Judge Stops the Insanity

Yesterday an Italian judge stopped the acquisition of Volare by Alitalia. Volare is an Italian LCC that since November 2004 has been operating in under administration in bankruptcy (not dissimilar in concept to US Chapter 11 bankruptcy). Thank heavens for that.

First, as we've already written, we don't believe it makes sense for legacy carriers to run LCC subsidiaries or divisions. Secondly, it's particularly egregious that Alitalia, which is itself in financial crisis and which is shamelessly hiding behind the skirts of the Italian government, should be the one to take over Volare. If the Italian government stopped protecting Alitalia, LCCs like Volare wouldn't be in bankruptcy, instead they'd likely be rolling in cash from backfilling for Alitalia.

Previous Alitalia posts here and here.

Old Norse Above Britain

We were trying to figure out why we thought it was so cool that Atlantic Airways announced service this summer from Faroe to Shetland to London. And then it came to us -- it's an example in miniature of the benefits of liberalization.

Where are these places? The Shetland Islands are the northern-most part of the United Kingdom, out in the North Sea. The last few decades they've done OK on the back of North Sea oil, to which they are very close.

Faroe is even further north, between Shetland and Iceland, a group of nominally Danish but in fact self-governing islands which speak a variant of Old Norse related to Icelandic. Oddly, Faroe is part of Denmark but not part of the EU (there are other such anomalies -- the Isle of Man, for instance, is part of the UK but not part of the EU). Here's a map showing the locations. Faroe and Shetland are lonely places with small populations -- Shetland has about 22,000 people, Faroe about 47,000. Historically they've been harsh places to live -- the traditional Faroe diet was heavily fish-based, with dried sheep meat (yum!) for special occasions. Not a lot of arable land, so not many vegetables, but Faroe has some spectacular scenery.

Nonetheless, Faroe supports its own airline, Atlantic Airways which flies four BAe-146 aircraft (photo here). We've discussed this oddball aircraft (and its later derivative, the Avro RJ) a couple of times (post on the woes of Mesaba, post on SN Brussels/Virgin Express). The one thing this aircraft has going for it is that it can fly from short runways, which is good because Faroe has a single airport with a very short runway. Short takeoff and landing capability also makes the BAe-146/Avro RJ the jet of choice at London City Airport, which has a short runway built on a former ship dock.

Atlantic Airways has previously offered London Stansted-Faroe nonstop service in the summer. This year, they're doing something different, offering London-Shetland-Faroe service, the hope being that there will be enough demand to support a viable flight between people wanting to go to Shetland (the first time a nonstop flight has ever been offered) and those who want to go to Faroe.

So what? The so-what is that Shetland-London is an internal UK flight being performed by another European airline. Yes, this is hardly the first time this type of thing has happened, but it's definitely one of the most unusual, and thus (to us at least) the charm. Shetland and Faroe happen to be different countries, but that aside, they clearly have a lot in common, being isolated rocks in a similar patch of cold dark sea.

Under the bad old days of regulation, Atlantic Airways could never have attempted to leverage Shetland as well as Faroe. Now, maybe it will work, maybe it won't, but at least this tiny airline from this tiny country can give it a try. A miniature example of the benefits of liberalization.

Update: Nate Silva, in the comments, points out that the Isle of Man is not legally part of the UK either, but is instead a crown dependency according to Wikipedia. Even more anomalous...

A World of Pain

In the post on the problems with mergers we mentioned that the only thing unions hate more than a merger was two airlines being run under common ownership. That turns out to be a key issue in the World Airways strike which started yesterday, as this article says.

Actually, it’s not a classic strike. The World contract forbids pilots from striking military charter flights, which is a large part of World’s business (as we mentioned in our post on Sec 1113, in the US airline business, union contracts never end, they become amendable, with the terms of the old contract enduring until a new contract is in place, so the clause forbidding strikes on military charter business is still intact).

A significant issue is that last year, the parent of World Airways bought another charter airline, North American. World flies DC-10s and MD-11s, while North American flies 757s and 767s. World Airways pilots want to make sure World gets as much growth opportunity as North American, a guarantee that apparently World won’t give. And so, in part for this reason, World Airways pilots are on strike, which apparently means the pilots won’t fly certain civilian charter flights. As we said, trying to run two airlines under common ownership is just begging for union grief.

World has had a renaissance since 9/11 on the back of military charter business, which has been strong with all the US military activity since 9/11. North American also does some military charter. The revival of the company’s fortunes since before 9/11 is apparent from its long-term stock graph, and its stock has maintained its value in recent months, notwithstanding that World is a significantly delinquent filer.

Both World and North American have interesting histories. World dates to 1948 and for decades was based in Oakland, run by a colorful character called Edward Daly. For most of its history World has been a charter carrier, with occasional generally unsuccessful forays into scheduled business. World was famous at the collapse of South Vietnam for flying the very last flights out of areas about to be captured. These are recounted here on the occasion of the anniversary of another famous World flight, airlifting Vietnamese orphans to the US, an action which induced the US govt into launching a program of such flights.

North American was started in the late 80s as a proxy for El Al, the Israeli airline. As we recall it, El Al was flying passengers from Tel Aviv to New York to Los Angeles. Since it as a foreign carrier it can’t sell tickets from New York to LA, it was losing a bundle flying mostly empty airplanes from New York to LA and back. The solution was to help start up North American (El Al took the maximum 25% stake that non-US entities may own of a US carrier), which flew 757s from New York to LA and back on behalf of El Al.

More on American Fleet Replacement

Flight International article on American Airlines' fleet replacement, which we touched upon in an earlier post. There have been a rash of articles recently driven by American's recent media day. Couple interesting things:

• Phasing out American's MD-80s could be a 10-year project (American has about 350 MD-80s)
  
• Aviation Partners Boeing apparently has worked on the potential for retrofitting blended winglets (we talked about them in the context of 757s earlier) to MD-80s. Apparently the savings aren't as good as on other aircraft. It would be interesting to know why.
• Winglets present gate space issues for American. MD-80 has a smaller wingspan than 737NG. American also currently exploits the fact that widebody wings are higher than MD-80s by letting wings overlap at gates. That doesn't work with blended winglets.

American has retrofitted one 737-800 with winglets, which it ordered at the same time as it acquired 20 shipsets of winglets for 757s (pdf). Presumably this is some sort of test aircraft as the Flight article says American will make a 737 winglet decision sometime in the next six months.

Articles: Southwest, Demand for Pilots in Asia

Airline Business story (cover story?) on Southwest and CEO Gary Kelly, who apparently does not particularly like being known as mild-mannered (hey Gary, think Clark Kent, he was also mild-mannered). Not a lot new there, but decent background reading for those who want to know more about Southwest and the Wright Amendment. We caught one small error while flipping through the story. Airline Business says that one of the restrictions of the Wright Amendment is that Southwest:

cannot, for instance, display connecting flights to or from Love on its website.

Not true. Look up, for instance, Albuquerque, New Mexico to Harlingen, Texas on Southwest's website and it includes a connection via Dallas Love Field. The Wright Amendment (and subsequent amendments) forbids carrying passengers from Dallas Love Field to outside a nine-state area. So long as transportation is within that nine state area (map here), Southwest can connect passengers through Dallas Love Field (and display it on its website). Our previous posts on Wright Amendment here.

Meanwhile, Flight International has good article on shortage of pilots in Asia. The huge expansion of Indian & Chinese carriers has resulted in huge demand for pilots, including foreign pilots. India has resorted to boosting the maximum age of pilots in stages from 60 to 65 and requiring pilots give 6 months notice of quitting. Clearly another factor limiting the growth of these carriers.

Another big source of pilot demand (not the subject of the article) is the Middle Eastern carriers (Emirates and its local wannabe competitors).

Ex-Im Bank in the News

MRO Wire noted that, coincidentally (see post below) Ex-Im Bank is selling a 737-400 that it recovered from Air Nauru. Not everything that Ex-Im guarantees works out. So in this case Ex-Im presumably has made good on its guarantee to whoever it was who actually lent money to Air Nauru to buy the airplane, and has recovered the collateral, namely the airplane. Now it's trying to sell the aircraft to minimize whatever loss Ex-Im is facing.

Nauru, by the way, is a tiny island in the Pacific that was once very rich because of phosphate mining (phosphate deposits are what you get when birds defecate for millenia in the same place -- no, we are not making this up). In its heyday, Air Nauru had an extensive network of flights across the Central Pacific and a fleet of Fokker 28s (a small Dutch twin-engine jet seating about 60-80, built in the pre-regional jet era, from which the later Fokker 100 was derived). Unfortunately, the phosphates are mostly now gone and the island nation has not been prudent in investing the proceeds. So now it's a tiny little basket-case.

Incidentally, the Ex-Im press release is interesting because it highlights an issue with all aircraft recoveries -- getting the maintenance records (the release says that Ex-Im is now gathering the records for the Air Nauru aircraft). Every part on an airplane needs to have a clearly documented history back to its manufacture. An airplane without maintenance records is useless. We discussed (in this post on Delta) how airlines can make things difficult for aircraft financiers in bankruptcy, and this is just one more way (records for your airplane? Yes, we have them around here somewhere, but we're so short-staffed, might take awhile to find them, so sorry) Better ways of record keeping (e.g. keeping complete, up to the minute, offsite duplicates) is a continuing pre-occupation with aircraft financiers, or at least those financiers who have a clue.

Later addition: In the comments, Lars Marius Garshol provides a link to this excellent Economist article on the sad history of Nauru.

737NG: Huge Strategic Error? Yes

Over the weekend, an anonymous commenter jumped in the wayback machine to a November post and said:

The 737NG a mistake? As a Boeing shareholder, I know I feel regret with every delivery of this ancient aircraft. It is really awful for Boeing to have milked this cow for all these years. 569 2005 orders seems pretty shameful. Boeing has delivered more 737s than Airbus has delivered aircraft of all types. There are more 737s flying than there are Airbus aircraft of all types. It is remarkable to think that at the inception of the 737 program, Airbus was not yet even a gleam in a Frenchman's eye and one could order factory new the 707, 727, DC-8, DC-9, VC-10, BAC 1-11, or Mercure. The 737 has outlived them all, as befits the true DC-3 replacement.

What we had said (that presumably was objectionable) was:

The huge strategic error in making the 737 New Generation instead of an all-new narrowbody, which conceded the A320 the technology and cabin comfort lead

Yeah, we stand by those words. Let us elaborate.

In the early 90s Boeing had to do something with the 737 Classic (737-300/400/500). The Classic sold very well, but that was luck more than design. Boeing thought the 757 and 767 would be the big short-medium haul sellers (Boeing designed them in the late 70s and the 767 was originally designed as a US domestic aircraft, whereas it's mostly been used in medium-long haul international applications), but once deregulation hit, it turned out airlines wanted smaller gauge aircraft.

Having used up its ammo on the 757/767s, Boeing needed to refresh the 737s. The Classic was a quick early 80s update of the first generation 737 (stretch, new engines, a little fillet in the tail), and in the absence of anything better (the McDonnell Douglas MD-80 wasn't that, and the A320 came along in the late 80s and was an untried quantity by a still relatively new manufacturer, it didn't get traction until into the 90s) it sold really well.

So, early 90s, A320 starting to get some traction, Boeing needs to do something with the 737 Classic. Solution: replace basically everything except the fuselage and the technology (i.e. in many ways still the same old 737 under the skin, although nice new screens in the cockpit). New wing, new (at least bigger) tail, new engines, new landing gear -- resulting in the 737 New Generation (737-600/700/800/900). Unfortunately, this left the A320 with clear advantages in fuselage width (which passengers seem to like no matter how often you tell them it's width at the shoulder that matters) and technology.

Don't get us wrong. The 737NG outclasses the A320 in some important ways. Want to fly above the traffic? The 737NG can go higher than the A320, giving it access to flight levels the A320 can't reach. The 737NG also has longer legs -- Aloha and ATA are flying 737NGs from the US west coast to Hawaii. There's a reason why A320 operators don't do that -- they can't, not economically. If you need range in a small package, there's only one choice. And the new 737-900ER looks to be shaping up as the best charter aircraft out there.

And the 737, all three generations, has a sales record that is probably unreachable by the A320. But that's because the 737 sold so well in the past -- many of those past sales have already been recycled into beer cans. Right now, right here, the A320 is outselling the 737NG. Is Airbus pricing the A320 at narrower margins? Maybe, doubt it (they have to be making money somewhere, the most likely place is in the A320 program). It's probably a huge cash cow by now, it's been in production for almost 20 years.

And that's a big problem for Boeing. Every airline that starts flying the A320 is one that gets used to Airbus. It expands the A320 parts supply line, increases the number of A320 qualified pilots, instructors, mechanics, sends Airbus into every corner of the world. With the common cockpit across the Airbus product line, other Airbus equipment will be the first thought of any airline that's grown up with A320 family aircraft.

Suppose Boeing had done (in our opinion) the right thing and launched a totally new narrowbody instead of the 737NG, including a fuselage that passengers liked even better than the A320, and a control system based on the 777 fly-by-wire (only electrical connections between the cockpit and the flight surfaces) system. Now you've got an airplane that outclasses the A320 in every dimension.

Would the A320 be selling as well today? Not likely. And in fact that would be a very big problem for Airbus right now. The A380 is not yet in service and is facing delays -- Airbus doesn't get any money beyond deposits until it delivers the aircraft, and even then it's not going to make money on the first ones it sells. The A380 sold in desultory numbers last year. The A340-500/600 program is only a few years old and already in trouble.

What does Airbus have going for it now? The A320, that's what. A 20-year old design to which Boeing has given greater longevity by pulling its punches in the early 90s. Would Airbus be an easier or a tougher competitor today if the A320 wasn't still selling?

And we're skeptical Boeing is currently making more on a 737NG than it would have made on a new aircraft. If you believe a new narrowbody would have sold better than the A320, then by now it would be well into cash-cow territory itself. Plus Boeing really screwed up the introduction of 737NG manufacturing in the late 90s. Perhaps (and no one can know) it would have been more careful if the aircraft had been all new.

One other thing: in the late 90s/earlier this decade everyone was worried that Boeing was getting out of the business (and that probably influenced a few sales around the world, don't you think?). That wouldn't have been on the table had the 737NG been an all-new aircraft.

So, we say again, 737NG, good airplane, bad Boeing mistake.

Image: Dassault Mercure -- French narrowbody from the early 1970s, definitely in the "what the heck is that" category (but mentioned by the anonymous commenter above), there were only 11 delivered (and one of those was a modified production prototype) and it only ever flew with Air Inter, the former French state-owned domestic carrier (now part of Air France). Last in service in the early 1990s. Good article here, if you want to know more. Dassault is far better known for its fighters (Mystere, Mirage, Rafale) and its Falcon series of high-end bizjets, oh, and also a killer CAD/CAM system through what is now a separate company.

Export Credit Agencies

Lufthansa not only publishes two yearly environmental publications (which we described as part of this post), it also publishes a periodic policy brief (pdf). The latest one contains a page (numbered page 3 but actually page 4) complaining of the subsidy other airlines get through ECA (export credit agency) financing. And we concur – ECA financing is a subsidy and one of the reasons why the airline business has too much capital.

[We did not include ECAs on the list of parties in this post that pump capital into the industry. Oversight is one reason, but another is that ECAs don’t play a big role in financing US mainline airlines (and the post was in the context of American) for reasons that will become apparent.]

ECAs support exports by subsidizing the financing thereof. Commercial aircraft are huge items of capital equipment and one of the major beneficiaries of ECAs. The US and Europe may claim they don’t subsidize aircraft manufacturers (except, in the case of Europe, through launch aid to Airbus), but the activity of their ECAs proves them wrong. Subsidizing aircraft finance makes aircraft cheaper, and that helps manufacturers sell more of them.

The ECAs most relevant to the airlines are:

• US Export-Import Bank (Ex-Im Bank), a US government agency which, of course, supports Boeing export financing


• Export Credits Guarantee Department (ECGD), a UK govt agency that supports Airbus export financing


• Coface, a private French insurer that acts on behalf of the French government in supporting Airbus export financing


• Euler Hermes, a public/private consortium that, similar to Coface, acts on behalf of the German government in supporting Airbus export financing


• Export Development Canada (EDC) a Canadian crown corporation (essentially, a government-owned company) that supports the financing of Bombardier exports.


• Banco Nacional de Desenvolvimento Econômico e Social (BNDES), a Brazilian govt development bank that supports Embraer orders.

The ECAs for Airbus and Boeing operate according to different rules (such as the Large Aircraft Sector Understanding, negotiated as part of an OECD agreement to limit export financing. OECD = Organization for Economic Cooperation and Development, the “developed, democratic countries” club). ECAs have nakedly mercantilist aims (make sure our manufacturers sell exports rather than the other guy’s manufacturers) in a world that is largely supposed to believe in free trade, and over the years the OECD has worked to ensure things don’t get out of hand.

ECAs for Boeing and Airbus first of all cannot finance aircraft in the home countries of Boeing and Airbus – the US, France, Germany, Spain and the UK. These countries, are, if you like, a demilitarized zone, which is why Lufthansa can’t take advantage of these offers. Since an ECA can’t finance in its own country anyway (it wouldn’t be an export then, would it), this is really an agreement not to poach in the other guy’s backyard.

Big exception: ECAs can, and do, finance aircraft for lessors located in the home countries, so long as the lessor is leasing the aircraft to an airline outside the home countries. Even huge aircraft leasing companies like ILFC benefit from ECA financing.

Airbus & Boeing ECAs can finance up to 85% of the net-net price of the aircraft (meaning after all rebates, coupons, credit memos, etc – the real price of the aircraft, which will often be 20-30% lower than the list price). The length (“tenor”) of the financing can be at most 12 years (10 years for narrowbodies) and the loan has to fully amortize over that term (it can either amortize on a straight-line basis – equal principal payments – or “mortgage style” – where principal plus interest is a constant). There’s also a set method to calculate the interest rate on such loans.

However, in practice, the Airbus & Boeing ECAs (especially Ex-Im, historically) have not directly lent money but rather provided “pure cover”, meaning providing a guarantee. When an ECA does this, it is putting the full faith and credit of its country behind it. The bank making the loan is then no longer relying on the credit of some random airline in some random country, but rather on the credit of, say, the US. And as you can imagine, that bank is then willing to lend at a very low interest rate because the loan is now relatively risk-free. In exchange for this, the ECA gets a 3% fee upfront (but this can be added to the amount borrowed). And, of course, the loan and guarantee is secured by the aircraft being financed.

But wait, there’s more. Often, the 15% not financed by an ECA is financed (at least partially) on commercial terms (think of it as a second mortgage on a house) by the bank (or syndicate of banks) that is arranging the export finance, so the financing approaches 100% of the price of the aircraft. Secondly, the 12-year term has, over time, become to be seen as rather burdensome, requiring too much principal be retired too quickly (12 years is also a lot less than the lifetime of a typical commercial aircraft).

So in the last decade or two, both Boeing and Airbus ECAs have agreed to share the first priority claim they have on the aircraft with a so-called mismatch (Airbus ECAs) or SOAR (Ex-Im) loan that starts at zero principal and increases (accretes) as the ECA-loan amortizes. So although the ECA loan lasts only for 12 years, the two loans, taken together, have a longer (15-year) amortization. Oh, the clever things that bankers dream up to make money and justify bonuses.

Billions of dollars of such aircraft financings are done every year each by Ex-Im and the Airbus ECAs. That this is a subsidy is undeniable – each such financing is clearly cheaper than any feasible commercial alternative, because otherwise the commercial alternative would have been selected. Moreover, it’s not just dodgy airlines in dodgy countries that take advantage of this. Ryanair, based in Ireland despite doing a majority of its flying out of the UK and Germany, has financed most of its 737s with a US guarantee. But easyJet, which also does a majority of its flying out of the UK and Germany, can’t take advantage, because it’s based in the UK (as we previously said in this post, any EU startup airline would do well to see if it makes sense to be based in Ireland. Access to ECA financing is just another advantage of being based in Ireland.)

In the case of Canadian EDC and Brazilian BNDES, the situation is different. First of all, Canada and Brazil aren’t limited by the large aircraft agreements, because Bombardier and Embraer make smaller aircraft (Canada and Brazil have been invited into the latest discussions because it’s clear that their aircraft increasingly are competitors to Airbus and Boeing aircraft). Secondly, EDC and BNDES generally make loans directly. In the case of the Brazilians, they don’t have much choice because a Brazilian government guarantee doesn’t carry much weight. Both EDC and BNDES have supported exports to US airlines. In fact EDC is one of the parties most at risk from the collapse of the 50-seat regional jet market.

In the case of Germany, ECA financing isn’t the only weapon in its arsenal. Germany also has a development bank, KfW, which is functions as a so-called “Market Window” (we didn’t know this term until we read this Ex-Im report (pdf), which is a good overview of ECAs). This is basically a government agency supporting exports but (at least purportedly) at market rates and terms. Uh-huh. If KfW is only supporting exports at market rates and terms, why is its presence necessary at all? We’re pretty confident that most see KfW as a source of below-market finance, whatever the legal niceties, although the EU has apparently recently forced changes at KfW that may reduce its ability to interfere.

What’s an ECA subsidy worth? Lufthansa claims up to $500,000 per year for an A330. We’re not sure where it gets this figure from. In theory, the benefit to the airline is the difference between the financing rate it would have paid, and the interest rate it pays with the aid of the ECA. Of course some airlines wouldn’t be able to borrow at all without ECA cover and would have to lease an aircraft. That makes the analysis a bit more complicated. Assuming the Lufthansa figure is right, it’s certainly an amount worth having.

The airline business has a lot of problems that need to be solved if it is ever to be a more normal business. Eliminating the ECAs is one of them. The manufacturers would sell fewer aircraft, but the airlines would be, eventually, on average, somewhat healthier.

Sayonara Shannon

Another thing contained in the pending US/EU open skies deal is the elimination of the notorious requirement that airlines flying across the Atlantic to Dublin also fly to Shannon, Ireland.

Until 1994, Ireland required all commercial trans Atlantic flights to enter or leave Ireland via Shannon. This bizarre policy (the Shannon Gateway Policy) was in place to promote economic development in the west of Ireland. In 1994, the rules changed to permit airlines to fly into Dublin, but each flight into Dublin had to be matched with a flight into Shannon. Of course, far fewer people want to go to Shannon than to Dublin, but that's too bad, airlines have to serve Shannon anyway. Again, the motive was to support economic development. If US/EU Open Skies is approved, the Shannon Gateway Policy will be history by 2008 (details here).

Both versions crippled development of Dublin airport as a trans Atlantic gateway/hub for Europe. Dublin airport has done well anyway in the last decade and a half on the back of LCC growth, particularly Ryanair, but it's clear that this policy has constrained the opportunities for Aer Lingus, the national flag carrier, and for decades it's made Dublin and Ireland harder to get to from North America than need be.

While (if you can't tell) we believe strongly in free-market solutions, we do think governments should seek to ameliorate social and economic ills -- but there are better and worse approaches. In our view, a particularly bad way of encouraging development of a depressed region is by simply mandating an arbitary level of service or production by that industry in that region, unconnected to any intrinsic demand.

One of the worst things about this type of policy is that it obscures the expense of it. Over time, Ireland could have achieved the same sort of economic development entirely through direct means: subsidies, the placing of government facilities in the area, the establishment of universities, and so forth and you'd be able to say that western Irish development had cost the Irish taxpayer this many billions of Euros and ask yourself whether it was worth it.

By contrast, it's virtually impossible to say what the Shannon Gateway Policy has cost Ireland over the years. It is certainly significant. In this way, at least, arbitrary requirements are worse than, say, the idiotic tax France is imposing on air travel to support third world development. At least we'll have some idea what that's costing the airline business because we can see the total tax raised, we can estimate the suppression in air travel demand, etc.

Another problem is that some of the development near Shannon now depends on this artificial provision of trans Atlantic flights, and is unlikely to survive without it. So now that the almost inevitable has occurred and the significant market distortion seems likely to be corrected, the Irish government has a problem on its hands.

In any event, if US/EU Open Skies is adopted, this part of it will materially benefit Dublin, Ireland and Aer Lingus. Aer Lingus is finally being run on close-to-commercial grounds. One of the Irishmen at Emirates has come back to take the reins (and promptly started a route back to Dubai, the first long-haul Aer Lingus route to the east), and the company is likely to be privatized. Having unfettered access to the North Atlantic can only be a good thing for the airline -- better late than never. Aer Lingus might be come somewhat more than a bit player on the Atlantic.

It will also be interesting to see how Aer Lingus chooses to exploit it. We like Continental's strategy of carpet bombing Europe with 757s. There's few European cities better suited to returning the favor than Dublin because of its promixity to North America and it's modest size (Ireland is a small country). 757s launched from Dublin could easily reach as far west as Chicago and maybe even, at a stretch, as far south as Atlanta. Something smaller gauge than Aer Lingus's A330s would enable Aer Lingus to tap smaller cities nonstop. Whether, however, it's worth investing in a new (and out of production) aircraft type is another question.

As we've said before, halting production of the 757 has left a hole. No other narrowbody is capable of spanning the North Atlantic (ignoring 737s and A319s in business-jet drag).

21 Billion Reasons to be Sorry

United reported earnings today, with the sort of eye-popping bankruptcy-related loss you rarely see this side of something like a WorldCom. 2005 loss of over $21bn included $20.6bn in bankruptcy related charges, about $17.7bn of that in the 4th quarter alone.

Some of the bigger components of that included:

$8.9bn in charges from distress termination of the pension plans. A lot of that is now the responsibility of the Pension Benefit Guarantee Corp (PBGC), the government corporation responsible for insuring pensions. The PBGC is funded by premiums paid by companies funding pensions, but because of companies like United dumping pensions, its finances are under great stress. If the PBGC can’t handle it, the Feds will almost certainly step in to bail it out – your taxes at work.

But the PBGC guarantees pensions up to a maximum amount, and that maximum is reduced the earlier you retire before age 65. Pilots have to retire at age 60, and in any event, their original pension promises were a lot higher than the PBGC limit for age 65. So pilots really take it in the shorts on this one.

United also separately clipped retirees for another $650mm worth of non-pension retiree benefits (like reduced medical benefits).

$6.5bn in charges related to broken employee contracts. Think of this as the present value of employee compensation foregone because of contracts re-set in bankruptcy (apart from pensions).

$3.0bn in charges relating to rejecting prior aircraft leases, financings and so forth. We looked in prior years, and it seems there were at least another $billion in charges taken previously. We talked how a bankrupt airline rejecting aircraft loans and leases generates unsecured claims against the bankruptcy estate in this post on Delta’s unsecured creditors. That’s what these charges represent.

Half a billion in professional fees

Now, most of this $20.6 billion is a “non-cash” charge. It’s an accounting item reflecting an acceptance of an unsecured claim on the bankruptcy estate, but it will be discharged through the bankruptcy process at pennies on the dollar. Oh, except for the professional fees also listed in the restructuring charges. The lawyers, consultants, bankers and accountants all get paid in cash in full thankyouverymuch.

How much has United paid in such fees since it filed? $230mm in 2005, $160mm in 2004, $142mm in 2003 and $10mm in 2002. Tap-tap-tap… Our calculator says $452mm (plus whatever’s in 2006 up through bankruptcy exit planned next month). Yes, almost half a billion dollars before this is all over. Come on in boys, the water’s fine! Well, all those United retirees having problems, say, paying for insulin, or heart medicine, will surely be comforted that at least it went for a good cause.

