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Small Lift Providers
("Regional Airlines")

The Boyd Group, Inc.
Advisors to the Aviation Industry
Since 1984
78 Beaver Brook Canyon Road
Evergreen, Colorado, 80439
303-674-2000
303-674-9995 Facsimile
aviation-info@aviationplanning.com

Two Words
$100 Oil
It's Re-Engineer-The-Business Time...
On An Emergency Basis

Sector One: Small Lift Providers

Say Good-Bye To A Lot of Regional Jets, Real Soon.
Fuel Pass-Throughs Will Pass Them Directly To The Desert

JANUARY, 2008. It should be back-to-the-drawing-board time for small lift providers, what some still call "regional airlines." Maybe time for a period of sheer panic, too. The issue: 50-seat and smaller RJs are being economically marginalized by skyrocketing fuel costs.

Major carriers will be looking to quickly cull out dozens of RJs in the coming months. And hundreds more in the next five years, with no replacement for this lift - or many of the markets they operate - in sight.

Most SLP agreements provide for fuel costs to be a pure pass-through to the major carrier, and that means the majors are eating a lot of red ink. A lot of RJ mission applications that once provided adequate revenue generation are now net drains on major airline systems. They cannot but move quickly to restructure (read: reduce) the fleets of RJs they're leasing in.

Faster Retirements Than Predicted. The Boyd Group's Global Fleet Demand Forecasts were the first to predict the decline in demand for new RJs, and also to predict that the number in operation represented a glut. That was as far back as 1999, when other consultants were still forecasting just the opposite from the comfort of their rearview mirrors, and the warmth of being within "the consensus.".

As attendees at our Annual Aviation Forecast Conference last October learned, retirements of CRJs and ERJs would result in global RJ fleets declining by over 1,200 units over the next ten years.

Now, with oil hovering at $100 a barrel, that forecast has been revised. The retirement projections are for over 1,700 RJs to come out of fleets for the same ten year period, with the rate front-loaded in the 2008 - 2013 period, representing approximately 835 RJs taken out of service in the US alone.

The net-new figure represents larger CRJs (mostly -900s) coming into SLP fleets to replace 50-seat -200s. But even here, there isn't a whole lot of demand going forward. There are no new-generation <70 seaters on the horizon to replace the current fleet of 50-seat and smaller RJs. That means new fleet mixes.

It also means fundamentally-revised airline route systems.

Note: The Boyd Group categorizes "regional jets" as CRJ and ERJ airliners, based on cabin ergonomics. It is inaccurate to define "regional jets" by seat capacity, otherwise airliners such as the F-100, the DC-9, the F-28, and even the 737-200/500 could be defined as "regional jets." Therefore, the Embraer E-Jet platform, which represents per-passenger cabin dimensions that are equal to and even better than 737s, is not considered a "regional jet" aircraft. That's because the market niche that aircraft was designed for was to fill the mainline airliner gap left open by Boeing and Airbus.

Late Night Oil Burning In The Planning Department. As we speak, planning departments at comprehensive network carriers are in full metal jacket status, working to moderate the level of financial drain smaller RJs are inflicting on their systems.

Legal departments are working, too, reviewing current service agreements with SLPs. Most contracts are relatively long-term - to 2013 or beyond. The problem is that there is no way that the current number of these RJs can be supported until then with jet-A heading to $3 a gallon and up. Culling the herd in is the cards.

Many agreements contain an early-out provision for the CNC, where a six-month notice can be given. In most cases, however, these notice dates don't become effective until late 2008 or 2009, and majors cannot afford to wait that long to cut RJ lift. So that means doing some deals with current SLPs. A cash payment in exchange for an early-out. Renegotiating the agreement with a financial incentive for the SLP to shift to larger CRJs or even into E-Jets, depending on the status of scope clauses at the CNC.

Wholly-Owned SLPs Could Be Going Away? Maybe - just maybe - if the financial hit becomes too onerous, some wholly-owned SLP subsidiaries could be shuttered. This is not a drill - we are talking financial bleeding here. With fuel costs going up, the economy (maybe) softening, and the specter of labor needing and demanding increases, such an action is not out of the question.

