May 25, 2015, c. Leeham Co. Airline stocks took a dive last week when it appeared fare wars and eroding capacity discipline is beginning among US carriers.
Southwest Airlines said it will be adding capacity at the rate of 6%-7% compared with recent increases of 2%-3% and American Airlines said it will begin matching the prices of Low Cost and Ultra Low Cost Carriers rather than see its market share erode.
And the markets went into a tizzy.
I’m old enough to remember when American aggressively matched the low fares of the emerging new entrant airlines after deregulation in the 1980s. The matching spread and the 1980s became a bloodbath.American’s creation of the SuperSaver fares were a direct response to the new entrants and to PeoplExpress in particular. PE was, in this country, the first ULCC: it charged for a lot of things that the airliners then flying didn’t: soft drinks, for food, and, if I remember correctly, some baggage. It didn’t go to the extreme that Ryanair, Spirit Air or Frontier Airlines do today, but it was then a step below the original Midway Airlines, New York Air and some others.
American’s CEO, Bob Crandall, was a take-no-prisoners competitor. He came up with SuperSavers to offer fares matching PE (and the other LCCs), but on a seat-limited basis and with restrictions (Saturday night stays, advance purchase requirements, etc.) while still providing for free what PE charged for. It helped drive PE out of business, though it must be said that PE’s own management sawed off its own wings with over-expansion and ill-conceived acquisitions of airlines that were sicker than it was.
American’s CEO today, Doug Parker, is no Bob Crandall but he worked for Crandall (though well down the totem pole) before moving on to America West Airlines, where he engineered the merger of US Airways and finally American itself. Parker was one of the first of the legacy airlines to begin charging for baggage and other service. Now, he’s following a page from Crandall’s book, pledging to match Spirit Air and Southwest fares to protect American’s market share.
But as a colleague put it, “The only problem is that Spirit isn’t People Express. [Spirit CEO Ben] Baldanza is a far savvier operator than [PeoplExpress CEO] Don Burr was on his best day, everyone has revenue management now, and loyalty programs don’t hold the sway with consumers that they used to. AA is going to find itself punching concrete if it tries to chase Spirit into the ground on yield.”
As for Southwest’s capacity expansion, I think some misunderstand what’s going on. Southwest is starting to add international destinations as quickly as it can. CEO Gary Kelly sees up to 50 non-US destinations of interest in North America (which includes Mexico, for those who are geographically challenged). This will account for a good portion of this added capacity. Southwest is adding capacity to Dallas Love Field, now that the restrictive Wright Amendment has expired. But it won’t be too long before Southwest is getting its maximum use out of the 18 gates it has at Love, for a total of 180 weekday daily flights–then this expansion is done.
Southwest is up-gauging from the Boeing 737-700 to the 737-800–another 32 seats per airplane. This is being done aggressively, and this is probably where the greatest danger comes from. But as WN flies increasingly into capacity-restricted airports (either by slots or gates), this is the only way WN can meet demand at these locations.
Southwest is also acquiring used 737-700s at bargain prices and in a lower fuel price environment, but it’s not entirely clear if this is incremental lift or replacing 737 Classics.
While American’s Parker was a leading advocate of “capacity discipline,” airplanes run at 85% load factors and traffic is growing. More capacity is needed (or so it seems to me, although one analyst thinks AA should cut capacity 5%).
But there is a softening of traffic and yields on key international routes and Asian LCCs are feeling the pinch now. This leads to global questions, in the literal sense: is there a problem emerging in a much larger arena than the hand-wringing over US fare and market share wars?
LNC will be looking at this later.