What does this mean?

So if most of this is a non-cash charge, how are we supposed to think of it? United doesn’t want you to think it has anything to do with its future prospects, and that’s right, it doesn’t – it reflects the value of obligations that United is shedding in bankruptcy.

It is a measure of (and a monument to) the economic loss suffered by others in United’s bankruptcy. In the decades before United entered Chapter 11, it assumed obligations: to employees, to aircraft financiers, to other parties to which United made promises. Ultimately, these promises were broken to the tune of $20 billion (at least – that’s just what was taken this year, but it’s enough to go on, don’t you think?). It is a measure of value destruction by a failed business model.

Every United senior manager from at least the last decade or so should be feeling mighty sheepish, if not outright guilty, about their part in this. Stephen Wolf, Gerry Greenwald, Jim Goodwin, Jack Creighton and all their direct reports played a role in this immense destruction of value (and plenty of current United senior managers have enough pre-Chapter 11 time at the company to be tarred with this brush: for instance, Brace, Hacker, McDonald). The bell has tolled, guys, and it says you collectively destroyed value in the amount of negative $20 billion (at least). Of course, most of them took their share a long time ago, and they’re not giving it back.

Not to let the union leaders off the hook. Rick Dubinsky, long gone with his lump sum (our guess) the rabble-rousing pilot leader who didn’t want to kill the golden goose, just “choke it by the neck until it gives us every last egg.” When that $20 billion egg hatches, Rick, that monstrous, malformed, malign, nightmare chick is going to look a lot like you. The mechanics who, after 9/11, nonetheless insisted on getting a pay rise in line with the pilots. And you, yes you Mr long-time United employee. You elected these guys, you believed them, you participated in the Summer of Love, you backed them up, you felt entitled. Well, hopefully you’re wiser, as well as sadder.

And we could go on and on. There’s a lot of blame to go around, but management and labor bear most of it.

Some of our prior posts on United here and here.

Air Canada: Equal Pay

Supreme Court of Canada rules that the country's human rights commission may consider whether Air Canada flight attendants should be paid the same as pilots and mechanics. This is under the doctrine of "equal pay for equal work", which attempts to determine whether certain jobs are being underpaid because of sex discrimination.

We think the concept makes no sense (and are glad that it's not law in the US). It's true some women-dominated jobs pay less than some men-dominated jobs. But we can think of a lot of reasons why that might be true. Even if one believes (and not everyone does) that some women-dominated jobs pay too little in some objective sense (it's difficult to understand how one judges this "objectively"), it may be that it's a symptom of deeper underlying causes.

In which case, adjusting pay through some non-market mechanism is treating the symptom, not the cause, and at the expense of interfering with the market, which is something one should always be very reluctant to do.

For instance, if boys and girls are socialized differently, so that girls are subtly (or unsubtly) directed away from learning subjects and adopting attitudes that are useful in pursuing certain higher paying jobs, then surely the thing to do is to address that issue head on.

In the specific case of flight attendants, while we believe the job of a flight attendant is worthy and difficult, a flight attendant clearly does not bear the responsibilities of a pilot and a mechanic. If a pilot screws up big time, there's a smoking crater, ditto if a mechanic screws up. Both must be familiar with complex systems and technologies. Flight attendant unions like to style flight attendants as safety professionals but while there's an important component of safety to their jobs the reality is that most of the time safety is not the minute-by-minute focus.

If a woman wants to be paid like a pilot or mechanic (and these days that's a lot less pay than it used to be) let her become a pilot or a mechanic. We're all for it. If in doing so, she is denied access to those professions, or is paid less, or in any way differentially suffers because she is not male, let the offending parties be swiftly punished and make restitution. But we don't think any group of people (like Canada's human rights commission) is smarter than the market.

Good luck, Air Canada.

Later addition -- to clarify, according to the Toronto Globe & Mail:

The flight attendants said they were paid differently for work that was of equal value to that performed by the male-dominated mechanical crews and pilots.

and:

The ruling opens up the possibility of cross-comparisons of wages between other groups that are not in the same union

This really is about comparing wages across professions. The idea that someone might decide that a pilot should be paid some fixed multiple of another, wholly unrelated profession is absurd.

Later later addition: Hello folks, we are not saying that companies should be permitted to pay people doing the same work different pay based on sex. And note that for pilots, flight attendants and mechanics that's not an issue anyway, because there's a single hourly scale -- it's not as if there's a male pilot wage rate and a female pilot wage rate, for example.

We are objecting to any group of people getting together and deciding the relative worth of one profession versus another.

Later later later addition: a reader sends us this link to a snarky interpretation of what this might mean one day.

Prior post on Air Canada here.

Best Book on Southwest /First Take on Southwest

The prior post about books got us thinking. The impact Southwest has had on this business is profound. As a quick first pass:

Inspired deregulation. Southwest dates to the early 1970s, pre-dating deregulation, which occurred 1979. Most people think of Southwest as a child of deregulation and that's true, but it's also a parent. How is that possible? Federal regulation of the airlines was smothering, but there was a way out, which was to limit commercial activity to just one state. No interstate commerce, no CAB, the regulator who said where and when and how often to fly.

The first airlines to find this loophole in a big way were Pacific Southwest Airlines (PSA -- merged into US Air in 1987) and then Air California (merged -- as AirCal -- into American in 1987), both in California. They were the inspiration for Southwest, though by that time, California had its own intra-state regulation, meaning both PSA and AirCal were reasonably soft by the time deregulation hit. Protection is a crutch.

PSA and AirCal were the inspiration for Southwest, and Southwest's success in the 1970s, its efficiency, its low fares and its profitability were widely cited as reasons for deregulating the airlines. Advocates wanted to spread those virtues across the country.

For Southwest, deregulation may have occurred at almost exactly the right time, after it had expanded to dominate much of Texas (giving it a solid base), but before it started to stagnate from lack of expansion possibilities.

Changed the industry forever: A big part of Southwest's business model is based on minimizing costs. How does one squeeze the most out of an expensive asset like an aircraft, and high paid employees like pilots? Keep them moving. Pilots get on airplane first thing in the morning, flies to first destination, spends as little time as possible on the ground, flies to second destination, etc etc etc.

Fly only one airplane type, because that means maximum flexibility in swapping equipment, pilots and whatnot, and minimum complexity (reduced spare parts inventory, reduced training requirements, etc). No first class, because that's complicated. No food, that's complicated. No seat assignments, because its cheap & simple and it gets people on the airplane faster than assigned seats. A lot of the Southwest model follows from simply seeking to minimize costs.

On top of that, Southwest layered a unique employee culture, but arguably, that follows too: if your system gets a lot out of employees, you can afford to put a lot into them, and once that's a principle, it follows that you'll choose them carefully and keep them happy so they stick around.

OK, there's more to the secret of Southwest, but keeping this in mind is a good first step.

Southwest stayed true to this concept after deregulation when essentially all others embraced a different philosophy that boils down to maximizing revenue, which manifests itself at a macro level in hub-and-spoke networks. The hub-and-spoke system maximizes connecting opportunities, which maximizes potential revenue.

[Some airlines took this to extremes. In the early-mid 90s, Northwest started to define its business as manufacturing connections. Connections are something no rational person wants. Except for extreme airline nerds, people want nonstop flights. A business should never define its mission in terms of making something no one wants. A connection is a regrettable byproduct, nothing more.]

There's just one problem, it's very costly. To maximize connecting opportunities, all aircraft must arrive at the hub at the same time, at which point you need to have enough facilities, employees and equipment to handle all of them. But an hour later, when the aircraft have departed, those same employees, facilities and equipment have nothing to do. Everything is inefficiently sized for peak, not average, volume.

Further, when airplanes arrive at the spokes, they must wait to the right time to come back to the hub so they can once again all arrive simultaneously. More dead time, more pilots twiddling their thumbs. To collect more revenue, you have multiple classes of service. Multiple aircraft types, different seating configurations for the same type of aircraft depending on business demand on different routes. Hot meals. Special meals for different dietary restrictions. Elaborate fare structures with weird fare restrictions with operations research geeks in the backroom optimizing fare bucket sizes. Assigned seats (which, before computers were cheap, was a non-trivial expense). Etc. It all adds revenue but it adds complexity too and that's expensive.

Southwest's network is not hub-and-spoke. It offers connections, but connections form as a byproduct of scheduling the aircraft and employees for maximum utilization.

At first, the legacy majors largely ignored Southwest. Then they laughed at it. Oh, Southwest will never work in the north. They can't deal with cold weather (some people seriously believed this). Just wait until they try operating someplace like Chicago. Then, when LUV came to town, they fought it. And almost always, they lost (yes, we ripped that construction off from Gandhi). But the tech boom masked a lot of deficiencies from the mid 90s to early 2001. The legacy majors didn't need to change their ways.

Four years past 9/11, the legacy majors have all changed their business models to copy at least some aspects of the Southwest model. Simplify, simplify, simplify. Meanwhile the Southwest model has been extended, modified, distorted and exported around the world and is generally somewhere in the genes of every LCC. It's the Toyota Production System (lean manufacturing) of the airline business (the Southwest model and the TPS have some obvious philosophical similarities, but we'll leave it at that for now).

OK, so about that book...

All of which is a very long winded way of complaining that there's still no really good book on Southwest Airlines -- no comprehensive, serious look at what Southwest did similar to the famous MIT book on Toyota: The Machine That Changed the World (essential reading for anyone remotely interested in business or engineering. If you're a regular reader of this blog, you should read this book. It's well written, and the material is compelling).

There are mediocre, wish-you'd-never-bothered books on Southwest by people who don't understand the airline business. One that comes to mind is Nuts!, which is OK if you don't know anything about Southwest (but it's also now 10 years old). One we thought was quite bad, chock full of the worst sort of management theory gobbledy-gook, was The Southwest Airlines Way. Here's how one subsection begins:

At United Airlines as at Southwest, operations agents play a boundary spanner role...

A "spanner" is what people of British persuasion call a wrench. But the author means someone who spans boundaries, so this is a horrible, and probably totally unnecessary, neologism. One more:

Due in part to the Shuttle's boundary spanner staffing (and other practices highlighted in this book) the United Shuttle achieved significantly higher levels of relational coordination compared to United's non-Shuttle sites (55 percent versus 42 percent of cross functional ties were rated by employees as strong or very strong).

In other words because Shuttle by United was designed to mimic Southwest, it's employees actually worked together a lot more (like Southwest...) than in the mainline United system. Why not say so? There might be something useful in the book, but most won't be able to get through the thick coating of academic goo.

[Shuttle by United was a now defunct mid-1990s internal United LCC that competed against Southwest, mainly in California. United later changed the name to United Shuttle. It ultimately failed to stem the tide and after 9/11 United conceded most of the intra-California market to Southwest, another example of an LCC subsidiary/division of a legacy major that didn't work.]

The book already!

Southwest Passage

This book is idiosyncratic, it deals only with the first part of Southwest's existence, but it's authentic and in our opinion it's a must read. The author is Lamar Muse, who was Southwest's first CEO. Muse left the company in somewhat strange circumstances (the company was quite successful, it's odd that a CEO would be let go) and later (with his son) created Muse Air ("Revenge Air"), a Southwest competitor that ultimately failed (Southwest bought it, re-named it TranStar -- with a very dramatic deep purple livery -- and then shut it down, all in the mid-late 80s).

So Lamar Muse and Southwest do not exactly sing from the same choirbook. But Muse lead Southwest during its tumultuous first years and so far as we know this is the only book written by an insider, and Muse includes excerpts from internal Southwest accounts during the time. Plus the ornery old guy is pretty interesting in his own right, having held a whole bunch of airline positions before Southwest.

Unfortunately, it's also out of print, and used copies are pricey (at least on Amazon). So find it in a library (interlibrary loan?). In a world painfully short of good books on Southwest, this is the one to read.

Recent previous posts on Southwest: one on Southwest at Denver, one on Southwest at Chicago Midway. Posts about Southwest and the Wright Amendment.

JAL Meltdown

James' World (sic -- we would have gone with James's World, but OK) has a well written description of the recent Japan Air Lines multi-day service meltdown in Tokyo, which makes JAL sound quite useless. He was disappointed we didn't blog the event, but we're probably not going to make individual service failures a feature here (unless we think they have systemic implications), and besides, he does a great job.

By the way, what is that thing through the A in the JAL symbol? Looks like a stylized samurai sword.

Bring Us a... Shrubbery! Jet Fuel, Alaska Air & Hedging

Flipping through Alaska’s earnings release we’re reminded again of how Alaska can’t use hedge accounting, which results in big swings in its quarterly earnings.

Huh? Excuse us as we dive into jet fuel. This will not be comprehensive, this is just a first pass.

Is hedging a good thing?

Many airlines hedge jet fuel purchases. This means using financial instruments to dampen the effect of the movement in the price of jet fuel. With the type of hedges that are typically used (we may get into details in a later post) if the price of oil goes up between now and when the hedge is used, the airline pays a lower-than-market price (after cashing in the hedge) and if the price of oil goes down, the airline pays a higher than market price for oil (after cashing in the hedge).

Hedging only protects an airline for a limited period of time. Suppose the price of oil is $30/barrel and then moves to $60 and stays there. Eventually every airline will be paying jet fuel prices reflecting $60 oil, no matter how good their hedges were before the price of oil started moving -- you can't hold back the markets forever. However, those with good hedges will pay less for some period of time, and that can be useful (because in the meantime, those without hedges may go bankrupt, shrink, etc). Southwest has hedges that last for years.

We think there is a good, if not fully definitive case for airlines to hedge jet fuel. The airline business is subject to a lot of uncertainty, and if the airline is sure that it can live with the price of oil that it can lock in with a hedge (and remember, if the price of oil goes down, a hedged airline will probably be paying a higher-than-market price), then using a hedge to reduce uncertainty is certainly defensible.

But hedging is not costless. Hedging is basically insurance and insurance costs something – sometimes you “win” (your house burns down but you’re covered so you get more back from the insurance company than you paid in premiums), sometimes you “lose” (your house doesn’t burn down, but you still paid the premium), but on average the insurance company is compensated to absorb this risk from you. Same with hedging.

So an airline that is financially solid may decide that over time, it’s better not to pay the cost of hedging. It also happens to be true, by the way, that historically, airlines have been able to pass along some of the price of oil, so if oil goes up, so do airline revenues (you can show this statistically). This means that to some extent there’s a natural hedge for oil. Still, we think airline jet-fuel hedging is thoroughly defensible.

Less defensible is what many legacy majors did at the beginning of 2004. They believed advice that the oil market was just going through a temporary increase, and so stopped entering hedges (Delta even cashed in one of its hedges). This was effectively a bet on the price of oil, and those who did lived to regret it when the price of oil went up, up, up. The whole point of hedging is that you've made a decision not to bet on the price of oil -- you're locking in the price of oil (at least on some portion of your expected jet fuel use) and you're OK with that.

Jet fuel vs other refined products & crude oil

The price of jet fuel is obviously related to the price of oil, but it’s not a tight relationship. The jet fuel market moves somewhat independently from the crude oil market. The difference between the price of a barrel of jet fuel and the price of a barrel of crude oil is called the “crack spread” (because oil is “cracked” into refined products) and is a measure of the differential demand for jet fuel relative to oil. The crack spread is almost always positive -- not a surprise, since oil refineries must be compensated for what they do. The crack spread, by the way, totally blew out last year when Hurricane Katrina hit (and shut down the refineries) and was far more, just by itself, than was the total price of jet fuel before 9/11, say.

The crack spread matters, because it means that hedging jet fuel is more complicated than hedging the price of oil. The first problem is that, as we understand it, there’s no market in jet fuel derivatives, at least in the US. For instance, you can’t (at least economically) buy jet fuel forward, or jet fuel futures. (by contrast, we understand there is a market in Europe, although it’s apparently only useful for hedging for periods of something like six months or less).

So to hedge jet fuel in the US requires using instruments based on other energy commodities – oil, heating oil, gasoline, etc. In particular, heating oil turns out to be a pretty good one (our understanding is that heating oil and kerosene are similar “fractions” of oil, meaning that if a refinery is making one, it’s likely not making the other, and vice versa. Heating oil and kerosene are both “middle-weight distillate products”).Here’s an investment banking report (pdf) that discusses the correlation of heating oil with jet fuel.

So what’s Alaska Airlines’ problem?

It turns out there’s not just one market for jet fuel in the US, there are many. As you’d expect, Alaska buys most of its jet fuel on the west coast. The west coast jet fuel market moves sufficiently differently from others that the instruments available to hedge jet fuel elsewhere don’t work sufficiently well against west coast jet fuel to satisfy the conditions that would enable Alaska Air to use “hedge accounting”.

Wha…?

Accounting rules are designed to ensure that a company fully reports the consequences of the risks to which it is subject. So, in general, if a company buys a financial instrument, it has to mark-it-to-market at the end of every reporting period, which means find out what it’s worth and report the difference from last time as a gain/loss through the income statement. Sounds reasonable.

But, if that derivative is being used solely to hedge something the company is exposed to as part of its business, the company can use “hedge accounting” and delay the effect on the income statement until such time as the hedge is used -- and at that time, offset the hedge gains/losses against the exposure. And there are various rules that the company has to satisfy before it can use hedge accounting to make sure that it’s on the up-and-up.

All this sounds reasonable too. Yes, you may have a heating oil futures contract that is worth a lot (because, say, the price of heating oil today is a lot more than when you bought the futures contract) but against that, because the price of jet fuel is also up, you stand to pay a lot more for jet fuel by the time the heating oil contract expires, so your gains on the heating oil will reduce the effective price of your jet fuel. So economically, one compensates for the other, so why complicate the income statement today with things that are going to cancel each other out in the future.

However, one of the rules is that whatever you’re using to hedge with be fairly tightly correlated with the risk you’re trying to hedge. This is where Alaska gets wedged – the problem is that the west coast jet fuel market moves sufficiently differently from the markets for the commodities (heating oil, crude oil, gasoline, etc) underlying the financial instruments available to Alaska that Alaska can’t satisfy this condition. So no hedge accounting for Alaska.

What this means is that if Alaska does hedge, then at the end of every quarter it has to report the value of all of the hedge contracts it currently has, and report the gain/loss in this value since the prior quarter. And that’s a number that is going to swing around like crazy depending on how the energy markets have moved. It doesn’t mean much economically (because you’re still using the gains/losses on your hedges to even out the price of fuel) but it sure makes your reported earnings jump around, and that confuses investors (and even more so, most journalists).

Or, Alaska could just stop hedging. But then it’s fully exposed to the price of fuel. So far as we can tell, Alaska has chosen (rightly, we think) to do the economically prudent thing (i.e. hedge) and suffer the accounting consequences.

This is one instance where accounting rules have, we think, a perverse effect because they significantly (and meaninglessly) increase the volatility of reported earnings of a company that is simply doing the best it can in the circumstances to reduce an economic risk that it faces. Alaska would certainly use better hedge instruments if they were available, but they're not, so it has to do the best it can with what it has.

Two prior posts on Alaska here and here.

Joe Sutter's New Book/747s and SSTs

Joe Sutter headed the original 747 design team, which is akin to being present at the Creation. He's still alive and kicking and has written his autobiography. It will be out in (Amazon says) June, but the Seattle P-I has some exerpts (via James Wallace/P-I blog). The blog also has links to other recent stories about Sutter and the creation of the 747. Worth reading, especially if you're a bit of an airline nerd (we resemble that remark and if you're reading this you should be worried).

There aren't many good aerospace/airline books so we hope this adds to the number. The last really good airline book we read we mentioned at the end of this post. Anyone with a good airline/commercial aerospace book recommendation, please add it to the comments.

One thing we did not see mentioned in those stories was why, on what was largely a single-deck aircraft (the upper deck was pretty small on the original aircraft, though it's since been stretched), Boeing put the cockpit on top. In 1969, a lot of people thought the future belonged to SSTs (supersonic transports -- The Concorde, the Russian Tu-144 "Concordski", The Boeing 2707...). The story goes that the 747 was designed (not for the military transport C-5A competition that Lockheed won, Sutter says that's not true and anyway, it's pretty clear the 747 is a very different aircraft) to be converted into freighters once the SSTs made them obsolete. Previous post on 747 cargo aircraft here.

In the event, that never happened. The Concorde was the only SST that made even a minimal impact, and that was pretty minimal. Although a wonderful aircraft, it was an economic disaster and somewhat of a dead end (imagine if the best commercial aircraft engineers in the UK and France had spent that time designing something useful).

By contrast, the 747 had a huge impact, though it sold so badly after the first burst of orders that in combination with the 2707 cancellation it almost put Boeing out of business (the famous billboard pictured above dates from this era). Employment at Boeing in Seattle, as this page says, went from 101K to 39K from 1967 to 1971. Which is why we've always thought that the launch aid that Airbus gets is not fair. Though, of course, if you ever tried firing Airbus employees in those numbers they'd burn the factory down.

Which reminds us, Connecting Flights has a link called "Concorde, the 30th Anniversary of a Bad Idea" that may be of interest to some of you.

People do love the idea of an SST. We once were at manufacturer seminar with a lot of non-airline folk and the manufacturer made the mistake of mentioning a hypersonic aircraft. The whole of the question and answer period was taken up with questions about the thing, even though it seems like an irrelevance, at least on any sort of reasonable time scale (as in, before we die). Quite frustrating to airline nerds who wanted to get into the nitty-gritty of the latest narrowbody.

American to Review Bonus Policy

FT (subscription required) carrying a story (don't see it elsewhere yet) that American will review the controversial bonus plan that has resulted in significant payouts despite the fact that American is not yet profitable. We discussed this (if not in excruciating detail) in a prior post.

Wondering when that was going to happen. We're a little surprised that CEO Gerard Arpey didn't get on top of this earlier, given that he's (rightly) pushed to permanently fix the traditionally fractious relations between management and unions at the company. That it's taken this long suggests there's yet more work to be done on the communication front, since it's clear that this has really angered workers (understandably, in our view -- $70mm in management bonuses, including some in seven figures, isn't right when the company is still in the red and asking employees to pull together).

Speak of the Devil (It Sucks to be a Regional Airline)

The Street reports on comments from the Mesa earnings call today (earnings report here). CEO Jonathan Ornstein (as featured in our post on Frankenstein) was unwilling to comment on reports that Northwest, in its request for proposals for regional jet (RJ) service (to possibly replace existing regional partners like Mesaba) is asking regionals to consider sharing fuel price risk. Well, it's just a (so far) unconfirmed report, but it's exactly what we've expected for some time. It sucks to be a regional -- legacy majors can ultimately have their wicked way with a regional, and making them share risk is just another step on the road to perdition, or at least lower average profitability.

Ornstein's Mesa may avoid it this time, it doesn't currently need the business, but someone (perhaps Northwest's existing regionals, which currently work only for Northwest so don't have many options) may go for it, and if so, precedent established.

He also said that he feels the inter-island Hawaii market that Mesa is going into should be profitable for an LCC (with which we wholly agree) but that Mesa is still planning to enter it with 50-seat RJs (which of course generate high cost seats). So apparently he fully understands that the aircraft he's pushing into Hawaii are unlikely to make profits. Uh *huh*. Well, at least the pilots who are bidding for the Hawaii routes will enjoy themselves.

Image: the one, the only, Jonathan Ornstein.

Ryanair Charges for Bags (More Unbundling)

That's what the headlines will read -- as we predicted when flybe started doing this. It's a bit more comprehensive than that, however (press release). Ryanair is combining this with measures designed to get people to web check-in -- there's no mention of airport kiosks.

[We've never subjected ourselves to (sorry, we mean, we've never flown) Ryanair but we don't think it has kiosks. Our suspicion is that it would probably resent the expense of buying/installing them, and might it make it a bit more difficult to pull out of airports that anger them. We could be wrong.]

Fares are to be reduced (to the extent that's a meaningful statement... You can reduce fares and still jack up the average fare by changing the number of fares sold at each fare level. Besides, Ryanair loves selling "free" -- net of taxes -- fares, hard to reduce those). Those who web check-in go straight to the gate and get boarding preference, thereby permitting (presumably) Ryanair to eliminate some of its airport personnel. Baggage allowance increased to 30 kilos, but you pay per bag, double if you don't do it in advance when you check in (they don't really want to take your money at the airport). Hmm, we forecast many large bags, since it's a per-bag charge -- why not one very large 30kg bag?

Unbundling continues. Those who check in bags will be very unhappy, but you can't say it's irrational. The traditional product was bundled, and we all got used to it. But there wasn't a huge amount of rhyme or reason to it. Why should someone who's checking bags be able to do so for free? You can bet US (as well as European) airlines will be watching this like a hawk. Who would bet against this happening in the US within the next few years? Next five years?

One very good reason to have free bag checkin is that people will try to take the kitchen sink on board. The state safety authorities are going to have to keep an eye on this. There was an interesting (not on-line) story recently in Airliners magazine (an enthusiasts magazine with a lot of pictures -- or "airline porn" as we refer to it) about the German inspectors who roam airports looking for safety violations. On board a Russian aircraft they found a woman who had all her luggage with her -- blocking an emergency exit (which is where you'd find the bodies piled up if there had been an otherwise survivable accident). Starting now the Germans may have to keep an eye on Ryanair flights, because you know people will do anything to save a quid/euro.

Update: we've now read elsewhere that Ryanair has a 10kg limit on carry-on luggage (easyJet apparently has no limit (?)). Wonder how stringently it enforces it.

American Throws Toys Out of Crib (Again)

American Airlines has done it yet again. Usually such a rational company, usually so well run, it's trying, apparently, to intimidate Southwest. Either that or it's just another temper tantrum.

American is offering a huge AAdvantage frequent flyer bonus for those who fly between Dallas (either Dallas/Ft Worth airport or Dallas Love Field) and St Louis, Kansas City, Austin or San Antonio. 30,000 miles if you fly three roundtrips in the appropriate period (basically March thru May), 60,000 if you fly six roundtrips. Register on aa.com with promotion code FLY3 before you try it. See the press release we linked to above. For a deal this good it may be worth a trip to Dallas just to fly it.

The economics of this are pretty bad for American. Frequent flyer miles aren't what they used to be, but they're perhaps worth somewhere around a penny a mile. So, you can buy a ticket from American (without even an overnight stay) to Kansas City or St Louis from Dallas for $98 roundtrip. That includes a 7.5% Federal excise tax but is before other taxes and fees. So, American keeps a bit more than $91 of that. Six times that is $547. That's what American gets.

Six roundtrips and you've got a 60K bonus, plus the 6,000 miles for the trips themselves (a minimum of 500 miles per flight times six times two). 66,000 miles at 1 penny a mile is $660, which is what American gives away. OK, so not everyone uses all their miles, but it's not like American was going to make any money on the flights themselves, even without a frequent flyer giveaway. So the economics of this are pretty wretched.

You can count on American to blow a gasket over Dallas Love Field and this is just more of the same. American probably shouldn't even be in Love Field, but it cannot stand, even for a second, the idea that Southwest has been even partly successful in removing the absurd restrictions that limit competition from there. So now this giveaway.

For what end? What does American expect to gain from this? You can't intimidate Southwest, they're the toughest (if also folksiest and friendliest) player in the business. American's not going to change Southwest's mind about pursuing the further opening of Love Field. Southwest's costs are lower than American, Southwest is more efficient than American. Whatever American does to Southwest, it's going to hurt American more than it hurts Southwest. This is a perfect example of the "bluster and wave a small stick" attitude that infects this business.

