It's been an airfare party this summer for travelers with many domestic flights cheaper than a nice bottle of wine. Chicago to Los Angeles can be had for $49, Dallas to San Francisco is just $40, and Denver to Dallas goes for only $25.
Airlines and their investors despise these fares, the result of a fierce pricing skirmish. The fare fight reprises a similar battle that broke out two years ago, one that dented industry revenue for more than 18 months. Only this past spring did carriers begin to feel confident that their pricing power was gradually returning.
Now there's a new war, and no clear end -- or winner -- in sight.
The renewed conflict pits the industry's deep-pocketed behemoths, led by United Continental Holdings Inc. and American Airlines Group Inc., against a trio of ultra low-cost carriers possessing cost advantages the big guys can't replicate. Financially, the leading airlines "are better positioned now than they've ever been," said Seth Kaplan, managing partner for trade journal Airline Weekly. "On the other hand, lowest cost historically has won."
Two things undergird the fare war of 2017: fuel and money. Jet fuel costs, while rising, remain inexpensive relative to what the industry paid in the past and, equally important, the major U.S. airlines remain solidly profitable. Because of these dynamics, neither side has blinked, just as almost every airline has used the fuel reprieve as an opportunity to increase domestic flying.
Fares -- and airline stock prices -- have shrunk accordingly. United shares have lost 28 percent over the past three months, given the zeal with which the Chicago-based carrier has taken the pricing battle to Spirit, where the share loss has been 41 percent. American and Southwest shares have declined 15 percent and 13 percent in the same period, respectively, while Delta has lost 10 percent and Allegiant 17 percent.
"Market share battles always get you into trouble," said George Ferguson, a senior aviation analyst with Bloomberg Intelligence. As the fares drop, shareholder anger grows -- and that wrath is likely to spur higher fares faster than any future jet fuel spike, Ferguson said.
United President Scott Kirby is the airline industry's primary U.S. fare setter, given his role as architect of a "price-matching" strategy when he was American's president. Kirby said Spirit has led the most recent ticket battles, with a 50 percent cut to walk-up fares on July 28, followed by a further cut in the following weeks.
Last month, Evercore ISI analyst Duane Pfennigwerth published a client note titled "It's Not Business, It's Strictly Personal" that was both a rant and plea to United's board to curb Kirby's price-matching. "We remain very surprised that the new board at United is giving this one, big personality the freedom to ... roll the dice on industry discipline," and start fare wars, Pfennigwerth wrote. "Investors and board should know that none of this had to happen."
Low costs are certainly an ultra low-cost carrier advantage. In the second quarter, Spirit Airlines Inc. had a cost per seat-mile, excluding fuel, of 5.83 cents, compared with 10.28 cents at United, which has a cost structure comparable to those of American and Delta Air Lines Inc. Privately held Frontier Airlines Inc., a low cost carrier modeled on Spirit, was at 5.43 cents as of Dec. 31, the company has said. By the same measure, Allegiant Travel Co.'s cost was 6.42 cents in the second quarter.
American executives have defended their price matching because half the airline's revenue comes from the 87 percent of people who fly with the carrier only once a year. This situation has prompted some of the biggest U.S. airlines to fight for every passenger in each of its hubs. In years past, airlines often ignored the most price-sensitive customers, choosing to keep the higher fares. In many markets that have little or no competition, that is still their position.
Yet the big hubs -- Atlanta, Charlotte, Chicago, Dallas, Denver, and Detroit -- are markedly different, and with the incursion of low-cost rivals, the legacy airlines perceive an existential threat that must be attacked, if not eradicated. The hubs are where legacy carriers dominate, and in doing so exploit the financial power of their connecting traffic by goosing fares from different markets. Delta, for example, holds roughly 75 percent market share at its four largest hubs, while American is at 91 percent in Charlotte, according to data compiled by Morgan Stanley.
When Spirit or Frontier entered with daily service, according to an analysis of fares in 2014-15 by consulting firm ICF International Inc., fares at eight U.S. legacy hubs dropped an average of 20 percent.
The low-cost carriers do have a soft underbelly, though. Spirit and Frontier have labor contracts pending with their pilots and are likely to assume higher costs as part of the new pacts, a process Allegiant completed last summer.
Spirit's pilots say they earn about 40 percent less than their U.S. peers flying the same Airbus planes and want to narrow that gap with their new contract. Frontier delayed its plans to go public this summer, likely because of the increased financial pressure expected from the competitive threats. In a securities filing, Denver-based Frontier also specifically warned future investors about sharper competition targeting its part of the low-fare market.
Business on 09/09/2017