Skip to main content

With the airline industry a terrorist attack away from slipping back into recession, and pricing power -- or yield -- showing little improvement, regional carriers are in a difficult position, reliant on network carriers and a hub-and-spoke model that many say is out of date.

But for now, business is booming. Increasingly, larger players like




United Airlines and


(AMR) - Get Alpha Metallurgical Resources Inc. Report

unit American Airlines have been turning to regional players to run small-market routes they no longer want to operate. A regional carrier will fly a small jet from Roswell, N.M., to a hub in Albuquerque, where passengers board a flight on a network carrier and head off to a larger, more popular destination in a bigger plane. Under long-term code-sharing agreements, the regional gets a cut for every passenger it shares with the network carrier.

Fueled by the downturn, regional carriers are growing fast, as larger operators cut costs and farm out smaller routes to players like

Mesa Airlines

(MESA) - Get Mesa Air Group Inc. Report


Atlantic Coast Airlines

( ACAI),

Alaska Airlines

Scroll to Continue

TheStreet Recommends

(ALK) - Get Alaska Air Group Inc. Report

and others. Through July 2003, Mesa's traffic was up 38.1% from July 2002 levels. And with United,

U.S. Airways

and others holding options to help Mesa expand its fleet, the company could grow even faster in the coming years.

With the industry on the verge of recovery,

talked with Jonathan Ornstein, CEO of Mesa Airlines, to get the latest on pricing, low-cost competition and the industry's future.


July traffic levels, across the board, were higher, boosting load factors and revenue. And as you announced, Mesa's load factor jumped to 70.4% from 62.4% a year ago, while revenue passenger miles jumped 56.7%. But have you seen any improvement in yield?

Jonathan Ornstein:

Very modest. I mean, it's not going down. Most of our operation is revenue guarantee, which is a nice way of saying cost plus. So we don't really watch the fares and yields throughout the large part of our operation. But we do about $100 million a year in revenue off of our 19-seat turboprops. We do see average fare data and it comes from a very diverse network. You know, we have five airplanes in Philadelphia, five airplanes in Kansas City, five airplanes in Albuquerque, so we sort of get a good sense of things. Our yields have been a little bit better, putting them three dollars above plan, because most of us felt yields may continue to soften. Let's just say we're not unhappy with the direction that yields have taken over the last 90 days.


One thing that many industry watchers have been pushing for is fundamental changes to the hub-and-spoke system, usually citing the profitability of point-to-point discount carriers like


(LUV) - Get Southwest Airlines Company Report



(JBLU) - Get JetBlue Airways Corporation Report



That's totally

false. People who say that don't understand the business.


So how do you see the business evolving?


It's very simple. If you took JetBlue or Southwest's cost structure, and when I say cost structure, let's speak bluntly -- wage levels, work rules, seniority -- and you were to overlay it on a United Airlines or a U.S. Air or an American or a


(DAL) - Get Delta Air Lines Inc. Report

with a hub network, they'd be the most profitable airlines in the world. Period. End of sentence. Do the math.

The reason why some of these carriers have proven to be successful is that they are buying all their goods and services at something closer to market than the other hub carriers. You cannot sell a product at market, which is what we all do, while you're building it at some price that is significantly higher than market. And you say, well, how is that possible? Well, do you think the market rate for a 747 captain these days is $350,000? I know at Virgin, they hire guys for $150,000.


Why have regional airlines -- many that don't have the cost advantage of a JetBlue or a Southwest -- been so profitable while larger carriers continue to struggle?


One, we operate smaller aircraft, which are, by definition, more efficient than larger aircraft. Anything that's smaller is less risk. I think Bob Crandall said you never go out of business flying an airplane that's too small. It's become very clear to people -- and this is something I learned at


(CAL) - Get Caleres Inc. Report

when we were doing the turnaround there -- you lose all your money with the bottom 20% of your fleet.

And it's generally because you're lowering your fares to fill the aircraft on routes that don't work. So what's happened with regional jets is, not only have they opened up new markets, but they frankly have allowed the major carriers to exit some markets where they were really bleeding. But they still get the connect traffic, which is really valuable, right, and has a beyond-revenue benefit by flying a smaller, more efficient regional jet.