Absurd. Also noted, the press release quotes Dan Garton, Exec VP of American. Dan Garton is the biggest beneficiary of the recently controversial bonus plan (we discussed it as part of this post), and apparently stands to take home about $1.5mm (we've also seen larger figures).

Wow, for this you can get $1.5mm at American? Where do we sign?

And Dan... stop waving that thing around, you might poke your eye out.

Frankenstein Lives in Belgium (Is Branson an Airline Genius?)

Via the Airline Business blog, Airline Business has an interview with Neil Burrows, the lucky guy (hah) who gets to knit together SN Brussels with Virgin Express, the two parts of the Frankenstein airline that now passes for Belgium’s national carrier.

Virgin Express is one of the main reasons why we’re skeptical of Virgin supremo Richard Branson’s vision when it comes to the airline business. We’re not saying he’s dumb, but we’re not sure he’s uniquely talented either. In 1996, Branson wanted to get into the European LCC game. At that time Ryanair was beginning to establish a base in the UK, easyJet was just getting started and there were one or two other shaky UK LCCs about (anyone remember Debonair? Something called AB?).

Branson bought a little charter outfit called EuroBelgian Airlines and turned it into Virgin Express. He then hired Jonathan Ornstein to run it. Neither was a brilliant move, though the late 1997 IPO was well received, with the combination of the Virgin name and following on from the recent Ryanair IPO.

The problem with Belgium is that it has some of the highest “social charges” in the European Union. That means the European equivalent of social security taxes related to employment. So if you’re looking to establish a European LCC, doing so in Belgium is a bad idea, especially when other guys like easyJet and Ryanair are based in low social-charge countries like the UK and Ireland.

[There are a lot of reasons why Ryanair is so profitable, a big one is that Irish corporate taxes are low. Ryanair’s tax rate is in the low teens (for the quarter ended Sep 30, 2005, it was 10.4%), whereas that of easyJet (based in the UK) is significantly higher – 29.7% for its financial year ending Sep 30, 2005, adjusting for goodwill amortization. We’ve never been entirely sure why all new European LCCs aren’t established in Ireland (presumably other European countries have ways of making life unpleasant).]

So using EuroBelgian as a foundation for Virgin Express crippled its potential as a LCC. Local flag carrier Sabena, however, helped by accommodating Virgin Express from the start. In fact, it contracted with Virgin Express to fly to London Heathrow using Sabena’s slots. One would have thought that if there was anywhere a high-cost carrier like Sabena could have made money (and would have wanted to have its brand represented) it would be Heathrow, by far the preferred airport of by far the richest city in Europe.

The other bad move was to ask Jonathan Ornstein to run Virgin Express. Ornstein currently runs Mesa, a big US regional airline, having rescued it in 1998 after it fell on hard times. To say the least, he’s somewhat controversial. If you want an ear-full, ask a pilot about him – he appears to rank just below Frank Lorenzo (who broke Continental’s pilot union in the 80s) in pilot demonology, on the strength of starting a non-union subsidiary at Mesa in 2002 using that as leverage to get an advantageous pilot contract in 2003, which he has used to undercut other regional airlines for contracts with legacy majors.

In 1996, all that was in the future, but it’s fair to say that regardless of what you think of Jonathan Ornstein, he’s a very *American* phenomenon, and he’s not shy about it. So putting him in charge of a European LCC in the most European of countries with some of the most restrictive labor laws was probably not the best move Branson ever made. To be fair to Ornstein, Ryanair’s Michael O’Leary would probably have been just as miserable, mired in a high cost airline in a high cost country. Suffice it to say that it was not a match made in heaven, one reason why Ornstein was glad to return to the US to rescue Mesa.

Virgin Express’s life was made much more difficult by the presence of Ryanair. Virgin Express flies out of Brussel’s main Zaventem airport, whereas Ryanair established itself in the previously empty Charleroi airport south of Brussels, where it got a pretty sweet deal from local government, one that was later challenged by the EU as being too sweet.

Virgin Express, for its part, never got its act together. It tried founding an Irish subsidiary to escape Belgian social charges, but that didn’t help and in early 2001, Branson had to give it a loan to keep it going. The fleet was halved, the Irish subsidiary was shut down, and Virgin Express exited the charter business. So Virgin Express has just limped along.

Put this together with the enormous role luck played in the success of Virgin Blue, with the late, overblown and high-spending entry Virgin America is making into the US (prior posts here, here and here), not to mention that Branson passed on investing in JetBlue (or the fact that at least some of Virgin Atlantic’s success is due to stringent UK restrictions on transatlantic competition at London Heathrow airport) and we question whether Branson deserves his reputation as an airline genius – though he’s clearly a genius of some sort.

The other part of the Frankenstein airline is SN Brussels. SN was the two-letter code of Sabena, the old Belgian flag carrier, the poster child for small, high-cost European flag carriers. In 1995, Swissair bought half of Sabena to get into the Europe Union (Switzerland’s neutrality extends to keeping itself out of the EU). Sabena was just the biggest of Swissair’s rather poorly chosen European airline investments, which ultimately included the German charter carrier LTU and the French carriers AOM, Air Liberte and Air Littoral.

[Dangers of obsolete webpages: this website (which “provides the most authentic and reliable information on Airlines” (sic)) still lists the AOM website as www.aom.com. That’s turns out to be the website of Adult Online Magazine, so beware… But the new AOM is probably more profitable than the old one, and may also leave customers more satisfied.]

Swissair tried to turn around Sabena, putting in place a new fleet, for instance, but by 2000, the airline was in big trouble, requiring Swissair and Belgium (the other shareholder) to pump in more money in early 2001. In fact, in early 2001 it was revealed that every one of Swissair’s European carriers (including itself) was losing money, truly a remarkable achievement. And then 9/11 hit. Swissair rolled over and died, as did Sabena. And in fact the Swiss and Belgian governments deserve a lot of credit for letting them die, showing a lot more guts than, say, the Italian government.

In both countries the solution was the same: create a substitute airline using the old major carrier’s regional affiliate. Sabena regional affiliate DAT was turned into SN Brussels, while Swissair regional affiliate Crossair became Swiss International. The Swiss aimed far too high, which is why Swiss International recently collapsed into the arms of Lufthansa. The Belgians were more modest in their aims, which is why SN Brussels, if not exactly a roaring success, hasn’t been a high profile failure either. The very name speaks to modesty.

SN Brussels is small, buttoned-down Belgian airline flying to European, Middle-Eastern and African destinations (and it codeshares with others to provide access to elsewhere). The board is headed by Viscount Etienne Davignon, a former member of the European Commission (day-to-day governing body of the EU) – in other words, a blue-blood member of the European establishment. Just the sort of airline to stitch together with Virgin Express, no?

In fact yes, because that’s what’s happened last year, the two were put under common ownership (but only after Branson cleaned up Virgin Express yet further, erasing its debts. And then, so far as we can tell, Branson also had to buy into the SN Brussels holding company). And the plan is to integrate them. Well, the competitive winds are whipping through Europe at the moment, you can’t be too picky about with whom you huddle for warmth.

Which is why we don’t think we’re unfair in characterizing the result as a Frankenstein airline: one part the remains of a failed European flag carrier, one part failed European LCC. Nothing matches – the culture, the business plan, the fleets (SN Brussels has a handful of small A319s, a handful of A330-300s and about 30 oddball Avro RJ/BAe 146s – we discussed this aircraft in a post about Mesaba, Virgin Express has some 737s). And run (lucky man) by a Brit. Well, if he does a good job at this, he can write his own ticket to anywhere he wants. And in the meantime, at least the beer’s good.

Slots a Factor in Jet's Purchase of Sahara/India's Private Airlines Arrive

Airline Business blog says that getting more slots at Indian airports was a factor in Jet Airways' purchase of Air Sahara -- slots are like "gold dust". Jet Airways' domestic business is apparently growing at 25% per year. In places like India and China, you have to remind yourself that airlines are a go-go growth business. This is by way of followup on our post querying where Indian carriers are going to fly all the aircraft they ordered last year, given local infrastructure constraints.

Background: Traditionally there were only two airlines of any consequence in India: Air India and Indian Airlines, both owned by the government. The split was originally Air India for international, Indian for domestic and neighboring countries.

[Although this type of split seems dumb today (many journeys involve a connection from an international to a domestic carrier, and it's generally simpler to connect on the same airline) they were common in the bad old days of govt ownership/regulation. Pan Am was almost completely banned from US domestic flying until deregulation in 1979, for instance, while British Airways had two predecessors, British European Airways for UK/Europe and British Overseas Airways Corp. (BOAC -- Better On A Camel) for everything else. Air France was originally international only, there was something called Air Inter for domestic. Apparently this made sense to bureaucrats everywhere.]

In the early 1990s, the Indian govt dipped a toe into the deregulation waters and permitted a few private carriers. Jet Airways established itself as the most viable of these. In the meantime, Air India and Indian Airways have been hamstrung by the government's endless indecision over replacement fleets (which has only just now been resolved or so it seems), to the point where significant portions of India's international route rights weren't being used simply for lack of aircraft. Virgin Atlantic, for instance, engaged in codesharing with Air India where Virgin flew the aircraft using Air India's route rights.

So in the last few years the restrictions have really come off, with the private carriers now being permitted to fly internationally as well. Last year Jet started flying to London and also applied for rights to fly to the USA (it is currently battling bizarre allegations by the CEO of an unrelated US company called Jet Airways Inc that Jet Airways India was funded by monies linked to Al Qaeda. This seems extremely unlikely. Jet Airways IPO'd last year with an underwriting team of some of the leading global investment banks).

Consequently, there has been a significant increase in new private carriers entering the scene. Two, for instance, are funded with beverage company money -- Air Deccan, funded by a local Coca Cola bottler, and Kingfisher, by the beer company. India has a reputation as a socially conservative place (at least by comparison with the US or Europe) but cheesecake (paneercake?) is apparently live and well, judging by this link on the airline's website. That sort of thing went out in the US a long time ago, until revived by Hooters Air.

In any event, the merger of Jet Airways and Air Sahara (the other private Indian airline that's survived since the early 1990s) is supposed to result in the single largest Indian carrier. We don't pretend to know a lot about the Indian industry so this is probably about as deep as we'll go into that market.

But we should note that opening international routes to India's private carriers has been accompanied by a general relaxation of route rights into India. In the future, folks will be able to get a nonstop flight into India who before would have connected through Dubai or Singapore. The pickings will no longer be quite as easy for the likes of Emirates and Singapore Airlines for which India has been a very good market simply because it's been constrained. Assuming Indian airports can keep up, the emergence of competent Indian carriers as a potentially significant international competitive presence is an interesting and novel development.

Lastly we will snarkily comment (because it so deserves it) on Air Sahara's advertising tagline: "Emotionally Yours." *Gack* It's difficult to think of anything else so irrelevant yet cringe-inducing yet on the polite side of offensive. Someone who wants an airline to be emotionally theirs probably needs a good psychiatrist. It doesn't say anything positive or pertinant about an airline. Or perhaps it's simply really badly translated from Hindi. In our mind it's reason enough to approve Jet's takeover.

Fun fact: Indian Airlines has the only A320s in the world with four-tire "bogey" landing gear. All other A320s have a single axle and two-tires per main landing gear -- see a picture here. Indian Airlines A320s have two axles and four tires per main landing gear, the same as you would generally see on a much larger aircraft -- here's a picture.

When it first came out in the late 80s, Airbus had a tough time selling the aircraft. Sometimes it seemed that it couldn't give away the aircraft (a bunch of them were being built for Pan Am, which went bust so they went to Braniff II, which went bust so they went to America West, which went Chapter 11 in the early 1990s, but many of them stayed there anyway... in fact, Braniff II titles were recently found under America West paint as the aircraft was stripped to repaint it into US Airways colors).

Indian Airlines was worried about the weight-bearing capacity of India's runways, so Airbus, to close the deal, agreed to modify the aircraft. Since then, Indian has acquired additional A320s, so now it also has some aircraft without bogey landing gear as well.

Is There a Pilot (or Dispatcher) On Board?

sPh wants to know more about how airlines designate alternates (see comment section to our piece on A380s and Las Vegas).

• Does an airport have to be certified as "A380 compliant" to be listed as an alternate? Related question, are all airports rated as alternates on an aircraft-type by aircraft-type basis?
  
• Can an airline pilot list an alternate where the airport says it doesn't want the type there, but the runway will accommodate the type? What's the penalty for doing so? Who sets these rules?

Our guess is that the answer to the first question is Yes and that the answer to the first part of the second is No.

We'd expect that in the event of a true emergency, where nothing will do but the nearest airport, most of the rules go out the window, but that declaring an alternate that doesn't want to be declared is a pretty big no no. For instance, military airports can be off-limits, as can (obviously) airports in hostile territory, even though an aircraft might technically be able to land there.

However, we'd like to hear it from a pilot (or perhaps a dispatcher) if we could. Use the comment section (if you desire complete anonymity) or send us an email (jt9d17r at yahoo dot com) and if you don't want us to use your name, we won't.

Viva Mexico Followup

Big article in Flight International giving current rundown on start-up situation in Mexico (see our post Viva Mexico on the topic). Five new start-ups, of which three are either underway or have signed contracts for aircraft, plus the two old incumbents (AeroMexico and Mexicana) of which Mexicana is now under contract to be sold. Unfortunately, although the article does not explicitly say so, it leaves the impression that some Mexican airline chiefs believe US Chapter 11 bankruptcy involves government aid, which, of course, it does not.

Paying Airlines to Pollute? (Airbus Offers Money In Lieu of Fuel Efficiency)

Extraordinary article at Flight International in which Airbus concedes Boeing's 777-200LR/300ER has a significant fuel burn advantage over the A340-500/600. But, says Airbus supersalesman (technically Chief Operating Officer - Customers (*), but supersalesman is more descriptive of his role) John Leahy the A340-600 and 777-300ER have:

comparable ranges and seat counts and Rolls-Royce guarantees that maintenance costs for four engines are the same as the twin. I can agree a figure with a customer that reflects the fuel burn delta and run that out over 12 years and pay it to them. But if the 777’s fuel burn advantage was to give it greater range, then we’d have to look at [improving the A340].

So first of all there's the interesting statement that Rolls guarantees engine maintenance for four engines (on the A340) will be the same as the two engines on the 777. That could be true, if, say, there's something really differentially expensive about materials on the GE90-115 engine on the 777. That's never been reported, so it seems unlikely. Apart from that it seems highly unlikely that four engines can be maintained in the same number of labor hours as two. That's quite a guarantee.

Move on to the main course. He's saying essentially that yup, the aircraft's got a problem, it burns more fuel, but we'll just give customers the present value of that. There are two issues with that, one money, the other the environment. Leahy says that the fuel burn disadvantage is "single digits". On a Boeing website, there's the claim that the 777-200LR on a long-range flight like Los Angeles-Singapore would be able to carry 21 more passengers, 22,300 lbs more freight plus burn 6,000 gallons less fuel than the A340-500.

Well, OK, so here's what we'll do. Since it's a Boeing claim, we'll really haircut it. We'll forget about the extra passengers and the extra freight and we'll only take the additional fuel burn. That's a lot to give up, because the price of a one-way ticket from LA to Singapore nonstop is pretty hefty, not to mention the freight (Boeing claims a 20+% fuel burn advantage for the 777. To be charitable to both sides, there's probably some set of circumstances that gives each result, with, we'd guess, most of everyday life occuring in between -- a 15% or so difference is still quite meaningful).

Let's suppose the airplane flies 6 times a week on that route (three times each way) and on the seventh day it rests. Kerosene at about $1.80 (big Excel file) so maybe $2/gallon including taxes and into-plane fees at the moment, not out of the question. 52 weeks in a year. Fire up the calculator, tap-tap-tap... We make it close to $3.75mm per year in extra fuel. OK, 12 years, present value that sucker at, say, 10% (yes, you can disagree with that, go right ahead, roll your own)... tum tum tum... Hmmm. Over $25mm. Well, OK, it's probably wrong maybe it's $15mm, maybe it's $30mm, we just want to get an order of magnitude estimate. But it's big. Maybe it's smaller for the A340-600 vs the 777-300ER than the A340-500 vs 777-200LR, who knows.

Even on an aircraft with a list price of $200-250mm (**) that's a lot to spot your competitor. Leahy has just offered this to the world. Every customer from now on is going to be insulted if bargaining on the A340-500/600 doesn't start from a similar premise. Not to mention those who already have the airplane knocking on Airbus's door asking for some money back. If Airbus is planning to sell, say, another 200 of the A340-500/600 we're talking $25mm times 200 = $5bn. Big bickies, as they say downunder.

Sorry, we forgot to mention why Airbus is willing to put up the cash. Here's Leahy again:

Is it a good investment [for Airbus] to spend a couple of billion dollars to get a better aircraft when you can solve the fuel burn problem with money?

So our estimate isn't totally crazy. We are talking $billions here. How many depends on a lot of things, including John Leahy's estimation of his own (considerable) sales skill (there's a story floating around that the reason Airbus didn't beat Boeing for Northwest's 787 order last year is that John Leahy was sick with appendicitis. It's true he had appendicitis. Whether it had such an impact is more questionable, but it's a measure of the man's talents that this is the story).

But that's just one aspect. The other aspect is the environmental issue, which matters to some of Airbus's better customers, including Lufthansa, one of the home-teams. How seriously does it take the environment? Well, they're German, so of course they take it very seriously indeed, both because the environment is a serious issue in Germany and because, of course, Germans are serious, thorough people.

So in particular, Lufthansa produces a yearly 37-page magazine called Balance: The Lufthansa Journal for Aviation, the Environment and Sustainability (pdf). But that's not all. They also produce yearly something called Balance, Facts and Figures: Key data on environmental care and sustainability at Lufthansa (noch einmals pdf). 70, yes, 70 pages. You can't imagine a single US carrier doing this, but we doubt that makes them any less fuel concious, somehow. You don't need to be an earth-firster to want to save fuel in the airline business these days.

Page 23. Specific fuel consumption: Liters/100 passenger kilometers (for Americans, this is the reverse of how we think of miles/gallon -- here it's gallons (actually liters) per mile (actually kilometers) so lower is better, yeah we think that's bass ackwards too. A340-600 is 4.12(***), not as good as the A340-300 (3.99), but we'd guess that's to do with lower seating density on longer-range A340-600s (in many airlines, A340-300s have been relegated to much shorter routes than they were originally designed for). By the way, a full 25% or more better are the charter/LCC aircraft in the Lufthansa group (like Thomas Cook), which just goes to show that if you really want to be environmentally friendly, you need to give up legroom.

So very seriously environmentally-concerned Lufthansa is polluting the earth something like 10-20% more than it needs to by running A340-600s? How will that look to the deep green German public? Sure, you can make up the cost of the kerosene with money from Airbus, but what about the damage to the earth? Who's going to pay for that? At the very least, Airbus ought to plant a few trees to make amends.

It may sound like we're joking, but we're not, at least not entirely. Environment is a serious issue in Europe. In fact, the European Union is trying to drag the airlines into Europe's emission's trading program (we'll do a separate post on that, but it's a program where a company must buy the right to emit incremental carbon dioxide, which obviously gives them an incentive to emit less CO2). It's a particularly emotional issue in Germany.

Were we running Boeing's sales programs, we'd make sure that everyone in Europe understands the gap Airbus now acknowledges in fuel burn between the two aircraft, and that Airbus intends to, essentially, pay airlines to pollute -- worse than blood money, it's CO2 money. The environmentally pure thing to do, surely (and here we are deeply tongue in cheek) is for Airbus to stop selling the A340 if it can't improve it. Think of global w-a-a-a-r-r-m-i-i-n-g...

Last two posts we did on A340 vs 777 are here and here, and there are a slew of references before that, or see here.

Image: The Lufthansa logo is a classic, the bird symbol (a crane) dating back to 1918. Luft-hansa itself essentially means Air-league, the Hansa being a trading union (or league) of north German/Baltic cities in medieval times (Lufthansa was formed from the merger of two predecessor airlines). In some sense, Lufthansa is akin to "United Air", which is appropriate because it's in the Star Alliance with, among others, United Airlines.

(*) whatever the heck that is -- our guess (and we could be totally wrong) is Airbus invented the position so it could keep promoting a man who is so key to Airbus's success, yet is unfortunately American so he cannot be appointed to one of the existing top jobs, which are doled out on the basis of European nationality -- one for France, one for Germany, this year it's Spain's turn, oh, we can probably trust a Brit in this job...)

(**) as Mark Twain would have said, there are lies, damn lies and aircraft list prices. Knock at least 20% off, more if you're a special customer, and aren't we all special in our own way?

(***) Assuming 250 seats on a 10,000 km sector and a 75% load factor, 4.12 liters/passenger-km means 77,250 liters of fuel burned. 15% savings is about 11,600 liters or about 3000 gallons, about half of what Boeing said would be saved on a longer flight (LA to Singapore is 14,100 km) against a somewhat different aircraft (A340-500 vs A340-600). Since this is all an order of magnitude estimate, we're OK with the result. Half of big bickies is still big bickies. Besides, the 4.12 number is probably quite sensitive to exact stage length, and may even increase for really long-hauls (since you burn a lot of fuel carrying fuel for the rest of the journey...)

AirTran & ExpressJet 4Q05/FY05 Earnings Reports

Find them here, if you're interested.

Oh, Canada! Why Northwest Wants a Separate Subsidiary

We've talked before about the 100-seat flashpoint within the US industry: the pressure JetBlue is bringing to this sector of the market, why Northwest believes it needs to replace 100-seat DC-9s flown by its own pilots and replace them with aircraft outsourced to a third party. But why does Northwest want these replacement aircraft outsourced? Why not fly the aircraft at Northwest with much lower wages than on the DC-9?

This blog entry (by an Air Canada pilot, reprinted from an Air Canada Pilot Association publication) shows why. Air Canada went through bankruptcy itself recently, and also crushed pilot pay. The dividing line between regional pilot and mainline pilot was decided, essentially, by manufacturer. Bombardier regional jets (RJs) are flown by Air Canada Jazz (regional partner/subsidiary) pilots (it's Canada, they think they need, well, jazzy names, to compensate for being such douce, low key folk, eh), while Air Canada pilots fly the Embraer 170-195 family aircraft. Both get paid much lower wages than, say, a DC-9 pilot used to get paid at Air Canada.

Well, guess what? Air Canada pilots are already saying they want to get paid more for the Embraer 195, because, guess what, it's about the same size as the old DC-9 and they sure got paid more for that, eh! And it's not like the price of Tim Hortons donuts have gone down in the meantime or a hockey game costs less or the price of heating oil is lower, eh? So what do you think a-boot that?

This is precisely why this solution is unpalatable to Northwest Airlines (which doesn't mean it might not eventually swallow it). Yes, Northwest pilots might agree to crush pilot rates for 100-seat flying and enable Northwest to acquire new 100-seat aircraft. But the minute they can, Northwest pilots will agitate to increase wages. And once Northwest has the aircraft on the property, and has recovered financially, it will be difficult for Northwest to resist such demands.

As we noted in an early article on regionals, the solution (from the airline's standpoint) to this issue is to outsource the aircraft to another company. It's almost impossible to resist a pilot strike (or other job action -- see our references to the Summer of Love) when an airline has money. But it's much easier to enforce a contract (including walkaway provisions) with a supplier. Outsourcing aircraft cuts the link to the DC-9 way of thinking far more permanently.

Not necessarily totally permanently, however. Just before 9/11, ALPA, the big US pilot union, had finally figured out that if it wanted to stop the outsourcing rot (from its standpoint) it needed contracts that governed all flying done under a brand, not just by an airline -- so called "brand scope" (definition of scope here). So a contract would govern not just Northwest, but any flying done under contract for Northwest whether by Mesaba, Pinnacle, the NewCo to which Northwest wants to outsource 70-105 seat aircraft or whatever else.

That would end the ability of Northwest to undercut existing Northwest-brand pilots by bringing in a lower-paying contractor. It's a good idea (from the union's standpoint) so far as it goes. And it's gone nowhere since 9/11, but in a different state of the world, who knows?

All Time Classic Alitalia Quote?

Alitalia is the perennially embarrassing (and uneconomic) Italian flag carrier. (We previously wrote about Alitalia in the context of a loan it received from General Electric) The Italian government is too gutless to do the right thing and let the company go bankrupt (despite European Union laws that are supposed to prevent Italy from interfering) and so has repeatedly at least violated the spirit of the law (and probably more, but in our less grandiose moments we realize this isn't our judgment to make, though of course we did) to keep the carrier alive.

But are employees grateful for this? Like heck they are. Few feel so entitled as those who are employees of a former (or current) state-owned airline (US legacy major employees had similar attitudes up through deregulation, and it's taken the better part of 30 years to change them).

So Alitalia employees are engaged in their fifth day of strikes. This is beginning to exhaust the patience of even the milquetoast Italian government, which has begun to mutter that perhaps it should just let just nature take its course. Here's the Italian labor minister, who apparently is on record as saying that he doesn't think letting Alitalia go away would be a disaster (unfortunately, his opinions are not representative of the rest of the Italian government):

If Alitalia can't compete, if it can't stay in the market and protect jobs, perhaps it will be necessary to think in terms of a solution that normally happens in such cases, without dramas and without excessive reliance on ideology.

This from an FT article (subscription). OK, so Italian Prime Minister Silvio Berlusconi (that's him in the background of the picture above) is asked about this possibility in an interview and he says (from another FT article):

It isn’t easy to do things like that. National pride is involved in having a flagship carrier . . . For sure, if the workers didn’t hold dozens and dozens of strikes, and instead behaved like Air France workers, things would be going better at Alitalia

You know things are bad when Air France workers are paragons of virtue next to those of Alitalia. Air France workers are notoriously militant -- a quick google shows Air France has suffered a strike (over a colleague "suspended over a deadly accident") as recently as 11 months ago. And that's just a strike that makes the international papers. In the meantime we've personally experienced a short strike (by certain ramp staff) at Paris Charles de Gaulle airport that inconvenienced thousands but didn't make the papers (a mere bagatelle).

And this is when Air France is doing pretty well. In 1994 when Air France was on the ropes, Air France employees shut down the airport, charging the runways among other behavior. France pumped $4 billion into Air France that time, or more than the market cap of any airline in the US at the moment, with the exception of Southwest. In fact that had to be one of the most painful aspects (to the Dutch) of Air France's 2004 takeover of KLM. If there was any justice in the world, at most times in the past it would have been the other way around.

Not that France would ever let Air France fail (or be sold to the Dutch of all people). That's the other part of the Berlusconi quote -- it's national pride. Yo, it's just an airline -- think Greyhound with wings. It's not a symbol of undying national glory. When one thinks of the glory of Italy one thinks of Fermi, Ferrari, Armani, Michelangelo, da Vinci, Dante, Machievelli, lasagna (sounds like an outtake from A Fish Called Wanda). The renaissance! Venice! Rome! Trust us when we tell you, Silvio, that to us, the name Alitalia only brings dishonor to Italy. Surely Don Corleone would have had it capped long ago.

[Let us just say that we are huge fans of Italy and most things Italian... just not Alitalia and Italy's week-kneed attitude towards it.]

OK, you get the idea. We don't really need to explain why France would never let Air France fail, do we?

Image: One proposed solution to the Alitalia problem from an Italian website. As if Ferrari parent Fiat doesn't have enough problems.

