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0:00Something strange is happening in the skies.
Eight years ago, American low-cost carriers
0:05were just printing money. Southwest, for example,
pocketed 20 cents of every dollar they brought in
0:11in operating profit. JetBlue, also 20, while
Spirit 24, and Allegiant a colossal 30. These
0:19are monumental profit margins for any industry,
but especially for the airline industry. While
0:25buoyed by rock-bottom fuel prices, the low-cost
carriers still triumphed over the competition:
0:30Delta’s operating margin peaked at only 19.6%,
while United’s just 13.6%. At that time, everyone
0:37was asking: how was it that the airlines charging
the lowest fares were making the highest profits?
0:45But today, eight years on, the incumbent
legacy carriers have regained their supremacy,
0:50and their low-cost counterparts are fighting
for their survival. These four are down to
0:55operating margins between 5.6% and -11.2%, while
their legacy counterparts are back up to 8% and
1:0210.9%—far closer to their 2015 or 2016 peaks.
So, what happened between 2016 and today? Well,
1:10of course, the most dramatic collapse in air
passenger volumes in modern aviation history
1:14due to the COVID pandemic, but finding a cause for
budget airlines’ woes is not as simple as that.
1:20Passenger volumes, at least in the US, have fully
recovered, hit an all time record in summer 2023,
1:26and have every likelihood of doing so again in
summer 2024. While COVID hurt low cost carriers
1:31just like any airline, they recovered, and then
financial performance started to turn downward
1:36once again, whereas their legacy counterparts
recovered, and then continued to recover
1:40further through today. So something strange is
happening: people want to fly more than ever,
1:45yet the budget airline business model in the US is
collapsing without any obvious reason as to why.
1:52But the airlines have to have a reason, at
least one to give to investors. They’re public
1:57companies, so the management team must paint
a narrative explaining why they’re not making
2:01money like they once did, and more importantly,
why it’s not the executive team’s fault. Spirit,
2:06for example, says “the competitive environment
remains challenging due to the elevated capacity
2:11in many of the markets we serve.” That’s
to say: other airlines are flying too much.
2:16Now, anecdotally, Spirit’s narrative of oversupply
is grounded in truth. The post-COVID demand
2:22recovery has been notably uneven between the
industry’s two main customer segments—business
2:26and leisure. Whereas more people are flying
for vacation or to see family than ever,
2:30increasingly digitized businesses are now less
willing to fly their staff around the world for
2:34meetings or conferences and the number of people
traveling for work still has not reached pre-COVID
2:39levels. Considering overall demand at records,
that means leisure travel demand is hugely strong,
2:44so the legacy airlines that traditionally were
more focused on serving business travelers have
2:48subtly recalibrated their networks to
capture more leisure demand. Las Vegas,
2:53which is almost entirely a vacation destination,
had 412,000 scheduled flights in 2023, which
2:59represents about a 10% jump compared to pre-COVID
averages. New York’s JFK airport, meanwhile,
3:05a major business market, still saw slightly
fewer flights in 2023 compared to pre-COVID.
3:11But at least in the case of Spirit, the
numbers don’t wholeheartedly back up their
3:15claim of competition as the primary
cause of their woes. On the one hand,
3:19Spirit’s load factors are down—whereas 84.7%
of seats were filled in 2015, only 81.3% are
3:27today. That is partially the effect you’d expect
if other airlines were dumping a lot of capacity
3:32into a market—there would be more overall seats
and therefore a smaller portion of them filled—but
3:38passenger counts are not a fixed total—they vary
depending on price as people decide whether to fly
3:44depending on how much it costs. So therefore,
you’d expect that oversupply in a market would
3:49also lead to lower revenue since airlines would
lower fares in order to fill seats. But revenue
3:54seems fine. In 2015 Spirit earned 10.08 cents
per seat, per mile flown, and today that’s down
4:00slightly to 9.63 after a high-water-mark of 10.44
in 2022. While this difference is meaningful,
4:08it just is not meaningful enough to explain
a profit collapse of 24% margin to -7.5%.
