2nd Annual MIT Airline Industry Conference No Ordinary Time: The Airline Industry in 2003 Growth of Low Fare Carriers William Swelbar Managing Director April 8, 2003 William Swelbar Managing Director
Low Cost Carriers "Thou Shalt Not Inherit the Earth"
Airline Industry Prosperity Has Always Been Closely Linked to the Health of the U.S. Economy -- A Relationship That Began to Break Down Over 30 Months Ago 0.8% 0.8% Domestic Passenger Revenue as % of Nominal GDP 0.7% 0.7% 0.6% 0.6% 0.5% 1989 I 1990 II 1991 III 1992 I 1994 I 1995 II 1996 III 1997 I 1999 I 2000 II 2001 III
What We Thought Was A Watershed Period in the Early 1990s Pales in Comparison to What We Are Currently Experiencing Recession Percent Change From Prior Year 15 10 5 0-5 -10-15 -20-25 -30 Gulf War Fare War $13 billion loss 9/11 Recession -35 1990-1990- 1991-1991- 1992-1992- I III I III I III Source: Dot Form 41 and Bureau of Economic Analysis 1993- I 1993- III 1994- I 1994-1995- 1995-1996- 1996-1997- 1997-1998- 1998-1999- 1999-2000- III I III I III I III I III I III I Nominal GDP Chg Dom Rev 2000-2001- 2001-2002- III I III I
Domestic Market Revenue Deterioration Has Been Well Documented -- Yet is the Heart of the Catharsis 0.1 0-0.1 Percent Change -0.2-0.3-0.4-0.5 2001 2002 2003 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan
The Revenue Environment is Both Cyclic and Structural -- Adapt or Die Item Cyclic (Short Term) Structural Comment Current Recession X Historically linked to GDP which is not down dramatically. Probably a small part of the current problem. Post 9/11 Hassle Factor X Clearly a big factor below 500 mile trips -- low fare carrier traffic growth above 500 miles suggests may not be a big problem in the aggregate. (1) Security Fees X X A problem that impacts price of air travel -- depresses traffic for all carriers -- some relief may come from Congress but may be a lasting issue in the post-9/11 world. Low Fare Carrier Penetration X Key structural change that will only get worse for the network carriers unless cost structures adjusted accordingly. Availability of low fares is shifting demand. Disappearance of Bubble Economy X Likely to be permanent. May still be being rung out -- telecommunications infrastructure overbuilt. Internet Marketing of Airline Seats X Has made fare offers transparent to business and leisure travelers. Genie may be out of the bottle for good. Other Changes in Business Traveler Price Elasticity X X Company policies have shifted to save money on travel budgets. Could be somewhat reversed in good times. First cut, last to increase. Teleconferencing may have come of age -- may not be reversible. (1) In the first quarter of 2000, 28.5 percent of passenger trips and 18.9 percent of domestic revenue came from markets of less than 500 miles.
Two Distinct Groups Among the Network Carrier Segment Have Emerged -- Or is It Just Timing Network Carriers Hub Airports Domestic Nonstop Air Service Index Change Mar. 2003 vs. Sep. 01-32% -26% -13% 0% +5% +7% +12% US Airways PIT -31% CLT -24% PHL -17% American STL -56% ORD -15% MIA -12% DFW -9% United Continental IAD -38% CLE -8% LAX -31% EWR +3% SFO -23% DEN -13% IAH +9% ORD -4% Northwest DTW +1% MEM +2% MSP +7% Delta ATL +1% SLC +3% JFK +7% CVG +22% DFW+36% Note: Changes in carrier service reflect total; changes in hub service reflect nonstop only. Source: OAG Schedules; Eclat Air Service Model
Some Network Carriers Have Reduced Their Exposure to the LCCs -- Some Face More Competition Increased Exposure Since 9/11 (Ranked By Exposure to All LCCs) LCC Competitive Intensity (Delta = 100) 1. Delta (+20.2%) Delta 2. US Airways (+11.7%) US Airways 3. Northwest (+9.1%) Northwest Decreased Exposure 4. United (- 9.0%) United 5. American (-15.7) American 6. Continental (-31.0) Continental Exposure to low fare competition -160-140 -120-100 -80-60 -40-20 0 20 40 60 80 100
