Delta’s CEO, Gerald Grinstein, elected to do more than talk about changing the pilots’ pension plans unless they agreed to concessionary steps. Like other legacy chiefs, he did that, too, but then, early in 2005, he took a radically different and, indeed, astonishing step, one possibly born of desperation. In effect, he broke away from the legacy airlines and more or less aligned Delta with the low-cost carriers (LCCs) by capping and simplifying fares, plus cutting domestic fares by as much as 50 percent. Various restrictions, including the requirement for overnight stays on Saturday, were scrapped; that move had been aimed at discouraging business-class travelers from using discount tickets. In announcing his U-turn on revenue, Grinstein said, “Following years of confusing fare complexity, many customers no longer believed they were receiving a quality product at a competitive price.”20
Within the industry, Delta was seen as forced to act because of the invasion of its markets by LCCs. They were competing with Delta at its Atlanta hub, on the East Coast, and in Florida. And three of them—JetBlue, Southwest, and AirTran—were limiting ticket prices to $299 one way, much less than the new cap of $499 that Delta had just placed on its fares. “Maybe they will get more real,” said JetBlue’s David Neeleman.21
Getting more real, however, would mean matching Delta’s much lower, much simpler fare structure with an equally radical new approach to paring costs; but even with their survival at stake, the legacy carriers probably won’t shrink their cost structure enough—enough, that is, to allow them to adopt the low-cost model and compete on even terms with LCCs. Within three years or so of 9/11, airline load factors had reached an all-time high and yet these companies were in a financial free fall.
It’s probably only a matter of time before some or all of the six legacy carriers make their exit. Whether any of them can survive will depend on events. One or more of them might find solid ground by upgrading service, improving on-time performance, and, in the bargain, gaining major concessions from the unions. Two of the six—Continental and American—appear to be in somewhat better shape, or less vulnerable, than the others.
Suppose, some airline watchers wonder, this less wobbly twosome was to sponge up the best routes and the choice equipment of the ones actually walking the plank. Would the investment promote their chances of survival? Probably not. JetBlue and other LCCs could and probably would pick up such assets themselves, probably for fifty cents or so on the dollar, and thereby become an even stronger and more erosive force.
THE SKIRMISHING between pilots and management over salaries and pensions obscures a large hidden cost to legacy carriers in the form of union work rules that prevent people from doing jobs that they are not specifically authorized to perform. A pilot may not touch luggage. A flight attendant isn’t allowed to change a blown lightbulb.
The low-cost carriers are not afflicted with these austere work rules because, for the most part, they have managed to dodge or contain the unions. Some of them pay wages that begin further down the scale than those paid by the major carriers. Some of them make their own arrangements with pilots, of whom there continues to be a surplus. Southwest Airlines, the senior and most successful LCC, has over time been able to make its pilots among the industry’s highest paid, yet without harming the company’s balance sheet, the best in the airline sector.
In the airline industry’s time of deepest woe, the more successful LCCs have injected their people with a team spirit built on pride and a sense of connecting with growth organizations that will make it and possibly flourish. The absence of rigid work rules gives the LCCs a big advantage over the legacy carriers. Flight attendants working for some LCCs routinely clean the airplanes between flights so that turnaround time can be shortened and the expense of using cabin service crews avoided. Similarly, baggage handlers are often seen helping with the tugs that push back the airplanes.
Moreover, at Southwest and JetBlue, management people do not hesitate to help clean up the airplane or assist with luggage on the ramp. Herb Kelleher does too when he is aboard a Southwest flight, and he also talks to passengers. David Neeleman, the highly original and inventive founder and leader of JetBlue, sent a message that got his company’s attention when he started assisting his crews while traveling. He may help the flight attendants or, during a stopover, pick up luggage, and even at times grab a handheld vac to help police the airplane and shorten ground time.
Shortening ground time is for these two carriers both a first principle and a cause. From the start, JetBlue’s management expected the first bag to arrive on the carousel within ten minutes of its plane’s arrival at the gate, the last one in twenty. Southwest negotiated labor contracts that allowed flexibility in operations of the system. According to a book on the airline, “When a Southwest plane pulls into the gate, employees in ground operations run for the aircraft like a pit crew scrambling to get an Indy car back on the track…. When a flight is running late, because of weather, it’s not uncommon to see pilots helping customers in wheelchairs board the plane, helping the operations agents take boarding passes, or helping the flight attendants clean up the cabin between flights.”22
Southwest is fully unionized, JetBlue not at all. JetBlue’s management is known to feel that the arrival of a union would mean that the company had somehow failed the workforce. Southwest was always open to the presence of unions, partly because of the congenial environment it had created. One or more persons employed by a legacy carrier might have a complaint that would oblige their union to file a grievance. A union involved with Southwest could do that, too, but thus far wouldn’t have had to. The difference is attitude.
The LCCs are not saddled with the traditional defined benefit plans that oppress the legacy carriers. Instead they offer 401(k)’s with company matches and profit sharing. Southwest provides stock option plans that at first were available only to management and pilots. Now they are available to flight attendants as well. Employees can also buy company stock at discounted prices. Few stocks have outperformed Southwest over the past twenty-five years.