Small Lift Providers To Watch. Clearly, 50-seaters are in the economic cross-hairs. And any jet airliner smaller than that is just marking time 'til the grim-reaper comes to take it to the Budweiser plant. So the question arises regarding how the SLP sector will survive.

The hard reality is that the SLP sector will be shrinking markedly over the next three years. Hard fact: there are more 50-seat jets than can be economically flown. Hard fact: that means cutbacks in the number of operators.

SLPs must move to hasten their fleet migration into larger CRJs or, better, into the Embraer E-Jet platform. But that means bigger units of capacity, higher sector costs, and, ergo, fewer markets where such aircraft can operate compared to what 50-seaters could do before the price of jet-A headed toward the Moon.

The first option - larger CRJs - will provide better per-seat economics for the CNC customer, and for CRJ-200 operators, a relatively painless shift. But it's still an RJ, and with more seats and higher sector costs, it won't do much for the communities that are in line to see loss of service as the 50-seat cost bar goes up and CNCs cut flights.

A Potential Winner In The Wings. The SLP to watch is Republic. It has dumped its 37-seat ERJs, and has adjusted its fleet to the point where over half of its inventory is now out of RJs and into E-Jets. And, regardless of the trendy babble to the contrary,  small mainline airliners such as these are the ones that have the long-term future, not RJs. Republic also has a wide stable of CNC customers, giving it enormous depth of revenue flows - not to mention some insulation from doom if the dragons of Wall Street drag a couple of CNCs into the merger pit. Without question, Republic is the best postured SLP to not only survive the upcoming RJ-Fleet-Valentine's Day Massacre, but to actually prosper.

Bombardier In The Catbird Seat? The need to chop 50-seaters out of fleets is likely one that CNCs are going to pursue with some urgency. But the current agreements likely don't consider Hugo Chavez, OPEC, and speculators running up the price of go-juice, as an Act of God that will allow modification of SLP contracts. But there could be the potential of CNCs assisting some of their CRJ-operator partners in acquiring larger CRJs, which would be a short-term bonanza for Bombardier.

Countering this are union scope clauses. In the current labor environment, it's not likely that pilot unions are going to relax anything, including restrictions on operations of more 70 to 100 seat jets outside of the mainline contract. While it's near-certain that Bombardier will see some additional -900 orders, a review of the market indicates that it will be in the neighborhood of maybe another 250 units. Even with this, the US skies will see over 500 fewer RJs in 2013.

Effect on Air Service. CNCs will be doing some serious triage on their RJ operations. The objective will be to maximize revenue. Any market that was on the margin in the past is likely not going to be there on the next schedule change, or by the end of 2008. Here's a general template for RJ markets that may be victims of the reduction in 50-seat fleets.

• RJ markets whose traffic flows involve high amounts of low-yield (read: Florida) connecting traffic, are prime candidates for the chopping block.

• Any RJ market over 1,000 SM that has load factors under 70%, and/or has high concentrations of low-fare traffic.

• RJ markets that are inflicted with chronic ATC delays. That means service to/from some NYC area airports. To a lesser degree, ORD, SFO, and LAX. Remember, the SLPs are paid largely on a cost-plus basis, and 30-minute to 45-minute out-to-off times burn a lot of fuel the CNC gets billed for.

• Use of RJs for fill-in frequencies in high-density markets may also be given a jaundiced eye.

• Another target for cuts: RJs used by CNCs for competitive-harassment hub missions, i.e., flown head to head against larger jets operated by competitors, intending to bleed some traffic away and possibly put the competitor's flights below the profit line. A strategy that may have made sense with $50 oil. Less so with $100 oil.

As for new market entry using RJs - it's still possible, particularly if the new traffic flows represent better revenue streams than existing markets. In particular, the emerging industrial centers in the Deep South are prime candidates.

