Podcast: Are North American Budget Carriers Losing Out To The Majors?

Listen in as Aviation Week Network editors discuss the changing fortunes of airlines as passengers focus on premium services and brand.

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Rush Transcript

Karen:

Hello everyone, and thank you for joining us for Window Seat, our Aviation Week Air Transport podcast. I'm ATW and Aviation Week Network Air Transport editor-in-chief Karen Walker. Welcome on board.

I'm absolutely delighted to be joined today by two friends and my expert colleagues, who are both based with me in the Washington DC area: ATW and Routes senior editor Aaron Karp, and CAPA's senior analyst, America's Lori Ranson. Aaron, Lori, great to have you onboard. Thank you for joining me this week.

Now, last week I was joined on this podcast by Delta Air Lines CEO Ed Bastian, and something he said made me want to have a follow-up conversation with you guys on the industry in more general. Ed, as we know, is one of the most highly regarded industry leaders worldwide, and it sometimes seems to me like everyone is watching for Delta's next move. So what struck me was when Ed talked about the health of Delta as a premium brand, and this is what he said, and I quote: "When you offer a premium experience, customers will pay. They see great value in that. Value in our industry has been talked about in terms of price, but that story has gotten pretty dated, and those that are focused on price have had a real challenge. And that's why we (i.e. Delta) have had a focus on premium for some time. That's why our brand is one of the healthiest brands in the entire country."

So I think it was interesting there, because when Ed was talking about the Delta brand being one of the healthiest in the entire country, he wasn't talking just about the airline industry. He was literally talking about the entire country, where brand is a very big thing in the US, and Delta is the fifth largest e-retailer in the US. So it's right up there with the Apples and Amazons of this world. And meanwhile, the other part to what he was pointing at there was when he said that those who are focused on price have had a real challenge. And he was clearly talking about the US ultra-low-cost carriers (ULCCs), who initially saw a boom in sales in the early days of the pandemic recovery, but many are struggling today. It seems like the big majors hold the advantage when it comes to attracting passengers right now. And again, I'm really talking about the US, but I think we're seeing a little bit of that in the greater North American market—by that I mean Canada, Mexico, Colombia, et cetera.

So I have a really fantastic panel here to talk a little bit about what's happening and why. Those are my big questions for Aaron and Lori, and I know they've both been tracking this very closely. Now, Aaron, you recently attended the Routes Americas 2024 event in Bogota, where several executives at both the low costs and the major airlines were speakers. So can you just give me some of your key takeaways as to what was on their minds as they spoke at this conference?

Aaron:

Well, I think particularly given that it was in Colombia, the conference coincided with JetSMART, which is a Chilean LCC, which got an air operator’s certificate (AOC) in Colombia and is now operating low-cost service in Colombia. And the JetSMART CEO, Estuardo Ortiz, said that he thought that they'd go to Colombia later, a couple of years from now. But when Viva Air Colombia and Ultra Air, which are two Colombian LCCs, collapsed last year, they decided it was an opportunity to get into the market. So I thought that was interesting from a local perspective. There was a lot of talk about JetSMART entering the market, and what that will mean in terms of whether it could revive the LCC sector in Colombia.

What's interesting is, our last two podcasts were with Greg Anderson from Allegiant Air and Ed Bastian from Delta, and one thing that strikes me is they talk very similarly about the market, in that Greg Anderson was saying that the majors are much better off than they were 10 to 15 years ago, their balance sheets are really good, and that they're offering a premium product that the customers want, and makes it difficult for the LCCs to compete with that premium product. The interesting thing is what several of them are doing, particularly Allegiant, which has always done this, and two of the newcomers, Avelo Airlines and Breeze Airways, and Sun Country Airlines to an extent, are simply not competing with the majors on most of their routes. They're deciding to connect either smaller markets to bigger markets, or sometimes two smaller markets together. And they can't wait to tell you that 90% of their routes are non-competitive, that they're the only one on the route. And they've talked about how they've tried to compete with the majors on routes and the price. There's just a ceiling on how much the fare can be, especially when you're trying to present yourself as an LCC.

So I think that's the interesting aspect. In terms of Spirit Airlines and Frontier Airlines, they're high-volume LCCs/ULCCs, and it's going to be hard for them to get out of serving the major routes, and so I think they have a bit of an interesting challenge. And one thing they're doing, and we can talk about it more, is Frontier, for example, is changing their product, and offering, for example, a front row in which they leave out the middle seat, and you can buy essentially what they're calling a business fare.

So, that's my overall takeaway from what was a very interesting conference in Colombia, and I think it gave a lot of insight into what's going on in North America.