Finding Alternate Airports for the A380

Via MRO Wire, Las Vegas Sun article on how Las Vegas airport will not undertake modifications necessary to accommodate the A380, and in fact in the (unlikely) event that an airline wants to serve Las Vegas with the A380, the airport will tell them no.

OK, fair enough. Only Virgin Atlantic and Japan Air Lines even serve Las Vegas with a 747 at the moment (and JAL is supposed to be dropping its service) so no big deal right? Well, the previous week there was an interesting article in Flight Intl about Airbus finding alternate airports for the A380 on behalf of customer airlines that are "struggling to convince some secondary airports to become emergency diversion destinations". You need a place to put the A380 if the destination airport for some reason closes or if there's a problem and the airplane needs to land short of its destination.

The link between the two articles is that Las Vegas is a reasonably common alternate for Los Angeles. It's on the way (at least from the east) and has at least one very long (14,500 ft) runway. Scratch that one off the list. That's the challenge: why should an airfield that will not itself be the beneficiary of traffic from the A380 pay for the necessary modifications to accommodate the aircraft? The Flight article mentions that Hanover, Germany is not keen to spend the dough to make it an alternate either.

There are precedents for manufacturers paying for infrastructure improvements. Boeing subsidized the airfield at Midway Atoll in the Pacific to make long-range twin-engine (ETOPS) services viable across the Pacific. McDonnell Douglas and Lockheed paid for LaGuardia to be upgraded to accommodate the DC-10 and L-1011. Let's hope that airlines that bought the A380 were wise enough to somehow make this expense Airbus's problem.

Image from Nevada Division of Environmental Protection shows (click image for bigger version) Las Vegas McCarran Intl Airport, with the Las Vegas Strip to the upper right. Nice and green...

A Little More on Allegiant (and Ryanair)

Reader David asks if there's any public info relative to Allegiant's business plan. None that we know of, but that set us to thinking.

First, Allegiant appears to be the first airline to profitably fly (so far) mainline aircraft to really quite small markets with low frequencies. For instance, Topeka and Peoria are not big cities. The recently failed Southeast and Transmeridian tried similar things, but perhaps not to the same extent as Allegiant. AirTran also flies to a few smaller cities (like Akron/Canton, Ohio or Flint, Michigan) but these are generally close to bigger cities so that they also function as alternative airports.

(Another interesting factoid is that on some routes, Allegiant competes with Southwest and on those routes does not necessarily undercut Soutwest. We looked at fares on Oklahoma City-Las Vegas, for instance. The lowest Allegiant fare was a dollar or two more than the lowest Southwest fare, booking several months in advance).

Allegiant seems to be unique in making a specialty of low frequency flying into small cities, which makes it superficially similar to Ryanair, which serves out-of-the-way places in Europe. But there's a big difference. Europe is so densely populated that even the middle-of-nowhere in Europe is close to somewhere.

Looking at it from another direction, however, there have always been charter programs bringing passengers into Nevada to play at casinos. For many years Casino Express flew two old 737s (called the King and the Queen because of the face cards painted on the tails) around the country to bring gamblers to Elko, Nevada (more profoundly in the middle of nowhere than anywhere in Europe) (Casino Express is now Xtra Airways, part of Excel Aviation USA, which is about 20% owned by Avion Group, Iceland).

In fact, Allegiant is part of a program bringing gamblers to Reno and Laughlin, Nevada on behalf of Harrah's. Allegiant scheduled service into Las Vegas seems just one step beyond that, especially since Allegiant is more than willing to sell you a Las Vegas hotel package along with the flight. That may explain why it's willing to be slightly undercut on fares by Southwest (which you'd think would be most people's first choice over Allegiant on familiarity grounds alone).

One way Allegiant almost certainly cuts cost (we haven't seen this printed anywhere, but it's reasonably obvious) is by arranging its flights to eliminate any overnight stays by crew. This is a Ryanair trick. Overnight expenses, meals and transportation for five people (two pilots, three flight attendants) are meaningful in the context of fares that (in the case of Allegiant) are somewhere around $100 one way.

Supposing overnight expense is several hundred dollars (Allegiant is serving small cities so perhaps it could get away something like this) that's the equivalent of fares paid by several people, which starts to eat meaningfully into profit margin since its aircraft seat only 150. In Europe, where just about everything is more expensive (and where Ryanair's average fares are only around 40 euros) it's definitely worth having.

We haven't checked Allegiant's schedule in detail, but we'd bet every flight is an out-and-back pair from Las Vegas (or Orlando).

Image: The airport in Elko, Nevada. There's not a lot there other than gambling and mining.

ATR "Joint Top of Regionals League"?

Somewhat misleading headline in Flight International article on 2005 regional aircraft orders. ATR is an EADS-Alenia (Alenia is an Italian aerospace company) joint venture that makes regional aircraft. To be more accurate, it makes turboprops (the ATR 42/72 series), having missed the regional jet (RJ) boat a decade or more ago. It's long since conceded that market to Bombardier and Embraer.

Here's what it says about itself:

ATR is leader in Turboprops in the 40 to 70 seat market segment

It would be overstating matters considerably to say this is the equivalent of being the being the leader in buggy whips, because for short routes (say under 300 miles or so) turboprops are still the most economical choice. But the market for turboprops is definitely not what it was pre-RJ (the first modern RJs entered service in 1993 or so).

And straight economics is not the only thing that drives the regional aircraft market. Passengers just don't seem to like turboprops as much. You can debate how strong the "turboprop avoidance factor" is, but it seems real (see last paragraph). So on a route that straight economics tells you should be served by a turboprop, if the other guy has an RJ into the same market, your competitor may end up sufficiently more than its fair share of the passengers to be profitable, despite the technically non-optimal equipment.

So here's Flight International proclaiming ATR "joint top of the regionals league" on the basis of a surge in turboprop orders last year. Said ATR's CEO:

This commercial success is evidence of the strong revival of the turboprop aircraft in the regional aviation market.

The ATR press release goes on to say:

The reasons for the revival of the turboprop are due to the soaring price of a barrel of crude oil, to the regional market’s growing traffic and to the obligation for airlines to reduce their costs.

Really? Let's look at the numbers.

Of the 90 aircraft in ATR's 2005 orderbook, 50 were from Indian airlines and another 10 from the Turkish Navy. Zero were from North America. So what?

The Turkish Navy order is something driven by non-commercial concerns so it's irrelevant. 2005 was the year the Indian airlines went wild -- few people expect them to order again in such size for many years. Thirdly, the North American market is where 75% or more of all 50-seat RJs were sold (the 50-seat RJ was the aircraft that obliterated the turboprop market). So if the reasons quoted were such a big deal and we're really seeing a revival of the turboprop market, where are the North American orders?

We can forgive ATR (which hasn't had this level of orders in over 15 years(!)) for making the most of it, but Flight International could show a bit more sense. Flight could at least have made reference to the very different order backlog positions of all three manufacturers (which it did publish -- see above). ATR's backlog is half that of Bombardier, which is itself half of Embraer. That's a more reasonable view of relative position of the three manufacturers in regional aircraft.

There's no question the 50-seat RJ market is in trouble, we've believed that for years. There's no question that Bombardier has been hit far worse than Embraer by this (check out how fast Bombardier's backlog is dropping), because Bombardier doesn't have anything like Embraer's E170/E190 aircraft. And it may be that one day there will be a sustained revival of the turboprop market (though if the bottom falls out of the 50-seat RJ market, that will further delay the revival of the turboprop because 50-seat RJs will be cheap for quite some time).

But saying that ATR is "joint top of the regionals league" without some caveat is materially misleading in our view, even if there is some narrow sense in which it is true. The reality, we think, is that the ATR 42/72 series of aircraft is a 20+ year old niche product, where in 2005 the stars aligned to give it an unusually good year for orders that's unlikely to be repeated anytime soon.

We're From the Government and We're Here to Help You

One of the biggest issues in the commercial aerospace world is the clash over launch aid to Airbus. When Airbus wants to finance a new aircraft program it goes to the European taxpayer, which forks over financing which is then paid back from profits (if any) on that program.

Boeing and the US have complained bitterly about such subsidies for years. Recently, the US has lodged a complaint with the World Trade Organization.

The European riposte to such complaints is that Boeing is a huge military contractor and receives similar subsidies through juicy military contracts, and that clearly Boeing commercial aircraft have benefited from technology developed on the military side. And it is indisputable, for instance, that Boeing developed an early lead in large jet aerodynamics through developing and debugging the B-47 and B-52 bombers back in the 1940s and 50s.

We've always seen the European riposte as hypocritical at best. EADS and BAE Systems (respectively 80% and 20% owner of Airbus) are huge military contractors in their own right, so if Boeing is sucking at the public teat through military contracts, then so is Airbus. And if Boeing is able to cross fertilize from the military side, so is Airbus.

But is Boeing able to cross-fertilize from the military side? Sounds like a stupid question, right? The answer, obviously, is "of course!", right?

Wrong. Read the following incredibly surreal article from the Seattle Times (via MRO Wire) about the ridiculous precautions Boeing is being forced to take to ensure that no technology developed for military purposes somehow ends up in the 787 -- including re-running experiments first performed in the 1970s to "re-learn", this time commercially, information that is now common knowledge about composites that was originally discovered in the course of military development. In this regard, at least, the law is an ass, and badly needs to be changed.

Image: Classic picture of the B-47 from aerospaceweb.org. First flight for this aircraft was in 1947. This is rather incredible when one considers that jets first saw military service towards the end of WWII, and played an insignificant role in that conflict. Yet only a few years later, Boeing designed, produced and flew an aircraft that has most of the features of a modern commercial aircraft, including high aspect ratio (essentially, long & narrow) swept wings and engines in pods. Lessons Boeing learned from debugging this aircraft catapulted it into a large-aircraft wing-design leadership position it has yet to lose.

Mergers: The Ugly Reality

United CEO Glenn Tilton is at it again. In an interview with the FT (via MSN Money central) he said:

Deregulation has done its work. It's time to recognise that we should compete on a grander scale. Should the opportunity present itself, we'll make sure we're in a position to take advantage.

Once again making it clear that he thinks the industry will consolidate and that the Federal government will be more tolerant of mergers this time around, in contrast to 2000-2001, when United was told it couldn’t buy US Airways.

Evidence is mixed – Secretary of Transportation Norman Mineta recently mused out loud about how Delta and Northwest might one day merge (apparently inducing laughter at Northwest HQ). But then the government went and rejected Northwest’s request that it be permitted anti-trust immunity along with Delta within the Skyteam alliance. So, the government thinks Delta and Northwest might merge one day but in the meantime they can’t collaborate. Clear as mud, as the Wall St Journal editorial page (subscription required) noted Wednesday. But let’s suppose it’s true the govt will approve mergers.

Any consultant facing this industry for the first time (or, say someone who spent most of his working life in, say, the oil business like Tilton) will tell you the same thing: it needs to consolidate to improve profitability. As we said before, it’s a lousy business, and on top of everything else, it’s fragmented relative to many other mature businesses. Aha! Merge those suckers to increase their market power! Turn it into an oligopoly, right?

Airline mergers have a lousy record

Large US airline mergers between equals or near-equals have a bad record. One reason is labor issues. In a post last month responding to reader questions, we discussed the seniority integration issues at the new US Airways, formed from the merger of the old US Airways and America West.

Most airline employees live and die by their seniority position. For instance, the most senior pilot gets his/her pick of available assignments, the second highest picks second, down the line. So how the two seniority lists are integrated is a very big issue.

This causes unbelievable stress. An ALPA (Air Line Pilot Association) official once told us he’d never seen a merger involving ALPA where ALPA hadn’t ended up being sued by groups from both sides (yes, suing their own national union) over integrating the seniority list. And it’s not just pilots -- all union groups go through some sort of seniority integration process and they almost all fight over it.

In the 1986 merger that created Northwest, between Northwest Orient and Republic (a different Republic from today’s Republic Airways Holding, a regional airline group) things got so out of hand that the two pilot groups didn’t merge until years after the airline. In the interim period, each group laid claim to aircraft types, with ex-Republic pilots exclusively flying one set of aircraft types and ex-Northwest Orient guys flying another set of types. Labor solidarity goes by the boards the minute someone's seniority is at stake.

It’s no surprise there’s a tendency for employee groups to become tribal after a merger, with employees of the constituent airlines identifying with each other rather than with the merged entity, and closely scrutinizing management decisions (such as closing duplicative facilities) for favoritism. We previously discussed one thing the new US Airways may be doing to mitigate such tribalism.

Further, executing a merger takes a long time. US Airways merged with America West in September 2005. They expect to have separate operating units for as long as two years, as the two operations are brought under common operating procedures. Every airline has its own FAA-certified operating manuals (and procedures do differ across the industry) and safely moving operations from one to the other is a painstaking process.

Consequently, the process takes a lot of management attention. In the 2001 merger of TWA into American, American was lucky to have a deep executive bench, and essentially split off a whole separate team to manage the process, leaving American management free to manage American. It’s a rare airline that has that luxury – we’ve discussed before the issue of finding and keeping talent in this industry. So a merger generally takes management’s eye somewhat off the competitive ball.

Of the mergers of near-equals since deregulation, the only one which is generally cited as a success is the Delta-Western merger of 1987. The fact that Western employees moved onto higher Delta wage scales may have had something to do with that. In contrast, the Pan Am-National merger of 1980 was a disaster, initiating a decade-long slide into liquidation. Cultural issues between southern-fried National employees and aristocratic Pan Am employees were a continuing problem.

We discussed the Northwest merger of 1986 above. The US Air-Piedmont-PSA merger of 1987 initiated a long period of mediocrity that ended in the 2002 US Airways bankruptcy. The 1987 merger between Continental and the remains of People Express, the old Frontier and New York Air was in a class of its own – Continental did not report a profit for the next eight years following this merger, though it must be admitted that few mergers have ever been more complex and executed with such little preparation.

The mergers that go most smoothly appear to be those where a big strong airline takes over a significantly smaller airline, even better if the smaller airline is in distress. American did a good job integrating much smaller and thrice-bankrupt TWA. But even small mergers can be problematic. American bought Reno Air in the late 90s, causing labor unrest among American’s pilots and resulting in an embarrassing sickout costing American about $150mm – more than American paid for Reno!

Airline mergers today

The US Airways-America West merger is the first between near-equals since the 1980s. It is still early days in this merger – seniority lists have yet to be integrated. Although America West is the smaller carrier, it effectively bought US Airways, which was twice bankrupt and widely viewed as on the verge of liquidation. We think a successful merger will depend critically on legacy US Airways employees continuing to regard the merger as their salvation. In our opinion it was, but you know what people say – what have you done for me lately?

Employees of other legacy majors will be much less inclined to be docile than those of US Airways. No legacy major has been in as desperate a situation as US Airways, and employees bitterly resent the significant wage cuts they’ve all taken in this downturn. This raises the stakes in any seniority integration yet further, since even the perception of losing in seniority integration adds insult to injury.

Further, in any future upturn, unions will seize on any excuse to pressure legacy majors to restore lost compensation, and mergers are inherently situations unions find objectionable. And unions don’t have to strike to succeed. United pilots forced significant wage increases in 2000 through a work-to-rule effort in the so-called Summer of Love (yes, we’ve mentioned this once before).

One last thing. One might ask why two airlines couldn’t be run separately under common ownership. First, if there’s anything unions hate more than a merger, it’s two airlines run separately under common ownership, because of the danger of being “whipsawed” (playing the unions of the two airlines against each other). Secondly, if the airlines are being run as one system (and if they’re not, what’s the point?) the National Mediation Board will almost certainly make a finding that they are legally a Single Transportation System (pdf, pp 18-19), meaning that the two airlines will be treated as one for labor purposes, meaning that there will have to be seniority integration anyway.

The nuance will kill you in this business.

All of this is to say that we think Glenn Tilton, as someone who only entered the industry three and a half years ago, seriously underestimates the risks of merging two large airlines. To be fair, he's in good company. People love talking about consolidation. It's so exciting moving divisions and armies around the map. Much more fun than focusing on the minutia of running a good business. But there are good reasons why the business is fragmented.

Image credits: Current and historic airline logos from aerosite.net, a must-see site for anyone who likes pretty airline graphics, and let's face it, don't we all?

Others Also Thought It Was Crazy

No doubt everyone is on the edge of their seat over the impending sale of the airport in Bratislava (Slovakia) that we discussed earlier (This Seems Crazy). Bratislava airport is so close to Vienna that it might as well be a Vienna airport, which is why we questioned the wisdom of selling Bratislava airport to Vienna airport -- why create a monopoly? The Viennese were the winning bids in a privatization effort -- and of course they would be, wouldn't they, if they wanted to nip competition in the bud.

Apparently the governing coalition in Slovakia has had second thoughts and is now blocking the bid. The FT has the story (subscription required). Whew! No doubt you're as relieved as we are. And for those of you who want the political background to this, this story has more than you ever wanted to know.

Bratislava airport traffic increased last year by 48% to 1.3mm passengers. As we discussed here, traffic in Central/Eastern Europe has been going gangbusters since these countries entered the European Union. Low cost carriers (LCCs) are all over the region.

Ben, Meet DOT Data, DOT Data, Meet Ben

Ben Mutzabaugh runs a button-down corporate blog called Today in the Sky for USA Today, keeping track of airline events.

He gets one wrong today, however, venturing the opinion that because Allegiant Air is a private company, there's no way to tell if it's profitable.

In fact US carriers, whether privately or publicly owned, are required to file data with the US Department of Transportation -- a lot of data, about all sorts of things, including their income statement ("Form 41"). This is distinct from the filings that a public airline must (also) make with the SEC. So in fact it's not hard to figure out whether Allegiant is profitable.

The relevant source is here (schedule P-12) and after a little downloading of a largish spreadsheet and some re-arranging, the answer is that for the first 9 months of 2005, Allegiant says they made net income of $4.5mm on revenues of $99.7mm. Profitable to date, be interesting to see how they did in the fourth quarter.

Glad to help, Ben.

Allegiant, by the way, is an interesting airline. It flies from obscure third-tier airports to vacation destinations, largely Las Vegas and Orlando (we previously mentioned Allegiant in the context of its recent entry into Worcester, MA). It's run by Maurice J. Gallagher, who was one of the founders of ValuJet (which eventually took over and assumed the name of AirTran). Last year it attracted a large private equity investment, including participation by Irelandia, which is an investment vehicle for Tony Ryan, who founded Ryanair in the 1980s. Ryan also founded the late, great aircraft leasing company GPA, which blew up in the airline downturn of the early 1990s and was in large part taken over by General Electric, forming the foundation of GECAS, now the world's largest aircraft leasing company.

Probably Not Invited to the Airbus Chalet at Farnborough This Year

Richard Aboulafia, quoted in the Seattle P-I article on Airbus's 2005 orders:

They have pushed back the frontiers of mediocrity.

There was an absence of quality in the Airbus numbers in the run-up to the end of the year.

And on A350 orders:

It's all fluff. They need a Singapore or an Emirates.

A forthright analyst is a wonderful thing...

Flight Intl: 787 vs A350

Flight Intl has a large article each on the 787 and A350, both reachable here. Flight's summaries of each article indicate the different positions of the programs.

Making a dream: After meeting the 787 sales challenge with a record-breaking order spree, will Boeing be able to satisfy the subsequent production demands?

For Boeing, the 787 program is now all about execution and finding a way to produce the aircraft quickly enough. One interesting tidbit: Boeing will build and store aircraft in advance of certification so as to be able to meet initial demand. This is one of the strategies to avoid the substantial production issues Boeing had in the mid-late 1990s at about the time it shifted to the 737NG.

Image (from Flight, originally from Boeing) shows the 747LCF, a heavily modified version of the 747 that will be used to transport 787 fuselages. Boeing has plans for three such aircraft, to be flown by Evergreen, possibly increasing to four or five depending on how much it increases 787 production rates. Compare with the Airbus Beluga, a highly modified A300 that does a similar job for Airbus.

Second chance: The A350 will arrive on the market two years after the Boeing 787. Can Airbus use that time to hone the new twinjet to outperform its rival?

For Airbus, the A350 is all about catching up, as the A350 is still in the late design process. Can it wring enough performance out of the aircraft to have second-mover advantage?

Potential advantage in going last

Second-mover advantage can work very well, as Airbus knows to its cost. In the early-mid 1990s, Boeing was last to market with the 777, following Airbus with the A340 and McDonnell Douglas with the MD-11. The MD-11 initially looked strong out of the gate, picking up the highly coveted Singapore Airlines order. But McDonnell Douglas shot itself in the foot by failing to deliver on performance promises, causing Singapore Airlines to cancel its order and jump to the A340, something from which the MD-11 never recovered.

The 777 was first delivered (1995) two years behind the A330/A340 (1993 for the A340) family. Although at the time it seemed this might cause Boeing to concede a big part of the DC-10/L-1011 replacement market to McDonnell Douglas and Airbus, the time lag ultimately worked in Boeing's favor. Boeing made the (then) aggressive decision to rely on two engines for a long-range aircraft.

This meant the 777 did not embody the design compromise inherent in the A330/A340. The A330/A340 were initially basically the same aircraft, with the same wing, the A330 having two engines for a short-medium haul mission and the A340 having four engines for a long haul mission -- Airbus wasn't willing to be as aggressive as Boeing, perhaps because the A340 was the first long-haul aircraft Airbus had ever designed. At the time, Airbus (and others) thought that basing two different aircraft on the same fundamental design was clever.

But from the get-go, the A340 was saddled with inefficiencies that come from (1) not being a pure design and (2) having four rather than two engines. The A340 also had somewhat marginal engines. The aircraft was initially projected to use ducted fans based on the IAE V2500, a then-sexy technology (a super-high bypass turbofan). When this didn't pan out, Airbus fell back on the CFM56, which is widely used on the 737 and A320 family aircraft. Unfortunately, the A340's thrust requirements pushed the limit on the capability of the CFM56. At the time, there just wasn't a better engine available.

This means the A340 has never been sprightly getting off the runway and up to cruising altitude. This was one of the issues that Singapore Airlines had with the A340-300, because on routes to Europe the A340 ended up at relatively low altitudes for the first few hours. Lower altitudes tend to be choppier and less pleasant for passengers (there was also some related air traffic control issue, the details of which we forget but may have to do with getting stuck behind slow traffic at lower altitudes). The A340 is also slow.

Meanwhile the 777, as a twin engine aircraft, has never had a problem getting to altitude. This is inherent in a twin-engine design. Aircraft are designed to be able to continue to fly even if they lose an engine on takeoff. Therefore the surplus power in a twin-engine aircraft is inherently greater than in a four-engine aircraft, since a twin engine aircraft has to be able to complete takeoff with half its maximum available power while a quad has to be able to complete takeoff on 3/4 of its maximum available power.

Another consequence of using the CFM56 at the limit of its ability was that it couldn't accommodate further development of the A340. So when Airbus designed the new larger A340-500/600 models, it had to reach for a whole new engine (from Rolls Royce), further reducing commonality between the initial and new versions of the aircraft.

Meanwhile, the more aggressively designed 777 suffered from none of these problems. In fact, it was able to use the newly designed GE90 engine (designed specifically for a long-range twin). All of three engines (from the manufacturers, Rolls, Pratt & Whitney and GE) on the early versions of the 777 had growth capacity, but the new GE90, which had only started to be developed, had by far the greatest potential. The 777-300ER wouldn't be feasible without the enormous thrust (115,000 lbs) that the latest versions of the GE90 can develop (it's also worth noting that the GE90 is the only engine available on the latest 777 versions because GE co-developed the aircraft in exchange for exclusivity).

So, long story short, going second (or in the case of the 777, third) can sometimes be a tremendous advantage.

Will it be an advantage this time?

However, in our view (and we are not engineers) it will be hard for Airbus to leapfrog the 787. The A350 is still fundamentally a derivative. There are now so many design changes from the A330-200 (on which it was initially based) that there's apparently only 5% commonality with the previous aircraft. Still, it's not a clean-sheet design, and in particular it won't have the shiny, new, mostly-composite "plastic fantastic" design that has attracted many 787 customers (of course, if Boeing screws this up, the A350 will suddenly look very good indeed).

Further, the A350 will use the same engines as the 787, so there's no advantage to be had there. Thirdly, as we've said before, the A350 keeps the same old A300 cross-section, with its somewhat claustrophobic low ceiling. Boeing made the same error with the latest 737 -- changed almost everything but kept the old 707/727/737/757 cross section and thereby conceded passenger comfort to the A320 -- and Airbus has been laughing all the way to the bank ever since. The 787 has a high ceiling design, in keeping with Boeing practice.

American Cutting Domestically: It's a Lousy Business

American on its earning call apparently said that it's doing the opposite of Continental, and cutting domestic capacity, according to The Street. American says it must cut its least rewarding flying. American's earnings release is here, for those who are interested.

Quote from Gerard Arpey, American's CEO:

I am very concerned that an industry that is chronically destroying capital is continuing to pour investment into the business, I'm scratching my head over that.

That's indisputable, but so what else is new? This is an industry that is chronically oversupplied with capital, which is a big reason why it consistently destroys it.

There's a laundry list of reasons why the airline industry is a bad business quite apart from capital issues. Some of these include:

• High fixed costs, low variable costs
• Low barriers to entry
• High barriers to exit (hard to kill an airline -- even hopeless Independence Air lingered a good six-twelve months beyond the point where it was clear the situation was hopeless)
• Highly unionized employee groups that have strong leverage in good times
  
• Susceptible to political and economic factors beyond its control (oil, terrorism, etc)
• Fragmented industry -- labor integration issues make mergers between big airlines difficult and therefore rare
• Cross-border ownership restrictions prevent cross-border mergers
• Government interference (some governments think of their airlines as symbols of national virility instead of operators of buses with wings)

Now add to this the fact that many external parties have a vested interest in keeping the airlines going, and therefore find ways of injecting the industry with capital:

Airframe manufacturers routinely supply backstop financing (or supply the junior portion of a 100% aircraft financing) because they want to sell aircraft. How bad do they want to sell aircraft? Airbus loaned the new US Airways $250mm in support of its merger (separate from any new aircraft financing). Both merger partners, the old US Airways and America West, are big Airbus customers. Had the old US Airways failed, it would have released over 100 late model Airbus aircraft onto the market giving Airbus an interest in keeping this customer afloat. In return for the loan, US Airways agreed to become a launch customer for the A350.

Aircraft engine manufacturers also want to sell engines, so they also provide junior financing for aircraft.

Big aircraft lessors like General Electric don't want big customers to go out of business (the aircraft market would be dislocated if hundreds of aircraft hit it at once) so find creative ways to keep clients in business.

Credit card companies don't want the airlines to go out of business. Frequent flyer credit cards are some of the most lucrative credit cards issued. That explains why, for instance, American Express (which issues the Delta credit card) lent Delta money to keep it out of bankruptcy in late 2004, and why Bank One (now part of J.P. Morgan Chase) took a big slice of the loan that kept United afloat in bankruptcy -- it issued United's frequent flyer credit card... Barclays paid US Airways $130mm to become its new frequent flyer card issuer.

And somewhat more esoteric, but the money's just as green:

• The state of Indiana provided interim bankruptcy financing to keep ATA in business.
• The Federal government injected about $4.5 bn into the passenger airlines after 9/11 and another $2bn+ during/after the Iraq War. It also loaned a bunch of money to airlines including US Airways, America West, ATA and Frontier.