But for those communities where traffic is already weak, or have no service now, the price of RJ entry is now a whole lot higher.

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Sector Two: "LCCs"

Plan On Seeing Some Real Competitive Bloodshed
Maybe Some Alliances. Even Desperation Mergers

Like Small Lift Providers ("regional airlines"), this sector - commonly, if somewhat inaccurately, called "low cost carriers" - is not well suited for an economic downturn.

Too much capacity coming on line, and revenue streams that are often vulnerable to competition and to an economic downturn. Most of these LCCs do not have the fleets to access the growing business and industrial traffic at emerging small communities in the Deep South, nor the international flows they generate.

By all means, do ignore the nonsense from some academics who gurgle on about how LCCs are driving Comprehensive Network Carriers out of domestic markets and into international flying. It would be nice if these guys bothered to learn about the industry. Essentially there has been no CNC "driven out" of a major market by an LCC.

In 2008, the shift selector at some LCCs may move into "S" - survival. Bank on it: there will be some very aggressive intra-sector LCC marketing moves aimed at taking on, and taking-out, some LCC competition. We are talking competitive bloodshed.

The reason is simple. Unlike Comprehensive Network Carriers, most LCCs don't have the ability to downsize quickly and cost-effectively. And as noted above, they are not particularly well postured to access the strongest emerging revenue flows. Result: they may turn on each other.

Okay, Just What Are LCCs? Carriers within this general category actually have little in common, other than being grouped on the basis of the fact they are not comprehensive network carriers. CNCs are comprised of diverse fleets, diverse route systems, and very diverse revenue streams.

The only thing LCCs have in common, and even here it's a bit fuzzy, is that they tend not to have diverse fleets, tend not to have diverse route systems, and tend to focus on low-fares in high-density markets. Tend is the operative word.

While the media and academics talk about LCCs like it's some monolithic sector of the industry, it isn't. There was nothing in regard to LCCs on those tablets Moses brought down from Mount Sinai. Fares? CNCs tend to match. Low costs? Not necessarily - Southwest has high labor costs, albeit spread over a lot of ASMs.

Simple fleets? Only in the mushroom-garden minds of college professors who haven't entered reality in decades. Frontier has three distinct types of lift - Airbus 318/319/320s, E-Jets (leased in from Republic), and 74-seat turboprops. AirTran has 717s and 737s - very different aircraft. jetBlue has 100-seat E-Jets and 150-seat A-320s. Even Southwest operates two types of 737s.

No Frills? Not much in common here. jetBlue has leather seats, TV sets, and seat selection. Frontier has TV and seat selection for its customers, too. AirTran has XM radio, and a business class cabin. Southwest doesn't charge for the first two checked bags.

But the nice point is that we know generally what carriers are within the LCC grouping. And it's a grouping that's facing a very nasty 2008.

The Southwest Tiger. The carrier that will be driving strategies in this category in 2008 will be Southwest. It knows that it has high labor costs that will eventually catch up with it. It knows that its slowly-vaporizing fuel hedges represent a slowly-closing window of competitive opportunity. It also fully recognizes the vulnerabilities of its current product compared to those of its competition. It knows it has a motivated workforce, but isn't swan-songed by happy-news written about it. Southwest knows it has to fight for the future, and that it isn't an invulnerable airline juggernaut.

A competitor that ruthlessly understands its strengths and weaknesses is dangerous to its rivals. That describes Southwest. It knows it must expand, and pounce on new revenue streams - even if it means decimating competitors. The days are over of happy co-existence, where WN entered markets, filled 737s with smiling, largely net-new fare-driven passengers, and flew on. Southwest needs market share, and it is very likely going to put competitors in its cross-hairs.

It also needs to build its business-travel base - which, beyond product enhancements, means clawing for share in existing markets. Watch for some very aggressive expansions - aimed specifically at pulling traffic out from under perceived-weaker competitors - in 2008.