Among the reasons for the success of Southwest and JetBlue has been the simplicity of operating one kind of airplane. That business model keeps maintenance and training costs low. The legacy carriers fly mixed fleets, and some of them even operate different engine types on the same airplane. Southwest operates only Boeing 737’s, and JetBlue uses the Airbus equivalent, the A320 (although it will be adding one other, shorter-range aircraft to its fleet).
In recent years, the most intense struggle between Boeing and Airbus has matched the 737 against the A320 for supremacy in the low-cost market. Over time, the A320 gradually gained the advantage because it is a newer airplane and, for various reasons, increasingly in favor with low-cost carriers. That is important, because those carriers, plus various leasing companies, are buying the new airplanes. The strapped legacy carriers are buying very little new equipment. Instead, some of them are cutting back. Well before reforming its fare structure, Delta decided to delay the delivery of 10 new Boeing aircraft and cancel options for 113 others.
Some of the low-cost carriers are more austere than others. There is a spectrum of passenger comfort and services. JetBlue, with reserved seating and seats with monitors showing twenty-four channels of direct satellite TV, lies at the gentler end. David Neeleman refers to his company as a services company (not as an airline). He removed a row of seats in the rear of his aircraft so that passengers seated there have more legroom. In distinguishing his approach from Southwest’s, he says, “We wanted to spare people the stress of getting to the airport in time to get seats with family. Otherwise you feel you are fighting your way into the airplane.”23
In the middle of the comfort spectrum are Southwest and Britain’s easyJet, among others. At the harsher end is Ireland’s highly successful Ryanair, often called a Greyhound bus; its CEO, Michael O’Leary, describes his business plan as “piling ’em high and selling ’em cheap.”
What actually defines Southwest and JetBlue is the co
herence of their business plans; the various pieces fit together and complement one another. Apart from keeping costs in line with a low-cost structure, this means training people to be friendly and, in turn, keeping them happy by communicating—explaining the steps that management is taking and why these will serve employee interest. And there is little sense of hierarchy in either place.
It began with Southwest, almost the only low-cost carrier to survive the hurly-burly of the immediate post-deregulation years. Fifty-eight airlines began life after deregulation, and only one—Southwest—stayed the course. If Kelleher, its leader, is the industry’s most successful figure, he is probably the most flamboyant as well. By one account, Southwest “was propelled by the outrageous antics of its chain-smoking, bourbon-swigging chief executive…who cultivated an outlaw image by riding a Harley-Davidson and dressing up in Elvis Presley costumes at company events.”24
David Neeleman is very different. He is a seventh-generation Mormon who was born in 1959 in São Paulo, Brazil, where his father did missionary work for a time. But the family had its roots in Salt Lake City, where Neeleman grew up and also began his professional life. He now lives simply with his wife and nine children in Connecticut, and commutes to the airline’s main office in Queens. (Neeleman and a few of his colleagues also work out of an office in Darien, Connecticut.)
Rather intuitively, it seems, Neeleman began edging into the role of airline entrepreneur while still in his mid-twenties. By 1985, he was maneuvering a minuscule airline, called Morris Air, into existence. He openly imitated Southwest by flying Boeing 737’s, serving peanuts-only snacks, and demanding swift turnarounds, with crews offloading the arriving aircraft, cleaning and refueling it, and taking it off again in just twenty minutes.25
Neeleman based Morris Air in Salt Lake City, and concentrated on flying between there and Los Angeles, a route he had studied and knew well. Morris Air got off to a good start and before long was growing and outperforming other airlines on that route.
Although fiercely determined to create a smaller version of Southwest, Neeleman had ideas of his own. One of them, as described in a book about JetBlue by Barbara S. Peterson, “would help usher in one of the most far-reaching changes in the way airlines do business: electronic ticketing.” An airline passenger, Neeleman decided, didn’t need to get a ticket—only a reservation number and a boarding pass. The more elaborate and costly ticketing process would be bypassed, and a great deal of money would thereby be saved. Also, the airline would be paid up front by customers with credit cards arriving at the airport. Neeleman was one of a very few airline bosses who was prepared then to reject an entrenched system that was relied upon by most of the other players, not least travel agents.26
Neeleman became rich when he sold Morris Air to Kelleher, who felt a need to beef up Southwest because United Airlines had Southwest in its sights. The deal included bringing Neeleman to Southwest in a senior role. His association with Kelleher didn’t last long, however. Neeleman’s innovative ideas, persistently advanced, strained the tolerances of older and more experienced members of the Kelleher team. Later, however, Neeleman would infuse his start-up, JetBlue, with the larger part of the Southwest culture.
The two business models have remained similar in ways that matter, but each has characteristics that set it apart from the other. Both fly their customers point-to-point, not to big hub airports from which many travelers must change planes so as to reach their actual destinations. Southwest’s route structure is built around short hauls. Its marketing and growth strategy was built around stealing these high-volume short-distance markets from the majors.
