Commoditizing Airlines

by: The Operations Room

by Marty Lariviere

We've been on a run of airline stories recently so we might as well mention two more. The first is from the Wall Street Journal, noting that Spirit Airlines (NASDAQ:SAVE) has risen to being the most profitable airline in the country on a per plane basis (A Stingy Spirit Lifts Airline's Profit, May 11). Here are the relevant numbers:

How have they managed to achieve this? A fanatical devotion to cost cutting and lots and lots of fees for ancillary services.

In a recent note, Maxim Group airline analyst Ray Neidl wrote that Spirit "flies for one reason only, to make money."

The ultra-low-cost model-pioneered in Europe by Irish carrier Ryanair Ltd.-requires airlines to strip all expendable costs. It means packing more seats onto planes, flying more hours a day and keeping seat prices separate from all related goods and services. Industry analysts say Spirit is the first in the U.S. to master the model, pioneering a route to consistent profits for smaller carriers. …

With flights averaging 85% to 90% full, Spirit and Allegiant fly the fullest planes in the industry.

Also, check out the eye candy. Fees can push the cost of flying Spirit, if not above the cost of other carriers, at least close to the cost of other carriers.

One the thing the Journal doesn't note is that Spirit's strategy has an extra tax benefit. The base ticket price is subject to an excise tax; all those bag fees and snack sales are not. Thus, not only is Southwest getting less revenue than Spirit, they are writing a bigger check to the IRS.

With that as background, a column by Stanford Professor Jeffrey Pfeffer in Businessweek is particularly intriguing (American Airlines Is on the Wrong Flight Path, May 9). While bemoaning the lack of service on major airlines and laying at least some of the blame for that on how old-style carriers have attempted to return to profitability by squeezing their employees, Professor Pfeffer states:

The idea that American is going to cut its way to profitability is ridiculous. A survey by the International Air Transport Assn. (the industry's trade group) shows that people are trying to avoid flying because the experience is so poor and many of the airlines' best customers have gone, when they can, to flying privately. The problem with American Airlines, as with the U.S. industry-and in fact many businesses-is not that its costs are too high but that its revenues are too low. Making the flying experience worse by fighting with the people who deliver that service doesn't seem like a sensible prescription for success.

So there is an interesting confluence of ideas here. First, cutting costs at an airline gets you something like Spirit. Spirit seems quite happy to be a commodity. Commodities are undifferentiated and are sold only on cost. American may not want to see its product from trans-Atlantic service to the Admirals Club as a commodity but if it is about getting from Point A to Point B, it pretty much is. That, of course, plays to Spirit's hand. If its competitors aren't willing to admit they are in a commodity business, Spirit will win with lower costs. Further, if American compromises its ability to support superior service by twisting its operations to be solely low-cost, I don't see how they beat Spirit. Spirit is at least honest about what they are selling.