Air travel and economic growth are widely recognized to be linked together; the industry typically grows at about double the rate of economic growth. However, despite the economic malaise in the United States, 2011 was not a bad year for the aviation industry here.
As US airlines dealt with stagnating demand and appreciating fuel prices, they still managed to pull of the most impressive feat in the business; making a profit. The trends in the industry that shaped these changes were:
The year of the capacity cut
The typical mindset of the airline industry has always been growth; gaining market share, buying more planes, serving more destinations. One need not look far to understand this; the Indian market itself is touted as one of the best in the world, primarily because there is so much traffic growth. But as we pointed out in our most recent podcast, the Indian airlines are making heavy losses, with capacity growth outpacing demand. For much of the 2000s, the US market was in a similar place.
Since the US airline industry was de-regulated in 1978, airline management has constantly overvalued market share and pure size (not unlike the Indian government’s treatment of Air India today). It is not incorrect to say that they literally chased market share off cliffs; if an airline’s hub was invaded, the typical response was the initiation of a price war, with heavy consequences for all. This was an industry that lost a net of US $59 billion between 2000 and 2010, and a large part had to do with the fact that carriers tried to grow their way to profitability, rather than actively managing their business to make it profitable.
Now capacity cuts are certainly not the only factor in the sustained profitability of US carriers in 2011 (the recent wave of consolidation was the biggest long term factor- it cut needless capacity from the market). But they are the biggest non-structural change from years past. Whether it was Delta cutting small turboprop markets and slicing off about a third of its New York JFK transatlantic operation or Frontier withdrawing from its mistake of a Milwaukee hub; US carriers very actively managed their capacity and were quick to slash unprofitable flying. Overall, the second half of 2011 has seen US carriers cut capacity by around 1% versus the same period in 2010, and North American carriers (basically throwing in Canada’s small market as well) are projected to have grown capacity by just 2.3% year over year versus 2010.
Capacity discipline helps keep revenue afloat
One of the most interesting paradoxes in the US market has been the unit revenue strength shown by not only traditional full service carriers like Delta and United, but even from low cost carriers (LCCs) such as Southwest Airlines and JetBlue. Typically, the industry’s problems during recessionary periods, and in general during the 2000s was that LCC’s would always undercut pricing by legacy carriers; when fares needed to go up, the Southwests, JetBlues and AirTrans’ of the world refused to increase them. But perhaps because the major two low cost carriers Southwest and JetBlue are dealing with flattening growth and rising costs, the LCCs have been much more receptive to keeping fares high, paying dividends for the industry as a whole.
Simply put, the US airline market is in the midst of perhaps the fastest growing revenue environment since the mid 90s, while the US economy itself is muddling through the tail end of the Global Financial Crisis (fingers crossed anyway). Premium travel has grown well, but recession policies curbing profligacy are still in effect, so the broader revenue gains have come mostly from smart management by the airlines.
That mythological creature known as profit
The airline industry is almost universally recognized as a poor investment; with relatively limited barriers to entry and irrational new entrants, the concept of pricing power barely exists. Richard Branson has been quoted as saying that, “the easiest way to become a millionaire is to start off a billionaire and go into the airline business.” Consistent profitability has, to this point, eluded the US airline industry for more than ten years; 2010 and 2011 together look to break this trend once and for all; North American carriers posted record profits in 2010 and are projected to make a round US $1.5 billion by IATA in 2011.
On a micro level, the performance of US carriers was very encouraging in 2011. Industry leaders United and Delta took advantage of Chapter 11 reorganizations and mergers to record projected profits of more than $800 million apiece. Southwest Airlines and JetBlue both utilized of continuously appreciating revenues to cover rising costs, and US Airways countered by showing remarkable cost discipline. Alaska Airlines seems to have hit upon a magic formula out in the Northwest, and niche players Spirit, Allegiant, and Hawaiian all maintained solid profitability. Even financially tenuous Virgin America finally recorded a quarterly operating profit earlier this year, and Frontier Airlines is currently in the midst of an analyst-approved re-structuring plan that will hopefully return it to profitability. In fact, outside of loss-leader American Airlines, which filed for Chapter 11 Bankruptcy Reorganization earlier this month, the US airline industry was singularly profitable in 2011, an all too rare occurrence in this business.
