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Why Budget Airlines are Suddenly Failing
Why Budget Airlines are Suddenly Failing
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0:00
Something strange is happening in the skies. Eight years ago, American low-cost carriers
0:05
were just printing money. Southwest, for example, pocketed 20 cents of every dollar they brought in
0:11
in operating profit. JetBlue, also 20, while Spirit 24, and Allegiant a colossal 30. These
0:19
are monumental profit margins for any industry, but especially for the airline industry. While
0:25
buoyed by rock-bottom fuel prices, the low-cost carriers still triumphed over the competition:
0:30
Delta’s operating margin peaked at only 19.6%, while United’s just 13.6%. At that time, everyone
0:37
was asking: how was it that the airlines charging the lowest fares were making the highest profits?
0:45
But today, eight years on, the incumbent legacy carriers have regained their supremacy,
0:50
and their low-cost counterparts are fighting for their survival. These four are down to
0:55
operating margins between 5.6% and -11.2%, while their legacy counterparts are back up to 8% and
1:02
10.9%—far closer to their 2015 or 2016 peaks. So, what happened between 2016 and today? Well,
1:10
of course, the most dramatic collapse in air passenger volumes in modern aviation history
1:14
due to the COVID pandemic, but finding a cause for budget airlines’ woes is not as simple as that.
1:20
Passenger volumes, at least in the US, have fully recovered, hit an all time record in summer 2023,
1:26
and have every likelihood of doing so again in summer 2024. While COVID hurt low cost carriers
1:31
just like any airline, they recovered, and then financial performance started to turn downward
1:36
once again, whereas their legacy counterparts recovered, and then continued to recover
1:40
further through today. So something strange is happening: people want to fly more than ever,
1:45
yet the budget airline business model in the US is collapsing without any obvious reason as to why.
1:52
But the airlines have to have a reason, at least one to give to investors. They’re public
1:57
companies, so the management team must paint a narrative explaining why they’re not making
2:01
money like they once did, and more importantly, why it’s not the executive team’s fault. Spirit,
2:06
for example, says “the competitive environment remains challenging due to the elevated capacity
2:11
in many of the markets we serve.” That’s to say: other airlines are flying too much.
2:16
Now, anecdotally, Spirit’s narrative of oversupply is grounded in truth. The post-COVID demand
2:22
recovery has been notably uneven between the industry’s two main customer segments—business
2:26
and leisure. Whereas more people are flying for vacation or to see family than ever,
2:30
increasingly digitized businesses are now less willing to fly their staff around the world for
2:34
meetings or conferences and the number of people traveling for work still has not reached pre-COVID
2:39
levels. Considering overall demand at records, that means leisure travel demand is hugely strong,
2:44
so the legacy airlines that traditionally were more focused on serving business travelers have
2:48
subtly recalibrated their networks to capture more leisure demand. Las Vegas,
2:53
which is almost entirely a vacation destination, had 412,000 scheduled flights in 2023, which
2:59
represents about a 10% jump compared to pre-COVID averages. New York’s JFK airport, meanwhile,
3:05
a major business market, still saw slightly fewer flights in 2023 compared to pre-COVID.
3:11
But at least in the case of Spirit, the numbers don’t wholeheartedly back up their
3:15
claim of competition as the primary cause of their woes. On the one hand,
3:19
Spirit’s load factors are down—whereas 84.7% of seats were filled in 2015, only 81.3% are
3:27
today. That is partially the effect you’d expect if other airlines were dumping a lot of capacity
3:32
into a market—there would be more overall seats and therefore a smaller portion of them filled—but
3:38
passenger counts are not a fixed total—they vary depending on price as people decide whether to fly
3:44
depending on how much it costs. So therefore, you’d expect that oversupply in a market would
3:49
also lead to lower revenue since airlines would lower fares in order to fill seats. But revenue
3:54
seems fine. In 2015 Spirit earned 10.08 cents per seat, per mile flown, and today that’s down
4:00
slightly to 9.63 after a high-water-mark of 10.44 in 2022. While this difference is meaningful,
4:08
it just is not meaningful enough to explain a profit collapse of 24% margin to -7.5%.
