As consolidation continues to overtake the US airline industry among legacy carriers, with US Airways and American Airlines serving as the most recent examples of companies pursuing merger matrimony, what is the competitive positioning like for the “other guys,” notably, the low-cost carriers?
In this post, I am going to conduct a mini competitive analysis of the three biggest low-cost carriers in the United States: Southwest Airlines, JetBlue Airways, and Spirit Airlines.
Business model: “Hybrid”
Competitive outlook: Survivor, contender.
JetBlue Airways has gone up against the odds and created a home for itself in the Americas by positioning its brand uniquely between legacy carriers and discount airlines – and serving that sector profitably. It has grown beyond merely focusing on transcontinental and east coast network growth out of its primary base at New York JFK airport by expanding rapidly in Boston, the Caribbean and upper Latin America. In fact, JetBlue has given the boot to American Airlines in both Boston and San Juan, Puerto Rico by establishing itself as the #1 carrier at both airports by seat capacity (both Boston and San Juan were once considered hubs for American). At Boston, JetBlue commands roughly 30% of the overall market share, and in San Juan, JetBlue holds 31.4% of the overall share, according to CAPA.
Network growth has been balanced between leisure and business markets. In Boston, for example, JetBlue has added a portfolio of destinations appealing to the Caribbean and Latin American VFR (visiting friends and relatives) market, along with new service to domestic US markets such as Dallas/Ft. Worth, Denver, Raleigh-Durham and Philadelphia. Boston to DFW and Philly are particularly interesting given that these two markets are (or were once) dominated by legacy carriers American and US Airways, with each respective carrier commanding extremely high profit margins on these monopoly routes. Southwest attempted Boston-Philadelphia in the past to create fare pressure on US Airways, but was ultimately driven out of the market.
JetBlue’s cost structure is slightly above that of Southwest (arguably, the two airlines are each others’ fiercest rival carriers). Unit costs at JetBlue for Q42012 stood at 7.58 cents, versus Southwest’s at 6.76 cents. However, one could argue that JetBlue can out-edge Southwest in R/ASM growth because it is much more nimble in terms of reaping benefits from faster network growth (see below section under ‘Southwest’). International markets are a particularly huge driver in this arena as leisure destinations can take as little as 6 months to reach maturity, compared to 2 years for business markets, according to CAPA.
Finally, JetBlue’s differentiated product mix has retained loyalty of its customers, a tried-and-true trademark that seemed to lose industry popularity years ago. Unlike its legacy and ultra-low cost peers which have resorted to complete product un-bundling, charging passengers for virtually every ancillary service saide from the base fare of a ticket, JetBlue still offers freebies in the form of a checked bag, complimentary refreshments and live satellite television without a extra charges. Up-sells are also available through the purchase of of extra legroom seating, priority boarding and expedited security screening. Compare this to United Airlines, which, despite charging for most of these frills, still has the most bloated cost structure of all US carriers at 12.3 cents, a third higher than JetBlue’s.
All of these items considered, JetBlue posted a $128 million profit for 2012, a 49% year-over-year increase from 2011, whereas United lost $723 million. While the two carriers are still completely different models at the end of the day, it is clear which carrier has the superior financial strength based on network planning, structural growth and passenger mix. As long as JetBlue can hold its own in this lucrative niche, it’s long-term prospects seem pretty good for now.
Business model: Ultra-low cost
Competitive outlook: Exploiter/innovator, cash cow
Spirit Airlines is the definition of a brand that people love to hate, but simultaneously will hate to love by showering it with repeat purchasing behavior knowing that flying them saves a pretty penny. Virtually every year since transitioning to an ultra low-cost carrier in 2007, Spirit has recorded strong financial performance and continuous profitable growth, tapping into a budget travel market sector that its competition hung out to dry in exchange for chasing higher-yielding corporate traffic.
The breakdown of Spirits ticket vs. non-ticket average revenue per passenger segment in 2008 versus 2012 illustrates the story quite well: in 2012, Spirit’s average base fare was $75 USD for a one-way ticket, down 20% from its $94 average in 2008. This compares with a reverse fluctuation in its non-core ancillary revenue, which was $19 in 2008 and jumped 168% to $51 in 2012, according to CAPA. Meanwhile, average load factors and network capacity have grown over the same period of time.
Although Europe’s Ryanair is to be credited for being the first pioneer to introduce the concept of total “bare bones” travel, the psychology behind Spirit’s business model is equally applicable. Spirit prices its products to influence customer behavior, which in turn lowers cost. An example of this is the carry-on and checked bag fee the carrier rigorously enforces: the customer is enticed by a low-fare, but avoids the bag fees by packing lighter, which, in turn, lowers fuel burn with less weight brought on the aircraft.
In addition to bag fees, Spirit essentially charges for every other aspect of the travel experience, including water served on-board, and even printing boarding passes at the airport. The reward? Spirits unit costs for 2012 totaled at 6 cents per available seat mile, roughly half of United’s. The carrier cuts down tremendously on resource expenses by essentially passing off every cost of travel, in addition to physically sitting in the seat itself, onto the passenger.