4:15But there’s another line in their reports
with a far more significant change—CASM:
4:21that’s cost per available seat-mile, or how much
it costs the airline to operate a flight on a per
4:26seat, per mile basis. Between 2015 and 2021,
this fluctuated roughly around eight cents,
4:32with some marginal upward growth. But between 2021
and 2022, the cost to transport a passenger a mile
4:39on Spirit exploded 45% higher to 11.67 cents.
This is the problem. After all, the true,
4:49technical, industry term for this grouping of
airlines is low-cost carrier, and that “cost”
4:55refers not to the fares the public pays, but
rather to how much the airlines themselves spend
5:00operating their flights. This often translates to
lower-fares for the public, but not always. So if
5:07a low-cost carrier loses their low operating
cost, like Spirit clearly did, it no longer
5:12has a business model. So what happened?
Well, in Spirit’s case it’s actually
5:17pretty simple—fuel prices went up. In fact, they
basically exploded in March 2022, and excluding
5:23fuel from their operating cost, their cost per
available seat mile actually declined marginally
5:28between 2021 and 2022. It’s a similar story for
JetBlue—their cost minus fuel was just about
5:33flat. But not all airlines are in the same boat.
Frontier’s cost per available seat mile excluding
5:38fuel still went up 17% between those two years.
Allegiant’s 32.1%. Southwest’s a colossal 39%. So,
5:49while fuel cost increases might be a major
explanation of the demise of the low-cost
5:53carrier model in the US, it’s far from everything.
When digging through those financial reports,
5:59beyond the complaints of rising fuel prices,
airlines attribute their issues to one other
6:04key cause: irregular operations. Essentially:
it’s gotten a lot harder to operate an airline
6:09on-time in the US, and when you can’t operate
an airline on-time, you really can’t effectively
6:15operate a low-cost carrier business model.
Prior to the pandemic, Spirit was regularly
6:19flying their aircraft around or even upward of 12
hours per day during the peak summer season—from
6:25before dawn until well into the evening, and
sometimes even overnight, with the shortest
6:29possible ground time in between each flight. But
these days, with plenty of demand and therefore
6:35reason to operate flights, Spirit still can’t get
their daily aircraft utilization up to pre-COVID
6:40levels—it’s peaked at just 10.8 hours in 2023.
Why Spirit can’t operate as much as they used
6:47to is a little of everything. Severe weather in
the US is more frequent, for example—whereas in
6:532000 an average of just one category four or five
hurricane hit the US each year, today that average
6:58is up to over two. Spirit, and most US low-cost
carriers, has a disproportionate number of its
7:04routes to or from places like Florida—home to the
kinds of beaches that leisure travelers seek out,
7:09but also the geography that hurricanes
are most likely to hit. So with hurricanes
7:13and other severe weather more frequently
preventing on-time operations, airlines need
7:17more slack in the schedule to keep it on track.
Similarly, the FAA is experiencing a shortage of
7:23air traffic controllers—since each individual is
only able to handle a certain number of flights
7:27at a given time, this creates delays as planes
are prevented from taking off until there’s ATC
7:32capacity. And this shortage has hit particularly
hard also in Florida, meaning the impact has once
7:37again been disproportionately felt by Spirit
and other leisure-focused low-cost-carriers.
7:42And the bad luck doesn’t stop there. You see,
almost half of Spirit’s aircraft fleet is
7:47composed of A320 NEOs specifically powered by
Pratt and Whitney’s PW1100G engine. This is an
7:54extremely advanced and efficient engine, which is
why the airline acquired them in the first place,
7:58but their manufacturer identified a potential
flaw in some of the metal used in these
8:02engines that could cause cracking in the turbine.
Therefore, they’ve had to move up the timeline for
8:07inspections on these engines which initially
took seven Spirit aircraft out of service,
8:11and since then has kept an above-average number
of the airline’s planes out of revenue service
8:15compared to typical operations. While
Spirit is the US low-cost operator that
8:20relies most on this engine type, and therefore is
experiencing the most hardship from its issues,
8:24JetBlue and Frontier also use the PW1100G and
therefore have also seen a revenue impact.