4:15
But there’s another line in their reports with a far more significant change—CASM:
4:21
that’s cost per available seat-mile, or how much it costs the airline to operate a flight on a per
4:26
seat, per mile basis. Between 2015 and 2021, this fluctuated roughly around eight cents,
4:32
with some marginal upward growth. But between 2021 and 2022, the cost to transport a passenger a mile
4:39
on Spirit exploded 45% higher to 11.67 cents. This is the problem. After all, the true,
4:49
technical, industry term for this grouping of airlines is low-cost carrier, and that “cost”
4:55
refers not to the fares the public pays, but rather to how much the airlines themselves spend
5:00
operating their flights. This often translates to lower-fares for the public, but not always. So if
5:07
a low-cost carrier loses their low operating cost, like Spirit clearly did, it no longer
5:12
has a business model. So what happened? Well, in Spirit’s case it’s actually
5:17
pretty simple—fuel prices went up. In fact, they basically exploded in March 2022, and excluding
5:23
fuel from their operating cost, their cost per available seat mile actually declined marginally
5:28
between 2021 and 2022. It’s a similar story for JetBlue—their cost minus fuel was just about
5:33
flat. But not all airlines are in the same boat. Frontier’s cost per available seat mile excluding
5:38
fuel still went up 17% between those two years. Allegiant’s 32.1%. Southwest’s a colossal 39%. So,
5:49
while fuel cost increases might be a major explanation of the demise of the low-cost
5:53
carrier model in the US, it’s far from everything. When digging through those financial reports,
5:59
beyond the complaints of rising fuel prices, airlines attribute their issues to one other
6:04
key cause: irregular operations. Essentially: it’s gotten a lot harder to operate an airline
6:09
on-time in the US, and when you can’t operate an airline on-time, you really can’t effectively
6:15
operate a low-cost carrier business model. Prior to the pandemic, Spirit was regularly
6:19
flying their aircraft around or even upward of 12 hours per day during the peak summer season—from
6:25
before dawn until well into the evening, and sometimes even overnight, with the shortest
6:29
possible ground time in between each flight. But these days, with plenty of demand and therefore
6:35
reason to operate flights, Spirit still can’t get their daily aircraft utilization up to pre-COVID
6:40
levels—it’s peaked at just 10.8 hours in 2023. Why Spirit can’t operate as much as they used
6:47
to is a little of everything. Severe weather in the US is more frequent, for example—whereas in
6:53
2000 an average of just one category four or five hurricane hit the US each year, today that average
6:58
is up to over two. Spirit, and most US low-cost carriers, has a disproportionate number of its
7:04
routes to or from places like Florida—home to the kinds of beaches that leisure travelers seek out,
7:09
but also the geography that hurricanes are most likely to hit. So with hurricanes
7:13
and other severe weather more frequently preventing on-time operations, airlines need
7:17
more slack in the schedule to keep it on track. Similarly, the FAA is experiencing a shortage of
7:23
air traffic controllers—since each individual is only able to handle a certain number of flights
7:27
at a given time, this creates delays as planes are prevented from taking off until there’s ATC
7:32
capacity. And this shortage has hit particularly hard also in Florida, meaning the impact has once
7:37
again been disproportionately felt by Spirit and other leisure-focused low-cost-carriers.
7:42
And the bad luck doesn’t stop there. You see, almost half of Spirit’s aircraft fleet is
7:47
composed of A320 NEOs specifically powered by Pratt and Whitney’s PW1100G engine. This is an
7:54
extremely advanced and efficient engine, which is why the airline acquired them in the first place,
7:58
but their manufacturer identified a potential flaw in some of the metal used in these
8:02
engines that could cause cracking in the turbine. Therefore, they’ve had to move up the timeline for
8:07
inspections on these engines which initially took seven Spirit aircraft out of service,
8:11
and since then has kept an above-average number of the airline’s planes out of revenue service
8:15
compared to typical operations. While Spirit is the US low-cost operator that
8:20
relies most on this engine type, and therefore is experiencing the most hardship from its issues,
8:24
JetBlue and Frontier also use the PW1100G and therefore have also seen a revenue impact.
8:31
So with this combination of issues, airlines are just having to fly aircraft less to keep
8:36
operations on-time. Even with lower utilization, Spirit still has seen weaker on-time ratings
8:42
over the past few years compared to pre-pandemic, which itself has costs—be it through compensation
8:47
for canceled flights, costs of booking hotels for unexpected overnights, revenue loss through
8:51
frustrated passengers avoiding flying the airline again, and more. So not only do they have to make
8:56
less money by flying aircraft less, they also have to pay more for the impact of delays.