JetBlue has been flying longer routes, including many transcontinental routes that Neeleman’s start-up plan had targeted. His assumption, since borne out, was that JetBlue could sell lots of $129 tickets to people who would otherwise be paying $899 to United or American for the same trip. But first he had to find the right airport location, one that would accommodate his purpose: to create an airline built around high-frequency, low-cost service. For that, he would need a major airport located in a major metropolitan area.
He wanted to be in New York, but Newark Airport and La Guardia were at full capacity. That left John F. Kennedy Airport. He chose it, thereby surprising many industry people. JFK, they thought, was in a serious and well-deserved decline, partly because people found it overly hard to reach. Also, it was seen as having “a growing crime problem, a sizable homeless population and, in popular lore at least, its cargo hangars functioned as a sort of ATM for organized crime.” And by this account, many other airline managements had decided against using JFK “after the Port Authority of New York and New Jersey had failed to get support for a one-billion-dollar plan to rebuild the airport around a central terminal.”27
However, JFK appealed to Neeleman and his team in part because it served mainly international carriers whose operations were concentrated in the late afternoon and early evening hours. The earlier part of the day offered a lot of dead time. “You know most of the time Kennedy is so quiet that you could go bowling on the runways,” observed one of Neeleman’s colleagues.28
Neeleman wanted JetBlue to start big and expand quickly. That part of his plan would depend on the availability of slots at the airport he chose and the willingness of the Department of Transportation to award them to JetBlue. (“Slots” is shorthand for rights to take off and land at specific times.) In Neeleman’s case, this was especially tricky, since he was asking for seventy-five slots, many more than are normally assigned. Airlines generally do not ask for more than a few slots at any one time, just enough to accommodate some modest expansion of service. But Neeleman was requesting a bushel basket of them, saying, in effect, “Our plan requires predictability. Give us seventy-five now, and over the next couple of years we will ramp up operations and use them all.”
Neeleman got the slots, partly (perhaps mainly) because his business plan impressed the Department of Transportation as bold but credible. It impressed other parties as well, starting with the financial community. “I’m initiating coverage of JetBlue Airways with a ‘1’ rating,” wrote the chief airline analyst at a major investment bank on April 9, 2002.
This company is doing an IPO of 5.5 million shares of common stock that was expected to price…with a range of $22–24. In that range, the stock would price in a market cap of approximately $1 billion. However, the retail demand is cult-like (think Krispy Kreme) and most analysts would not be surprised to see a first trade of up to $2 billion in market cap…. It’s been a longtime since we’ve put the words “hot” and “deal” (not to mention “airline”) in the same sentence, so I’m not sure whether the overall market is ready for more. If history’s any indication, though, I do know that the underlying fundamentals…should justify some pretty extraordinary valuations…in the intermediate term.
JetBlue is a low-fare, low-cost passenger airline that has differentiated itself in a commodity business with customer service and live TV. With both short-haul and long-haul routes, it focuses on underserved markets and large metropolitan areas that have high average fares. It is the first start-up carrier to use all new A320 aircraft—it has 24 now and will have another 59 by 2007. So, shiny new planes, low fare, friendly service and live TV are its marketing schtick.
Equally impressed, it seems, were senior Airbus people in Toulouse. “First of all, Neeleman was impressive,” says Benoit Debain, senior vice president for finance. “He had sold Morris Air to Southwest, and he had $130 million equity. That is a lot for a start-up. We had at first been skeptical about a plan that included taking out some seats and putting TV in the rest of them. The banks in the U.S. would say, ‘You can’t make money that way.’”29
At first, however, JetBlue was to have been a joint venture with Richard Branson, Britain’s remarkably successful creator of Virgin this and Virgin that. But the joint business plan immediately collided with the statute that limits (as noted) a foreign entity’s ownership of an American venture to
25 percent of voting shares and 49 percent of total equity.
Branson had wanted the partnership with Neeleman to enlarge his standing in the American market. He was not content with being a passive voice and withdrew from it, a step he now deeply regrets. “In retrospect,” Branson says, “I should have taken a forty-nine percent minority share and called it VirginBlue instead of JetBlue.”30 Had he done so, he would have made yet another fortune. He and Neeleman parted amicably.
Like most airline watchers, Neeleman has been awaiting the demise of US Airways. When and if that actually comes about, JetBlue would move into the ultrahigh-fare short-haul market in the Northeast. But planning for the step has led JetBlue away from one of the first principles of the Southwest model: keep things simple and cover the entire route structure with just one airplane. Instead, Neeleman will penetrate the new short-haul markets not with his fleet of A320’s but with another airplane—a hundred-seater made by Embraer, a Brazilian company that specializes (very successfully) in regional aircraft and is now the world’s fourth-largest airplane maker.
Whether Neeleman is fated to regret his divergence from the Southwest model won’t be clear for some time. In May 2005, US Airways drew a reprieve from near-term disaster by merging with America West, another seriously sick carrier, in a deal creating the sixth-largest U.S. airline. Moreover, Airbus is loaning the partners $250 million that will be largely devoted to buying up to twenty A350’s.31 With US Airways a little less close to the edge of the cliff, the question for JetBlue is whether its new Embraer airplanes can be aligned with its route planning or will become a problem.
Boeing Versus Airbus Page 10