Spirit has also barely batted an eye at its competition, resisting any need to engage in a turf war to protect its Caribbean and Latin American network in light of JetBlue’s recent international push. Spirit’s largest operation is based at Fort Lauderdale, and offers service to Peru, Mexico, Dominican Republic, Puerto Rico, Bahamas, Jamaica, Colombia, Guatemala, Panama, Costa Rica, Honduras, Nicaragua, US Virgin Islands, Haiti and St. Maarten from this hub. JetBlue has plans to ramp up its own Fort Lauderdale hub operations to serve competing markets, which Spirit may return to battle against in the distant future, but right now, Spirit’s focus has shifted towards taking on domestic legacy strongholds.
In what could be considered almost a “new normal” for Spirit, or a radical take on the old Southwest-style approach, if you will, the ULCC has struck gold in expanding into populated US markets and attracting fliers from legacy stronghold hubs such as Dallas/Ft. Worth, Chicago O’Hare, Houston Intercontinental, Minneapolis/St. Paul, Denver, Detroit and Philadelphia, among others. DFW has jumped to Spirits #2 spot in terms of largest bases, despite the fact that the carrier returned to serve DFW less than 5 years ago. Spirit’s strategy in these regions is to attract the budget-conscious traveler with low price points, who otherwise would have either not traveled or commuted via rail, bus or car as opposed to competing airlines.
Spirit ended 2012 with a $108 million profit, and has plans to support annual capacity growth between 18 to 22% through 2015. According to CAPA, Spirit estimates that there are still more than 400 remaining markets that are un served by the airline today that “meet its market criteria – more than 200 passengers per day each way, high average fares and a price level Spirit can achieve that allows it to stimulate enough to demand to record 14% margin or higher.” Markets that are unprofitable are quickly dropped, such as DFW-Boston and Chicago-Los Angeles, without much repercussion nor emotional afterthought.
Monetizing every aspect of the travel experience may not lead to the best public relations profile, but Spirit has all but abandoned fuzzy, warm feelings about its brand as a critical pillar for its survival. As long as the airline can continue filling its seats with an appropriate price mix, and keep its costs low, then it will keep its place filling the ULCC void in North America.
Business model: Low cost, low-fare
Competitive outlook: Evolver, Uncertain
Of the three carriers covered in this post, Southwest Airlines is perhaps the most vulnerable to understanding its overall strategic fit in serving the domestic US market, along with its slowly growing trans-border market served via subsidiary carrier AirTran.
The harsh reality is, Southwest is the oldest low-cost carrier and the largest domestic US carrier. It celebrated its 40th birthday earlier this decade, and operates a fleet of nearly 700 aircraft. While it’s cost base is still below that of JetBlue’s at 6.76 cents for 2012, it’s passenger unit revenue growth was relatively flat at 2.6%, while JetBlue’s was 3.6%. Couple this with pressure mounting from legacy US carriers that have been able to lower their unit costs through Chapter 11 reorganizations and consolidation, and the situation is slightly worrisome. When American Airlines filed for bankruptcy in November 2011, Southwest CEO Gary Kelly sent out a memo to all employees that great customer service could not overcome high costs, and that lowering them became a high priority for the airline.
Revenue growth is also going to be a huge area of consideration. As stated above, much of Southwest’s areas of critical need can be exposed by pointing towards competitor JetBlue. From a product perspective, JetBlue offers up-sells and frills that appeal to the business traveler: priority boarding, seat selection, extra legroom, security-screening, second checked bag and some premium products such as movies. Southwest offers few similar, overlapping amenities, and also misses out on revenue by not charging for change and cancellation fees, although it recently stated plans to implement a no-show fee. Passengers traveling on subsidiary AirTran branded flights still pay luggage fees, which the carrier will continue to collect until both airlines are fully integrated. No final decisions have been announced as to which checked bag policy will prevail over the other once they are merged.
Network growth is also a challenge. Unlike JetBlue, and to a lesser degree, Spirit, Southwest’s growth into international markets is retarded by a much more conservative mindset and roll-out strategy. International services can only be supported on AirTran’s infrastructure, but the carrier is slowly building up new services to markets in Mexico and the Caribbean from a diversified portfolio of gateway cities in California, Colorado, Florida, Illinois and Texas. However, many of the new nonstop city parings announced have pre-existing competition.
Finally, the AirTran acquisition was strategic in allowing Southwest to expand its network in a low-profile manner, launching its first international push and gaining access to Atlanta. However, the acquisition has not been painless; Southwest has cut many of AirTran’s services to under-performing, smaller markets and de-hubbed Atlanta. It has also removed AirTran’s Business Class product offering, which may have deflected loyal traffic away from AirTran towards legacy competitors.
Still, there are plenty of major bragging points. Southwest celebrated its 40th consecutive year of profitability in 2012 with a $421 million net profit. The carrier won rights to build an FIDS facility at Houston Hobby airport in 2012, and has exciting fleet modernization plans on the way. That being said, the scales may be balanced at the moment right now, and as CAPA states, “Southwest will have to prove its relevancy in the US market.”