9:02
These US low-cost carriers are all in an untenable state—something has to change
9:08
to ensure their survival. And they each have some rather unique theories on how to do that. JetBlue,
9:14
for example, is making some fairly drastic changes to their route map and schedules. In recent years,
9:19
rather uniquely for a low-cost carrier, they’ve started long-haul flights to European destinations
9:24
on narrow-body aircraft configured with a huge number of business-class seats. This service
9:29
is going decently—reviewers are lauding its quality, flights are filling acceptably, and
9:34
they’re expanding to more and more destinations. Bizarrely, though, they originally scheduled these
9:39
routes as year-round, and had essentially the same seat capacity in the winter as in the summer,
9:44
despite transatlantic demand in the winter being massively lower. Essentially every other
9:49
transatlantic airline scales down service in the winter, so faced with increased economic pressure,
9:54
JetBlue opted to start cutting certain routes down to summer-only. They’re then redistributing those
9:59
aircraft to domestic routes—in particular, a few from Phoenix to the east coast, and then a New
10:04
York to Vancouver and New York to San Juan route. This makes sense. One other key post-pandemic
10:09
trend is that leisure travelers are now opting to pay for business class at a far higher rate than
10:15
before—essentially, more people are willing to pay for luxury on vacation. Most low-cost
10:20
carriers are in a tough position where they’re unable to capture this highly-profitable demand,
10:24
but while JetBlue still has most of its aircraft configured in an all economy-class configuration,
10:29
this sub-fleet of aircraft configured with business class for its longer-distance routes can
10:33
be better used on domestic routes in the winter when transatlantic demand is low. In addition to
10:38
this network recalibration, they’ve massively boosted service out of San Juan, Puerto Rico.
10:43
This also seems smart. Puerto Rico is, of course, an American territory, but no major US airline
10:49
has a hub there and so they only fly to San Juan from their mainland hubs, which works efficiently
10:53
for bringing mainland tourists to Puerto Rico, but less well for the 3 million people actually
10:57
living there. So JetBlue is increasingly turning San Juan into a major hub that does connect it
11:02
to destinations in the mainland US, but also to destinations across Latin America like Cancun and
11:08
Columbia—the places Spanish-speaking Puerto Ricans are more likely to go.
11:12
Frontier is making some even more dramatic changes: essentially, they’re bailing on the
11:17
budget airline business model, at least from a passenger perspective. Out of nowhere in May,
11:23
2024, they announced they were fundamentally changing their pricing model—no longer would
11:28
they charge for seat assignments and carry ons and change fees. Unlike essentially every budget
11:33
airline, they’d now primarily sell bundled fares just like United, Delta, or American.
11:39
From a passenger perspective, they’re now far more similar to the legacy carriers. They’ve also been
11:44
subtly changing how things work behind-the-scenes. In the past, Frontier was massively operationally
11:50
complex with random routes all across the country, which meant aircraft and crew would be scheduled
11:54
on long, winding journeys spanning across multiple days to staff each flight—an aircraft
11:59
and crew might fly from Salt Lake City to San Antonio to New Orleans to Cancun to St Louis,
12:05
and since none of those destinations were Frontier hubs, with additional aircraft and crew,
12:09
one delay on that sequence of journeys would lead to a delay on all the following flights without
12:14
any easy opportunity to swap an aircraft or crew out to get the schedule back on track. Today,
12:19
though, the airline has been opening new hubs—they now have thirteen across the US, and only 3.5% of
12:25
flights don’t go through one of them. That means Frontier’s operations are now far simpler as many
12:30
flights just operate as an out-and-back from a hub, and even if they don’t, the far higher
12:35
proportion of flights hitting a hub mean there are far more opportunities to rectify a delay and
12:39
prevent it from cascading onward to the following flights. A reduction in delays therefore allows
12:44
the airline to improve its all important aircraft utilization which then, of course, reduces cost.
