You’ve really got to hand it to our friends over at Runway Girl Network. Earlier in the week, I read an article by Gavin Werbeloff that made me shout gleefully (something a lot more impolite than “YES! This man is correct! Give him cookies and accolades!”) I actually shouted it out loud and confused my wife.
Regardless, it sparked my creativity. I’m leading up to a point here- so do bear with me.
It seems to meÂ that the industry gets obsessed with fads. I’m so old that the fad I was beginning to notice was going 10Y on 777s. The thing is, I never saw it as a move purely designed to increase unit revenue while decreasing unit cost. I always saw it as a way of psychological warfare directed at frequent flyers. As aÂ professor drilled into my skull, it’s an airline’s duty to extract as much money from each customer as possible.
Frequent flyers often fly on someone else’s money – part of me honestly believes that making economy into an insufferable torture space was designed to increase premium revenues by inciting revolts within corporate middle-management to force the purchase of premium economy or higher fares. It never happened, but the results are the same. Economy cabins are denser and more miserable than ever.
When I was in University, I had a very intelligent professor with years of airline experience. I respected what he had to say, but we would disagree from time to time. Because of this I commentedÂ to said professor, “There will be 11Y A380s within five years.”
Four years later; Airbus announced that by lowering some panels, you could, indeed, go 3-5-3 on the A380. Now, no one has taken this – but they will.
Thing is, there is a huge fetishization over unit cost to the point where analysts with a focus on unit cost often lose all sight of every other metric or possibility for an airline to operate profitably. This can also explain the cult-like following right now of ineffective and clunky streaming IFE systems. In-seat IFE weighs more, weight increases fuel burn, which increases – you guessed it – UNIT COST!
So, thanks to the DOJ having the ferocity of a taxidermied chinchilla, all the legacy carriers have merged. Words like synergy have been shouted loudly, and Wall Street analysts are happy. Capacity discipline has been the name of the game. Capacity discipline, of course, lowers available seat miles. Thing is, even with the available seat miles being down, unit revenue goes up because there’s less competition. Happy times, indeed. Happy times, they were. Since then the merger-mania airlines, like Delta, have been earning billion dollar profits. Margins are also up. Heck, Delta’s is about 3.2%. Okay, so not exactly a great margin compared to a pharmaceutical company – but fantastic for an industry that had a decade of unpleasantry.
“Hang on a second”, says Wall Street analyst droid 1725.6, “Spirit’s margin is 12.89% – that’s fast food restaurant territory! Delta, United, American- you are all terrible! Look what Spirit does! If you don’t change your evil ways, we’ll say your stock has a ‘sell’ rating!”
Poor Jetblue, they got hit even harder. “You are a ‘low cost carrier,” said the droid, “while I am not sure what that means other than it sounds good on paper, Spirit also professes to be one – but look at their margins compared to yours. You are literally the worst! Hang your head in shame!”
I’ll get back to JetBlue in a minute.
Now, a smart airline trader will make money on both the up and down trade of an airline stock, so the complaining about growth usually comes from large institutional investors that are less interested in volatility and base all their projections on assuming x% growth every n period of time – thing is they also own a lot of stock.
So, in fear of their options, or in fear of their market caps taking a dive, what have airlines done? Started helplessly fixating on unit cost. After all, full-service airlines can’t change to an ancillary revenue-based model like Spirit overnight. The only way they can be more like the darling airline Spirit is to really pack in the pax. What does that do. Say it with me now. Lowers unit cost!
As the article that sparked me into rant mode pointed out, airlines are spending a non-trivial amount of capital on “densifying” aircraft. This is often after having reduced density only a few years prior (also at non-trivial expense). This almost made sense when fuel was an obscene expense, but right now we are living in a period of ridiculously low oil prices. That, too, is a fad. These prices are unsustainable long-term. Thing is, “long-term” to a modern Wall Street trader is about three hours… I digress. Where was I?
Ah yes: airlines, facing an extreme increase in costs had to both lower their unit cost for their own benefit while finding a way to continue to offer “competitive” fares. Densification of economy is a miserable thing for passengers, yes, but what’s worse? No service, reduced service, or fits of bankruptcy!
With oil prices as low as they are, our capacity-disciplined airline friends are reaping the benefits hugely. Expect great quarters for everyone.
“CONTINUE TO DENSIFY!” says a chorus of computer programs in the New York area.
“Okay sir, we will, please don’t hurt us… Mummy made me a ham sandwich today – would you like that as well?” says the airline industry writ large.
“JETBLUE! STOP HITTING YOURSELF!” Says a seemingly disembodied voice as it continues to move Jetblue’s fist into its head.
JetBlue had a really great idea. Earn profit and attract customers by, gasp, being different. Free bags, more seat pitch, good IFE, trademark snacks. They illustrated that you could be an airline that operated on the gospel of low-cost without sacrificing too much in comfort. Customers love them. After the usual start up drain every airline faces, this model proved profitable. Unfortunately for them, their key-performance indicatorsÂ were wrong when compared to almighty Spirit. Their institutional investors demanded growth “or else.” So what was an airline to do? Change everything about themselves to appease short-term focused investors, of course. JetBlue decided to add 10% more capacity to some of their A320s while adding fare classes that eliminated one piece of free checked luggage.
JetBlue’s faithful were more disposed with these changes than the frequent flyers of the big three who also went down this path.
Wall Street doesn’t care.
To them, loyalty programs, indeed any sort of customer loyalty, is a liability.
Maybe people would be less irate if prices came down. That’s never going to happen!
Wall Street has rather missed the point about the business by fixating on their darling Spirit. There can only be one Spirit. Spirit is all about ancillary revenue. Their unit cost this past quarter was actually higher than Delta’s! Spirit is not about customer retention, or comfort, or anything. They know they are “not for everyone.” Their entire business model is predicated on being different. If everyone was like Spirit, how could Spirit continue to present itself as the “un-airline”? They couldn’t.
The other side of the coin is that by dragging every other airline down to their level, in a period of extremely low oil prices and generally improved margins and revenue, is that customers have feelings, preferences, and emotions. Indeed, the most loyal frequent flyers are actually part of the complex revenue management systems of the big three. Annoy them and you might have a problem. I understand that, to a point, domestic air travel is a bit of a captive audience situation – but Wall Street does not care. Wall Street is now about making money, not off the potential of a business, but by the microsecond fluctuation in stock value based off of rumors and innuendo or finding new and unpleasant ways to make life worse for actual paying customers. They also hate diversified business models in any industry. Harder to analyze and project if people are competing on things other than rock solid price.
Some say that the margins just aren’t there in increasing passenger comfort. They cite the abortive American attempt at More Room Throughout Coach. They may be right – but there’s also no point in decreasing the benefits of the paying customers when things were already growing.
Make travel so unbearable and expensive at the same time and people will seek options that are not flying. Workers can telecommute. Leisure travelers can drive (especially with the price of petrol as it is). Yes, there will be a period where hugely-dense cabins and low oil prices result in massive profits, but when fuel prices go back up and people have realized that flying has become so unpleasant and cut back on travel even more… especially when factoring in the costs of densifying aircrafts, airlines will realize they have spent dollars to earn cents, all to appease firms that cashed out quarters ago.
The best part is if any C-level executive came out and said, “we want to focus on consistent profits, reasonable growth, and stick to our business model,” they’d be hauled in front of the board, consisting of representatives of these institutional investors – and shot! The snake shall continue to eat itself.
I love this business so much sometimes.
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