Karen:

Thanks, Aaron. That's great. Lots there to talk about straight away, and I would love a bit more discussion about that sort of ... I think that is interesting, that you're seeing some of these ULCCs and startups say, "We're just going to stay in markets or find markets where the majors are not operating." So I think I'd like to hear a little bit more about just how sustainable is that, especially when it comes to growth.

Meanwhile, you did touch quickly there on Spirit Airlines, where there's just been so much focus since the proposed merger that JetBlue wanted to do, that essentially crashed. They lost the lawsuit that the US Department of Justice started. So, we're now seeing a situation where that's not going to happen. Spirit is now scrambling for cash. Lori, can you talk a little bit about what all that means? Because Spirit is a big name on the low-cost side in the US. So, what's going on?

Lori:

Yeah, I mean, if you think about it, Spirit was the ULCC pioneer in the US, 10-15 years ago. They really ushered in the model here. And what has happened over the last few years—Spirit was having some headwinds even before the pandemic in terms of cost inflation, and maybe bumping up against majors that were starting to build their premium products before the pandemic, and then we all know it really took off during the pandemic. And then for the last two years, Spirit has essentially been in limbo, because you had this whole merger saga, the lawsuit, the bidding war between Frontier and JetBlue for Spirit, and so they haven't been able to think long-term or standalone in about two to three years.

And being in that limbo and experiencing what the larger ULCCs are now experiencing—this customer shift to a more premium product—(a person) can get basic economy on another carrier that is superior to what they offer. So, it's just been a cascade of events, and now Spirit is doing everything it can to raise cash, because it has a debt payment that's about a $1.1 billion debt payment due in 2025. So, they've done some sale leaseback; they recently just pushed out Airbus deliveries, they're furloughing pilots. And so they really just find themselves in a situation where it almost seems like they have to come up with a strategy very quickly, but they haven't had time to think about that in probably two years.

And so, what is their strategy? They've talked about maybe a little bit more of connecting itineraries to a degree. They've talked about product. They haven't really given a lot of detail about product, but clearly they understand that they've got to adjust their product and offer something that's a little more upscale within the framework of the ULCC model. But they have all of these headwinds while they're trying to do it.

There has been some talk about Chapter 11. That died down a little bit, but I was having an interesting conversation with someone a couple of days ago who said, "Still, if you're a Spirit shareholder, do you hang on for the long term? Or you look at Spirit's fleet? It's very marketable. Do you push for liquidation and cash out now?" So I think that's a possible and real scenario if you're looking in the marketplace.

So, it's going to be interesting going forward, probably the next five or six months. I should also bring up that JetBlue and Spirit are now in pilot negotiations, now that the merger agreement has dissipated, and it's going to be tough for each carrier right now. They're trying to lower their costs, they're shrinking their network, but pilots are going to want parity in pay with the rest of the industry, and that pay is at historical highs. That's something to think about as we go forward as well.

Karen:

Thank you, Lori. A lot going on that Spirit is having to deal with, a lot. It's not just one thing here certainly, so it's a very complicated situation for them. I think it's particularly interesting when you look at Spirit, as you say. I mean, they were like the Ryanair of the US, weren't they? They're the ones that really started that ultra-low cost—real, real basic fares, absolute basic fares, everything else was an ancillary add-on. And the thing is that ... And then you got Frontier who came in, Denver-based, very, very similar model. So, those are what I still think of as the two real ULCC names that seem to be most affected at the moment, for different reasons. Spirit's got a lot of other things going on, but this change in what Ed Bastian referred to—a passenger taste for a brand, to be associated with a good brand—they like the idea of having some sort of premium thing.

He particularly talked about, you can be on your first flight with Delta, but if you join the SkyTeam's loyalty program, you get free Wi-Fi access. And that goes a long way with a lot of young people, and they tend to talk about it. They tend to tell other people, "I flew on Delta and I got free Wi-Fi." So the thing is that, when it comes to the Spirits and Frontiers of this world, just like the Ryanairs, everything is about keeping cost to an absolute minimum. Lori, you just said, one of the problems there is, if the pilots want parity with the majors, that's a huge problem. But it's also in terms of that model of ... It is offering the basic fare, and everything else you pay for.

So Aaron, with Frontier, they're not dealing with all the things that Spirit is dealing with, but you just alluded to some of the customer options that they're proposing, which essentially makes them more complicated, by having this thing where they're offering (that) you can buy a seat that guarantees a middle seat next to you free; they've got multiple cabins now in there. How long can that go on without their cost base going up?

