Where Have All the Low-Cost Airlines Gone?

NEW YORK ( MainStreet) -- After American Airlines ( AMR) filed for bankruptcy in November, Southwest ( LUV) CEO Gary Kelly wrote a letter to his employees emphasizing what he believed to be the biggest make-or-break factor for airlines: cost.

"All the majors from 1989 have gone bankrupt. Pan Am. Eastern. Braniff. Continental. America West. TWA. US Air ( LCC). United ( UAL). Delta ( DAL). Northwest. And now, American," he wrote at the time. "Why? Not because of customer service, but because of high costs. Great customer service cannot overcome high costs. That is the imperative I wrote about a decade ago: low costs."
Discount airlines exist, but the few that remain must rely more on extra fees and sales of secondary services to survive.

As Kelly sees it, the only way forward for the remaining airlines in the U.S. is to become more efficient and bring down operating costs. In effect, large nationwide carriers such as American, Delta and United -- the so-called legacy carriers -- must begin operating more like low-cost airlines. Or as Kelly put it, "The old legacy airlines are dead and buried."

Traditionally, there has been a firm distinction between legacy carriers, which airline analyst Rick Seaney refers to as airlines with operating costs of roughly 11 to 13 cents per mile, and low-cost airlines that have costs of about 8 to 9.5 cents per mile. These low-cost carriers were usually bootstrap operations that relied on cheap labor, inexpensive jet leases and no-frills flight experiences to keep costs down and offer insanely low prices to travelers. Now the legacy carriers are relying on some of these strategies just to survive.

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"They are all becoming low-cost airlines," says Seaney, who co-founded FareCompare, a Web site that tracks airfares. "Airlines are dumping their business-class seats for economy seats, and if you want luxuries, you'll have to pay extra for them as a separate fee."

Of course, if you told travelers that major airlines such as Delta and United were now considered "low cost," many would probably laugh. For most consumers -- at least those who have been flying for more than the past decade -- the true low-cost carriers were those that flew a limited number of routes for a cost that often seemed closer to bus fare than airfare. These included carriers such as Independence Air, Skybus, People Express, New York Air and USA 3000 Airlines, to name a few. They tended to be small start-ups with short life spans -- Independence Air and Skybus barely lasted two years -- and the majority have since gone out of business or, in the case of USA 3000, are about to.

"History is littered with these low-cost airline start-ups," says George Hobica, an airline expert and founder of Airfarewatchdog.com. "They were more likely to fail than not even when money was loose, and money is tight now."

In their place, all we're left with are a couple of cheap airlines and the national carriers who borrow some of their tricks without the dirt-cheap prices.

How low-cost airlines are different today
The two most prominent low-cost carriers operating today in the U.S. are arguably Spirit ( SAVE) and Allegiant Air, and the one major difference between them and the low-cost carriers of old: more fees.

"The only real low-cost carriers now are high-fee carriers," Hobica says, and for some, that may undermine their very image as low cost.

Spirit, in particular, has become notorious for relying on often outrageous extra charges to gin up revenues, whether it's a $30-to-$45 fee for carry-on luggage or an additional fee for not paying that fee far enough in advance. Previous low-cost airlines such as Skybus and People Express had fees of their own, but not to the same degree. The net effect is that by introducing as many fees as possible, they can still promise an ultra-low base fee that significantly undercuts the competition. (The same is true if you think about low-cost airlines abroad, most notably Ryanair.)

Fees aren't the only tactics these airlines have used to boost profits. According to Hobica, the discount airlines rely on secondary revenue sources such as selling tickets to hotels and rent-a-cars, something Spirit and Allegiant do. Even a few years ago, Skybus tried to pad its revenue by placing advertisements inside the plane, but clearly that wasn't enough.

At the same time, low-cost airlines have been forced to focus on more offbeat routes in hopes that large carriers don't cover much, if at all, and effectively "pick up the scraps," as Seaney puts it. Unfortunately, while these tricks may be enough to keep the existing discount airlines in business for now, the market for start-ups is tough and getting tougher.

Perhaps the biggest single reason we're not seeing more discount airlines pop up is the rising cost of gas.

"Starting an airline is a sexy thing for people who have money, but not for people who want to make money," Seaney says. "I'm positive there are half a dozen start-up airline business plans out there waiting for $70-a-barrel oil."

Even if gas prices were to drop tomorrow, new discount airlines would have to contend with limited bank lending and a consolidating industry. That, Hobica says, makes it all the much harder for smaller airlines to compete.

The future of low-cost carriers
For discount carriers to survive, they will likely need to find new and creative ways to broaden their supplemental businesses.

"They will need to try to upsell other products like rental cars, hotels, vacations, cruises, credit cards, anything travel-related," Hobica says. And of course, Hobica says they will continue to lean on ancillary fees, much to the chagrin of many customers.

Beyond that, the future of low-cost carriers could ultimately come down to advances in jet engine technology. If gas prices continue to go up without an affordable fuel-efficient jet, discount airlines may no longer be able to manage their costs.

"What they really need," Seaney says, "is a magical jet engine that runs on oxygen."

If only.

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