But the Fact Remains That the Network Carriers Competitive Intensity Among Themselves Dwarfs Their Respective LCC Exposure Still Too Much Capacity? Share of Passengers in Each Carrier's LCC Markets 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% AA AS CO DL HP NW UA US Major LCC Other Maj
Regarding LCC Competition, A Pattern Emerges. When the Unit Cost Gap Widens, the LCC Segment Exploits the Opportunity LCC Growth vs. CASM Differential 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 LCC ASM Share CASM Diff. 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0
The Low Cost Carrier Segment of the Industry Has Increased Its Share of Service in Almost Every U.S. Region Since 9/11, and No Better Time Than the Past 30 Months March 2003 Sept. 2001 7.9% 6.9% +1.0 pts. March 2003 Sept. 2001 8.4% 6.2% +2.2 pts. 0% 6% 12% 18% 24% 30% 36% 42% 48% 54% March 2003 Sept. 2001 8.7% 7.9% +0.8 pts. 0% 6% 12% 18% 24% 30% 36% 42% March 2003 September 2001 23.4% 27.8% +4.4 pts. 0% 6% 12% 18% 24% 30% 36% 42% 48% 54% 0% 6% 12% 18% 24% 30% March 2003 September 2001 24.4% 24.8% -0.4 pts. March 2003 Sept. 2001 11.4% 9.1% +2.3 pts. 0% 6% 12% 18% 24% 30% 36% 42% 48% 54% 0% 6% 12% 18% 24% 30% 36% 42% 48% 54%
Low Cost Carrier Market Penetration Has Deepened Since 9/11, But the Markets Share is Concentrated in Large and Medium Hubs Domestic Markets ASI Change LCC ASI Change LCC Current ASI Share Large Hubs -9.9% +9.6% 11.8% Medium Hubs -6.5% +1.5% 27.3% Small Hubs -3.5% +23.3% 7.4% Non Hubs -1.8% +28.0% 0.4% We estimate that the low cost carrier segment of the industry has captured an incremental 4 percentage points of domestic market share since pre 9/11
LCC Penetration into Top 10 CMSA Markets -- September 1997 San Francisco 23% San Francisco 3% Oakland 57% San Jose 38% Burbank 56% Los Angeles Ontario 18% 42% Orange County Long Beach 11% 0% Los Angeles 24% Large Hub Medium Hub Small Hub Houston 28% Chicago 13% Dallas/Ft. Worth 26% Houston (IAH) 3% Houston (HOU) 68% Chicago (ORD) 0% Dallas/Ft. Worth (DFW) 0% Dallas/Ft. Worth (DAL) 97% Philadelphia 0% Chicago (MDW) 64% Washington 6% Manchester Washington (BWI) 14% Boston 3% Boston 1% Westchester County Providence Newark Islip 13% 0% 6% New York (JFK) 1% New York (LGA) 0% Washington (IAD) 0% Atlanta 6% Washington (DCA) 0% New York 0.3%
LCC Penetration into Top 10 CMSA Markets -- March 2003 Swift and Sustaining San Francisco 29% San Francisco 2% Oakland 61% San Jose 39% Burbank 64% Los Angeles Ontario 22% 54% Orange County Long Beach 18% 46% Los Angeles 31% Large Hub Medium Hub Small Hub Houston 28% Chicago 17% Dallas/Ft. Worth 24% Houston (IAH) 3% Houston (HOU) 76% Chicago (ORD) 0.3% Dallas/Ft. Worth (DFW) 2% Dallas/Ft. Worth (DAL) 87% Philadelphia 2% Chicago (MDW) 75% Washington 17% Manchester 20% Washington (BWI) 46% Boston 6% Boston 3% Westchester County Providence Newark Islip 18% 1% 47% New York (JFK) 22% New York (LGA) 3% Washington (IAD) 3% Atlanta 13% Washington (DCA) 1% New York 8%
Has Low Hanging Fruit Been Picked? -- 97% of Domestic City Pairs Have Less Than 100 PDEWs, Accounting for Just 31% of Domestic Passenger Traffic U.S. City Pairs U.S. Passengers Greater Than 100 PDEW 3% Less Than 100 PDEW 31% Less Than 100 PDEW 97% Note: PDEW = Passenger Per Day Each Way Greater Than 100 PDEW 69%
Has Low Hanging Fruit Been Picked? -- 12% of LCC City Pairs Have Less Than 100 PDEWs, Accounting for Just 2% of Their Traffic LCC Markets Less Than 100 PDEW 12% LCC Passengers Less Than 100 PDEW 2% Greater Than 100 PDEW 88% Greater Than 100 PDEW 98% Note: PDEW = Passenger Per Day Each Way