A La Carte Pricing & "Unbundling" - two more buzz-terms, referring to the concept of charging a base fare, and nickel-and-diming the passenger for everything else. Early seat assignment. Pillows. Baggage check. "Just pay for what you want" is the concept. Well, consumers generally expect those things, and except for the low-fare vacation sector - which isn't very brand-loyal - a la carte pricing has only limited potential for most low-fare carriers, as well as CNCs.

First, it adds moving parts to the process. The money has to be collected and accounted for. The passenger has to go through some additional processing to hand over the loot to get his bag checked. Second, for major carriers, it exposes them to competitive reaction. If the high-paid advisors lurking in the basement at United convince the CEO to charge for baggage check, and American doesn't follow suit, UA is competitive toast.

Finally, the unbundling thing isn't a cash bonanza - it is, by definition, hitting the customer up for some things he/she takes for granted, and it will take in marginal amounts of new revenue, when the costs of collection, accounting, and monitoring are considered.

What About The New "ULCCs?" There's a new buzz-term out there: the "ultra-low cost carrier." The type that charges for everything, and, according to the parrots in the media, have super-low costs that give them a huge advantage. They're the wave of the future, according to some stories.

Like, Skybus. The carrier which reported 7.8 cent ASM costs - which are high - while paying flight attendants 9 bucks an hour, charging for sodas on board, and having a RASM of 4.4 cents. Gonna make it up on volume, no doubt. The lore is that Skybus is a clone of Europe's very successful Ryan Air, and therefore it has a slam-dunk model, which includes seats for as low as ten bucks.

Unfortunately, this isn't Europe. Skybus isn't Michael O'Leary. And peddling seats at $10 and $25, ten at a time on each flight, only means the first 20 seats of your 70% load factor simply don't count, because you're essentially giving them away. And - memo to the media - the "frills" that Skybus leaves off are not that much of a cost-burden to the competition. The "ancillary revenues" from charging for pillows and snacks and the like, are chump change.

Finally, an airline carries people. It is a people-intensive business. People have problems. An airline that brags about not having a telephone number for people to call has taken a powder from reality. It's unknown which second-rate B-school class might have conjured up this concept, but it's not going anywhere in the real world.

It's a business plan that, if left unchanged, will indeed take the airline someplace. Directly to point of financial impact.

But watch for lots of buzz about "ULCCs" and "ancillary revenues" and such in the early part of 2008.

LCC Consolidation? Possible - But Only To Slash Capacity. There are a number of potential combinations of LCCs - none of them made-in-heaven - that could take place in 2008. All would be driven by a need to circle the wagons in a downturn and/or as a refuge in case Southwest decides to make the most of its current fuel cost advantages and expand carnivorously.

The only problem is that there simply are not many synergies to be gained. Frontier and jetBlue have Airbus fleets, but the two route systems have very little to offer each other from the standpoint of being a combined stronger airline. Both would retain their relative strengths and weaknesses. AirTran and Frontier have an innovative web-sharing plan, but the two fleets could not be more incompatible. Spirit could look at jetBlue - but most of what Spirit has on its route system jetBlue can get by itself.

Then there is the foreign connection, represented by the Lufthansa investment in jetBlue. The gossip lines lit up like the tree in Rockefeller Center when that deal was announced. This is the first tie-up that will lead to great international traffic flows, is the talk.

Probably not. There isn't much real connectivity potential between Lufthansa's three JFK departures and jetBlue. There are facility issues. There are competitive options that are already in place. Most likely: Lufthansa saw a sound financial investment. Period.

But this is the brave new world of $100 oil. Anything is possible. Southwest could buy Frontier, simply for the purpose of gaining more Denver dominance, and take the cost of eventually sorting it out operationally. Not likely.

But two years ago, neither were oil prices expected to be at the century level.

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Sector Three: Comprehensive Network Carriers

Next Crisis: Not Cost Control, Per Se..
It's Now "Dynamic Minute Control"

With the current fuel price outlook, it might seem that major carriers are tapped out in terms of ability to get costs down. Add in the reality that labor is also tapped out, and is not in any mood for further givebacks. Actually, it's unlikely that any labor union is fixin' to leave the bargaining table in the next three years without some healthy gains. 