Arpey knows this at least as well as anyone. He's not really scratching his head, he's just wishing it would stop. It won't -- the reward for American doing a better job than any of its peers in staying away from bankruptcy is that its peers get reloaded with capital and relieved of many obligations and come right back at American.

In this case, at least, American is acting rationally by drawing down domestic capacity. If only it were always so rational.

Image credit: 1968 American Airlines route map (click above image to see larger version) from AirTimes, a virtual museum of the airline industry. This was shortly after American changed to the livery that it still has -- American's livery is one of the oldest in the world, but still, we think, one of the best. The map also shows how small American was, 38 or so years ago, almost 10 years into the US jet age, with regionally restricted domestic service and international service only to Mexico and Canada.

Experimental feature: Links to US airline earnings releases.

Followup: Hawaiian and Aloha Ready Selves for Mesa

Article about Hawaiian and Aloha improving frequent flyer programs and experimenting with fare cuts in anticipation of Mesa's entry into the inter-island Hawaii market.

Mentions that Hawaii residents

have cut back interisland travel in recent years in favor of more travel to the Mainland

but doesn't mention that's because fares have increased substantially since 9/11 on interisland routes (by up to 40-60% according to figures we've seen).

MaxJet Announces Washington DC to London

Followup on our prior musings on boutique airlines and business-class LCCs.

Business-class LCC MaxJet expands into a second trans Atlantic market (pdf), Washington Dulles airport to London Stansted as of March 15. Existing route to go daily.

Click here for our biggest piece on MaxJet, EOS and the rest, and here for a full list of enplaned MaxJet references.

Alaska Airlines: The Mother of Invention

Interesting article in Seattle P-I about the development of GPS-based precision navigation systems at Alaska Airlines. Two pilots at Alaska took the initiative in developing this system (RNP -- Required Navigation Performance) and now have a company, Naverus, that helps creates RNP paths in/out of airports. The system was first used for landings at Juneau, Alaska, which can be a pretty foggy/cloudy place and which is surrounded by some serious terrain.

There must be something in the water in Alaska's homebase of Seattle, or maybe it's just the presence of nearby Microsoft, but Alaska employees seem to have an entrepreneurial bent. The digEplayer, a hand-held in-flight entertainment device, was developed by an Alaska Airlines employee.

Prior article on Alaska's ramp worker outsourcing woes.

*Sigh* Iberia to Launch LCC?

The Independent (London) is reporting Iberia is to launch an LCC subsidiary. Unclear if it's true -- we don't see it on other media yet. The Spanish carrier has certainly been thinking about it for quite some time. Last year Iberia sold a portion of its stake in GDS Amadeus, and some dreaded Iberia would use the money to invest either in an LCC or in a Latin American carrier. To date we're unaware it's done either.

Iberia is being badly hurt in Europe by LCC competition. Last week it apparently announced a 17% cut in domestic capacity in the face of LCC competition. Curiously, there was a time when ur-LCC Ryanair steered clear of Spain because perceived competition from charter carriers. Then easyJet and Go (remember them? The former British Airways -- BA -- LCC subsidiary) demonstrated Spain was good business. Since then LCCs have piled into Spain. And now back from Spain into Europe, in the form of Vueling (which is partly owned by an investor group lead by JetBlue President/COO Dave Barger) based in Barcelona, where, perhaps not so coincidentally, Iberia apparently wants to put its LCC.

LCCs have dug into the large portion of Northern Europe/Spain traffic that was traditionally flown by charter carriers. We've heard this proportion was as big as 80% at one point. A traditional flag carrier like Iberia could coexist quite well with charter carriers because the products were so different (1 or 2 week package tour including charter flight on the one hand, traditional scheduled airline product on the other).

But throw LCCs into the mix and barriers break down, because LCCs attracts customers from both traditional segments. In fact, LCC pressure is such that most European charter carriers are morphing into part-LCCs through big "seat-only" offerings. For instance, this Airline Business article states that Air Berlin is > 50% seat-only and Thomas Cook (50/50 joint venture between Lufthansa and German retailer Karstadt) is aiming to double the proportion of seat-only business to 40%. Both of Air Berlin and Thomas Cook are substantial operators.

So not only does Iberia suffer from the new LCCs, it also suffers as carriers that once offered a complementary product become competitors.

In general, we think it's a bad idea for a legacy or flag carrier that is under pressure from LCCs to create an LCC subsidiary or division. Empirically it hasn't worked well. There's a long list of failures: Continental Lite, Delta Express, Shuttle by United, MetroJet (US Airways), Zip (Air Canada), Tango (simultaneously Air Canada -- why fail in mono when you could fail in stereo).

Either such an entity is a failure (in which case it was a waste of money) or it's a success. But if it's a success, what then? BA may have made money selling its Go subsidiary. But creating Go put the BA stamp of approval on the LCC business model, increased the amount of LCC competition in the UK and presumably accelerated the degradation of the UK fare environment. Not only that, but media-darling Go must have been somewhat of a distraction to BA during its existence. What does it do to employee morale to see the company invest elsewhere?

In the end, Go simply served to bulk up BA bete noire easyJet (though we're not sure this was a good thing for easyJet). We think legacy carriers should eschew separate LCC operations and concentrate on fixing themselves, which is a hard-enough task when under LCC attack without daydreaming of LCC subsidiaries. For instance, Delta spent a lot of money on the soon-to-be defunct Song that it could have spent on far less glamorous but probably more necessary nuts-and-bolts issues. In the end the Song adventure was an expensive distraction.

And as the Independent article notes, now seems like a particularly inopportune time to establish yet another European LCC, with about 50 of them already out there and a shakeout expected soon. We have a decent amount of respect for Iberia management, which will diminish if it goes through with this.

Continental: Chapter 11 Shoe on Other Foot

FT article (subscription required) reports two takeaways from Continental's earnings today:

• Continental says it's tough to compete with airlines slimming fast in Chapter 11. Oh the irony. One advantage Continental had from the mid 1990s through 9/11 was that two bouts of Chapter 11 (in the early 80s & early 90s) had left it sleeker than its legacy competitors. For instance, Continental already outsourced most heavy maintenance during this period. Now it's playing against other airlines that have gone through the Chapter 11 health spa. Which isn't to take anything away from the superb job Continental has done in avoiding Chapter 11, despite having far fewer resources than American, the only other big legacy major to avoid Chapter 11 this time around.

• Continental pushing back on low-cost carrier interlopers, jacking up planned domestic growth this year from 2.2% to 3.6%. International growth planned for 12.5%. As usual, Continental publishes fairly comprehensive guidance about how it sees the rest of the year. This is the sort of incremental capacity increase/pushback that airline analysts hate. Monkey see, monkey do, and the more monkeys do it, the more capacity there is, the softer pricing becomes (because it's more or less a commodity business).
  

Experimental feature: links to earnings releases.

Airbus 2005 Orders Part Deux

James Wallace has a cross section of media reaction to Airbus’ order announcement. Scott Hamilton has a quick-and-dirty analysis, as usual in pdf form. Here is Airbus’s own Excel spreadsheet of 2005 orders, if anyone feels like doing some slicing and dicing. The FT (subscription) decries a "meaningless numbers game", incorrectly claiming that two weeks ago Boeing claimed it had won. As Kieran Daly of Flight International notes, Boeing was careful not to make any such claims, saying only that it was satisfied with its performance. FI 1, FT nil.

It boils down to this: Airbus sold a tonne of A320 family aircraft (A318, A319, A320, A321) aircraft, especially the A320 itself. It didn’t sell much of anything else except the A330-200 (which competes against and is in our opinion superior to the long-in-the-tooth Boeing 767-300ER, but will itself be put out of business by the A350 & 787).

In particular, Airbus sold only 30 of the A330-300 + A340 aircraft, which are Airbus’s direct competition to the 777. Further, the Airbus A380 megajumbo sold only 20 copies, of which only 10 were passenger, of which 5 were sold to an Indian carrier that has only recently started service. As Scott notes, the 747 outsold the A380 this year by more than 2-to-1. The A350’s issues against the 787 were already well known.

Scott also identifies a Chinese order for 150 A320s as the one that put Airbus over the top. Apparently the firming of this order came earlier than anyone expected. We coincidentally talked to a former Airbus executive today who said that the first year Airbus exceeded Boeing’s orderbook it did so by getting a leasing company to bring forward an order planned for the next year.

Late addition: Flight International article details the remarkable 414 gross orders that Airbus closed in December.

You can’t look at one year’s orders in isolation, but Airbus’s 2005 orderbook does reinforce what we’ve said before – Airbus has a great narrowbody cash cow, but a real headache in the widebody arena. How many A320 orders would Airbus have been willing to forego in 2005 to win the Emirates, Qantas and Cathay Pacific campaigns, all of which ended with the Airbus twin-aisle product being shut out?

As many have noted (including both Scott and the former Airbus executive mentioned above) Airbus’s A340 problem is especially acute because it’s the next biggest aircraft to the A380 and there’s already a wide size gap between these two aircraft (where the 747-8 happens to sit). If the A340 becomes a cipher, that leaves a giant gap between the A350 and the A380, which the 777 and 747-8 will own by default.

A large part of the A380 rationale was to deny Boeing ownership of the one part of the market that it previously monopolized with the 747, so Airbus can’t let the 777 and 747-8 go uncontested. Yet so far Airbus’s solution to this issue, the A340-600E, seems a dollar short (where will Airbus find technology that applied to the A340 makes up the efficiency gap with the 777, but cannot be applied to the 777?) and a day late (Airbus is talking production by 2011, by which time the barn may contain few horses).

So perhaps an all-new aircraft? Where are the engineering resources? More to the point, where’s the money? Theoretically, Airbus can get launch aid from Europe. But coming on top of the A350 and so soon after the A340-500/600 was launched (2002/3) this would almost certainly create a significant political problem because it would be definite proof that Airbus is not subject to the normal consequences of failing in the market.

Links to aircraft pages:
747-8
767
777
787
A320
A330/A340
A350
A380

Image credit: One of Airbus's bigger headaches, the A340-600. Airbus photo via A340.net.

Airbus 2005 Orders: Dog Did My Homework!

There's only one thing more remarkable than not being able to turn in your homework because the dog ate it. That, of course, is when, when all hope seems lost, your dog does your homework for you.

After significantly trailing Boeing after 11 months in terms of 2005 orders, Airbus somehow finishes the year ahead, with 1055 net new orders (the total stood at only 687 at the end of November) vs 1002 for Boeing. Yes, Airbus booked 368 firm orders in December, a number greater than the total for the year earlier in this cycle (Boeing booked 204 in the same month).

Congratulations, Airbus! That sure is some swell dog you have.

But, Airbus concedes, Boeing booked more orders by value (as opposed to number of sales). You can't have everything, apparently. Also, according to the Flight International article, Airbus whiffed on its 2005 A350 target of 200 orders, booking only 172.

Flight says "Just over one week ago EADS co-chief executive Noël Forgeard claimed the manufacturer had reached its target, a claim now attributed to mis-translation." Mistranslation by Flight or by Airbus? Other news sources correctly reported that Airbus had suggested it had missed for the year.

As the Wall St Journal article notes (subscription required), some firm orders are of variable quality. For instance, 100 are by IndiGo, an Indian startup carrier that has yet to start flying. As we mentioned once before, it may be an issue to find a place to fly/park all the aircraft recently ordered by Indian carriers.

Nonetheless, the promise of a bird in the hand is better than none at all.

Bonus linkage:
Airbus press release
Airbus interactive order page
Boeing interactive order page

Image: Standard French Poodle, which of course was historically bred to be a retriever.

Bankruptcy Improves Customer Service?

In the comments section of our recent post on Perverse Incentives/Poor Union Leadership, we noted that some believe that bankruptcy has actually improved customer service at United:

Interestingly, one thing many have said is that the customer facing side of United has gotten a lot better since Ch 11. A lot of employees who formerly had a sense of entitlement got that old-tyme religion -- pilots addressing passengers before they board, stuff like that. Nothing like the prospect of the noose to concentrate the mind, apparently.

And today (barely 24 hours later) there's a piece in the New York Times suggesting this same thing. You read it here first.

US Legacies Have Yet to Order

Scott Hamilton has a geographic analysis (pdf, unfortunately) of Boeing’s 2005 orders (Airbus will report its 2005 totals today). Once you exclude Air Canada and two big US leasing companies (GECAS and ILFC) from the North American totals, the US accounted for only 13.3% of the gross new orders (Scott says the “US” accounts for 16.8%, but it’s clear he means North America, so one must further exclude Air Canada).

Scott says the US amounts to about half the world’s airline market. We’d put it at around/under 40%. Whichever way you look at it, it’s clear that the US isn’t pulling its weight, which isn’t too surprising – the US airline industry as a whole has yet to turn the corner since 9/11.

Some aerospace analysts, in fact, are counting-on/hoping-for a burst of US orders in the last half of this decade to extend the aerospace upcycle. To see why that’s a reasonable hope, consider the fleet of American Airlines. American’s operating fleet as of Sep 30, 2005 (see page 16) included 34 A300-600Rs, 143 757-200s, 74 767-200/300ERs and 354 MD-80s (*).

Given the delivery dates for these aircraft, American will be reasonably looking to retire these aircraft from its fleet starting sometime in the next 5-10 years. We’re not saying that every one of these aircraft will be out of the American fleet within 10 years, but we are saying that it won’t be too much longer than that for most of these aircraft, and for some, like many of the MD-80s, it ideally needs to be closer to 5 years than to 10. The JT8D-200 engines on MD-80s are pretty thirsty relative to more modern engines, for instance, not to mention more noisy.

One possibility is that American does not replace all of these aircraft. American has a lot of wood to chop before it could justify replacement, and it’s nowhere close to being there. For instance, unlike United, US Airways, Delta and Northwest, American hasn’t used Chapter 11 to jettison obligations. It will take quite some time for American to dig its way out and it may be that by the time American is in a position to consider replacement, getting a bit smaller is the rational response.

But even if American doesn’t replace every last aircraft, the volumes will likely be impressive if/when American does order. American will likely get the best pricing available. Airbus and Boeing list prices are, of course, a bad joke – no one pays them, and especially not a prestigious client like American that can order in volume. A discount of 30% from list for a key client like American would not be out of the question.

Even so, we’re talking enormous dollars when American orders. Full replacement of the fleet mentioned above is easily a $30bn proposition (not list prices, actual). The total number of aircraft listed above is far greater than all of Boeing’s production (290 aircraft) in 2005.

To some extent the fleets of other US legacy majors will also need renewal as this decade comes to a close and the next one opens (Continental perhaps least of all, since it replaced almost all its fleet starting in the mid-late 1990s). And that’s why aerospace analysts hope the upcycle will be prolonged by the late recovery of US legacy airlines.

(*) Note, American also has other aircraft – 777-200ERs, 737NGs – that will not require replacement in the next 5-10 years.

Image credit: MD-80 postcard from the airline postcard collection of Bill Demarest -- lots of historic stuff there.

Eurostar Continues to Crush Airlines

Times (London) article on increasing dominance of Eurostar (the under-channel train) on the London to Paris route.

When the route was first initiated, the UK side had only low-speed track. The Eurostar zipped along the French countryside, but meandered through England. High speed rail has been progressively laid on the UK side and by 2007 the Channel Tunnel Rail Link should be completed and high speed track will be ready all the way to a new London terminus at St Pancras station (as opposed to the current station in Waterloo). This will drive travel time down to 2 1/4 hours.

Eurostar grabbed the lion's share of traffic almost from the get-go, simply because it's a lot more productive to spend several hours working on a train than wrestling with the various stages of an air journey during approximately the same period of time. But with every decrease in travel time, Eurostar only gets more attractive.

Unfortunately, as the Times article says, over a decade after starting operations, Eurostar is still not profitable, though it expects to be within a year or two.

If there's anywhere similar service should exist (and be profitable) in the US, it's in the Northeast corridor, especially NYC to Washington DC and NYC to Boston (comparable distances to London to Paris). Amtrak Acela on these routes is a pale shadow of European high speed rail. Air traffic on the Northeast corridor was crushed by 9/11, as people moved to other modes of transport, including Amtrak. Recently, JetBlue has started low cost service from New York JFK airport to Boston. It will be interesting to see whether that changes share between modes significantly.

Amtrak, of course, is not profitable, but it would be interesting to know whether a dedicated Boston-NYC-Washington railroad could be, shorn of Amtrak's mandates to also run trains in places where they don't make sense.

First Sign of Avian Flu Impact?

New York Times article (registration required) wherein a UN official recommends screening flights from affected European areas for people and their belongings. Says there are 80 flights/day arriving into Frankfurt alone from affected areas.

Needless to say, even if no one gets sick, this has the potential to increase expenses and delays, though if the threat is as bad as it's feared, a little prevention is no bad thing.

Boyd on Virgin America

Michael Boyd this week has a take on a potential initial service pattern for Virgin America, based on government filings (if you look at the Boyd link more than a week from today's date, you will need to scroll down the page -- Mike's not yet in the blog age). Appendix 12 of Virgin America's DOT application (pdf) shows an illustrative schedule between unnamed airports.

Boyd takes a stab of guessing what those might be (the image above is the resulting route map), while giving an appropriate caveat that airline plans can and do change. For instance, the original JetBlue application listed many potential mid-range destinations from New York, most of which JetBlue has yet to touch six years after initiating service (this may change now that it's rolling out 100-seat E190 aircraft). The curious thing is that Virgin America does not plan to be very big in any one city -- the illustrative schedule given in the application is diffuse, with eight markets between seven airports (flight times are consistent with transcon routes).

An unusual strategy (Mike correctly notes this could result in higher marketing expense), but airlines are free to change their minds, so this could simply be a head-fake. MaxJet, for instance, talked up the prospect of serving London from Baltimore, but in the end started service from JFK Airport in NYC. Since NYC-London is much the largest trans Atlantic market (and is thus by far the most rational market to consider for an airline planning point-to-point trans Atlantic service), one might reasonably speculate that perhaps MaxJet had NYC in mind all along.

One last comment: Mike, the word you want in reference to Virgin's reputation is not "cache" (a place in which to store things) but "cachet" (prestige).

Liverpool John Lennon Airport: Living the Low Cost Carrier Dream

Small item in FT today (subscription required) saying 2005 Liverpool John Lennon Airport traffic reached 4.4mm, representing growth of 32%. That's what happens when Ryanair and easyJet start competing with each other at a UK provincial airport. Liverpool just needs to hope that neither wins.

Liverpool Airport was one of the greatest beneficiaries of low cost competition in the UK. Growth has been at a compound average of over 20% since 1997. Liverpool has grown in significant part as a low cost alternative to nearby Manchester (which has had relatively sedate compound growth of around 4% since 1997), in much the same way as London Stansted and Luton airports have absorbed much of the low cost-driven growth of London. The initial Liverpool surge in the late 1990s was driven by easyJet, but in the last year or two Ryanair has greatly expanded. easyJet has not backed off, recently basing an eighth aircraft at the airport.

The airport owner/operator, Peel Holdings, is also pretty slick, for instance getting Yoko Ono's approval to name the airport after famous local son John Lennon (including using the tag line from Imagine, "above us only sky" and a John Lennon cartoon/self-portrait). Naming airports after people is nowhere near as prevalent in Europe as it is in the US. Liverpool will have scheduled service to over 45 European airports this summer, almost all of it low cost, an unthinkable variety and volume a decade ago.

Peel is using the same approach with its newest airport, Doncaster Sheffield Robin Hood airport, a converted former military base. The UK is so densely populated that many secondary airports are within easy driving distance of significant populations so attracting good volumes is generally just a matter of securing low cost carrier service. Robin Hood airport, for instance, handled half a million passengers in its first six months of operation.

Previous post on long term effects of low-cost carriers. Previous post on growth of Glasgow Prestwick airport.

A340 Ugliness in WSJ

Significant article today in Wall St Journal (subscription required) summarizing distressing status of Airbus's mid-size twin-aisle long-haul program (A340, A350).

Here's some of the key info (all Airbus stats for 11 months to Nov 2005, because Airbus still hasn't come clean about its 2005 orderbook):

• A340 and A330-300 orders number just 30, 777 orders number 154
• Boeing twin-aisle dominance in 2005 gives it much larger share of value than of numbers of aircraft. CSFB estimates Boeing got 54% of 2005 orders by number, 70% by value.
• Airbus supersalesman John Leahy says that Boeing was resurgent in 2005 because it cut prices. But WSJ notes Tim Clark of Emirates says the 777 is more reliable than the A340 and that the 777 has exceeded all planned performance criteria. Air Canada Chairman Robert Milton says the 777 has considerable economic efficiencies over Airbus models. Air France CFO says that A340s "from the 1990s" (presumably A340-300s, since Air France does not fly the second-generation A340) burns 15-20% more fuel (enplaned comment: holy cow!) than similar vintage 777s.

Airbus's mid-sized long-haul product range doesn't seem to be working, as we've said before. WSJ says Airbus is considering tweaking the products again.

It's hard for us to see Airbus making its money back on the A340-500/600 program. Yes, it was a derivative from the A340-200/300 program, but it involved a heavily modified wing (wing root extension, as opposed to a wing tip extension), new engines, new landing gear and a big weight increase (so a significant number of other components were likely beefed up). And it will be difficult for Airbus to devote more resources to the A340 given all its other commitments. Plus, we kinda doubt there's an economic way to tweak the A340 to make up the performance gap on the 777.

The A340 platform has always been outclassed by the 777. Time for a new platform? Or just wait for the A350?

Credit Where it's Due: Great Lede

As if to demonstrate airline jouralists can nail it, just tonight there's this great lede from an AP article:

For each of its big unions Northwest Airlines Corp. has a big idea, each one so odious to workers that they're threatening a strike that could put it out of business.

Blam, everything you need to know about the situation cleanly and correctly summarized in the first sentence (but remember, "threatening a strike" doesn't mean will strike). Plus, how often do you get to use the word odious? Three cheers for the (uncredited in the above article) AP writer.

Allegedly Aging JetBlue/Approach With Caution

A little dated, but this article on how JetBlue is (allegedly) growing old fast, by Ted Reed at The Street, is an excellent example of bad airline journalism – and not only that, apparently poor airline analysis by people who probably ought to know better.

To be fair, Ted Reed can be pretty decent airline reporter. He wrote the piece we looked at last week on making General Aviation pay its fair share. That was a legitimately good piece of airline journalism, and not too many other reporters are capable of something like that.

But let’s pick apart his article from Jan 6, which we think lacked appropriate perspective. The thesis is that JetBlue is becoming burdened with the problems of old age a lot earlier than people expected. Huh?

OK, JetBlue is about six years old. Last year it grew on an ASM basis over 25%. That’s still deeply in the “rapid growth” arena of mainline (as opposed to regional) airlines. Growth for all prior years was even higher than that.

Growth helps keep airline costs down. Airline wages increase with seniority, so an airline that is growing has entering classes that are each a lot bigger than the one before, so the average seniority of employees is lower, so average wages are lower relative to an airline with the same wage structure but slow or no growth. This is one reason why Southwest, which has been growing at about 10% per year for much of its existence, has a good cost structure.

The polar opposite of JetBlue is the old US Airways, which grew so little (and shrank so much after 9/11) that its junior pilot had over 16 years of seniority at the time of the merger with America West. Since airline seniority scales typically top out at 12 years, that means that every pilot was being paid at top of scale for his/her position.

Growth also makes for happy employees, since there’s a lot of advancement possible. A Southwest pilot, for instance, is likely to be in the left (captain’s) seat a long time before someone at one of the legacy major airlines. More money, more authority, happy camper.

JetBlue is in the superleagues of growth and absent catastrophe, that’s not going to change much soon. So it’s a young carrier and going to stay that way, on average, for a while. So the increased maintenance that JetBlue has on its older aircraft first affects only a small portion of JetBlue’s fleet (i.e. that relatively small proportion of the fleet that is old). Secondly, JetBlue is almost certainly going to start reaping some benefits of scale as its cost centers re-evaluate how they do things (now that the airline has reached significant size). So age (which in a growing airline means bigger size) isn't all bad.

What else afflicts JetBlue as it allegedly hobbles into old age? How about a non-union workforce, which, of course, is unique in the industry (other than SkyWest, which is a regional, not mainline airline). It will always be a challenge to keep it non-union, but it’s generally better than having unions already. What else? Oh yeah, the only US airline with E190s in its fleet. We can’t be certain these will be a success, but judging by how anxious Northwest (for instance) is to get them into its fleet, it looks like competitors are certainly worried about that prospect.

Now, we don’t want anyone to think we’ve drunk the JetBlue Kool-Aid. We haven’t. JetBlue has ordered a boatload of aircraft and it may be challenging to find homes for them all. There are some things JetBlue was probably counting on (for instance, we imagine, the eventual collapse of US Airways) that look a lot more iffy today. We find some statements of JetBlue self-regard (like bringing humanity back to the airline business) to be a little too much.

But… there’s not a competitor in the business that doesn’t wish it had JetBlue’s E190s, JetBlue’s reputation and, to get back to Ted Reed's article, JetBlue’s seniority profile (although we think fewer wish they had JetBlue’s order profile – that’s a lot of airplanes to find a home for, but that’s a revenue issue, not a cost issue).

JetBlue has its problems and some of those problems relate to assimilating growth and the maturity of the airline. But compared to other airlines, JetBlue has high quality problems indeed and that perspective is totally missing from the article. We can’t be certain the analysts quoted in the article are missing this perspective, but at the very least they goofed in not insisting that such perspective be noted, to the extent they spoke to the reporter.

It may be that what they’re actually moaning about is the performance of the stock, which for the last two years hasn’t been great. Maybe that has to do with it no longer being treated like a tech stock – it was a rocketship the first 18 months. If it’s taken these analysts two years to understand the bloom is off that rose, perhaps they should be in another line of work.

Treat all airline journalism and analysis with caution

Here’s our view: anytime you see anything other than a fact reported in an airline article, treat it with great skepticism (and airline journos sometimes get facts wrong too). The number of good airline reporters is small. The Wall St Journal does a good job, the Financial Times is generally reliable. The latest NYTimes airline reporter looks like he is better than the previous person (but that’s saying a lot less than it should). There is the occasional reporter in the other US newspapers who is good (we mentioned Don Phillips last week). Most are easily led astray. We’ll leave the trade press out of it for now.

This is not too surprising. There’s little money in the airline business, so not only is there a brain drain from the business, there’s hardly a great attraction for truly talented people to keep track of it either.

For the same reason, treat analyst statements with skepticism. There are a lot of analysts who shouldn’t be. We think some of the more reliable Wall St analysts include Gary Chase of Lehman, Doug Runte at Morgan Stanley, Jamie “Mr Bombast” Baker at JP Morgan and David Strine of Bear Stearns. Signs of a good analyst include having a clear opinion, with appropriate caveats following close behind (“We think X, Y and Z will happen, but here’s what could result in a different outcome”). Temporizing is a bad sign (but saying “I’ll give you a definitive answer later once I’ve had a chance to review the data” is legitimate in the face of significant new information), so is changing one’s mind at the drop of a hat or agreeing with whoever is in the room at the moment.

Oh, very important: good analysts acknowledge past mistakes. What they do is hard -- predicting the future. That results in mistakes and good analysts learn from them and acknowledge them to others.

And, it goes without saying, almost everything you find on the web about the airlines warrants extreme skepticism. That obviously includes this. Heh.

Image credit: Nice picture of one of JetBlue's new E190s from (oo la la) avions de ligne. The circular bump on the top of the fuselage (behind the wing) is the satellite TV antenna.

