Things in the Sky

Last week, Southwest announced what AirTran cities will end up being converted to Southwest stations, and that included revealing a few more cities that would be eliminated. This announcement follows previous announcements in August and November announcing AirTran station closures. Here’s a chart of AirTran cities along with the number of originating passengers from August 2010 through July 2011, courtesy of the DOT T100 database:

The vast majority of the cities that are being cut are some of the smallest in the AirTran network. The two largest stations being eliminated are Dallas/Ft. Worth and Newport News/Williamsburg. Southwest cant serve the former due to the Wright Amendment, and the latter city was probably cut due to its proximity Southwest’s Norfolk operation.

By the way — It’s worth noting that the numbers for the two “smallest” cities – Bermuda and Des Moines – are a bit misleading. AirTran only started flying to Bermuda a few months ago, and the same goes for its own-metal flying to Des Moines, which had been previously served through AirTran’s small partnership with SkyWest. Also, while Washington-Dulles is one of the airports losing AirTran service, but that airport continues on as a Southwest station.

Cranky Flier already had a good rundown and analysis of the latest cities to be cut, so I recommend taking a look there. But this latest round of network changes has got me thinking about the Southwest network going forward. Here’s what CEO Gary Kelly had to say about the AirTran deal when it was announced:

It offers Customers more low-fare destinations as we extend our network and diversify into new markets, including significant opportunities to and from Atlanta, the busiest airport in the U.S. and the largest domestic market we do not serve, as well as Washington, D.C. via Ronald Reagan National Airport. The acquisition also allows us to expand our presence in key markets, like New York LaGuardia, Boston Logan, and Baltimore/Washington. It presents us the opportunity to extend our service to many smaller domestic cities that we don’t serve today, and provides access to key near-international leisure markets in the Caribbean and Mexico.

A lot of what Kelly mentioned in that quote is already done, at least to some extent. Southwest will be launching its own service to Atlanta next month, and it now has access to AirTran’s slot portfolio at LGA and DCA. The carrier is already adjusting its schedule at the former, and will be launching service from LaGuardia to Denver and to St. Louis. But further expansion at the slot-controlled airports is iffy – Southwest lost out to JetBlue in the slot swap and additional slots are hard to come by. (Though one possibility that comes to mind is a potential divestiture in any potential M&A activity with American crops up.)

And while Kelly did mention the opportunity presented by smaller markets, the cuts in AirTran’s smaller-city service would indicate that opportunities might be limited in this area.

So what’s next for Southwest? Near-international seems to be an important opportunity for them, especially as the airline plans to increase its Mexican flying to destinations like Cabo, Mexico City, and Cancun. And the fact that Southwest’s soon-to-be-delivered 737-800s will be equipped for ETOPS would indicate that Hawaii is a possible location for a future expansion in Southwest’s network. The expiration of the Wright Amendment in 2014 could open up some interesting opportunities from Dallas as well, though the number of gates at the airport is restricted.

Obviously, those three opportunities are significant, but I’m just wondering where Southwest sees itself growing over the next 5-10 years or so. It seems that Southwest might not grow significantly over that time period, especially as the carrier mentioned that its latest Boeing order “intended to predominately serve as replacement aircraft as the airline continues the modernization of its fleet.” Obviously, the airline’s orderbook of 737-800s will allow it to increase capacity on existing routes, but I’m just wondering how many cities left in the US that would support a Southwest level of service.

The dramatic growth in regional flying, especially of the 50-seat jet variety during the late 1990s through early 2000s, was nothing short of impressive. Nevertheless, totally regional jet flying in the US appears to have topped out over the past few years. Here’s a chart of total block hours of major regional jets at US carriers over the past few years (2011 isn’t included because all of the data hasn’t come out yet):

A quick look at this graph leads to a few interesting points/questions/things to consider:

• If so many 50-seat regional jets weren’t tied up in long-term, multi-year contracts, how many would still be flying today to support mainline flying?
• While larger regional jets certainly have an increased presence in the US industry than they did a few years ago, 50-seaters still dominate the landscape. Will scope clauses at mainline carriers continue to relax to allow for more of these aircraft to enter the market, or might management and labor find a way to bring this flying in-house? (The latter isn’t the most likely scenario but it’s worth considering.)
• If oil prices were to keep on rising, let’s say to $120 for hypothetical, how much further would regional jet flying be reduced?
• What happens to all the 50-seaters as more and more come off contract over the coming years? Obviously exactly what happens depends on the economy, oil prices, etc., but still interesting to consider.
• What replaces 50-seaters as they age? The only regional jets in production right now are of the larger variety, and the only aircraft in the 50-seat area that’s currently in production (that I can think of) is the ATR 42. In what scenarios aircraft like the CRJ-700/900, E-170/175, Q400, ATR-42/72 work as replacements?

