Thursday, May 17, 2007
They wowed Wall Street with profits and eye-popping revenue growth, and seduced consumers with low fares and amenities such as individual TVs and leather seats.
But the darlings of the industry are increasingly running into their own set of problems. Their challenges include mounting costs, growing pains, and aggressive competition from larger airlines and one other.
As a result, many low-cost carriers are tweaking their business plans, branching out into new areas and reassessing their growth strategies to remain competitive. They also could look to mergers and acquisitions, some experts say.
"The low-cost model is changing," said Douglas Abbey, a partner with the Velocity Group, an aviation consultancy. "We're seeing each carrier do something slightly different than they have historically. Each is moving to the beat of a different drummer. They're each looking for new sweet spots."
That's not to say the nation's half-dozen low-cost carriers, as a group, are in major trouble. Most continue to expand, and several, including Southwest Airlines and AirTran Airways, continue to post profits.
But they all face new concerns beyond rising fuel costs and other industry woes.
Much of their recent growth has come at the expense of larger, older airlines that struggled first during an economic downtown in 2000 and then after the terrorist attacks in 2001. The low-cost carriers followed a fairly cut and dry approach to expansion: enter cities with little existing competition and high fares.
Now, though, most larger cities have discount service, meaning low-cost carriers are increasingly competing against each other.
Just look at Denver, where three airlines are fighting aggressively for market share.
United Airlines - the dominant carrier with more than 55 percent of the market - has lost ground in recent years to homegrown Frontier. The local airline now captures a fifth of all passengers at Denver International Airport. Last year, though, Southwest Airlines started Denver service, lowering fares and helping accelerate passenger growth.
While it's unclear how it will shake out in the long term, all three airlines seem to be taking a financial hit in Denver, highlighting the difficulties low-cost carriers face as they compete against each other.
"In Denver, you have a front-row box seat to how this all will play out," said George Hamlin, a managing director at Airline Capital Associates, an aviation consulting and financial advisory firm. "As low-cost carriers continue to expand, they're going to butt up against each other more."
Several low-cost carriers founded in the 1990s also are struggling to manage their growth, a common problem for many fast-growing businesses.
JetBlue, for instance, faced operational problems last winter that led to a rash of cancellations and left customers outraged. It's also been criticized for expanding too quickly, and the carrier has scaled back its growth plans and canceled some aircraft orders.
"The low-cost carriers are going through what, traditionally, the legacy carriers have had to go through," said Evergreen-based aviation consultant Mike Boyd. "They're ordering way too many airplanes and getting stuck with less traffic. Meanwhile, carriers like United are the ones that benefit because they have a much better revenue stream because of their broader network."
Low-cost carriers have lost some ground against their larger competitors, which shed billions of dollars in costs in recent years.
United, for instance, cut more than $7 billion during its recent bankruptcy. Other larger carriers such as Continental and American managed to avoid bankruptcy but still lowered costs significantly and are posting profits.
That's not to say that legacy airlines are growing gangbusters. In fact, they continue to scale back domestic capacity, and several are facing worrisome labor relations issues. And several, including United, are losing money.
But they have managed to keep expenses in check.
Discount carriers have seen their average operating costs rise by 28 percent since 2003, compared with a 12 percent increase for the airline industry as a whole, according to Bureau of Transportation Statistics.
"The product and feel of the larger carriers is getting closer to the product and feel of the low-cost carriers, so the distinction between the two has blurred," said Stuart Klaskin, a Florida aviation consultant. "And the low-cost guys have become kind of ubiquitous. They're not so unusual anymore. They've become Starbucks."
Each low-cost carrier appears to be taking a different path to adjust to the new challenges.
Southwest is moving past its "no-frills" image as it looks for new ways to bolster revenue, which could include flying internationally and adding Internet access and other entertainment option on its planes, among other things.
Frontier is branching out from Denver and flying different types of planes, including a new turboprop operation scheduled to start this summer.
AirTran has mounted an aggressive bid to buy Midwest Airlines and recently signed a frequent-flier agreement with Frontier.
Some observers say the low- cost segment of the industry is ripe for consolidation, involving either their fellow discount airlines or the larger carriers. One analyst recently mentioned Frontier as a possible merger or acquisition target for Southwest, JetBlue, AirTran or Alaska.
Despite their challenges, low-cost carriers likely will continue to grow and become an even bigger force in the industry. That's good news for consumers, who will benefit from the downward pressure on fares.
"That's what everybody wants, to be a low-cost airline," said airline economist Dave Swierenga of consulting firm AeroEcon. "Their problems aside, it is the place to be."