Perverse Incentives/Poor Union Leadership

Article in the Denver Post worth reading for some excerpts from an internal United memo about how to sell management incentives included in the plan of re-organization. Also reminded us of a couple of important points (or at least, points we think are important):

Perverse incentives undermine the system and confidence therein. Giving management a stake in a restructured company may be standard operating procedure, but creates perverse incentives when it's the same management that took the company into bankruptcy.

Management has a fiduciary duty to shareholders, in which capacity it's presumed to want to keep a company out of bankruptcy (since bankruptcy is generally really bad for equity) -- at least right up until the company is close to bankruptcy (in the "zone of insolvency") at which point management is obligated to stop maximizing shareholder value and works instead to maximize enterprise value (i.e. the total value of the company).

But there's a pretty obvious conflict of interest if the same management that's supposed to want to keep an airline out of bankruptcy can benefit from taking it into bankruptcy. And without saying that top United management took the company bankrupt to line its own pockets, it's also true that top United pre-bankruptcy management pockets will be lined by having gone through bankruptcy. That is a perverse incentive, one that undermines the system (if only by undermining confidence in the system).

There are solutions: for instance, legislate that no top pre-bankruptcy management can benefit from distributions at reorganization. It's crude and would have disadvantages as well as advantages -- it's a significant disincentive to remain at the company for those pre-bankruptcy managers who were blameless in the bankruptcy and could make significant contributions to the reorganization.

That said, we'd probably still be in favor of something like this, because it's quite rare that anyone is truly indispensable to a re-org process. Current United management, for instance, is not on anyone's list of the top airline managers, yet still got its way through the process. In our view such managment disincentives are a relatively small risk to take relative to the benefit of eliminating a perverse systemic incentive that brings disrepute to the system.

Just to emphasize: we're not arguing to get rid of incentives, we're just saying those incentives shouldn't be available to top management that was at the company at the time it filed.

Whether or not Glenn Tilton or Robert Milton (CEO of Air Canada -- a non-US example) is to blame for having put his respective airline into bankruptcy, it is unseemly that each of these gentlemen benefit from it to the extent they will or have. It makes the bankruptcy process look like a scam, whether or not it is, and thereby undermines confidence in our economic system. Had there been laws that prevented them from reaping big rewards from bankruptcy they might not have stayed at their companies through bankruptcy, but it's doubtful this would have prevented United or Air Canada from re-organizing.

Another solution might simply be that management of a bankrupt company can't propose the plan of reorganization -- i.e. bankruptcy management is in a caretaker position, and therefore isn't in a position to propose giving itself a lot of money in a re-org. Anyone wonder why there's no private equity involved in the United re-organization? Any credible private equity stumping up any meaningful amount of re-org equity would want management control -- and that might not include hiring Glenn Tilton & Co. It's not like Glenn's the best available. Greg Brenneman (former Continental COO) is out there, Gordon Bethune (former Continental CEO) is out there, Doug Parker is out there (well, he's busy, but there's a price for everything)... United's bankruptcy process hasn't had a remotely optimal outcome.

Low quality of airline union leadership. Airline managements are blessed by the poor quality of some of the union leaders. The United flight attendant leader is quoted, referring to the management bonuses embedded within United Airlines' plan of reorganization:

In medieval times, people guilty of this kind of greed would have been boiled in oil.

No, people guilty of that kind of greed in medieval times were called knights, lords, princes and kings. To mix metaphors, the top dogs of medieval times showed no compunction about awarding themselves the lion's share, and then some. If anything, what's happening today is a return to that age, not something distinct from it.

OK, so it's a minor example of the less-than-stellar intellect of some of the airline labor leadership. The United flight attendant union has talked a big game throughout United's bankruptcy, but has lost essentially every important battle (which, to be fair, is what you'd expect: the flight attendants have some of the worst leverage of any airline labor group. So what should they have done? Pick their spots, educate their membership on what was achievable and build some credibility). It's another example of the ineffective "bluster and carry a small stick" phenomenon that's prevalent in this industry.

And also to be fair, they're not the worst. That would probably be the Northwest mechanics union, AMFA, which tried to teach Northwest a lesson last year and has essentially been thrown off the property, probably the most comprehensive airline union defeat since Frank Lorenzo broke the Continental pilot's union in the early 1980s.

Self-serving managements and poor union leadership. It's a great combination.

Image credit: 1936 United logo from www.airtimes.com.

Taking Apart Some Misconceptions

A comment to the recent Virgin America post included a rich seam of what we view as some major misconceptions. We don't want to discourage questions, but these were statements, not questions, and we don't want other readers to believe they're true, at least not without considering why they might be wrong.

Virgin America isn't going to be competing with Southwest or even United. They are here to take on JetBlue and Frontier. These low cost carriers offer things that SWA doesn't offer. TV on-demand, assigned seating, and that feeling of flying a 'hip' airline.

It's a largely a commodity business. Airlines have to have pretty widely separated products (e.g. economy class vs first class) before they genuinely start to not compete. Virgin America will almost certainly compete with United out of San Francisco (if that's where Virgin America chooses to fly). Frontier is absolutely competing with Southwest at Denver, for instance. Just ask them. As we've mentioned before, JetBlue has carefully avoided serving the same nonstop markets as Southwest, hip image, seat-back TVs and assigned seating notwithstanding.

United is too heavly entrenched at SFO to even feel a pinch. They may have to lower fares a bit or run special fares on dates but nothing that will hurt numbers too seriously for United at SFO.

If Virgin America launches significant service at SFO (San Francisco Intl Airport), United will absolutely feel it (they certainly felt Independence Air at Washington Dulles) and that's why it will almost certainly retaliate sharply.

However, JetBlue may have to become more competitve on their trans-continent because JetBlue has no code shares and Virgin America will likely code share with Virgin Atlantic making a flight from LA to London via NYC much easier than having to change airlines and tickets and rebook bags.

Assuming Virgin America serves the transcon routes and assuming it codeshares with Virgin Atlantic, what sort of traffic will fly West Coast-NY-London on a Virgin America/Atlantic connection instead of getting a nonstop West Coast-London? Right, junk traffic, the lowest of the low yield. Anyone who at all values their time will take a nonstop. So, how significant is such traffic likely to be to Virgin America's success relative to JetBlue? Right, not very.

As a previous commenter stated, Airlines don't make their money on fares but rather cargo. I am sure VA is trying to ink some good deals in order to make money quickly.

The statement in the comments appeared to refer to the success of the freight business vs passenger airlines, and it's unclear whether that's really true for air freight once you strip out the likes of Fedex and UPS, which have huge barriers to entry to their business and where air is but one (important) component. Atlas/Polar went through bankruptcy this downturn, for instance. Kitty Hawk and others have been through bankruptcy before. But for the sake of argument let's assume it's true.

Doesn't follow, or even make much sense, that the freight component of a passenger carrier's business is where it "makes money". There wouldn't be freight space to sell unless there were passenger seats being sold. The only thing matters is whether the plane generates enough revenue to cover costs, whether revenue is from premium class, economy class, freight, ticket change fees, buy-on-board/ancillary products/services (a big revenue contributor in the case of Ryanair and easyJet) or whatever. You tune the mix to optimize revenue. That legacy majors (for instance) sell all of freight, premium seats and economy seats strongly suggests they need to sell all three of these things to make money (or minimize losses).

Also worth noting: belly cargo capacity of a narrowbody (such as the A320s that Virgin America has ordered) is relatively modest and therefore cargo is not generally a big factor in passenger narrowbody operations (certainly much less so than widebody).

Also, a majority of international arrivals and departures are coming from the big west and east coast cities. Boston, NYC region, DC, Atlanta, Miami, LA, SFO, and Seattle. Although quite a few international flights come into Dallas, Chicago, and Minneapolis, still a vast majority come into the US via the big coastal cities. Thus making VA's trans-continental decision a wise one and making SFO a very wise location

Again, no one ever got rich supplying part of a connection unless they had the lowest costs. Read our post on why BA has pulled out of most non non-stop markets from London to understand why. It's worse for an off-line connection (connecting from airline A to airline B rather than airline A to airline A) because it generally means more inconvenience.

If any airline was going to make money from the suggest strategy, it would be JetBlue, which now has by far the biggest domestic system at JFK airport in NYC (see image above). There are many small, unaligned (no alliance link) international carriers that have JFK as the sole US port of entry -- like AeroSvit or Bangladesh Biman, to pick two examples just in first two letters of the alphabet in the JFK listing. But the JetBlue doctrine is clear: no foreign entanglements (apologies to James Monroe). JetBlue doesn't do connections with other carriers. So how significant a factor do we think such traffic might be to the success of Virgin America at SFO? Right, not very.

Virgin America Mystery/Airline Brain Drain

Stories about Virgin America signing a lease for a HQ in Burlingame, CA, just south of San Francisco Intl Airport (SFO). Says the Virgin VP Airports:

The new jobs created by Virgin America will represent a significant economic boom to the Bay Area, which is a rich talent pool filled with energetic, creative people we'll need to create the new airline.

Hmmm. It's not impossible to HQ a low-cost carrier (LCC) in a high cost area. JetBlue is based in Southern Connecticut (executive HQ) and Forest Hills, NY (operational HQ) (CEO David Neeleman appears to prefer to raise his many children in bucolic Connecticut rather than Queens). It's the right move for an airline that so closely identifies itself with NYC. Maintaining that hip New York image while based in, say, Salt Lake City, would be difficult.

If Virgin America plans on identifying itself strongly with the Bay Area, then having an HQ there might make sense too, though it's very expensive. But unlike the New York airports before JetBlue (and we're not including Newark here), the Bay Area airports do have clearly dominant players, and its hard to see any startup coming to dominate SFO (or another Bay Area airport) the way JetBlue is coming to dominate JFK airport in New York.

Going up against United at SFO doesn't seem like a smart move:

• United just finished beating the **** out of Independence Air at Washington Dulles, an airport that is far less important to United than SFO. One has to expect a withering response from United if Virgin America messes with SFO.
  
• One of the few interesting moves United has managed during its wretched three-year bankruptcy is United p.s., its premium trancon service (there's a front page Wall St Journal article on this today, subscription required). So United's probably the least vulnerable legacy US carrier on that front.
  

Going up against Southwest at Oakland or San Jose seems like a bad move too, though at least Southwest doesn't compete in the premium sector.

So why it makes sense for Virgin America to be based in the Bay Area remains a mystery.

But... (enplaned segue alert) the Virgin America statement above ties in to something else that broke this week, namely the conflict over American's executive bonus incentive program, which is scheduled to pay some American executives (but not the CEO) some large bonuses, despite the fact that American parent AMR will turn in a large loss for 2005. Executive VP Dan Garton, for instance, will receive $1.7mm, which is hard for line employees to accept, given the airline is not yet making money. Texas columnists came down on both sides of the story, pro & anti management.

So what's this got to do with the Virgin America statement above? A serious issue in this industry is finding and keeping talented people. The airlines have lost a ton of money over the past five years, and that's translated to reduced wages. The ones we hear about the most are line employees: flight attendants, ramp workers, mechanics, customer service reps and most of all, pilots. Yes, they've all suffered terribly, but that's not our point, not this time.

The issue is salaried and management employees. It turns out there's a limited number of people who are (1) competent and (2) so fascinated by the airline business that they're willing to work for significantly less just to get their daily fix. Airlines are already a backwater. If you're a bright young thing on the make your first thought is not "airlines". Since 9/11 a lot of talent has drained from a business that wasn't overrun with it to start with. And we firmly believe it's more efficient to pay above market wages to fewer really bright employees than pay average salaries to a greater number of mediocre employees. Unfortunately, we don't think that's ever been the philosophy of the airlines.

At some point good people need to get paid to stay in the airline business (and we're not defending this particular American Airlines bonus scheme, which at the very least seems to have been ill designed). The problem is how you square that with keeping line employees on-side. A pilot who's just taken a 30% paycut is not going to like it if a middle manager gets a wage increase. It may be true the market for competent middle managers is a lot stronger than the market for airline pilots, but it's still going to anger the pilot, which can have consequences.

That's the sort of tough problem you wish you had a few really bright managers to solve.

Pretending There's No Alternative To Raising Fare Caps

Decent article on the one-year anniversary of Delta's fare caps contains the following questionable statement:

American executives had worried that with the lower cap, some flights could end up completely sold out well before the day of departure, forcing some corporate fliers to turn to other carriers on last-minute trips.

This in itself is a very poor excuse to raise the fare cap (which is what American did). If an airline finds itself running out of last minute (we prefer the term "walk up") seats, it can do one of two things:

• Reduce the number of seats sold in advance at lower prices
• Increase walk-up fares

Both will increase revenues. Now, it may be that profits are maximized by doing the latter, not the former. But it's disingenous to pretend there's no alternative to increasing the fare cap, though it certainly sounds better than admitting that heck, we're going to keep fares high because, well, we can. Not that there's anything wrong with that per se. It's a free market, companies can set prices as they wish. Just don't pretend that you're being forced into doing something you want to do.

When you get right down to it, the legacy majors still can't let go of those steeply ramped fare curves. They're getting better,but the average ratio of highest to lowest fares on a given route is still a lot higher for the legacy majors than it is for a low cost carrier (LCC) like Southwest.

[At least in the US that is. In Europe the LCCs have very steeply pitched fare curves (a lot of which has to do with the penchant for selling a certain number of extremely low, even "free" -- net of taxes -- fares). This gets back to European LCCs not being business-friendly. US LCCs probably give last minute travelers a better deal than European LCCs, especially when you consider that Southwest and JetBlue have several inches more legroom than the typical Euro LCC.]

Bluster and Wave a Big Stick

One thing that's worth remembering (and which we should have pointed out in a couple of places already, but didn't) is that "bluster and wave a big stick" (sorry, Teddy) is standard operating procedure in the airline business especially when simple negotiation isn't getting you what you want.

So, for instance, Continental has told ExpressJet that it's going to pull 69 regional jets (RJs) from the ExpressJet contract with Continental. As we said before, we think Continental has good reasons to pull RJs from ExpressJet (don't put all your eggs in one basket) apart from those stated (cost). But always remember there's a price for everything, and this could just be a gambit to get a lower price from ExpressJet. As it happens, we don't think so in this case given that there are those good strategic reasons (those eggs in one basket) to put RJs elsewhere.

Perhaps somewhat more likely is Northwest & Mesaba. As we posted here before, Northwest has said it will pull all its ARJ-85 RJs from Mesaba, cutting Mesaba's business with Northwest at least in half. But at the same time, Mesaba has been after its own pilots to cut costs (and Mesaba pilots are not paid overly well to start with). Further, Northwest once before threatened to pull the ARJs from Mesaba's fleet (Winter/Spring 2003/2004). Moreover, there's no better way for Northwest to get a really great deal from its ARJ financiers than to say it's going to ground them (there's not a great used market for these aircraft).

Oh wait, you financiers say you'll let me keep the aircraft at a really good price? Oh, and you pilots say you'll fly the aircraft for less? Well, twist our arms, perhaps we can keep these things in the system after all.

Perhaps. Yet at the same time, if Northwest succeeds in outsourcing aircraft up to 100 seats, there's much less reason to keep the old-fashioned Mesaba ARJ-85s, at least long term (though perhaps they might feature as part of a bridge to a new regime).

By the way, bluster and carry a big stick should not be confused with the other, much less effective, strategy, "bluster and wave a small stick", which is also prevalent through the business. See, for instance, American's wholly irrational and ultimately ineffective reaction to JetBlue at Long Beach.

Spirit Snacks -- Don't Leave Home Without Your Credit Card

Kinda odd. Spirit Airlines (not to be confused with Spirit AeroSystems) will only sell you snacks if you have a credit or debit card "for your convenience".

Without being too snarky about this, our impression of Spirit is that it likely has a higher proportion of customers without credit cards than some other airlines. And given its Caribbean strategy, we'd imagine the proportion of such passengers will only increase. What are these folks supposed to do, go hungry?

Fun fact: Spirit President & COO B. Ben Baldanza is a serious gamer. Do a google search for Ben Baldanza and you'll find his name all over the gaming sites (leading one to wonder when he has time for airlines). Traditional games, that is, not Doom, Quake and the like. And yes, it's the same guy, the pictures from the airlines sites match the pictures from the gaming sites. Apparently we should have kept playing Dungeons & Dragons.

Airbus: A320 Replacement Not Until 2015

Via MRO Wire, Reuters report with the CEO of Airbus correcting the "mistaken" impression left by the CEO of parent EADS that Airbus was working on an A320 replacement. See our earlier post.

The A320 is selling very well indeed for an airplane that is almost 20 years old. Given the issues Airbus is having with its widebody range, putting a question mark over the cashcow A320 program is the last thing Airbus needs.

So, new Boeing narrowbody in 2013-2015 range, new Airbus narrowbody by 2015.

Who Dares, Wins: SkyWest Takes Delta For Everything It's Got (Long)

By now, readers may be tired of us banging on about how it sucks to be a regional airline, however much they may (or may not) be convinced. There’s an exception to this, however, that’s worth studying, namely SkyWest. This didn't happen yesterday, this happened last fall, but few people seem to fully appreciate what SkyWest achieved, especially since it happened so quietly (which may have been the point).

SkyWest was a pre-9/11 regional darling, with good juicy contracts with both United and Delta, both for 50-seat RJs and turboprops. Both of these airlines subsequently entered Chapter 11 bankruptcy, United in Dec 2002 and Delta in Sep 2005. The 50-seat RJ is yesterday’s news and turboprops were largely unwanted even before 9/11. Those bare facts would strongly suggest that by now, SkyWest would be a pale shadow of what it was. But it’s not. SkyWest is an example of how management can make a difference even when dealt a poor hand.

For instance, SkyWest was one of three pre-9/11 United regional partners. The other two were ACA (which became Independence Air, which recently winked out of existence) and Air Wisconsin, which despite its loyalty to United was unceremoniously dumped last year and had to buy its way (through a $125mm investment) into a contract with US Airways (this worked out in the end, but it looked pretty dubious at the time). SkyWest is the only United Express survivor, and now does much more for United than it did, including flying 70-seat RJs.

SkyWest has done a great job of capitalizing on the misfortunes of others. United was left in the lurch when ACA refused to renegotiate its deal after United filed Chapter 11. At the time, ACA flew about 50% of United’s regional jet capacity. United therefore (1) wanted to show that it could come to agreement with at least one of its regionals (i.e. the fault was that of ACA, not United) and (2) was thus not inclined to bargain for every last dollar when SkyWest offered to help United. SkyWest did well by helping United in its hour of need.

But that’s nothing compared to what SkyWest accomplished in the case of the Delta bankruptcy. What happened there was truly daring, perhaps the greatest coup of this downturn. In the weeks after Delta filed Chapter 11, SkyWest management secured hundreds of millions of dollars of value for their company from beneath the eyes of the bankruptcy court and Delta’s creditors, who didn’t seem to notice.

A More Dangerous Bankruptcy than United

SkyWest stood to lose a lot in the Delta bankruptcy, arguably significantly more than it lost in the United Ch 11 renegotiation. The reason is that in the meantime the 50-seat RJ market had softened considerably. As we previously discussed, the market for 50-seat RJs was never as strong as it was when ACA was pulling theirs from United. From then on, it’s been in steady decline, as relaxed scope clauses meant that legacy majors could focus on larger RJs and as Independence Air slowly collapsed.

Further, a Delta Ch 11 filing (which was widely anticipated in summer 2005) was itself likely to be the worst blow to ever hit the 50-seat RJ market because Delta was (and is) by far the largest employer of 50-seat RJs and (in summer 2005) had two regional subsidiaries, ASA (not to be confused with ACA) and Comair that between them owned or leased over 200 50-seaters. As we’ve discussed before, an airline in Ch 11 can mark-to-market its aircraft leases and loans, and with such a dominant position in the RJ market, Delta could do severe damage 50-seat RJ values in Ch 11.

This stood to be particularly dangerous to those airlines, like SkyWest, that had long-term obligations for 50-seat RJs, because they stood to be squeezed between their own static aircraft ownership payments and reduced RJ contract rates.

Aircraft ownership (aircraft rent or aircraft depreciation plus aircraft finance interest) is about 25% of the costs of a typical regional airline. Suppose post-Delta bankruptcy lease rates for 50-seat RJs dropped by 25%. That would mean the cost of providing 50-seat RJ lift under a new contract using newly-leased aircraft would drop by 6.25% (= 25% times 25%). That would mean that Delta would want to reduce its regional airline contracts (not its aircraft leases, but the contracts it had with SkyWest and other regional airlines for 50-seat RJ lift) by at least 6.25%, because an airline in Chapter 11 will seek to mark-to-market all its contracts, not just leases.

But that’s a huge problem for an airline like SkyWest with long-term RJ obligations. SkyWest isn’t in bankruptcy, it doesn’t get to mark-to-market its own RJ leases, yet Delta would get to (try to) mark-to-market the RJ contracts it had with SkyWest. In other words, SkyWest faced significant revenue reduction from a Delta bankruptcy without offsetting expense reduction. Since in round-figures, SkyWest’s operating margins are about 10% on such flying, cutting 6.25 percentage points amounts to approximately a 60% reduction in operating profit on flying 50-seat RJs. Reminder: this is just an example to demonstrate the scale of the issue that SkyWest potentially faced.

Doubling Down

SkyWest did something unexpected. In August 2005, prior to Delta bankruptcy, SkyWest bought ASA from Delta. On the face of it, this was sheer lunacy. ASA flies 100% for Delta, mostly 50-seat RJs. ASA has value as a regional airline only to the extent it has a contract with Delta. Any such contract can be rejected by Delta the minute Delta hits bankruptcy. With Delta facing imminent bankruptcy, SkyWest was essentially doubling down on what already looked to be a loser bet, including taking responsibility for almost all existing ASA aircraft finance obligations (Delta did keep responsibility for 40 such ASA aircraft financings, subleasing these aircraft to ASA instead).

The terms were interesting. SkyWest was to pay $350mm cash up front ($20mm representing aircraft purchase deposits that ASA had already made) and then $125mm cash in additional payment ($30mm representing aircraft deposits) to be made should a bankrupt Delta assume the SkyWest and ASA RJ contracts untouched (or after four years, whichever came first).

If you knew Delta would escape bankruptcy (or, if for some reason you knew that Delta would assume its ASA contract in Chapter 11) then $425mm (= $350mm + $125mm -$20mm - $30mm) was likely a bargain price for an airline the size of ASA (over $1bn in yearly revenues, and presumably an operating margin not dissimilar to that of SkyWest). But if Delta filed Ch 11 and rejected its ASA contract, then ASA was worth, well, potentially very little.

An Unpersuasive Sweetener

What about that sweetener of $125mm ($95mm net of the aircraft deposit amount) that Delta would get if it affirmed SkyWest’s and ASA’s contract in Chapter 11? Couldn’t that be inducement enough for Delta to want to affirm the ASA and SkyWest contracts?

Not hardly. We’ll give an example in round terms. We’re not saying these would have been the actual figures, we’re saying here are some plausible figures that show the order of magnitude of what was at risk.

We’ve already discussed how the reduction in 50-seat RJ values post a Delta bankruptcy would feed through to a reduction in 50-seat RJ contract rates. We think that a reduction in 50-seat RJ contract rates of around 10% is well within the realm of possibility, between the drop in 50-seat RJ rents and other reductions that Delta would demand.

In round figures, between ASA and SkyWest, Delta was probably paying over $1 billion for 50-seat RJ lift. So the potential savings to Delta of crushing ASA and SkyWest contract rates after a bankruptcy was in the $100mm range (10% of $1 bn/year – nice round numbers). Perhaps it was only $50mm, perhaps it was more than $100mm, this is only to establish an order of magnitude. That’s an annual savings.

Stack that up against the one-time $95mm figure and you can plainly see that there’s an excellent argument to be made that in bankruptcy the economically rational thing was for Delta to tear up its agreements with ASA and SkyWest, because the recurring savings from doing so was more valuable than the one time additional payment of $95mm it would get for assuming the contracts.

[Some will say that regardless of legalities, it seems awfully unfair that Delta could ever do such a thing. But that’s how bankruptcy law works, and it’s designed to do so to make sure that all creditors in a similar position get equally screwed. Just because Delta happened to enter its agreement with SkyWest only weeks before it ultimately filed doesn’t mean, legally (as we understand it, and we are, thank heavens, not lawyers) that SkyWest is any more entitled to having its agreements assumed than any other party.]SkyWest Walks Away Unharmed

That’s not what happened. Delta did go bankrupt, and weeks later, it did assume both the ASA and SkyWest contracts. In effect, the capitalized value of the foregone potential savings (again, likely on the scale of $100mm per year) were thus transferred from Delta to SkyWest for a payment of $95mm. SkyWest’s apparently massive gamble paid off big time, and it acquired ASA for $425mm plus neither the ASA nor SkyWest contract was molested. Awesome, incredible deal. Gigantic value transfer/preservation by SkyWest.

Why did this happen, and moreover, why did creditors permit it to happen? We don’t know for sure, but here's one possibility (and we’d love to know more details because we’re almost certainly wrong about something).

Delta was in dire straits when SkyWest entered the agreement to buy ASA. In August 2005, Delta’s credit card processing agreement expired and its processor required a massive deposit from Delta to continue to run Delta’s credit card purchases. Clearly an airline has no ability to stay in business if it can’t charge customer credit cards, which was at stake. Delta needed to raise money, and it needed to raise money fast. This almost certainly motivated the sale of ASA at that time.

That still doesn’t explain why Delta didn’t turn around and screw SkyWest (as its creditors would have wanted it to if they understood what was happening, see below) the minute Delta went bankrupt. The only thing we can think of is that there was a gentlemen’s agreement between Delta and SkyWest managements that the minute Delta went Ch 11, it would seek to assume the ASA and SkyWest agreements, because that’s what happened.

Sounds really unlikely, doesn’t it? Managements of big companies are supposed to do the economically rational thing. But we are unpersuaded by other explanations. We are pretty certain that Delta was exceptionally desperate to raise money at the time it sold ASA to SkyWest. Nor do we believe, for instance, that the additional $125mm that SkyWest then paid Delta in bankruptcy was desperately needed cash that was couldn’t be found any other way. Delta stood to gain a lot from renegotiating its 50-seat RJ deals with SkyWest and ASA, and there was no reasonable alternative for ASA and SkyWest to keeping its 50-seat RJs employed at Delta, so we don’t believe SkyWest and ASA could have credibly threatened to take their RJs elsewhere – though we don’t rule out the possibility that Delta management could have been conned into thinking so.

You could have probably designed a security to give Delta $125mm in exchange for paying back investors from the ASA/SkyWest contract savings (there are a lot of hedge funds that follow the airline business closely which might well have been interested). Even if that were not possible, Delta was in a position to obtain the last $125mm payment from SkyWest at any time by assuming the ASA and SkyWest contracts. Having the right to get $125mm at short notice is almost as good as having the $125 then and there, so there was no reason for Delta to assume the ASA/SkyWest contracts immediately. Finance 101: don't exercise your options early.

The other striking thing was how simple it was for Delta to get the assumption of these contracts past the bankruptcy court. There are no objections in the court docket, although both US Airways and United renegotiated their regional airline contracts for significant savings (and Northwest is in the midst of wreaking havoc with its unfortunate regional partners). Had the court understood this, we doubt it would have permitted the SkyWest and ASA contracts to be assumed so easily.