Internet connectivity provider Gogo filed for an IPO on Friday last week, and its prospectus filed with the SEC has some interesting nuggets of information. Personally, I was quite excited to read through everything as many airlines haven’t provided much in terms of details when it comes to Wi-Fi usage and revenue, and unlike baggage or change fees, they aren’t required to break out these revenues when they report financial data to the DOT.

SplatF went through much of the IPO filing already, and they take a stab at perhaps the most interesting data point: usage rate. “With roughly 355 million passengers having flown on Gogo-enabled planes since 2008, Gogo has only provided 15 million sessions — about 4% take-up,” the website reports. But it does appear that Gogo is making some decent progress in revenue growth. SplatF notes that “total ‘average revenue per passenger’ on commercial airliners in the first 9 months of this year was $0.41, up from $0.26 in the year-ago period, and up from $0.15 in full-year 2009.”

I found a couple of interesting things in the SEC filing as well. First, it’s worth putting  Gogo’s commercial airline revenue in context. Gogo generated just under $59 million in service revenue during the first nine months of 2011. That’s over a 100% increase from the same period a year ago, but so far it appears that connectivity has yet to become a major source of revenue for airlines, as they only get a portion of those revenues. But even if we disregard that for a second – that $59 million for Gogo as a whole pales in comparison to other carriers. In the first six months of 2011, for example, Delta alone earned over $424 million in baggage fees, according to the DOT.

It’s also worth noting that so far Gogo’s commercial aviation business appears to be dragging down the company’s financial results as a whole. The segment loss for commercial aviation was $20.8 million in the first nine months in the year, while Gogo’s business aviation segment recorded a segment profit of over $19 million. That $20.8 million loss, however, is a strong improvement from a $50.8 million loss in the same period last year (page F-17 of the SEC filing has a breakdown of these segment results).

But while Gogo has been experiencing losses over the past couple of years, at least its results are improving. The company’s operating loss for the first nine months of the year was $26.5 million, much smaller loss than the $66.4 million loss experienced over the same nine months last year.

Gogo also detailed its growth strategy, and I found a few bits interesting. It’s not entirely surprising that the company wants to keep expanding service with existing customers, saying it palns to “leverage…[its] unique ability to cost-effectively  equip each commercial aircraft type in an airline’s fleet to increase the number of Gogo-equipped aircraft, targeting full-fleet availability of the Gogo service for all of our airline partners.”

What will be very interesting to watch is Gogo’s plan to go international through a partnership with Inmarsat. Gogo said that it hopes to laverage ” our existing domestic relationships with members of each of the major global airline alliances, as well as the strength of our platform offering and proven track record, to help us to partner with members of these alliances outside North America.”

If Gogo is targeting the alliances, Skyteam seems like a logical step. Delta is already a huge customer for Gogo, as the compnay noted that “approximately 45% of revenue generated by our CA [commercial aviation] segment for the nine months ended September 30, 2011 was generated through our agreement with Delta Air Lines.” United has already announced a deal with Panasonic for Wi-Fi, which includes international aircraft, and based on Delta’s recent emphasis on inflight Wi-Fi I’m sure they’d like to stay competitive here. (American has also said that its upcoming 777-300ER aircraft will feature Wi-Fi service, but it didn’t provide much in terms of details.)

…Republic, who presented at an investor conference today. The company had an interesting chart comparing its branded fleet in October 2009 to what it should be at the end of next year. The total number of aircraft will have decreased over 25% that time period, though the average size of aircraft will have increased at the same time as the carrier removed smaller aircraft like the ERJ from its fleet while adding A320s.

By the end of next year, Frontier will be down to four fleet types – the E190, A318, A319, and A320.

(Editor’s Note – Most of this post was written over this weekend, but I’ve made a few minor changes to reflect AA’s major announcement today.)

In September 2009, American Airlines parent AMR Corporate announced that it was taking “significant steps to face near-term challenges,” including changes in the airline’s route network. American would “eliminate unprofitable flying and reallocate resources” to Chicago, Dallas, Los Angeles, Miami, and New York – the “cornerstones” of American’s network that were “critical markets.”

But despite these network and other changes, American’s financial performance continues to lag its peers. AMR’s operating margin in the third quarter was a mere 0.6%, far lower than Delta’s 8.8% margin.  Meanwhile, American’s operating margin in the third quarter was 440 basis points better than the third quarter of 2009, while Delta’s operating margin rose 607 basis points.

American has lagged Delta in revenue production as well. Its consolidated passenger revenue per available seat was 12.78 cents in the third quarter, a 20.4% increase from the same period in 2009. While a double-digit unit revenue increase is certainly strong, it is less than a 29.2% increase in consolidated PRASM for Delta over the same period.