Aaron:

I think they're hoping this is one way to generate more revenue. So one example is, Frontier now has four different sections, essentially, in their cabin. They have the BizFares, which include perks such as premium seating, no fee for carry-on. They have the UpFront Plus, guaranteeing a window or an aisle seat and an empty seat in between. So you can see they feel like they have to offer some sort of premium service to compete with the majors, because the majors offer the basic economy product, but they also offer the premium economy product, and that's very popular for people to upgrade to. And so I think that it's just a matter of service. Frontier and Spirit in particular have this issue where they have large fleets, they compete with the majors in major markets, and from a service standpoint, they're just having a lot of problems right now and trying to refashion their product so it looks more like the majors, but obviously needing to keep a much lower cost base.

Karen:

And Lori, when it comes to also this other thing that you're seeing the ULCCs do to compete, and you've both referred to this, essentially staying out of markets where they're competing a lot with the majors. Again, for Spirit … I look at that and I think, well, how long can they do that? Because they need the mass market. And if they're just looking at thin routes ... and Spirit's been in places like Orlando, Fort Lauderdale—it's based in Fort Lauderdale. Those are big markets. So how sustainable is it to just start to say, "We'll focus on those markets where we're not competing with the majors directly?"

Lori:

I'm not sure it's that sustainable, simply because, as we've talked about the model of Frontier and Spirit, it's high utilization and it's high volume. So on thin routes, you're not going to have the frequencies that you need to push that utilization up, to keep your costs down. So, I am not really sure if it's a long-term strategy that is sustainable. And Frontier has also said it's redeploying its capacity from markets (such as) Las Vegas (and) Orlando, where it was oversaturated, going to places such as Cleveland, where there's not as much capacity. But at some point you're just moving around furniture on the deck of the ship. We just have to see how this plays out.

But I think the bottom line is, these carriers, they have to push their assets to keep costs down. That could be more important now than ever. And I think there's this whole issue. Some people say there's a cost convergence, where the gap is narrowing, and that's a permanent fixture. Others may not agree. But it's really interesting to see this unfold, and they both still believe that costs are key, but there are going to be major challenges in terms of maintaining that cost advantage. And I think we've seen that play out over the last at least six months to a year, right?

Karen:

Correct. Yes. And Lori, you also track the Mexican and Colombian markets and South American markets in general, but are you seeing similar sorts of effects there, especially on the markets that are just the other side of the border?

Lori

Yeah. I think Aaron can chime in, but I think trips per capita in those markets are still so low in general that there's much more opportunity for traffic stimulation. And a lot of these people that are traveling on the LCCs, it's their first time using air travel, so their expectations are different. And if they travel with this ULCC, the price is good, they can get where they need to go, it's not the same as here where it's a mature market. You have to educate the passenger about what the ULCC model is about, how it works. So, I don't see the same challenges emerging in those markets anytime soon, just from a broad overview perspective.

Karen:

I think you're right. And again, something that I keep referring back to, what Ed Bastian said, but he talked about the saturation of the US domestic market. And what he said was, there really aren't new destinations to grow to. What you do is you grow your aircraft size, which a major can do. Delta's bringing in all these A350s. They can do that. That's not really a ULCC carrier strategy. Aaron, can you just talk to pick up a little bit on that also? As Lori said, the difference maybe there when you just go south of the border (where) a lot of the potential for expansion is for customers who've never flown before, so they're competing with buses, not with major airlines. Is that correct?

Aaron:

Yes. So, I was talking about being in Colombia with JetSMART, and JetSMART is entering a market that there's basically not much or no ULCC service, because of the collapse of the two carriers. And so they see a huge opportunity, because there's no one else competing with them. And I think, as Lori said, throughout Latin America, it's been the same story really for 15, 20 years, is that there's emerging middle class, there are people moving from buses to aircraft. The planes are full, and people are very happy to travel by plane, because it's so much better than the bus, and so they're not really complaining because it's a much better service. And particularly the bus services in many places in Latin America are not luxury bus services, so you're packed in a bus going long distances.

And so I think the Latin American CEOs think that there's just a huge opportunity, because there's such a market of passengers. One of the statistics I heard in Colombia was that the amount of average trips by Americans is significantly higher than the amount of average trips in most Latin American countries. I think for the average Colombian, they take half an airline trip a year, whereas the average American is taking three or four. They figure, even with the same customers, we could triple or quadruple our service.

Karen:

Lori, can I just ask you also, if we look north, and I know you also track the Canadian market a lot too, what's happening there with the ultra-low costs versus the majors? I mean, Air Canada seems to be making quite a strong comeback.

Lori:

Yeah, Air Canada is. And obviously you know that Lynx Air, one of the ultra-low cost upstarts in Canada, exited the market in February. It wasn't even two years in operation. Canada's just such a different market. Landmass-wise, it's far bigger than the US, but the population's about 38 million, so you're all competing for a smaller passenger base. Canada is notorious for being a really expensive place for airlines to operate, and so it makes it really tough for a ULCC that doesn't have a lot of scale. Lynx only had nine aircraft when it ceased operations. It had another 36 on order. That's actually good news for the market at large, because we're removing a lot of future capacity that could come into the market.