The motion itself (pdf) is brief, as if the request was routine (whereas it was anything but). It cites as supporting reasons only getting Delta's hands on the $125mm and the need to maintain SkyWest/ASA's services. But vendors have no ability to withdraw services until the bankrupt company rejects a contract, and if regional service is so important, why did Delta fail to affirm its regional contracts with Republic/Chautauqua and Mesa?

But it turns out that it’s easy to assume contracts in the early days of a bankruptcy. The judge is new to the case, the creditor committees are not fully formed and are thus not perhaps as alert as they should be. Apparently no one with standing (the right to be heard by the judge – you can’t just walk off the street and object to something that Delta wants to do) objected that what Delta wanted to do was at odds with precedent. No one so much as argued for a delay. We bet that's the way it was designed to be. Slide it through before anyone's in a position to argue.

[There’s also a structural issue with creditor committees – they’re often stacked with folks with no desire to anger the management, like manufacturers. Does a manufacturer really want to anger someone who may be in a position a few years hence, to order airplanes (perhaps at this airline, perhaps at another)?]

Sitting Pretty

Whatever the exact reasons, whether you think SkyWest cut a gentlemen's agreement that Delta hurried past the judge, or whether it convinced Delta that it, SkyWest, had a gun to Delta's head, the fact of the matter is that SkyWest pulled off a tremendous coup. It's now a monstrous regional airline, by far the largest, and with Delta contracts that go for 15 years. Skywest stock is now trading at levels last seen shortly before and after 9/11 and a market cap 2.5 times that of the next highest regional.

This doesn’t mean everything is peaches and cream for SkyWest. Delta's not out of bankruptcy yet, and there's a (probably remote) chance that it could liquidate rather than restructure. ASA’s pilots have been negotiating a new pilot agreement for years, and are unhappy about it. SkyWest’s pilots are non-union, but unhappy about their pay and may not stay non union. And the fact that SkyWest has maintained the integrity of its Delta contracts will be used by ASA/SkyWest employees as a reason for to pay them more. But these are high quality problems to have relative to other regionals.

Further, at some point SkyWest will have to pay the piper. Contracts (even the 15-year ones it has with Delta) aren’t forever – Delta could always go bankrupt again, for instance. So in the long run, SkyWest has the same problems as everyone else. But as Keynes said, in the long run we’re all dead, what matters is the immediate future, and for SkyWest, that is bright indeed, compared to its peers.

Bonus Linkage:
Sale agreement for ASA from Delta to SkyWest
SkyWest regional jet contract with Delta
ASA regional jet contract with Delta
(unfortunately, some of this is heavily redacted, but if you want to see a contract between a regional airline and a major airline, here you go. Most other regional airline contracts are available as part of various Edgar filings, if you poke around long enough, but most economic terms are redacted)

Jeffrey Shane: Liberalization Hero

Jeffrey Shane is a US Under Secretary of Transportation who has been involved with liberalizing international air transport for the better part of three decades, during which time it's evolved from a highly-restrictive set of bilateral agreements between countries (specifying how much service by how many airlines and even fares and service levels and aircraft types) to the current system which is generally based on Open Skies agreements that generally permit unlimited service at unrestricted fare levels between countries (unfortunately there are still many exceptions). Shane was recently instrumental in the recent further trans Atlantic liberalization that is still pending.

Good article about Shane in the International Herald Tribune by the dean of airline reporters, Don Phillips. It's good to know that the government includes some competent individuals.

The article references a speech Shane made about a month ago, looking back at liberalizaton since the 1970s and where we are today. Recommended reading. We've come a long way.

It's interesting to note the list of primary US international carriers in the 1970s that he gives in the speech: Pan Am, TWA, Northwest, Braniff and (on the freight side) Flying Tiger. Except for Northwest, they're now all gone: Pan Am liquidated, TWA bought by American (after its third bankruptcy), Braniff liquidated, Flying Tiger sold to FedEx.

That's not a criticism of liberalization but rather an indication of how protected these carriers were by the prior restrictive regime and how unable they were to make the adapt to a competitive world. It was well understood at the time of American domestic deregulation (1979) that the traditional champions would find it hard to adjust. Protection makes companies weak. Pan Am seemed like a mighty carrier, but it was a hot-house plant. Once the protectionist greenhouse was dismantled, it withered and died.

Which is why the true measure of the success of government policy is not what it does for producers (like the airlines) but what it does for the consumers (the passengers). And by measure liberalization has been a stunning success. Air travel has only gotten cheaper and more prevalent over time. Shane can take great satisfaction from that.

Email Address Available/Trivia Question

jt9d17r at yahoo dot com (see also profile). We won't print anything without your agreement, unless you're egregiously abusive.

Yes, we know there's no such thing as a JT9D17R.

Trivia question: why is it wrong and what should it be? Be the first one to say so in the comment section and award yourself a prize.

Recurring Issue w/Bloglines & Atom Feeds

Readers using Atom and Bloglines may notice, as we do, that Bloglines fails to update the Atom feeds in a timely manner, claiming an error in the feed (but other readers, e.g. Firefox Sage or Google Lens are OK with the Atom feeds).

Until we figure this out, we suggest Bloglines readers use the Feedburner (RSS 2.0) feed. Bloglines seems to have the least problem with that, at least for now.

New World Carrier: Silly Name, Interesting Thought/Where Are Europe's High Touch LCCs?

The Centre for Asia Pacific Aviation (CAPA) is one of those consultancies (this time Australian) that hands out free samples of its thinking from time to time, but unfortunately still chooses to do so in the form of a PDF (rather than through a feed or some other more user-friendly form). As we noted on a previous occasion, since the object of the exercise is presumably to advertise to everyone how bright CAPA is, imprisoning the info within a PDF is probably not a great idea.

On page 18 of CAPA's most recent free sample (pdf), CAPA introduces the idea of a New World Carrier (though it seems that the name originated within Virgin Blue). This is essentially a low cost carrier (LCC) that is taking on traditional characteristics of a legacy carrier, but in clever, low cost ways. Think JetBlue in the US but particularly Virgin Blue in Australia, which is what CAPA's article is really about.

The first thing we can say without fear of contradiction is that "New World Carrier" is a really lousy, non-descriptive (not to mention pretentious) name for what amounts to a high-touch LCC. So, for instance, JetBlue offers a frequent flyer program, but designed it in such a way that it is minimally expensive for it to manage it. Virgin Blue goes much further, offering a form of business class that includes access to lounges (which are also available a la carte). It's also invested in GDS-bypassing links to corporations of the type we discussed a little while ago.

[Virgin Blue, by the way, is the Australian Virgin franchise holder, which was established as a 50/50 venture between Virgin and Patrick Corporation, an Australian transport (mostly ports and ground transport) conglomerate. It was established in 2000, and in our opinion is a good example of how it's better to be lucky than smart. At the time there was a vicious four way domestic Australian battle between Qantas, Ansett Australia (the two incumbents), Impulse and Virgin Blue. Then Ansett fell over, after its then parent, Air New Zealand, refused to back it after Ansett got into trouble over maintenance issues, among other problems.

A rough US equivalent might be if both American and United ceased flying overnight. Just about any US startup would make money under those conditions. So it was no trick at all for Virgin Blue to succeed, especially since Impulse had recently sold out to Qantas (Qantas low-cost division JetStar is Impulse's legacy). "Virgin Blue", by the way, is a reference to Australian slang, in which a man with red hair gets the nickname "Blue". Virgin's house color is of course red.]

But it's not a vacuous concept because it's clear that there are many different levels of LCC developing. At one end there's Ryanair, which revels in cutting every possible amenity in its quest for the absolute lowest cost travel (nothing like Ryanair exists in the US and it's unclear whether Americans would put up with it) and at the other end you've got JetBlue and Virgin Blue -- or even MaxJet, if like us, you think of MaxJet as a business class LCC, rather than a superluxury boutique airline.

CAPA muses on this topic for several pages, but for us the key paragraph (page 21) is this:

Many other markets are either too small to drive cost advantages, or the race for the lowest cost is too close between similar sized carriers for a category killer to develop. These are the markets where the next NWCs will emerge as they run out of room to stimulate leisure travel and instead take a much greater share of business travellers.

Our interpretation: Virgin Blue has simply run out of room to expand as a classic LCC. In fact, given that its initial growth after Ansett collapsed was a gimme (any capacity it put in the market was absorbed) it may already be too large as a plain vanilla LCC. And if the Aussie LCC niche is saturated, then product extension into other niches is the only way to grow. And the key to that is finding ways to offer additional value in a low cost manner.

CAPA then touches on two thoughts, with which we agree:

• The most analogous market to Australia is Canada -- similar size, similar market structure (roughly speaking, one legacy flag carrier -- Qantas, Air Canada -- and one big LCC each -- Virgin Blue, WestJet). WestJet's days of easy growth appear to be behind it, with a resurgent post-bankruptcy Air Canada and an embarrassing continuing industrial espionage scandal. WestJet may also need to consider product extensions away from its relatively pure LCC model (WestJet already offers seat-back TVs, a la JetBlue).
• Europe and the US do not appear to have yet exhausted the potential of the LCC model, though some disagree. In these much bigger markets, there's room for more than one flavor of LCC, each one of them offering a limited product selection.

Where are Europe's High Touch LCCs?

This ties into something we've noted for a while (not covered by CAPA, so far as we can tell). There are no European high touch LCCs, yet there probably should be.

Currently European LCCs offer a much more stripped down product than US LCCs -- seat pitch is bone-crushingly tight in Europe, for instance. There's a difference between the products of easyJet and Ryanair, but from a US view it's slight (biggest difference is that easyJet favors airports closer to town, whereas Ryanair likes alternative airports). Neither of them will give you a seat-back TV and unlimited snacks, as on JetBlue.

One reason European leisure travelers are used to such conditions is that at one time most European leisure travel was on charter carriers, which generally feature the same privations. So Europeans have been conditioned to accept such things (some might note that many Americans are somewhat larger than Europeans, though this Economist article says that's changing). European LCCs are also much more about short-haul than the US, so presumably comfort also matters somewhat less.

But at the same time, intra-European business travel is still relatively high-touch, with business class lounges and meals (though a US-style first class seat is unknown in intra-Europe "business class"). Yet most big European LCCs don't offer so much as a fully refundable (or at least fully-creditable to a future flight) ticket, which is surely the minimum a business traveler wants.

Our view is that a serious attack on the business market is an opportunity that the European LCCs have yet to exploit. If true, the flip side is that when European LCCs do start seriously addressing the European business market there's a lot more pain to come for traditional European flag carriers. Sure, it will be buffered by the fact that the main European business airports are difficult for LCCs to get into, but Southwest, for instance, does significant business-travel business in the US, despite not serving, for instance, New York City, which is by far the largest business market.

Bonus linkage: International Air Carrier Association website (association of European charter carriers)

Another recent post on Euro LCCs here.

Suggestion/Comment Thread

Leave your suggestions/comments/rotten tomatoes in the comment section of this thread. It can be done anonymously, so don't be coy.

100 Seat Flashpoint: JetBlue's Role

Two things to keep in mind as 2006 progresses. One we’ve already discussed: the showdown between Northwest Airlines and its pilots over the issue of outsourcing aircraft up to 100 seats, which we think has the potential to be the most significant labor dispute in the airline business in perhaps the last decade or so.

The other is what JetBlue does with its new 100-seat aircraft, the Embraer 190. And yes, this issue is linked to the Northwest issue. It’s all about 100-seat aircraft.

What’s so special about 100-seat aircraft? We’ve discussed the issue of outsourcing and scope before. Basically, legacy major airlines have the right to outsource aircraft up to about 70 seats. Such outsourcing is to so-called regional airlines, which do nothing more than operate the aircraft under contract to the major airlines. Regional airlines have lower costs, in large part because they pay less than major airlines.

Legacy major airlines, for their part, typically don’t fly aircraft any smaller than, say, 125 seats. Any smaller and it’s more economic to use a 70-seat aircraft flown by a regional partner. So in the system of each legacy major airline there’s a capacity gap – there are no aircraft in the 100-seat category.

(The exception is Northwest, where the gap is not from 70 to 125 but rather from 50 to 100 – Northwest can’t outsource anything larger than 50 seats and for historic reasons it flies a lot of 100-seat aircraft itself. This is why the 100-seat issue is so acute for Northwest because 100-seat aircraft are still flown at Northwest itself).

This means that there are a lot of routes in the US that are being non-optimally served by legacy major airlines, routes that would be best served by something in the 100-seat category.

Another factor is that Embraer has recently built a 100-seat aircraft (the Embraer 190, otherwise known as the EMB-190, otherwise known as the E190) that is a lot more economic to fly than previous 100-seaters. The E190 is a lot lighter per-seat than, say, the 717 (which was a derivative of the DC-9 aircraft which has a design dating back to the 1960s). Indeed 100-seat aircraft built in the last decade or two haven’t sold all that well, in part because below, say, 125 seats, major airline pilots simply became too expensive.

Into this breach steps JetBlue. JetBlue CEO David Neeleman likes to go where other airlines can’t, because it creates a protected niche where JetBlue can thrive. Prior examples of this include getting slot waivers to fly into JFK airport in New York and entering slot-protected Long Beach Airport. 100-seat aircraft is another example. As we’ve discussed earlier, JetBlue is also paying its E190 pilots modestly, a lot more modestly than, say, Northwest pilots are paid to fly the only slightly larger DC-9. In consequence, JetBlue’s per-seat costs for the E190 are expected to be only slightly higher than they are for the A320, which in JetBlue’s configuration has 156 seats.

Generally, all other things being equal, per-seat costs for an aircraft drop with increased aircraft size (there are economies of scale for aircraft size). So any time you can fly a smaller aircraft with only slightly higher per-seat costs, that’s pretty exciting from a network planning standpoint. A network planner's ideal aircraft would combine the size of a Piper Cub with the per-seat costs of a 777.

Observers have noted for at least couple years that JetBlue’s E190s have the potential to be game-changing. In particular, we agree with those who say the E190 is a 50-seat regional jet (RJ) killer. As we’ve previously discussed, 50-seat RJs are a high per-seat cost aircraft that requires high fares to thrive. Pre-9/11, such fares were common within legacy major airline systems. Further, Pre-9/11 scope clauses generally limited legacy major airlines to outsourcing aircraft of 50 seats or less. These two factors caused the legacy major airlines to order far more 50-seaters than would be optimal today.

The way we think of the JetBlue E190 threat is this: JetBlue will enter cities/markets that are too small to be efficiently served by current “mainline” aircraft like A320s or 737s. By definition, such cities or markets are therefore currently served by major airlines in large part by regional jets. E190 per-seat costs are better than 50-seat RJs, so JetBlue will undercut average fares currently offered by major airlines on RJs. Lower fares will also stimulate additional traffic that JetBlue needs to fill larger E190s.

Further, the E190 is significantly more comfortable than the typical 50-seat RJ (either Bombardier’s CRJ100/200 or Embraer’s ERJ-145) and the most prevalent 70-seat RJ, Bombardier’s CRJ700. While the E190 has the same seating configuration (two seats on each side of a single aisle) as the CRJ700, similarities end there. The E190 has a much bigger, more pleasant cabin, including seats that are slightly wider than that of the A320 and even real overhead baggage space. Passengers will not mourn if 50-seat RJs lose out to E190s.

(Some major airlines now have the E170 in their regional system which is the 70-seat baby brother of the E190, featuring the same level of cabin comfort, but not quite the same economics).

Thus far, JetBlue has announced service to Austin and Richmond with the E190 (here and here). These are the type of secondary cities that (with the exception of upstate New York and Burlington, Vermont, both of which are served for political, not economic, reasons) JetBlue has yet to serve. It is also has the E190 on the Boston-New York route, which is a less imaginative but apparently quite popular use of the aircraft.

Which is another reason why the Northwest pilot issue is so important. If Northwest gets its way with its pilots over 100 seaters, every other legacy major airline will seek (and eventually get) the same thing, and the legacy carriers will be able to respond to JetBlue relatively quickly. If not, JetBlue will have this niche to itself (and other LCCs that try the same thing) that much longer (probably until the next serious downturn when pilots will again have to give ground).

Either way, the legacy major airlines are going to wish that they hadn’t contracted for quite as many 50-seat RJs as they have. That's a story for another day.

Good Article at The Street on Making GA Pay

Good article at The Street takes on the issue of making General Aviation (GA -- civilian non-commercial aviation, everyone from those flying Piper Cubs to the bizjets) pay its fair share of the bill for air traffic control (ATC) and airports. We previously touched on this in the context of a recent move by Ft Lauderdale Airport to consider landing fees for GA aircraft.

Key issue:

Bolen says the NBAA particularly opposes changes that would shift the method of assessing corporate jet fees away from the fuel tax to some sort of per-flight charge.

The NBAA being the bizjet association. They don't want to pay the sort of per-flight fees that commercial aircraft do, even though a Gulfstream V takes up almost as much space in the sky (and on the runway) as does a 737. That's why, according to the article, bizjets take up about 15% of the capacity of the air transport system while covering only 4% of the costs. No, that's not fair. Further, bizjets take up valuable slots at certain highly congested airports. We don't have a problem with that, so long as they pay for the slots like everyone else.

But again, we're cynical this will ever change much -- though we certainly hope it does. The NBAA is great at shielding itself behind the image of the allegedly impecunious Piper Cub owner (though anyone who can afford to fly privately is doing at least OK, anyone...) while at the same time it has some of the best connections to the powers that be of anyone, because bizjet fliers are the richest in the world and Congresscritters like flying bizjets as much as anyone.

MRO Update

Good recent Flight International article updating status of the MRO (Maintenance, Repair & Overhaul) business in North America. We don’t follow MRO very closely, so it’s good to see a decent update. We also recently found an interesting blog specializing on the MRO business: MRO Wire. (Goodrich is a large MRO provider in the US through its former Tramco subsidiary).

For many years, consultants urged US legacy major airlines to outsource heavy maintenance, and for years that advice was largely irrelevant because it was impossible to do so under the union agreements most airlines had with their mechanics. In-house legacy airline maintenance was more expensive than that offered by third parties, but they were stuck with it, though Continental managed to ditch most in-house heavy maintenance in its 1980s and 1990s bankruptcies, and Southwest has pretty much always outsourced, and America West had managed to accomplish that too.

That’s all changed since 9/11. United and US Airways ditched most in-house heavy maintenance in Chapter 11, Delta apparently has just done the same, and Northwest actually managed it outside of Chapter 11 during its mechanics strike. We earlier touched on Alaska’s outsourcing of its heavy maintenance. American is really the only legacy major remaining with a large in-house presence.

With the mass outsourcing of heavy maintenance in the US, two other things have changed. One is that there’s no longer quite the excess capacity in the MRO business that there was. Establishing an MRO business (at least for airframes) is pretty easy. All you need is ramp space (at a pinch you can even do without a hangar, though in practice, few do) and trained mechanics. For that reason, it’s typically been a lousy business (the engine part of the business is different, it requires a lot more investment in technology, and that business has largely consolidated into a few big players, the engine manufacturers prominent among them).

Secondly, there’s a greater demand for fast turnarounds at the maintenance centers. There’s tension between speed and cost at third-party MRO providers. With excess MRO capacity, MRO providers would underbid each other. However, that’s a penny-wise pound-foolish proposition if the low-cost bidder then takes two weeks longer to accomplish the job, since an airline doesn’t want a $30 million asset sitting around the hangar for two additional weeks. The article makes it sound as if the low-bid emphasis is changing, which is good, if true. It will be interesting to see whether MRO economics improve.

Another trend is for airlines to hand over the management of spares as well. The airline hands over spare parts to a maintenance organization, which guarantees to provide spare parts when needed for a fee. In theory everyone should win: the airline no longer has capital tied up in spare parts and the maintenance organization can share a pool of parts across many clients, with everyone hopefully realizing some economy of scale benefit.

In some ways this is just the extension into spare parts of the power-by-the-hour concept that engine maintainers have offered for years and years. Under such contracts, the airline pays a set fee per hour for engine maintenance, essentially come what may, it then being up to the maintainer to ensure the engine is appropriately repaired.

The airline gets certainty of cost (essentially insurance as well as engine maintenance), the maintainer realizes economies of scale. Some of these are non-intuitive. For instance, leased aircraft generally have return conditions that specify, for instance, the engines must be returned with a certain minimum time (or cycles) left on components. The power-by-the-hour provider can cherry-pick through its large pool of parts to find parts that just meet these conditions. So whereas previously an aircraft lessor might well get a components that were in much better shape than return conditions require, that better-than-required condition is now being kept by the power-by the-hour provider instead. The airline business is all about nuance.

Possibly interesting aside: American's maintenance base in Tulsa, Oklahoma is apparently the largest in the world. Tulsa isn't exactly a cosmopolitan place, but that benefits American. First, Tulsa is a low wage place, which means that what American pays its mechanics goes further and they get a higher standard of living on the same wages (OK, OK, some will question how high anyone's standard of living can be in Tulsa).

Secondly, however, by concentrating all those mechanics in a relatively small place, American gains leverage over them. In a larger metropolitan area, a mechanic has a lot more alternatives to working at an airline, or at any rate, at one particular airline. By contrast, someone whose whole life is in Tulsa, Oklahoma and who is a mechanic for American (the American maintenance base is apparently the largest private employer in Tulsa) has far fewer alternatives -- there's are just too many American mechanics and not enough else for them to consider doing. No surprise, then, that American's Tulsa base was perhaps the most moderate of its tech bases during the March/April 2003 showdown between American and its unions (much to the annoyance of hard-liners elsewhere). And that's been rewarded: American is consolidated engineering activity there.

Whether American can, in the end, truly make its maintenance activities competitive with third party MRO organizations remains to be seen, but it deserves credit for trying.

Bonus links: www.the-mechanic.com for a look at how hardline hardline-mechanics can be (scroll down the page).
And here's a possibly interesting article from Air Transport World last year on American's Tulsa maintenance base.
Aerial view.

More EOS Scuttlebutt at Connecting Flights

New Connecting Flights post on EOS worth reading if you're following its progress. Our prior posts on EOS and boutique airlines here and here.

SE Asian LCCs: Necessary Preconditions Missing

The opening of Singapore Airlines Budget Terminal was in the news recently (the Airline Business blog has some nice pictures). It looks appropriately low rent.

But we've long been skeptical about South East Asian low cost carriers (LCCs) or "budget carriers". Don't look for another Ryanair or JetBlue in that part of the world anytime soon. The problem is (at least) twofold:

1. There's no open sky area similar to, say, the EU or the US.
2. To one degree or another, the countries of South East Asia all practice crony capitalism (whether the cronies happen to be mostly virtuous people, as in Singapore, or less virtuous, as in some other countries in the region). Nothing gets done in any of those countries without the approval of the powers (of each country) that be.

The first point is obviously problematic because it means it's hard for SE Asian LCCs to fly across borders, and almost impossible for them to fly domestic routes within other SE Asian countries.

The second point is important because in the US and the EU, LCCs have largely been run by revolutionaries who want to overturn the accepted order and (especially in Europe) like nothing better than sticking a finger in the eye of authority. Think Michael O'Leary of Ryanair or Stelios of easyJet, or, less stridently, David Neeleman of JetBlue (who doesn't have O'Leary's mouth -- few do -- but clearly wants to teach the rest of the industry a lesson or two).

That's just not how things work in South East Asia. How do things work? Well, Malaysian LCC Air Asia expanded into Thailand through a joint venture 50% owned by... yes, a holding company founded by the Thai Prime Minister. Imagine if Ryanair had expanded into the UK through a joint venture with a holding company founded by UK Prime Minister Tony Blair. Not.

As we said, nothing of much consequence happens in the SE Asian economies without at least the acquiescence of the powers that be. And that's true even in a squeaky clean environment like Singapore. Would Singapore ever let LCCs grow to become a serious threat to Singapore Airlines? In the current environment, that's very hard to imagine. Yet the US let Pan Am, TWA, Braniff and Eastern go, and even the Swiss let Swissair die and the Belgians let Sabena die (the Italians and Greeks have yet to discover the same maturity). We think such an environment is a precondition to the growth of real LCCs.

And it's understandable, to some degree. Picking on Singapore some more, that country is in a much rougher neighborhood than any European country. Singapore Airlines is not just a symbol of great national pride, it's a foundation of national prosperity.

But however good the reasons, the fact remains that it's probably too much to expect LCCs (at least as we conceive them in the European and North American contexts) to thrive in that part of the world. Maybe some other form of LCC will develop, but it will be significantly different from JetBlue or Ryanair. The countries are not politically or economically relaxed enough.

It Continues to Suck to be a Regional

Star-Tribune article on how Mesaba's fleet is likely to halve. Actually, it's worse than that. Mesaba's jet fleet is apparently disappearing entirely, and that's the bulk of its business. What's left is just turboprops.

Mesaba Aviation is the main unit of MAIR Holdings. Historical note: Mesaba and Northwest were the first to enter a contract-flying arrangement in the mid-1990s in connection with Mesaba agreeing to fly ARJ-85 aircraft on behalf of Northwest. Almost all regional jet flying in the US is now performed under similar contracts. In the late 1990s, Mesaba was actually considered to be hot stuff, since it grew tremendously as its ARJs delivered.

Mesaba flies only for Northwest, and shortly after Northwest filed Chapter 11 bankruptcy, Mesaba did too -- but not MAIR Holdings. So the holding company (which also owns Big Sky, a small third-tier regional airline, and has a bunch of cash) in not in bankruptcy.

The ARJ-85 (click photo for bigger version) is a derivative of the BAE-146, an unusual, four-engine, high-wing small jet aircraft. The ARJ-85 was designed to fly about 85 passengers, although scope restrictions meant that Mesaba actually has 69 seats on the aircraft it flies for Northwest -- including, unusually, a first class section. Quite comfy for passengers, since there were so few seats in the Mesaba configuration. The ARJ is a regional jet, but it's an odd-ball regional jet. It's no longer produced, and in fact its manufacturer, now known as BAe Systems, no longer manufactures any commercial aircraft except through its 20% stake in Airbus.

The BAE-146/ARJ program was not what you'd call a roaring success. For instance, Mesaba was the only operator of the ARJ in the US. The engines on the BAE-146 had problems, and although the ARJ was a better aircraft than the BAE-146, the bottom line is that its economics are unattractive. Apart from anything else, four engines is two too many engines -- double the maintenance, for instance. Northwest appears to have bought them (well, actually, over half of them were leased) because it got a great deal. But there are now much better aircraft available (such as the Embraer 170/175/190/195 family) and Northwest is taking the opportunity that bankruptcy gives it to dump the aircraft.

Which means that Mesaba is going to get a lot smaller, assuming it doesn't find other business somewhere else. Another example of how the major airlines generally have the power in the major airline/regional airline relationship. Northwest has dumped Mesaba as a jet provider, and there's nothing Mesaba can do about it.

It could be worse for MAIR Holdings shareholders. So long as MAIR Holdings avoids being included in the Mesaba bankruptcy case, Mesaba creditors can't get access to cash held at MAIR Holdings. So however bad things get at Mesaba, MAIR still has the opportunity to invest that cash in Big Sky, in some other aviation project or return it to shareholders. Still, Mesaba is another example (prior articles on the topic here and here) of how it sucks to be a regional airline in the US.

Airbus Developing All Composite Narrowbody

Seattle P-I article on Airbus's announcement that it will, after all, pursue all-composite aircraft. The A320 replacement will apparently be an all-composite aircraft, though Airbus is not yet discussing timing.