8:31So with this combination of issues, airlines
are just having to fly aircraft less to keep
8:36operations on-time. Even with lower utilization,
Spirit still has seen weaker on-time ratings
8:42over the past few years compared to pre-pandemic,
which itself has costs—be it through compensation
8:47for canceled flights, costs of booking hotels
for unexpected overnights, revenue loss through
8:51frustrated passengers avoiding flying the airline
again, and more. So not only do they have to make
8:56less money by flying aircraft less, they also
have to pay more for the impact of delays.
9:02These US low-cost carriers are all in an
untenable state—something has to change
9:08to ensure their survival. And they each have some
rather unique theories on how to do that. JetBlue,
9:14for example, is making some fairly drastic changes
to their route map and schedules. In recent years,
9:19rather uniquely for a low-cost carrier, they’ve
started long-haul flights to European destinations
9:24on narrow-body aircraft configured with a huge
number of business-class seats. This service
9:29is going decently—reviewers are lauding its
quality, flights are filling acceptably, and
9:34they’re expanding to more and more destinations.
Bizarrely, though, they originally scheduled these
9:39routes as year-round, and had essentially the
same seat capacity in the winter as in the summer,
9:44despite transatlantic demand in the winter
being massively lower. Essentially every other
9:49transatlantic airline scales down service in the
winter, so faced with increased economic pressure,
9:54JetBlue opted to start cutting certain routes down
to summer-only. They’re then redistributing those
9:59aircraft to domestic routes—in particular, a few
from Phoenix to the east coast, and then a New
10:04York to Vancouver and New York to San Juan route.
This makes sense. One other key post-pandemic
10:09trend is that leisure travelers are now opting to
pay for business class at a far higher rate than
10:15before—essentially, more people are willing
to pay for luxury on vacation. Most low-cost
10:20carriers are in a tough position where they’re
unable to capture this highly-profitable demand,
10:24but while JetBlue still has most of its aircraft
configured in an all economy-class configuration,
10:29this sub-fleet of aircraft configured with
business class for its longer-distance routes can
10:33be better used on domestic routes in the winter
when transatlantic demand is low. In addition to
10:38this network recalibration, they’ve massively
boosted service out of San Juan, Puerto Rico.
10:43This also seems smart. Puerto Rico is, of course,
an American territory, but no major US airline
10:49has a hub there and so they only fly to San Juan
from their mainland hubs, which works efficiently
10:53for bringing mainland tourists to Puerto Rico,
but less well for the 3 million people actually
10:57living there. So JetBlue is increasingly turning
San Juan into a major hub that does connect it
11:02to destinations in the mainland US, but also to
destinations across Latin America like Cancun and
11:08Columbia—the places Spanish-speaking
Puerto Ricans are more likely to go.
11:12Frontier is making some even more dramatic
changes: essentially, they’re bailing on the
11:17budget airline business model, at least from a
passenger perspective. Out of nowhere in May,
11:232024, they announced they were fundamentally
changing their pricing model—no longer would
11:28they charge for seat assignments and carry ons
and change fees. Unlike essentially every budget
11:33airline, they’d now primarily sell bundled
fares just like United, Delta, or American.
11:39From a passenger perspective, they’re now far more
similar to the legacy carriers. They’ve also been
11:44subtly changing how things work behind-the-scenes.
In the past, Frontier was massively operationally
11:50complex with random routes all across the country,
which meant aircraft and crew would be scheduled
11:54on long, winding journeys spanning across
multiple days to staff each flight—an aircraft
11:59and crew might fly from Salt Lake City to San
Antonio to New Orleans to Cancun to St Louis,
12:05and since none of those destinations were
Frontier hubs, with additional aircraft and crew,
12:09one delay on that sequence of journeys would lead
to a delay on all the following flights without
12:14any easy opportunity to swap an aircraft or crew
out to get the schedule back on track. Today,
12:19though, the airline has been opening new hubs—they
now have thirteen across the US, and only 3.5% of
12:25flights don’t go through one of them. That means
Frontier’s operations are now far simpler as many
12:30flights just operate as an out-and-back from
a hub, and even if they don’t, the far higher
12:35proportion of flights hitting a hub mean there
are far more opportunities to rectify a delay and
12:39prevent it from cascading onward to the following
flights. A reduction in delays therefore allows
12:44the airline to improve its all important aircraft
utilization which then, of course, reduces cost.
