Low-Cost Airline Growth Proves Costly

While network carriers have been shrinking capacity, low-cost competitors have been expanding. Some say the upstart growth is too undisciplined.
Author:
Publish date:

CHARLOTTE, N.C. -- In the airline industry, when

AMR

(AMR)

CEO Gerard Arpey speaks, people listen.

At least, they generally do.

Last week, as American announced a

mainline capacity cut of 11% to 12%

, Arpey blasted low-cost competitors for continued expansion in recent years. The industry "has been hurt by some airlines growing faster than conditions warranted, and that impact has worsened in light of recent economic trends and soaring fuel prices," he said in a prepared statement.

Added American spokesman Tim Smith: "We're not naming names, but you don't have to look any further than a number of airlines that have vastly increased capacity the last couple of years, going far beyond not only the growth of the economy but the demand for their own product as well."

Nevertheless, last week, some carriers were still announcing growth plans.

In fact, over the past three years, as network carriers have steadily shrunk domestic capacity, expansion has continued at low-cost carriers such as

AirTran

(AAI)

,

JetBlue

(JBLU) - Get Report

and

Southwest

(LUV) - Get Report

.

Expansion and Contraction

"To paraphrase Dickens, it's 'A Tale of Two Airline Industries,'" says FTN Midwest analyst Mike Derchin. "Low-cost carriers are growing while the network guys are shrinking domestically, and this has gone on every month for the last three years. The change is that the rate of descent by the network airlines after Labor Day and in 2009 is likely to be steeper."

Derchin's research indicates that network carriers have shrunk every month starting in January 2005, with the sole exception of February 2008, when leap year added an extra day. Network carriers reduced capacity by 2.8% in 2005, by 4.6% in 2006, by 2.2% in 2007 and by 3.6% in 2008, the research shows.

Yet in 2007, AirTran grew by 19.4%, JetBlue by 11.6%, and Southwest by 7.5%, according to the airlines' figures.

Continental

(CAL) - Get Report

, the fastest-growing legacy carrier, grew by 5.6%. At American, capacity shrank by 2.4%.

Overall, domestic capacity rose marginally, by 0.5% in 2007, according to the Air Transport Association. International capacity on U.S. carriers rose by 12%, and system capacity rose by 3.14%.

Network carriers have higher costs due to older employees, older airplanes, higher-paid executives and more complex operational and corporate structures. The discrepancy remains despite an intense effort since 2001 to take out costs, largely through bankruptcy.

This year, low-cost carrier growth is more discreet.

Last week, Southwest said it will keep six aircraft it had planned to retire, enabling it to boost Denver service. It may seem counterintuitive, but between April and May, Southwest increased its 2008 capacity growth estimate.

"The fact that the rest of the industry is going to be contracting is going to provide some opportunities for Southwest Airlines in the future," chairman emeritus Herb Kelleher told reporters at the company's annual meeting.

JetBlue said last week it will add five new routes, including Burbank to Washington D.C. and Las Vegas, and three north-southwestern routes. While the longhaul flying is on A320s pulled from seasonal Florida routes, some western routes will be flown with new Embraer 190s.

"We feel as though our growth rate is appropriate for the environment, but we will continue to aggressively manage our growth plans based on changing economic factors," says JetBlue spokesman Bryan Baldwin.

JetBlue has reduced 2008 growth to between 3% and 5%, from between 5% and 8%, with most of the growth driven by increased run rates on airplanes added to the fleet in 2007. In the fourth quarter, aircraft utilization will decline by about half an hour each day and capacity will decline by 2.8%, the first quarter of negative growth in JetBlue history.

AirTran, meanwhile, said last month that it will halt planned capacity increases in September and will keep its capacity level in 2009. It had been planning to grow 10% next year. "Routes we might have gone into in a $50 or $60

per barrel of oil environment don't hold up at $100," said AirTran CEO Bob Fornaro on an April earnings call.

In a recent report, CreditSights analyst Roger King applauded the AirTran and JetBlue strategies. He said AirTran benefits from sharing an Atlanta hub with

Delta

(DAL) - Get Report

because it "flies under the price umbrella of Delta with a lower cost structure."

Meanwhile, he said, JetBlue has transformed itself from a high-growth carrier "to an emphasis on margin and EBITDAR by pruning slowly developing new markets and raising fares more aggressively than the market."