism, noting that the Express operation will represent only a tiny percentage of the carrier's total available seat miles. 'If this plan somehow falls short of internal projections, at only 3 per cent of system capacity, the downside is probably not significant,' suggests Vivian Lee, an analyst with BT Securities.
Delta Express' proponents believe the upside is appreciably greater, especially if Delta is able to preempt its competitors in Florida markets which they do not presently serve. 'If they can lower fares [in these markets] before their competition does it to them, they have a better chance of protecting their franchise,' says Renee Shaker at Moody's.
Indeed, it is not inconceivable that Delta Express and Southwest can coexist in Florida, reasonably peacefully, even if either carrier or both grow their operation in that market further. Southwest and United's Shuttle have reached a rapprochement of sorts on the west coast, after United backed out of many markets where it had initially taken on Southwest. Furthermore, perennially popular Florida still has growth potential, particularly if, as expected, leisure travel remains strong.
Should Express flourish, Delta hopes to apply whatever lessons it learns from this operation to its mainline system, where appropriate. 'In some ways, the unit will be regarded as a proxy for learning about electronic ticketing, quicker turn times of aircraft at the gate, higher utilisation during the day, and new ways to handle bags and other innovations,' Lee believes.
Barnette, for one, predicts Delta Express will succeed. He confidently projects the operation will contribute positively to Delta's 'overall corporate profitability goals right out of the box.' It needs to, because the ability of Delta to cut costs further depends largely on the success of Express after mid-1966, when the carrier abandoned its goal of achieving a 7.5 cent per ASM unit cost by 1997 and replaced it with a goal of achieving a 12 per cent operating margin in three years. At the end of the second quarter that margin stood at 10.4 per cent.
Whether this performance target is met - and the chances of this occurring are certainly boosted by Express' operating efficiencies - the experience Delta gains through the new unit should undoubtedly help it compete better over the long term against ValuJet or any other low-cost airline posing a major competitive threat. And it is not far-fetched to expect that an Express operation could one day be deployed in Atlanta or elsewhere in Delta's system, should the airline deem this a competitive necessity.
Shuttle craftAfter initially fumbling with a misguided route strategy, Shuttle by United is growing stronger by the month, feeding high-yielding business travellers to United Airlines' hubs in Los Angeles and San Francisco, and generating what one analyst projects is a $320 million annual halo benefit for its parent.
United is apparently so satisfied with the performance of the Shuttle, which it says was profitable on a stand-alone basis in the second quarter by an amount it declines to quantify, that it expanded the shuttle's 12-city route structure to 18 at the end of October, and increased its daily departures to 410, a 125 per cent increase over its inaugural schedule.
In addition, the carrier is spending $15 million to reconfigure the Shuttle's 45 aircraft (23 B737-200s and 22 B737-500s), adding eight coach seats and new galley equipment, and dedicating the planes solely to Shuttle operations.
More significantly, the dust has now settled in the west coast markets, after United's launch of the Shuttle product in October 1994. The Shuttle's share of traffic has climbed almost 13 points, from 33.5 per cent in 1994 to 46.2 per cent in the second quarter of this year, according to figures from the Department of Transportation (see table). This growth has come mostly at the expense of airlines in the market, such as USAir, America West and Delta. But Southwest has largely held its own in markets where it competes with the Shuttle. The Dallas-based carrier's market share has dropped from 31 per cent in the second quarter of 1994 to 29 per cent in the same period this year.
Key to the peaceful coexistence between Southwest and United is the latter's decision to retreat from Southwest markets - Oakland to Seattle, Ontario and Burbank, and San Diego-Sacramento - following some aggressive pricing moves by the Dallas-based carrier. Instead, the Shuttle focused solely on flights that feed the San Francisco and Los Angeles hubs of the United mainline operation.
More significantly, the Shuttle's realigned route strategy has enabled it to feed high-yielding business travellers to its longer-haul domestic and international flights in San Francisco and Los Angeles. Brian Harris, airline analyst for Lehman Brothers, claims the Shuttle provides $320 million in incremental revenues annually to the parent airline in its US transcontinental service (where, he adds, United controls 42 per cent of the market, compared to American's 26 per cent market share) and other long-haul routes. Regardless of the validity of this estimate, the Shuttle is clearly vital to United's efforts to protect and strengthen its West Coast operation, which produces 48 per cent of its total revenues.
On the down side, United needs to continue to try to cut the Shuttle's operating costs, particularly through new distribution and airport processing procedures. Original projections put the Shuttle's ASM costs at 7.4 cents per mile, but they remain 'north of eight cents,' reports Amos Kazzaz, president of the Shuttle. United, like Delta, also is using the Shuttle to experiment with new technology, including automatic check in machines, that it could eventually adopt throughout its system.
Kazzaz and Dave Ridley, Southwest's vice president of marketing and sales, both believe there is enough traffic in Shuttle markets to sustain the two carriers; both expect continued growth on the west coast, though United will undoubtedly continue to steer clear of Southwest's territory.
Beyond that, Kazzaz says he expects the Shuttle 'most likely' will operate in another geographic region within the next five years. Denver - another major United hub, where low-cost operators Western Pacific and Frontier are growing and putting pressure on the incumbent - could well be the next target market, with Chicago a more distant possibility.
Source: Airline Business