12:51
Not all low-cost carriers have yet instituted such a dramatic series of changes, but it seems like
12:56
they’ll need to: the vultures are circling. Southwest, while technically operating in a
13:01
niche between legacy business airlines and ultra low cost carriers, has felt the same post-COVID
13:06
squeeze as the rest of the cheap leisure airlines. At the end of the first quarter of 2024,
13:11
the company announced a net loss of $231 million. For a company that went 11 years or 47 quarters
13:19
without announcing a loss prior to the pandemic, the news was undeniably disappointing, something
13:24
even CEO Bob Jordan was willing to concede. Now, some reasons for the company’s slow start
13:30
to 2024 had little to do with what Southwest had control over at the present moment—principally
13:36
the reputational damage done by the prior year’s wide-scale operational meltdown that led to over
13:40
a week of disruption over the peak Christmas travel period, and the continued struggles with
13:44
Boeing’s quality control of the 737-MAX. Still, Jordan articulated that he had a
13:49
plan—that Southwest would change. First, it’d stop operating out of Bellingham, Cozumel,
13:55
Houston, and Syracuse, while also reducing capacity out of Atlanta and Chicago. While
14:00
relatively minor airports in Bellingham, Cozumel, and Syracuse, it was the first time the company
14:05
had entirely entirely dropped service to specific markets since 2019. The other changes: the company
14:11
would slow hiring to cull about 2,000 employees and, most radically, it would begin looking into
14:16
how the company seats and boards—potentially moving away from its no-assigned-seats model to
14:20
offer perks for an upcharge. And these changes were on top of a few more tweaks Southwest
14:25
had made in the month of March that actually helped turn the end of the quarter to a more
14:29
manageable crisis. They flew less midweek, they reduced short-haul business market flights, they
14:33
ran fewer flights outside peak hours of the day. But to some, this just wasn’t enough. In early
14:40
June, Elliott Investment management bought a $1.9 billion dollar stake in the airline,
14:45
and with roughly an 11% claim to its equity, they wanted to make more substantial moves. This sent
14:51
shockwaves, because not only is Elliott massive, for the leadership of publicly-traded companies,
14:57
it’s frightening, as Forbes called Paul Singer—Elliott’s founder—Wall Street’s
15:01
most feared Activist investor. To incumbent CEOs and board members, the term activist
15:07
investor is a bit of a euphemism. Usually the strategy is simple: the investor buys a
15:12
significant minority share and begins work to boost the value of their shares by pressuring
15:16
the company to change. Once they have a foot in the door, the fund can then lobby leadership
15:20
or stakeholders to adopt their strategy, which can vary from altering simple business
15:25
approaches to fundamentally restructuring company leadership. In this particular case, however,
15:30
Southwest had now been boarded by Elliott, a firm not known for having the lightest of touch.
15:37
While limited on airline experience, Elliott is notorious for the ruthless restructuring of the
15:42
high-profile companies it enters, from Barnes & Noble and Cabelas to AT&T, Athenahealth, and
15:47
even the Italian soccer club AC Milan. And like the infamous firm has done with so many companies
15:53
before, the activist investor started its tenure with Southwest by pushing to oust its leadership.
15:59
In a slide deck published to its website that effectively acts as the company’s public playbook,
16:03
Elliott pulled a quite specific quote by Herb Kelleher, Southwest’s founder, early on, then
16:08
outlined its way forward: change up the board, freshen up the leadership. In the move’s wake,
16:13
Bob Jordan announced he wouldn’t step down under the pressure. But pressure only continued to mount
16:19
after the company filed an 8-K form with the SEC that the company’s revenue per available
16:23
seat mile, or RASM, was now expected to drop 4 to 4.5% rather than the 1.5-3.5% it had projected
16:32
earlier. Announcing an even steeper decline in a key indicator for an airline’s health has only
16:38
furthered Elliott’s case for radical change. While the shakeup is still in its early stages,
16:43
and it's unclear whether Elliot will be successful in their mission, what is clear is that change is
16:48
coming for Southwest, and low cost carriers like it—whether initiated internally or externally.
16:55
Much has been made of Elliott’s investment into the airline—experts have warned that the firm’s
17:00
focus on short-term gains may harm the company’s long term future. Industry insiders have pointed
17:05
out that Elliott may fundamentally misunderstand what’s made Southwest Southwest for the past five
17:11
decades. But what all can seemingly agree on is that the company has been slow to change for too
17:17
long. And in a current environment so unfriendly to low-cost and ultra-low-cost carriers,
17:22
for those in C-suite positions, it’s time to adapt or start updating the resume.
17:28
There is a genuine question to be asked as to whether the low-cost carrier business
17:32
model is viable long-term in the US. It thrives in Europe, but Europe is far more densely populated,
17:39
meaning people don’t tend to travel as physically far from home for vacation or business. The US is
17:45
vast—cities are far, far apart—and the fundamental basis of the low-cost carrier business model is to
17:51
find ways to optimize and reduce operating costs relative to the legacy carriers. Carriers can do
17:56
this by minimizing time on the ground, flying to secondary airports, paying their employees less,
18:01
packing in seats more densely, but what they can’t do is pay less for fuel. Fuel costs what fuel
18:08
costs, and so Spirit is paying just about as much as United to buy the fuel to fly from New York to
18:14
LA. But with such a long, five-hour flight, that fuel cost represents a far higher proportion of
18:21
overall costs, meaning the other costs, that they could minimize, represent a smaller portion. So
18:27
today, in 2024, there’s a perfect storm of higher fuel costs meeting a collection
18:32
of outside factors making it harder for low-cost carriers to optimize costs overall. Essentially,
18:38
low-cost carriers just can’t be low-cost in the US anymore, and without that, well, what are they?
18:47
As you can tell so well by this video, a ton of the job of running an airline is about looking at
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