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Cost advantage of low-cost airlines seen eroding

April 12, 2006

By Kyle Peterson

CHICAGO (Reuters) – Low-cost carriers like Southwest
Airlines Co. and JetBlue Airways Corp. are seeing their cost
advantage slipping as major carriers slim down into leaner,
meaner operations.

While low-cost carriers still have the upper hand in the
war for low-fare travelers, experts say the cost gap between
legacy carriers and low-cost rivals has narrowed.

Cost-cuts by major airlines such as AMR Corp.’s American
Airlines and UAL Corp.’s United Airlines have leveled the
industry playing field.

“I don’t know who’s going to live or who’s going to die.
But we do know this: it’s going to be a very nasty competitive
mess,” airline consultant Michael Boyd said.

Some low-cost airlines, such as ATA Airlines Inc. and FLYi
Inc.’s Independence Air, have already stumbled or fallen. ATA
ended a 16-month bankruptcy in February. Independence ceased
operations in January.

Boyd said excess capacity in low-cost carrier markets has
made it hard to raise fares and has eroded revenue to the point
where it is a hazard to some carriers. He noted that Southwest,
JetBlue and AirTran Holdings Inc.’s AirTran Airways are adding
about 250 100- to 150-seat planes to their fleets in the next
36 months.

In general, domestic air fares have risen by more than 10
percent in the last year. Capacity additions by low-cost
carriers may put pressure on those airlines to cut ticket
prices, but carriers probably will be able to support fares in
spite of the new capacity, said Terry Trippler, an analyst at
travel Web site Cheapseats.com.

Meanwhile, airlines like Southwest are being forced to move
into markets they otherwise might avoid in hopes of poaching
business from other carriers, he said. Southwest recently
started operations in Denver and Philadelphia and requested
gates at Washington D.C.’s Dulles International Airport.

“Today you have Southwest Airlines in a reactive mode
opening up cities they probably would not have opened up,” Boyd
said.

JetBlue, meanwhile, is considering deferring deliveries of
some aircraft or issuing new equity as it seeks to keep costs
down. Chief Executive David Neeleman said last month JetBlue
would scrutinize its routes for excess capacity.

THE RACE TO CUT COSTS

The airline industry has been hurt by overcapacity, soaring
fuel costs and stiff competition. These factors and others have
forced major carriers to trim costs to more closely resemble
their low-cost counterparts.

Delta Air Lines Inc. and Northwest Airlines Inc. are
restructuring in bankruptcy, where they have court protection
to cut costs, especially the costs of organized labor. UAL left
bankruptcy in February after slashing its costs by $7 billion a
year.

Cost-cutting by major carriers represents a significant
change in the industry. Nowadays, low-cost carriers have to
work much harder to sell tickets cheaper than the majors.

“This clearly is an issue,” said airline consultant Robert
Mann. “In the last decade, network carriers have been spilling
low-cost demand to carriers like Southwest and JetBlue.”

He said low-cost airlines may see their cost advantage
diminish further as their hedges against oil exposure diminish.
Southwest uses extensive hedging to blunt the impact of high
fuel costs. But as the price of oil rises, Southwest’s newer
hedges offer less protection.

U.S. crude oil hovered below $69 a barrel on Wednesday, not
far from a record high above $70.

As of March, Southwest had hedged 70 percent of its fuel at
$36 a barrel of oil. That compares with hedges on 85 percent of
its fuel consumption at $26 a barrel in 2005.

“It’s clear that Southwest and JetBlue costs go up when
their hedges go out,” Mann said.

Low-cost carriers may lose more of their cost advantage
over major carriers and there could well be consolidation or
failures among those airlines. But Michael Roach, airline
consultant at Roach & Sbarra, said it’s unlikely that major
carriers will ever beat low-cost competitors at their own game.

A “well-established” brand like Southwest Airlines has
traction, Roach said. He also noted that AirTran is making the
most of bankrupt Delta’s retrenchment on East Coast routes.


Source: reuters



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