Has Low Hanging Fruit Been Picked? -- In Fact, City Pairs With Less Than 100 PDEWs Make Up Less Than 3% of the LCC Traffic Today 25% 20% 21.0% 15% 15.1% 10% 5% 0% 5.0% 3.8% 4.5% 3.5% 2.6% 1.1% 0.8% 0.7% 0.0% 0.0% JetBlue Frontier AirTran Spirit ATA Southwest Markets Passengers Note: PDEW = Passenger Per Day Each Way
As the Network Segment Addresses Their Respective Cost Issues, There Will Be Less Spread to Exploit 80 70 60 50 40 30 20 10 Seat Mile Costs Mainline and 50-Seat Regional Jet 0 0 500 1000 1500 2000 2500 3000 RJ Cost Curve Mainline Cost Curve (Pre-Restructuring) Hypothetical Cost Curve (Post-Restructuring)
Making it Harder for the LCCs to Grow at Current Rates. In Fact, There Are Scenarios Where Some Low Cost Carriers Will Shrink LCC Growth vs. CASM Differential 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 LCC ASM Share CASM Diff. Estimated 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0
Low Cost Carriers Currently Serve 940 of the Largest City Pair Markets. If the 100 PDEW Level is the Ticket for Entry, Then Only 213 Remain 213 U.S. Markets With Over 100 PDEWs That Have No Low Cost Carrier Service 118 (55%) Remain 74 (35%) Slot Controlled 5 (2%) Misc. Reasons 16 (8%) Over 2,000 Miles
Only 118 Markets Are Immediate Candidates for New LCC Service, and Not Enough to Feed All of the Current Players Those 118 Markets Would Produce An Additional 1.6% Market Share for LCC Carriers % of Current New ASMs % of U.S. 9.3% 10,533,680,270 1.6% jetblue 2.1% 152,314,500 0.0% Frontier 4.6% 237,209,850 0.0% AirTran 16.7% 1,305,218,100 0.2% Southwest 1.9% 1,305,530,540 0.2% New/Speculative/Other n. m. 7,533,407,280 1.1%
If the Analysis is Correct, 118 May Be Overstating the LCC Opportunities Going Forward -- Assuming No Major Carrier Liquidations, of Course 82 Markets Are New/Speculative/Other: Here is Why Served By Secondary LCC Market Hub Dominant Hub To Hub DFW To Wright Amendment "Blocked" Airports Leisure Markets Other 24 22 20 9 6 1 82
Conclusions It s the economy stupid! No it s not. Bubbles burst. Consumers revolt. Businesses stop spending. Too much transparency via the internet? Domestic revenue now at 1995 levels. It s all the result of LCC growth! No it s not. During the 1997-2000 period, significant capacity growth by the network carriers resulted in multiple competitive options. Despite the cutbacks in capacity, the competitive intensity among the network carriers is significantly greater than competition from the LCC segment. Delta, Northwest and Continental are safe. No they re not. Balance sheet and cost issues have forced US Airways, United and American to go first. We have demonstrated the greatest opportunities for LCC expansion lie in Delta s backyard. Northwest, finally, faces increasing LCC competition. And Continental s balance sheet is not a picture of health. They too will have to restructure.
Conclusions (continued) The LCCs will grow at current rates into the foreseeable future. No they won t. Recent and ongoing restructurings will push down the network carriers respective cost curves to levels not dreamed of 18 months ago. If the cash spread is one attribute of LCC market exploitation, then the window is closing. All of the current LCCs will be survivors. No they won t. Only Southwest and jetblue have real staying power. AirTran is interesting. But is jetblue smelling blood in the Georgia clay believed to be their s or Delta s. Frontier, Spirit and ATA each have unique attributes but questionable staying power. There are still a myriad of market opportunities available and ready-made for the LCC segment. No there aren t. Assuming no major liquidations, of course. And assuming that the appetite for small local markets doesn t change or inflict the LCC version of self-diversion.
Low Cost Carriers "Thou Shalt Not Inherit the Earth"
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