The Decline of the Regional Jet and Small Cities
Alongside this pattern of capacity draw-downs and growing revenues, 2011 marked the end of the line for the 50 seat regional jets which became pervasive in the early part of this decade as feed aircraft for US full service carriers. But the combination of rising fuel costs, and a loss of pricing power due to over-supply of these jets appear to have killed off the economics of 37-50 seat regional jets once and for all. Delta was most aggressive in making these cuts; it will have retired more than 120 regional jets since the merger with Northwest back in 2008 by 2012. But other players are cutting back as well, and American’s recent bankruptcy looks to allow them to shrink American Eagle as well.
Naturally, the decline of regional jets has hurt its most frequent users; small airports. These locales, typically enhanced by the federal government’s Essential Air Service (EAS) programs, depend almost solely on regional jets to provide them with air links to the rest of the United States. However, as we saw with Delta cutting service to 24 small cities, and the general decline of EAS flying by US major carriers, many routes to small American cities just aren’t worth the while of the airlines any more. I personally feel that longer term; this problem will be solved by a Renaissance in more economic turboprop aircraft. But in the near future, small cities will face a significant drop in capacity.
An investment in the passenger experience… for those who are willing to pay
2011 was also marked by continued investment in the passenger experience, a welcome trend after the dark period in the middle of the decade when US carriers slashed service in an effort to more ably compete with low cost carriers.
The past few years have marked a return to upgrading the passenger experience with one significant caveat; it now comes at a price. US legacy carriers are now relying more heavily than ever on high-revenue passengers to drive profitability, and for these passengers, the travel experience is only getting better.
United, Delta, and American all added/re-enforced their Premium Economy cabins this year, and most major frequent flyer programs (FFPs) rolled out increased perks for high-value travelers. But beyond these lucky few, the most significant investments came in the space of ancillary products (in the US things like food, duty free, fast boarding, et. al), where the US carriers heavily expanded their offering. Even as the US carriers moved towards fleet-wide WiFi and a future in-flight entertainment (IFE) system based on streaming media, they simultaneously continued to charge for it; there is now most certainly a value proposition for WiFi in the air.
All of that being said, it’s also time that I took a look at how I feel the industry is moving in 2012. Thus, here are my 5 (not-so) fearless predictions for the US airline industry in 2012, in no particular order
- No US carrier will order the A380 or any other Very Large Aircraft (VLA) – Despite John Leahy’s comments about United Airlines earlier this year; the US international market is too fragmented with the individual carriers having too many potential hubs for an A380 sized airliner to work; this market is moving towards 787 and A350 sized fleets, not the other way around.
- United will order the MAX for their narrow-body replacement – In December, both Boeing and Airbus submitted RFPs to the new United Airlines for an order to replace the carrier’s fleet of 150-200 seat aircraft. Their new Continental Airlines based management was consistently pro-Boeing in the past, and the MAX with its significant fuel burn reductions will be available before the neo; a must in such a competitive market as the US
- US Airways will take a flier at American while in Bankruptcy– Considering that US Airways president Scot Kirby is on record as saying that the US airline industry needs more consolidation, it is highly likely that US Airways will make a bid for American Airlines while the latter languishes in Chapter 11 Bankruptcy.
- A major US regional carrier will shut down– Pinnacle came close in 2011, and the deteriorating economics of regional jets dictate that one of the players will likely fall in 2012. My personal choice? Cincinnati-driven Comair.
- Delta will de-hub Cincinnati and Memphis – The writing has been on the wall for Cincinnati and Memphis with Delta for a long time. These two hubs were built on the regional jet, and with the decline of that type, coupled with a shifting of resources to Delta’s new hub at La Guardia, I predict that Delta will officially de-hub these two operations in 2012.
Readers, what are your thoughts on 2011 and 2012 in the US market? Let us know in a comment below.