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Old 02-08-2006, 11:03 AM   #3  
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pickleford's Avatar
Joined APC: Dec 2005
Posts: 16

Another story.

Economic Realities Coming Home To Roost
LCCs Add A Destination: The Red Sea

What ever will they all talk about now ?

We're referring, of course, the the Parrot Jungle of analysts and media types who for the past three or so years have been chanting about how low cost carriers had all the answers. About how stupid legacy carriers are, what with their hubs and all. About how the LCC model was, well, the wave of the future.

Heck, a couple of weeks ago, even Norman Mineta told reporters on a trip to China that US legacy carriers wouldn't be profitable until they dumped their connecting hubs. He even quoted some fleet utilization numbers, comparing legacies with LCCs. Of course, Norm isn't exactly an expert on the airline industry, or anything else, for that matter. He was working off a crib sheet some staffer slipped him. The fact is that Mineta wouldn't know the difference between Form 41 and a bottle of Grecian Formula 44. He probably had no idea what the data was, only that somebody told him that it meant bad stuff about legacy carriers.

But, gee, it's not just Norm. Everybody, it seems, is saying it: LCCs are the future. It's, well, the consensus.

Living On The Hedge. Reality has a habit of ruining really fun fantasies. Like the one about how the typical LCC model is the secret to financial fun and profit. Unfortunately, market realities are a bit different from the consensus-thinking among the consensus-worshippers.

Deal with it: reality has caught up with LCCs. Fuel costs are hitting home. Increasing intra-LCC competition is taking its toll, too. Today, if it's got a wing, carries passengers, and depends on jet-A for motivation, it's probably losing money.

jetBlue has announced its first quarterly loss, and - just two months into 2006 - they've suggested that they'll lose money for the rest of the year. Frontier is losing money. AirTran reported a razor-thin profit.

But the real news is Southwest. True, it reported a profit for the last quarter, but it was predicated entirely on the fuel-hedge cost advantage it currently enjoys. Take that away, and the Southwest Model - as it's currently structured, and within the current pricing environment - doesn't make money.

In fact, if Southwest was paying all-up for fuel, as is most of its competitors, it would have lost in the neighborhood of around $90 million last quarter. Worse, its all-up ASM costs would have been well over nine cents. Hardly what would be considered as low cost.

Needless to say, Southwest is well aware of this, and it's a lead-pipe cinch they're moving to fix things. So plan on some very un-Southwest changes in the months ahead. They will also almost certainly loosen up on fare increases - where they can. This was covered a couple weeks ago. (Go There)

The LCC Achilles Heel - Revenue. Again, take it to the bank - there are two sides to the airline ledger. One is costs. The other is revenue. The LCC cost advantage v legacies is materially less than it was three years ago. Legacies can get their costs down, but for LCCs to get their revenue streams up, well, that's a different story. It's one thing to stimulate traffic to points in Florida and to Las Vegas. It's another to access the markets where the real, fundamental economic and revenue growth will be in the future. It ain't between Philly and West Palm. Or Hartford and 'Lauderdale. Or BWI and LAX, either.

Orlando's Nice. But Taipei & Montgomery Are Where It's At. That fleet of A-320s or 737s or E-190s are great airliners, but they're not well suited to take advantage of the the new domestic and international revenue flows that are starting to emerge.

The economic impact analyses The Boyd Group accomplishes for various clients reveal a lot of air traffic relationships that traditional studies miss. For example, the major increase that is now emerging in high-yield business traffic generated by Montgomery's Hyundai plant to places like Lansing, or Flint, or Rochester, or Toledo. Or to the company's design studios in Los Angeles. Or their corporate headquarters in Korea. Or the traffic generated by dozens of second-tier and third-tier suppliers located all across the country as well as internationally.

More Examples. Beyond these domestic traffic flows, it's legacy carriers that have the upper hand in capturing the high-yield revenues represented by the international traffic generated, say, from the Haier plant in the Carolinas to Shanghai and Beijing. Or the traffic to Europe generated by that new, partially Russian-owned steel mill being built in Columbus, Mississippi.

Think this is minor stuff? Think again. Here's a hint: When a German company - BMW - opened a plant in Spartanburg, SC, traffic between GSP and industrial points in Michigan jumped 30%. We are in a global economy, and that is affecting traffic at mid-size and smaller points across the nation that the LCC model can't access. So, when you hear some PR flack at a legacy carrier touting a "revenue premium" - he's right.

Less Low-Hanging Fruit. More Fighting For Discretionary Scraps. The LCC model, such as it is, works. But it has limits. And they're getting reached pretty quickly. Sure, you can stimulate traffic - to a point - between New York and Florida. With the right fares, those discretionary dollars sitting in banks in Nassau County can be shifted from that planned camping trip in the Adirondacks to a quick vacation in Orlando.

However, there is a finite limit to those available discretionary dollars. The potential for traditional LCCs to generate new revenues with cheap fares to Florida or 'Vegas is getting pretty close to being tapped out. So the next option is to try to stimulate traffic to Lincoln. Or Grand Rapids. Or Toledo. Possible, but no gold mine.

Fact: there's a finite limit to the LCC model of low-fare stimulation on high-density 100-150 seat airplanes. And that's just one of the challenges facing LCCs. Add in tougher competition from legacies, more competition from other LCCs, and increasing fuel and labor costs, and the rosy picture painted by Norman Mineta becomes a pipe dream.

Like most of what he babbles about.
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