It's also notable because only recently, Airbus was raising safety issues about the use of all-composite fuselages in the context of Boeing's new 787. Apparently all composite fuselages are now OK.

Airlines such as Southwest have already asked Boeing to apply 787 technology to a 737 replacement (the 737 and A320 are narrowbody competitors). Boeing has earlier said that a 737 replacement is likely in the 2013-15 timeframe.

Airbus's Murky 2005 Order Status

2005 A350 orders fell short of Airbus’ goal of 200, according to AP:

Forgeard, who shares leadership of EADS with German Thomas Enders, also suggested that orders for the Airbus A350 -- designed to rival Boeing's long-range, fuel-efficient 787 Dreamliner -- had fallen short of the target of 200 at the end of 2005. The number sold was "within 10 or 15 percent" of that goal, he said.

No they didn’t, according to Flight International:

Airbus has beaten its target for more than 200 A350 "orders and commitments" in 2005 by at least 10%, EADS co-chief executive Noël Forgeard said today.

Hmm, be nice if they got their stories straight. Our guess is that Airbus missed, though one should never underestimate the guile of Airbus. Another Flight International story is about whether Airbus was beaten by Boeing or not in total orders in 2005 (related Flight International blog entry here). Airbus is coy about 2005 firm orders, it won’t release the total until the 17th. Are we the only ones to wonder whether Airbus will be tempted to pre-date some late arriving firm orders? Why the 2.5 week gap from year end to announcement?

Then again, what constitutes a firm order these days? There are so many different characterizations: what’s a commitment vs a firm order, and how difficult is it to re-interpret one as really being the other when it’s convenient to do so?

Image is an A350 rendering in the livery of the Brazilian airline TAM.

Picking on Mike Boyd: Southwest@Denver

We previously directed readers to Mike Boyd’s 2006 predictions. Interesting stuff in there, but we don’t agree with all of it and we’re going to pick on items from time to time. The item of the day is Southwest Airlines at Denver.

Southwest recently started service at Denver after a break of 20 years. It’s worth noting that in its 30+ year history, Southwest has exited only a handful of airports because it’s generally reluctant to exit markets – Southwest wants its customers to feel they can count on Southwest to always be there. The old Denver Stapleton Airport was congested and that was much less acceptable to Southwest in the early 80s than it would be today.

It’s always news when LUV comes to town (LUV is Southwest’s stock symbol, a reference to Dallas Love Field, its hometown airport) and it was even more so when Southwest announced its return to Denver. First, Denver is a hub for both United (dominant) and Frontier. Further, Denver is a relatively expensive airport at which to do business. There was a time when Southwest would not challenge a legacy major airline (like United) at one of its hubs. There was also a time when Southwest would not do business at high cost airports.

Mike Boyd makes some points we agree with, the biggest being that Southwest is likely looking to thrive at Denver at the expense of Frontier. We agree. However, along the way he makes some points that we disagree with. For instance, Mike says that it is somehow new that Southwest is looking to take share at the expense of other low cost carriers (LCCs) like Frontier, rather than simply grow the market through stimulation.

Not true. One of the greatest threats to other LCCs has always been Southwest. For instance, Southwest has made America West’s life miserable since at least the late 1980s. JetBlue’s business plan was clearly designed with this in mind. JetBlue has played keepaway from Southwest ever since inception (every JetBlue nonstop route has at least one endpoint that is not a Southwest airport).

Further, although Frontier is a LCC, it’s an LCC with costs that are higher than Southwest. That means Southwest can afford to charge average fares lower than those of Frontier, and that means some (likely modest yet non-negligible) level of stimulation is still possible at Denver. We’ve seen estimates of Southwest’s cost advantage as high as 15%, which is far above Frontier’s operating margin. That's a problem for Frontier.

Another thing Mike says is that Southwest must change its product to be successful in Denver. In particular, he says Southwest must offer advance seat selection. Anyone who flies Southwest knows it doesn’t offer assigned seats.

Southwest might very well one day offer advance seat selection, but that decision is unlikely to be driven by the Denver market for the simple reason that initially Denver will be more of a big new destination for existing Southwest customers, more so than a big source of new Southwest customers. It’s unclear Mike has grasped this.

The three cities that Southwest initially connected to Denver are Chicago (Midway), Phoenix and Las Vegas. These are three of the biggest stations in the Southwest network. Until recently, Denver was one of the biggest missing destinations from these cities in the Southwest network. It will therefore be easy for Southwest to fill flights to Denver largely with folks at Chicago, Phoenix and Las Vegas (or connections thru these cities) who tend to fly Southwest to anywhere Southwest flies – and now no longer have to make an exception when they fly to Denver.

More recently, Southwest added flights to Denver from Salt Lake City and Baltimore. Baltimore is another huge Southwest city. Salt Lake City has a significantly smaller Southwest operation than the other four destinations from Denver, but we’d bet that it’s still a decent source of Southwest traffic, especially for a short flight like Denver.

Again, we agree with Mike that Southwest has Frontier in its sights. We disagree that Southwest needs to significantly change its business model to be effective in Denver. The right way to think of Denver in the Southwest system (at least initially) is as a big spoke from the existing Southwest cities that Southwest chooses to serve from Denver. These will be a source of good traffic to Denver for Southwest. These folks are all quite used to lack of advance seat assignment on Southwest.

Some portion of these folks who will fly Southwest to Denver would otherwise have flown Frontier. That’s a loss of traffic that Frontier will find troublesome. At the same time, Southwest has the ability to (and probably will) on average undercut previous Frontier fares on Denver point-of-sale traffic. That’s another problem for Frontier (the same things will apply to United at Denver, but less so because far less of United’s much larger Denver system will be affected, and of course Denver is only one part of the United system whereas it’s every part of the Frontier system).

The Triumph of Freddie Laker?

A reader asks about alleged nickel-and-diming in the industry, as reported in a recent USA Today article on how some airlines are now charging for things that used to be included. Meals, pillows, drinks, checked baggage, advance seat selection, emergency seat row seating, you name it, some airline is charging for it. According to some quoted in the article, this is just another annoying way for airlines to try to generate more revenue.

For those who are used to an all-included model, yes, this is annoying, though over the long-term, any additional revenue the industry generates is likely to be competed away. Airlines don’t have much pricing power, to say the least. So the right way to think of this is that those who are willing to pay for additional service will permit lower ticket prices for those who don’t.

Not a lot of this is new. Both Laker Airways (a UK carrier that pioneered low cost trans Atlantic travel in the late 70s/early 80s) and People Express (the most prominent of the first crop of US low cost carriers – LCCs – after deregulation) had highly unbundled products. European LCCs like Ryanair and easyJet charge extra for many services (we earlier noted that UK LCC flybe now charges extra for checking bags). To some extent the best seats are already, in effect “sold” – American Airlines, for instance, gives emergency exit row seats to high status frequent flyer members.

There’s no reason why airlines shouldn’t charge extra for services except that traditionally they haven’t. But why should those without bags subsidize free checked baggage for those who do have bags? Why should those who are not hungry pay for the food of those who are? Why not get a few extra bucks for the emergency exit row seats, since those are clearly prized?

The big difference is that after half-a-decade of misery, even legacy major airlines are willing to experiment with everything. The fact is that for many, perhaps most of these services, the cost of providing the service is larger than the value generally received by the passenger. Airlines now only want to include features passengers do value more than the cost of provision.

The most obvious example is meals. It costs a lot to get a hot meal to a passenger’s tray table, the cost of the meal itself being only part of the expense. There’s the cost of getting it on (and its remains off) the aircraft, there’s the time of flight attendants to perform the meal service, there’s the cost of fitting and maintaining hot galleys, there’s the opportunity cost because space/weight taken by galleys can’t be used for other things (like additional rows of seating, or freight). And traditionally there were at least half-a-dozen (and sometimes a lot more than that) special meal types available – more complexity. And after all that, most people didn’t even like economy class hot meals.

American Airlines, for instance, now sells food on its domestic US flights. Pre-9/11 that’s something American management would have regarded as unthinkable. Now it’s routine.

So yes, expect more unbundling of the airline product. If you’re really one of those who wants nothing more than basic transportation, and you’re not willing to pay a dime extra for anything more than that, then that’s likely what you’ll get. The lowest price will get you a middle seat at the back of the airplane and if you bought four such tickets for you and your family, then you’ll all end up in middle seats, assuming the aircraft is full.

But the trend isn’t all one-way. A signature part of JetBlue’s service is seat-back TVs. Passengers don’t pay extra on JetBlue for that. There’s some evidence customers do value TV more than what it costs JetBlue to provide it – on some routes, at least, JetBlue realizes a significant average fare premium over what legacy major airline competitors get, and TVs are likely part of that (Americans love to watch TV and eat junk food, and JetBlue provides TVs and junk food). Airlines such as American have dispensed with charging for movies on domestic flights. So there’s some rebundling going on, but again, the key is that airlines will include in the price only those things where cost of provision is less than value received by the passenger.

RSS Feed Fixed (Hopefully)

RSS feed should now be fixed.  We used Microsoft Word (not Blogger for Word) to edit one post and that munged things up.  Sorry about that.

Section 1113

In response to our recent post on why scope is such a big deal at Northwest Airlines, reader air boss said (presumably relative to our comment that the Northwest situation with its pilots is not one that seems likely to be solved through negotiation):

As a practical matter, this will come down to Company 1113 motions to set up a 70-110 (maybe more) seat 'NewCo' as a specific manifestation of "new scope" and retain the NWA flying albeit on different economic and lifestyle terms.

Our response is "maybe", by which point many readers are already wondering what the heck is Section 1113 and why should they care.

We previously discussed that in Chapter 11, companies can choose to accept or reject executory contracts. Union agreements are such executory contracts -- but there are tight restrictions on the ability of companies to reject labor contracts, and these restrictions are governed by Section 1113 of the bankruptcy code.

There's some interesting history here. There was a time when such restrictions didn't exist. Then, in 1983, Frank Lorenzo took recently-acquired Continental Airlines into bankruptcy specifically to use Chapter 11 to reject its existing labor agreements. Congress was so outraged by this tactic (which Lorenzo used to successfully break Continental's unions) that it enacted Sec 1113 to prevent companies from using bankruptcy laws to abrogate labor agreements, except when the bankruptcy judge is convinced that the company has no choice.

Sec 1113 sets up a procedure through which a company in bankruptcy can apply to the bankruptcy judge for relief from an existing labor agreement. Click here for the full Sec 1113 text. There are some decent non-technical summaries about Sec 1113 at various airline union websites, since this is something that they have been very much concerned with over the past few years, as airlines have used Sec 1113 (or more often, the threat thereof) to get significant concessions from unions in bankruptcy. Simply google Section 1113 bankruptcy code.

There are basically two operational provisions. One is Sec 1113(e) which allows a judge to impose emergency "interim" changes in "terms, conditions, wages, benefits, or work rules" necessary (the judge must be convinced) to keep the company in business. Note, this does not otherwise eliminate the existing contract, simply impose temporary changes in it. Sec 1113(e) has been successfully invoked in the past several years, for instance, early in the United bankruptcy and in the second US Airways bankruptcy.

The second is Sec 1113(c). This is the real hammer. Under Sec 1113(c), the judge can reject a labor contract. But there's a process. The company must have tried negotiation. It must have provided labor with sufficient information to evaluate what the company proposes. The judge must find that labor was provided with sufficient information, that labor rejected management's proposal "without due cause" and that the "the balance of the equities" favors rejection of the labor agreement. Also, there's a schedule set out in Sec 1113. This process doesn't happen overnight.

Obviously there are some rather vague phrases being used here. We're not (thank heavens) lawyers, but the heuristic that has always worked for us is that basically the company has to convince the judge that the survival of the company requires new labor terms and those terms are being unreasonably rejected by labor.

Here's the kicker and why our reaction to air boss's comment was "maybe". It is unclear (because it has never been tested) what the union can do after its contract is rejected by the bankruptcy court under Sec 1113(c). There's a separate labor law in the US for airlines and railroads, the Railway Labor Act (RLA), with the National Mediation Board the government agency that oversees it (as opposed to the National Labor Relations Board that oversees most US labor relations). There's never been an RLA agreement rejected under Sec 1113(c).

This obviously matters a great deal. If the union can strike after such a rejection, then it has a lot more leverage than if it can't strike after such a rejection. It's all very weird, because one of the fundamental principles of the RLA is that a union is never without a contract -- contracts never end, they simply become "amendable". So the situation is exceptionally undefined. It's also good to emphasize that Sec 1113(c) is an all-or-nothing thing. It's not as if there's a proposal that the judge approves and that's what's implemented. Once the contract is rejected, management can do what it likes.

Perhaps for that reason, although managements have filed Sec 1113(c) motions, none has ever gone all the way in the context of an airline because it's always induced a negotiated settlement. But there's a first time for everything, and if you push a union too far, it may decide that it has little to lose by taking its chances. We suspect that the scope issue is driving Northwest's pilots close to this point.

Followup: US Airways Fares

The new US Airways chose the stock symbol LCC (LCC is an abbreviation for low cost carrier -- most people associate low cost carrier with airlines like Southwest, which also offers low fares). That's a stock symbol with attitude. In our first post, we noted that US Airways' east coast fares didn't fulfill the promise of its stock symbol.

Today there's news that US Airways is finally starting to reduce its east coast fares, albeit in only 20 markets and with a long list of days in which its new lower fares won't apply. Better than nothing, but hopefully this is just a start.

Northwest: Why Scope Matters So Much

Wall St Journal article (subscription required, unfortunately) about how Northwest continues to push for the creation of a new subsidiary to fly 70-105 seat aircraft. Northwest's pilot union continues, for it's part, to be adamant in its refusal to consider any such thing.

We previously discussed the issue of scope in the context of a largish article about regionals. Here's the relevant material again:

In fact, if major airlines could get away with it, they'd likely contract all flying to third party operating entities (perhaps keep their own flight attendants on board to maintain service quality), which would end up in the same low bid system as the regionals.

But the majors can't do this, because major airline pilot contracts say they can't. These are the so-called "scope clauses" within such contracts, which reserve all flying on big aircraft for, say, United, to pilots in the United pilot union, where "big aircraft" in the case of United means bigger than 70 seats. Scope clauses are a big deal -- read the article again and you'll see at the end where Northwest is trying to jack up the maximum size of aircraft that can be outsourced to regionals. In airline-speak they're trying to "relax the scope clause".

So major airline pilots reserve all flying of large aircraft to themselves through the "scope clause" of their contracts. Northwest currently cannot outsource aircraft larger than 50 seats (there is a grandfather clause for up to 36 larger aircraft outsourced by Northwest to its regional partner Mesaba Aviation).

Northwest's scope clause is, in fact, particularly onerous relative to scope clauses at other major airlines. United, Delta, American & US Airways can outsource (to regional airlines) aircraft up to at least 70 seats (US Airways can even outsource some aircraft of 86 seats). Continental's limit is 59 seats, but can do a virtually unlimited number of those.

The issue at Northwest is particularly acute because Northwest flies smaller mainline aircraft than any other major airline. Northwest itself flies over 100 DC-9s (photo above). These geriatric aircraft (many of them over 30 years old or more) have just over 100 seats. Click here for further DC-9 data.

Now, go over to airlinepilotcentral.com and check out the difference between the pay scales for a Northwest DC-9 and, say, a JetBlue Embraer 190 (which is 99 seats). Northwest likely has its eye on the Embraer 195, a slightly larger aircraft than the 190 which in two-class configuration (i.e. first and economy class, vs JetBlue's all economy class configuration) that Northwest would be likely to use would also have 99 seats (aircraft must have 1 flight attendant per 50 seats or portion thereof, plus the govt requires additional facilities for physically challenged passengers on aircraft with 100 or more seats, so 99 seats is a likely maximum number of seats).

A new regional operation flying the EMB-195 for Northwest is likely to pay at rates similar to JetBlue. That's the whole reason Northwest is pushing this -- it needs to get more competitive payscales. Northwest says it would be willing to staff such a new operation with furloughed Northwest pilots.

The JetBlue EMB-190 captain pay scale is about 28-37% less per hour (depending on seniority level) than the Northwest DC-9 pay scale (and that's before considering work rules and so forth, which probably permit JetBlue pilots to be more productive than Northwest pilots). Note that the Northwest payscale already reflects two recent paycuts.

Pay is one issue, another is the "principle" of scope. As we noted above, currently the standard scope limit is more or less 70 seats (ignoring certain rights that US Airways has to outsource 86-seat aircraft). In fact, US Airways recently gave back to its pilots certain rights that it had to (under some conditions) outsource EMB-190/195s itself. So pilots are more-or-less maintaining 70-seats as a quasi-de facto industry scope limit (note, before 9/11 the industry limit was more-or-less 50 seats, though certain airlines had rights to outsource 70-seat regional jets). Clearly, Northwest's proposals would bust a huge hole in that. So Northwest pilots feel some pressure to hold the line for the pilot profession.

But most of all, Northwest's pilot union is being asked to do something that is anathema -- voluntarily eliminate the positions of about 1000 Northwest mainline pilots (roughly 20% or more of the total) and concede that flying size aircraft will never again be performed by Northwest mainline pilots.

That's why we regard this particular dispute as one of the least likely to be solved through negotiation. Northwest sees the difference between what it pays DC-9 pilots and what JetBlue pays EMB-190 pilots and knows it must close the gap. Its pilot union, however, simply can't negotiate this one away.

Other relevant facts: Northwest historically has some of the ugliest labor relations in the industry. Employees there seriously distrust management. And Northwest management is some of the most brutally rational in the industry, to the point where reasonable people begin to wonder whether it's counterproductive (we avoid traveling on Northwest whenever possible. It's more-than-average unpleasant). So the prognosis for a negotiated settlement here is bad.

Kerry Skeen: the Ego That Ate Independence Air

Washington Post article (registration required) on Kerry Skeen (CEO of about-to-be-departed low-cost carrier wannabe Independence Air) has him saying that he has "no regrets".

Good grief. It takes an ego of monstrous proportions to be able to say that after having destroyed hundreds of millions of dollars of shareholder value and thousands of jobs. That's why we titled yesterday's piece on Independence Air "Sic Transit Gloria Skeen". This was all about Kerry Skeen's ego.

And he's not finished. He's asked the bankruptcy judge to approve $3.2mm in bonuses to keep a wind-down team employed. No, we are not making this up.

Flight Intl Articles: 737NG Improvements, Airbus FUD

Couple of interesting articles from latest Flight International:

• Boeing is developing improvements to the 737NG (NG = New Generation = 737-600/700/800/900) to allow it to operate off of shorter fields. This airplane keeps getting better. Unfortunately, it will never have a fuselage competitive with the A320 (the A320 is wider, passengers do seem to care). Still, the 737NG is capable of many more missions (for instance, a 737NG can fly to Hawaii from the US west coast -- the A320 can't do that economically).
  
• Boeing accusing Airbus of spreading fear, uncertainty and doubt (FUD) about the composite construction of the 787. Airbus does have a history of (unwisely) playing the safety card. For many years it advertised that four engines were a better way to go for long-haul aircraft (the A340 has four engines, the competing 777 has two) with pictures of the A340 flying over a dark and stormy sea. This seems to have stopped (surprise surprise surprise) now Airbus is offering the super long haul A350, which has... two engines.
  

Mike Boyd 2006 Predictions

We don't have much time at the moment, so in lieu of a post today, we suggest reading Mike Boyd's 2006 predictions. We don't necessarily agree with him, but as usual it's interesting reading.

Sic Transit Gloria Skeen: Independence Air Dead

Independence Air has finally thrown in the towel, announcing the cessation of operations after Jan 5. Prior Independence Air posts here and here.

The Independence Air saga began long before the United Airlines bankruptcy that precipitated it. Independence Air was originally Atlantic Coast Airlines (ACA), a regional airline flying for United and Delta. ACA was United’s first 50-seat regional jet (RJ) operator. In fact, when United hit Chapter 11 in Dec 2002, ACA flew roughly half of all RJs in the United network.

ACA had incredibly generous contracts with both United and Delta, a legacy of the glory days of the RJ business. In the mid-to-late 1990s, very much a high-fare era relative to today, the legacy major airlines realized the 50-seat RJ was a powerful new network tool. At the time, the few 50-seat RJs in service were flown under very different conditions than today.

For instance, Comair at the time was still a real airline setting its own fares, schedules, and so forth, and taking its own cost risks. It had a tight marketing agreement with Delta, but Delta had only limited ability to tell Comair what to do. Comair operated under what is known as a “pro-rate” agreement, where the revenues from joint tickets with Delta were split on a pro-rata basis (hence the term “pro-rate”). Comair, the RJ-pioneer, made a ton of money under its Delta pro-rate agreement with the 50-seat RJ.

So when network planners at United and others decided they wanted full control of 50-seat RJs in their network, the regionals were able to negotiate juicy contracts, complete with double-digit margins and elimination of most significant risks (like fuel prices). In the long run, of course, regionals were selling their souls (see also here), but in the late 1990s, flying 50-seat RJs under contract to the majors was one of the best gigs in the airline business. RJ-driven revenue growth was huge, and profitability was basically proportionate to revenue.

But ACA had problems. The first is that CEO and co-founder Kerry Skeen (picture above) is not the type to want to dance to the tune of another, which is what contract-flying regional airlines do. Consequently, by the time United went bankrupt, ACA was disliked by United and Delta which both viewed ACA as arrogant.

Secondly, ACA had at least two big strategic weaknesses. It had been through one round of labor contracts since the RJ contracts kicked in, which resulted in juicy ACA wages. ACA’s costs were increasingly uncompetitive relative to newer RJ operators like Chautauqua (now Republic). The other weakness was the Delta contract restricted ACA from flying for more than one other partner and there were symmetric restrictions in the United contract. This meant that so long as United and Delta remained ACA partners, ACA growth was entirely determined by what it could get from United and Delta. Further partners weren’t an option so long as these restrictions remained.

Further, ACA flew an aircraft for Delta (the 328JET) made by a manufacturer that was out of business (Fairchild Dornier) and had serious engine problems that made the aircraft uneconomic to operate. Under the contract, this was Delta’s problem, not ACA’s, but it meant the Delta relationship was basically at a dead end.

None of this mattered while United and Delta remained out of bankruptcy, because ACA had a contract. The United contract even guaranteed ACA a proportion of all future United regional flying. Life was good, and it stayed good even after 9/11, because for the regionals, the key event was not 9/11 (because that didn’t affect contracts) it was major airline bankruptcies (since in Chapter 11, companies can reject executory contracts, including an RJ contract).

In the runup to United’s bankruptcy, ACA’s reaction was to (1) assume United wouldn’t go bankrupt (though many observers correctly called the govt’s rejection of United’s loan application that was the proximate cause of United’s Dec 2002 filing) and (2) state that United needed RJs so much that it was very unlikely to significantly reduce ACA’s rates. In the US Airways bankruptcy (Aug 2002), that airline reduced RJ rates only slightly and ACA said this showed United would do likewise. But there was a difference – US Airways had never paid its regionals well.

In Dec 2002 United filed for bankruptcy. In early 2003, ACA sued United to immediately either accept or reject its contract. This was bizarre behavior towards the source of 80-85% of ACA’s revenue and not a reaction the other two United RJ operators had. It was a heck of a way to begin its negotiation with United, and one ACA lost. By July the breach was complete – ACA announced that unless United assumed its contract unaltered (which United always had the right to do) ACA would strike out on its own.

One question is whether this was a bluff. Some were of the opinion United would have a tough time replacing ACA’s 50-seat RJs, given the size of ACA’s United operation and that ACA was trying to force United into assuming its contract unaltered. We’ve never believed that. United always had options (like using mainline aircraft to fly RJ routes) and couldn’t afford to be seen as being bested by ACA. Moreover, we think Kerry Skeen was itching to be on his own.

The minute United went bankrupt, ACA’s options as a regional were limited. With such a large presence in United’s regional system, United was never likely to give ACA much growth (too many eggs in one basket). With above average costs, ACA’s profitability was a regional was bound to fall with a renegotiated United contract. And getting contracts from partners other than United and Delta was difficult because of the restriction in the Delta contract discussed above. Delta would surely demand significant concessions for waiving this provision. Further, other legacy majors were hardly likely to be attracted to a regional that had sued one of its major airline partners.

ACA’s earlier arrogance now badly hurt it. In our view, a wiser management would have worked with its partners post 9/11 to address their concerns in exchange for eliminating troublesome contractual restrictions. A wiser management would not have sued United post bankruptcy, but asked, instead, how ACA could help United.

But this assumes that ACA management had real interest in remaining subordinate to its major partners, something to which we think Kerry Skeen was never reconciled. Kerry Skeen got one thing right – the regional airline business sucks (and he was not shy about saying so, though not in so many words). ACA’s future as a regional airline was indeed likely to be dull, boring and not particularly remunerative.

But limited as ACA’s options were after United went Chapter 11, they were still far, far better than striking out on its own as Independence Air. 50-seat RJs require two things to work – the first is the low wages of a regional (relative to those of a major airline – see airlinepilotcentral.com to view comparisons). The other is the high fares that exist within some parts of a legacy major system (and were far more prevalent pre-9/11 than today). The 50-seat RJ is fundamentally a high (per seat) cost piece of equipment.

The 50-seat RJ is far less viable today than it was pre-9/11 even within a major airline system. Successful independent 50-seat RJ operators are rare (Lauda Air might have been one back in the mid-late 1990s, before it became simply the lower-cost part of Austrian Airlines). A low-cost carrier 50-seat RJ operator had never been seen before ACA decided to become one.

Independence Air had a chance, incidentally, to dump its RJs or at least some of them. United needed to replace ACA, and other United regionals would have taken RJs off of ACA’s hands. The 50-seat RJ was probably never more in demand than it was then in spring 2004 as United sought replacement capacity for ACA (and 50-seat RJ demand has dropped ever since). Getting rid of 20, 30 or more (all, optimally) RJs would have been a great move. As it was, Independence Air had 87 50-seat RJs when it launched in June through August of 2004.

So Independence Air dumped a huge amount of capacity into the markets it entered. There are no precedents for such an instant system that we can recall. In August 2004 there were 300 Independence Air departures a day from Washington Dulles that weren’t there in May. 50-seat RJ departures, certainly, but that’s still a lot of seats.

In the event, Independence Air described a bone-headed catastrophic year-and-a-half arc through the airline business. This is, without question, one of the epic flameouts in the airline business. Nothing excuses taking this extraordinary risk, though Independence Air management has tried to pin the tail on fuel prices. At the end of the first quarter of 2004, ACA had over $350mm in cash. All gone now. The Independence Air press release manfully attempts to find some good in what’s happened, but to balance the enormity of the disaster, Independence Air would have had to have incidentally found a cure for cancer.

Bonus link: there's a pilot/employee website (including bulletin board) for Independence Air at www.aca-lounge.com.

Spirit AeroSystems: Another Challenge for the 787

Long article in Chicago Tribune on the additional challenges to the 787 posed by Boeing's spinoff of its Wichita manufacturing site now known as Spirit AeroSystems (Tribune requires free registration, but check it soon, since we've noticed Chicago Tribune articles tend to require payment once they're a little bit old, and this one is from Dec 30).

We’ve commented before on the execution risk inherent in the 787 – Boeing has promised a great aircraft, it better be able to build it given that Boeing's applying composite technology to an unprecedented degree in a commercial aircraft. The spinoff appears to up the ante yet further.