Southwest to Write Its Own Philadelphia Story
Eric Gillin
10/29/03 - 01:40 PM EST
After three years of steady growth,
Southwest Airlines (LUV Quote) is getting aggressive, expanding its low-cost service to Philadelphia, the nation's fourth-largest city and home to
US Airways' (UAIR Quote) most important hub.
On Tuesday, Southwest said it would begin flying up to 14 daily departures from Philadelphia International Airport in May 2004, using four gates. The debut of service in Philadelphia puts a sizeable chunk of US Air's business at risk at an especially vulnerable time for the carrier, which just emerged from bankruptcy in the spring and whose shares only recently began trading.
In Philadelphia, Prudential Equity Group estimates that US Air has a 72% market share and generates 25% of its total annual revenue, or more than $1 billion, from its operations at the airport. Philadelphia accounts for five times the revenue US Air generates from LaGuardia Airport in New York, so US Air will likely defend the hub by any means necessary.
"Philadelphia will not be an easy market for Southwest to penetrate ... however, we believe that the odds strongly favor Southwest in the long term," said Gary Chase, airline analyst for Lehman Brothers. "Even after its restructuring, US Airways does not have a low enough cost structure to compete with Southwest."
An earlier battle between US Air and Southwest over the Baltimore market illustrates this phenomenon. In 1993, Southwest announced plans to begin service with eight daily departures from Baltimore-Washington International, where US Air had 55% of the market share. The battle grew heated and fares plunged to as low as $19 one-way to Cleveland, but over time, US Air's higher cost structure made such fares untenable.
Unable to keep up, US Air's position in Baltimore was eroded by the low-cost competition. Today, Southwest Airlines is the dominant carrier from BWI, commanding 43% of the market share.
Let the Games Begin
US Air generates 25% of its revenue flying out of Philadelphia, where it maintains a hub and has 72% market share. Here's a look at the top 10 destinations from Philly and where US Air must protect share. |
| Destination |
# of Passengers |
US Air Market Share |
| Chicago |
805,500 |
26% |
| Orlando |
798,370 |
70 |
| Los Angeles |
513,340 |
45 |
| Fort Lauderdale |
472,310 |
67 |
| Bay Area |
454,990 |
46 |
| Las Vegas |
427,220 |
42 |
| Tampa |
421,070 |
75 |
| Houston |
249,450 |
32 |
| Phoenix |
247,340 |
46 |
| Miami |
241,110 |
55 |
| Source: Morgan Stanley Research |
"It required nine years of Southwest effort to dismantle US Airways' hub in Baltimore, and US Airways fought aggressively, at least at first, to maintain a beachhead there," said Jamie Baker, airline analyst at J.P. Morgan. "Nonetheless, once Southwest's market share of BWI began to [move] into the low teens, US Airways' share began its decisive and irreversible slide."
Southwest's move in Philadelphia doesn't just affect US Airways, however. By moving into such a large market that's so close to New York City and Washington D.C. at the same time
JetBlue (JBLU Quote) plans to debut service from Boston's Logan Airport in January 2004, the entire northeastern travel corridor will see competition increase. Furthermore, it puts JetBlue and Southwest on an inevitable collision course where the young upstart and the old master will compete head to head.
"More psychological than anything at the moment, Southwest's Philadelphia service certainly brings it and JetBlue closer to hand-to-hand combat in the Northeast," said Baker. "While route overlap between the two remains highly limited, Southwest's apparent bias towards Northeast expansion is not expected to make life easier for JetBlue."
It won't make life easier for many other carriers, either. Because of Philadelphia's proximity to New York City, large service increases along with lower prices -- exactly what happened when Southwest entered BWI -- will put pressure on New York-based operators to keep fares low as well.
By and large, analysts cheered the news, telling investors they felt Southwest would be successful in Philadelphia and the return of aggressive growth could lead to more upside for shares in the months and years to come.
"In the long run, as Southwest's frequency into and out of the Philadelphia market increases, we believe significant upside potential exists for the franchise," said Daniel Hemme, analyst at Prudential Equity Group, in a research note.
Cheap, Cheap, Cheap
When a low-cost carrier enters a new market, fare levels plunge, a phenomenon known as the "Southwest Effect." On some routes, Southwest's fare could be a third of the average fare paid in 2002. |
| Destination |
Avg. Fare* |
Southwest Fare** |
% Difference |
| Boston |
$186 |
$56 |
-69.9% |
| Charlotte |
241 |
89 |
-63.1 |
| Chicago |
144 |
102 |
-29.2 |
| Denver |
184 |
125 |
-32.1 |
| Houston |
212 |
133 |
-37.3 |
| Los Angeles |
190 |
144 |
-24.2 |
| Miami |
138 |
101 |
-26.8 |
| Pittsburgh |
141 |
53 |
-62.4 |
| San Francisco |
211 |
151 |
-28.4 |
| St. Louis |
217 |
98 |
-54.8 |
* -- As of 2002.
** -- Estimated.
Source: Lehman Brothers Research
|
Even without adding new cities such as Philadelphia, Lehman Brothers estimates that Southwest has about $3 billion in revenue opportunities out there just by "connecting the dots" in its existing network. In 2003, analysts expect Southwest to book $5.9 billion in revenue, up 7.5% from 2002, but in the years to come, growth is expected to accelerate as Southwest adds cities and continues to connect the dots.
Indeed, when Southwest announced third-quarter earnings, the carrier said it had exercised options to take even more planes than originally planned, accelerating a growth plan that had been stifled during the industry's three-year slide. After growing capacity 6% in 2002 and just 4% in 2003, the carrier will grow by 7% in 2004 and 10% in 2005, matching growth levels last seen during 1999's boom year for travel.
"Southwest will start service to Philadelphia, its 59th city, in May 2004. Southwest will start with four gates, but could grow to eight," said William Greene, airline analyst at Morgan Stanley, in a research note. "Initially, Southwest will have up to 14 daily flights. Typically, Southwest operates nine to 10 flights per gate, suggesting it could grow to as many as 80 daily flights in Philadelphia."
In reaction to the news, on Tuesday, shares of US Airways took a bit hit, dropping 3%, while Southwest gained 2%. On Wednesday, as investors digested analyst comments, shares of US Air continued to slide, falling 68 cents, or 5.5%, to $11.80. Southwest gave back some of Tuesday's gain, dipping 10 cents, or 0.5%, to $19.11, which values the company at about 31 times estimated 2004 earnings.