But I think both Air Canada and WestJet, which are the country's two largest airlines, it's a little bit like what the majors are doing here. They have distinct product offerings, and WestJet actually folded its ULCC subsidiary into its main line last year, simply deciding ‘we don't have to have a distinct ULCC operator in our portfolio.’ We can just fold it in, manage our cost, and offer a broader product offering. And Air Canada does the same thing. I mean, it has its lower cost operator, Rouge. And so, these carriers have scale. They can offer the products that they believe that Canadians want, a range of products. And so it's very hard for anyone to come in and compete with those two airlines. And I think that's been proven time and time again, if you just look at the history of the market. So, there is one remaining ULCC in Canada, Flair. It has paused its growth for the time being. I think a lot of industry watchers are going to be seeing how Flair ... what happens to Flair over the next year or so. So, something to watch, definitely.

Karen:

Yeah. It's interesting. If I think of the long-term history of the Canadian aviation market, of its air transport market, ultimately it all seems to stabilize back to the same thing. There are some changes, but not that much. Ultimately it comes back to, there's always Air Canada. There seems to be one strong LCC, WestJet. But WestJet, as we know, has adapted its model. And others come and go, but that's the point. It really always tends to settle down. In the US ... My last question for each of you—Aaron I'll start with you—is looking back at the US and the changes that are going on here, and the differing political environment. What's happening with the LCCs? Do you think there's going to be more industry consolidation in the US? Aaron, I'll start with you.

Aaron:

Well, it's interesting because Spirit Airlines was down there in Colombia, and they've talked about how they see that there will be consolidation, because they don't think there can be a competitive US market without it. The big four control 80% of the market. So they believe, even with the rejection, even with seemingly the Justice Department's current view of being ‘anti-airline merger,’ that it'll inevitably just happen, because you'll have to create a bigger carrier to compete with the larger carriers.

I think generally speaking, Avelo, Breeze and Allegiant have an advantage in that Allegiant's been operating this model forever of bringing people from small cities to leisure destinations. And Avelo and Breeze are new carriers, they're just three years old. And one example with Avelo is that they started service from Raleigh-Durham a year ago, and they started with flights to Fort Lauderdale, Tampa and Orlando, where they competed with the majors, and they just couldn't do it. Load factors were high, but there was a ceiling on the fares. So now they're operating to markets like Albany, New York; Rochester, New York; Manchester, New Hampshire; and are having much more success.

David Neeleman, the CEO of Breeze, has said that they can operate as many as 2,000 routes. Allegiant is saying they operate 500 routes now. They say they can operate another 1,400—90% of which will be non-competitive. So, I think you do have this separation where there's the three carriers, and Sun Country a little bit in that category too, that have found that they can operate thin routes, they don't have ... their A220s are the fleet for Breeze, and so they don't have to have high volumes of passengers to fly these long, thin routes.

So, I think that's where the US market is, and I think Spirit and Frontier are going to continue to scramble to find their way. And I think the other carriers, the other Breezes, the Avelos, Sun Country and Allegiant have found that they can compete with the majors by not competing.

Karen:

And Lori, what about you? I mean, at the end of the day, we've still got the Alaska and Hawaiian merger as a potential. It seems to me that, at some point, Spirit's going to look at some point like a rock-bottom good deal, that somebody will step in. But do you think there's going to be more consolidation in the US industry?

Lori:

I think so. I think it's hard to predict one that will happen, because the big four, they're so big, they don't need to do anything. They don't need to scoop up any kind of distressed assets. They're so dominant. We'll see what happens with Alaska and Hawaiian. I think we've all talked about before that, logically that combination makes sense, but sometimes the government views consolidation differently, as we've seen over the last couple of years.

So, it's hard to say when it will happen, or how it will happen. Will it happen with someone exiting the market, and then those assets get scooped up? Will it happen in a true combination of two airlines? I think it's something that we should stay tuned to see. We don't know if we're going to have a new administration next year that would think of mergers differently. It's just, there's a lot of unknowns. But I do think overall there's a lot of capacity, too much capacity in the domestic market, so that has to be rationalized in some way going forward.

Karen:

Good. Very good point. Aaron, Lori, thank you so much for joining me today. As an added bonus for our listeners, a feature on this topic authored by Aaron will be in the next issue of the ATW magazine, our May issue, so please look out for that.

A big thank you to our producer, Cory Hitt, and as always, a huge thank you to our listeners for following Window Seat. Remember to follow us on Apple Podcasts, or wherever you like to listen. Until next time, this is Karen Walker, disembarking from Window Seat.