I don't think it's a surprise, and I will say this publicly, that

America West

( AWA) probably had the best results of any of the hub network carriers. One, they had some of the lowest costs, and two, they had the highest proportion of regional jets to mainline jets than any other carrier.


A big story at America West is that they tweaked their business-fare structure, dropping prices for business travelers, closing the gap between leisure fares and business fares. What's your thought on the business-travel environment? Are these guys going to come back?


At some point, there will be more business traffic. But the fact is, there has been a structural shift. And we have to appreciate that there's been a proliferation of low-cost carriers, whether it be


( FRNT) or


( AAI) or JetBlue or Southwest. Technology has gotten better, which has reduced the requirement for face-to-face meetings, and the bottom line is the system cannot support the cost structure.

Everyone wants to ignore it because no one wants to take the bull by the horns. I mean, the days of being able to offer people the kind of wage levels we were able to

are over. The Uniteds, Americans and Deltas could afford

labor costs because they were able to charge the business traveler so much money -- those days are over. They're over. They may come back, but they're not going to come back to the extent that they're going to be able to charge a guy $800 to fly from LaGuardia

in New York to Chicago.


Mesa is growing extremely fast. Where do you see the airline three to four years down the road?


Clearly, the biggest impediment to our growth now is getting the delivery and financing of these regional jets. I don't think that's going to change for the next few years. There's a big arbitrage that exists between these small jets and our costs and the larger jets at the major carriers. I do think that arbitrage will narrow. But, I think you're talking way out there. Four, five, six years from now.

Our growth, if you look at it, we generate around 4.5 billion

available seat miles this year, we're thinking we'll do between 6 billion and 6.5 billion ASMs next year. That number will go up significantly if we're able to secure -- for example -- these

memorandums of intent that we have with U.S. Airways and if United was to exercise some of the options it has on additional aircraft. I mean, we actually think that next year could be as potentially high as 8 billion ASMs. And we look at ASMs because, basically, how we get paid is by how many ASMs we generate. A lot of people had called for the demise of the regional jet, but I can tell you we cannot fulfill the demand we have from our existing partners right now.


With regional airlines growing so fast, it seems like we're at a tipping point within the commercial airline industry. How unique is the idea of a mega-regional, something smaller than hub and spoke, but much larger than your current size?


I have a very strong belief that the regional jets work remarkably well in hub operations, supporting mainline flying. We're feeding into all these cities and the way regional jets work is, you can't look at it on a segment basis, you have to look at it on the beyond revenue as well. In other words, if we're flying someone from Carlsbad to Phoenix, just flying to Phoenix doesn't work. But the fact we're picking up 15 people in Carlsbad and they're going to New York, Philadelphia and Washington, you add all that revenue -- that becomes very, very positive for the hub network. I don't believe -- and I feel very strongly about this -- that there is any future for regional jets flying point-to-point.

You have regional jets that will continue to support hub operations and that will be very powerful. And the likelihood of becoming a super carrier? I mean, yeah, you could easily see us at $1 billion in revenue. If we were to implement all of the aircraft we have under option right now, we could be at $1.5 billion, $1.6 billion. I'd say that's a pretty big regional carrier.

Look at what Atlantic Coast is doing and, as I said in my conference call, I can't say I'm not a bit envious. I think they're taking a high-risk strategy, but at some point, I want to become large enough to be able to say I want my regional jets to feed my own hub somewhere. But you need those other narrow body, low-cost aircraft to make the rest of the hub work and run larger jets, the 737s, or the A320s.


This is the billion-dollar question, literally. Is the airline industry recovering with an eye on profits in 2005? Or are we dragging along the bottom until another shock comes along, like a terrorist attack?


That's a good question. It's hard to predict what would happen if there was some major disruption as the result of an attack, fuel prices spiking because of a war, something like that. If you look at the history of aviation, though, I remember during the dark days of the early 1990s everyone thought the industry was coming to an end, but it has a remarkable way of coming back. The question about whether it comes back is its sustainability. And the only way it will be able to sustain a recovery is if the carriers can, long term, put in place cost structures that will allow them to be profitable in what I feel is a new environment, in terms of revenue.