So far, the airline’s bankruptcy filing does not appear to have a large effect on American’s network strategy, as it said today on its website that it plans “to maintain a strong presence in domestic and international markets, including our cornerstones in Dallas/Fort Worth, Chicago, New York, Miami, and Los Angeles.”

While the idea of an airline cutting back on loss-making routes and focusing on core markets is certainly a valid strategy, it appears that American’s cornerstone strategy had not provided enough benefits to allow the Dallas-based carrier to keep up with its peers. Two cornerstone markets worthy of extra review, in my opinion, are Los Angeles and New York.

Los Angeles

American might be putting more emphasis on Los Angeles, most notably launching a slew of regional routes in recent months, but other carriers view the city as important. United has historically viewed the city as a hub, Delta has been building up there, and Virgin America has added service on key American routes, like New York or, more recently, Chicago and Dallas. What remains unclear is how American expects to become a dominant player in this market.

Two New York Strategies

In late 2009 US Airways announced a similar plan to American’s cornerstone strategy, saying that it would focus on Charlotte, Philadelphia, Phoenix, and Washington, DC. The carrier announced at the same time that its Boston, Las Vegas, and New York-LaGuardia crew bases would be closed. The news came after the carrier had made the initial announcement about its slot swap with Delta, which entailed a large shrink of US Airways’ LaGuardia operation.

“The problem in New York is the fragmentation in New York. We weren’t big enough in New York,” said US Airways CFO Derek Kerr at a recent investor conference when asked about its slot swap deal with Delta. He continued: “as we look at it, if you’re not number one in your market or a strong number two in your market, you’re going to lose money in those markets.”

While that “problem” in New York is being solved with the slot swap, it isn’t necessarily in American’s favor. After the transaction closes and the divesture of 32 slots is completed, Delta’s share of LaGuardia slots will increase from 24.2% to 44.7%, according to the government’s tentative approval of the deal, released earlier this year. American’s share would remain constant at 20.6%, the second-largest position at the airport.

And while American’s competitive position at LaGuardia will continue to be squeezed, the carrier faces stiff competition at other New York airports. According to DOT DB1B market data for the first quarter, American trails behind Delta, Continental/United, and JetBlue in terms of its share of originating domestic passengers from the total number of passengers leaving from JFK, LaGuardia, and Newark.

Where Scope Falls Into All of This

Scope relief from American’s pilots, represented by the Allied Pilots Association, might be a necessary factor for the airline’s cornerstone strategy to succeed. The scope clause, which covers important topics like regional flying  and domestic codehsaring can have significant implications for American’s future.

American’s existing scope clause is one of the most restrictive in the industry, allowing only a very limited number of large regional jets and turboprops and its network. As a result, American has less flexibility than other carriers when it comes to matching aircraft size with demand. The airline has proposed a solution where larger regional jets would be operated by mainline pilots with special pay rates and work rules, but it remains unclear if this idea will move past the proposal stage.

Another very important part of scope, domestic codesharing, also plays a large role in the success of the cornerstone strategy. The carrier specifically mentions in a summary of its proposal to the APA why this is important:

We would like to expand our network in the northeast. However, we face slot constraints, so we cannot add flying in peak demand times without cutting flying in the same time window. As a result, we cannot grow our northeast operations without domestic codesharing.

American notes in its scope proposal that it seeks to place the AA code “on a Shuttle between BOS, LGA, and DCA.”

Under the proposed scope clause the carrier would also be allowed to “place the Company code on a domestic airline based at JFK” (JetBlue?), and this would be implemented “for the purposes of feeding AA international growth at JFK.” Outlining the proposal further, American said that before codesharing begins, it must launch six new mainline JFK departures, half of which must be international or transcontinental flying.

In terms of West Coast flying, American is also seeking an expansion of its relationship with Alaska, saying in its summary:

Today, Alaska puts more passengers onto our network than we put onto theirs. This enables us to serve many markets more successfully than we could without this codeshare. An expansion of the Alaska Codeshare Agreement would allow us to maintain a significant network presence in the northwest and along the West Coast, while fully utilizing our aircraft in the most productive manner across our domestic network.

According to the carrier’s scope proposal, the number of markets that can be added to the codeshare would be calculated off a baseline of “mainline block hours in the LA Basin and Bay Area.”

Concluding Thoughts

Two of American’s cornerstone markets – Los Angeles and New York – are highly competitive, and in the case of the latter, slot-controlled to restrict growth. A revised scope clause with the APA would enable American to become a stronger competitor in these markets by operating larger regional jets, and also enabling the expansion of codeshare agreements.

Whether American’s pilots think that these moves are in their best interest is another story. It would indicate that they do not, as American’s contract proposal was quickly rejected, but the carrier’s bankruptcy filing certainly can change the tone of negotiations.