One might conclude that major airlines have already squeezed the cost turnip bone dry since 9/11. Aircraft and airport leases have been re-negotiated. Debt, at most carriers, has been reduced or re-structured. Labor costs - at least for now - have been slashed. Some union work rules eliminated.

So, what will carriers look at to control costs?

It will be dynamic minute management in the future. When substantial parts of airline operational costs are time-delineated, such as maintenance, time is money. When time is an issue in whether the passengers make connections or expensively mis-connect, time is money. Each minute represents money. And squandering them costs money.

It sounds like common sense. But anybody who's watched airport operations to any extent can see enormous numbers of minutes squandered to the gods of waste.

• A 757 arrives, and the jetway is still positioned for the A-320 that departed 30 minutes before. That means the greeting agent may spend five precious minutes or more, monkeying to get the jetway to the airplane. Five minutes may mean the difference between connecting those six passengers to London, or having to re-route them (and their revenue) on another airline.

• The amount of time getting the "carry-on" luggage out of that RJ's bin and onto the jetway can be the difference in whether several other passengers connect or mis-connect. Sometimes, it doesn't seem to be a big priority. They get there when they get there. And the airline system gets a cost hit.

• Keeping an arriving 767 waiting for to be guided into the gate for just two minutes can add up to hundreds of dollars in waste. Getting it parked and those engines shut down stops the clock on a whole passel of cost factors. Yet how often does this happen, and there's little thought given.

• Departure and push out procedures that eat up an extra minute here or there represent millions in costs to a major carrier.

• Dynamic departure management can save millions, too. Blind focus on departure schedules instead of arrival schedules lose hubbing airlines millions each year. Kicking a flight out on time sounds great. But knowledge of the flight plan for each specific departure can sometimes allow a "late departure" that still gets the customer to the arrival gate on-time. If that "late departure" means not leaving late connecting passengers behind, that's money in the bank. Remember - passengers are paying to get someplace at the time promised.

• Dynamic flight management is something that airlines will need to get into, if they have any hope of cutting ATC costs. As Captain Michael Baiada of the ATH Group pointed out at our Annual Forecast Conference, airlines need to recognize that the time between gate departure and gate arrival is their "production" line, yet they essentially turn it over to the FAA - one of the most mis-managed entities in Washington - to direct and run it. As the ATH Group's programs have shown, airlines do have some ability to manage their own production lines over and above the ATC system. The result can be thousands of saved minutes each week. And lots of dollars not lost.

Most carriers will say that they have "task teams" or "continuous improvement programs" that already monitor these types of things, so all is well. Sure.

Consolidation Won't Alleviate Fuel Prices. It Won't Cut Capacity.
But It Will Make Wall Street Wealthy.

What needs to be said about major airline consolidation has already been said. It's trendy. It's supposed to be inevitable, and it's supposed to solve the industry's problems.

None of that's accurate, regardless of how many times it's repeated, or how many talking heads in the media keep saying it. But, money's to be made, so watch for the potential in 2008. One thing to keep in mind: the definition of "consolidation" - it means taking two or more things, combining them, and ending up with less.

But when the dust settles, there's no guarantee the industry will have less capacity, particularly in main traffic flows. A lot of folks on Wall Street have been led to believe that there's a set amount of capacity out there, and one merger will restrict other carriers from expanding to fill any void.

What is certain, however, is that there would be fewer connecting hub operations, and that means less service where capacity reductions aren't really needed and won't do much for improving the industry: small and mid-size communities.

We pretty much covered this in a November Hot Flash. The reality is that this is business. And business realities are not always consumer-friendly. Click here to review it.

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Check on the Hot Flash weekly for updates. And consider subscriptions to our new Aviation Research Report series. New insights that other consultants miss entirely.

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© 2008 The Boyd Group/ASRC, Inc. All Rights Reserved.