12:51Not all low-cost carriers have yet instituted such
a dramatic series of changes, but it seems like
12:56they’ll need to: the vultures are circling.
Southwest, while technically operating in a
13:01niche between legacy business airlines and ultra
low cost carriers, has felt the same post-COVID
13:06squeeze as the rest of the cheap leisure
airlines. At the end of the first quarter of 2024,
13:11the company announced a net loss of $231 million.
For a company that went 11 years or 47 quarters
13:19without announcing a loss prior to the pandemic,
the news was undeniably disappointing, something
13:24even CEO Bob Jordan was willing to concede.
Now, some reasons for the company’s slow start
13:30to 2024 had little to do with what Southwest had
control over at the present moment—principally
13:36the reputational damage done by the prior year’s
wide-scale operational meltdown that led to over
13:40a week of disruption over the peak Christmas
travel period, and the continued struggles with
13:44Boeing’s quality control of the 737-MAX.
Still, Jordan articulated that he had a
13:49plan—that Southwest would change. First, it’d
stop operating out of Bellingham, Cozumel,
13:55Houston, and Syracuse, while also reducing
capacity out of Atlanta and Chicago. While
14:00relatively minor airports in Bellingham, Cozumel,
and Syracuse, it was the first time the company
14:05had entirely entirely dropped service to specific
markets since 2019. The other changes: the company
14:11would slow hiring to cull about 2,000 employees
and, most radically, it would begin looking into
14:16how the company seats and boards—potentially
moving away from its no-assigned-seats model to
14:20offer perks for an upcharge. And these changes
were on top of a few more tweaks Southwest
14:25had made in the month of March that actually
helped turn the end of the quarter to a more
14:29manageable crisis. They flew less midweek, they
reduced short-haul business market flights, they
14:33ran fewer flights outside peak hours of the day.
But to some, this just wasn’t enough. In early
14:40June, Elliott Investment management bought
a $1.9 billion dollar stake in the airline,
14:45and with roughly an 11% claim to its equity, they
wanted to make more substantial moves. This sent
14:51shockwaves, because not only is Elliott massive,
for the leadership of publicly-traded companies,
14:57it’s frightening, as Forbes called Paul
Singer—Elliott’s founder—Wall Street’s
15:01most feared Activist investor. To incumbent
CEOs and board members, the term activist
15:07investor is a bit of a euphemism. Usually
the strategy is simple: the investor buys a
15:12significant minority share and begins work to
boost the value of their shares by pressuring
15:16the company to change. Once they have a foot
in the door, the fund can then lobby leadership
15:20or stakeholders to adopt their strategy,
which can vary from altering simple business
15:25approaches to fundamentally restructuring company
leadership. In this particular case, however,
15:30Southwest had now been boarded by Elliott, a
firm not known for having the lightest of touch.
15:37While limited on airline experience, Elliott is
notorious for the ruthless restructuring of the
15:42high-profile companies it enters, from Barnes
& Noble and Cabelas to AT&T, Athenahealth, and
15:47even the Italian soccer club AC Milan. And like
the infamous firm has done with so many companies
15:53before, the activist investor started its tenure
with Southwest by pushing to oust its leadership.
15:59In a slide deck published to its website that
effectively acts as the company’s public playbook,
16:03Elliott pulled a quite specific quote by Herb
Kelleher, Southwest’s founder, early on, then
16:08outlined its way forward: change up the board,
freshen up the leadership. In the move’s wake,
16:13Bob Jordan announced he wouldn’t step down under
the pressure. But pressure only continued to mount
16:19after the company filed an 8-K form with the
SEC that the company’s revenue per available
16:23seat mile, or RASM, was now expected to drop 4
to 4.5% rather than the 1.5-3.5% it had projected
16:32earlier. Announcing an even steeper decline in
a key indicator for an airline’s health has only
16:38furthered Elliott’s case for radical change.
While the shakeup is still in its early stages,
16:43and it's unclear whether Elliot will be successful
in their mission, what is clear is that change is
16:48coming for Southwest, and low cost carriers like
it—whether initiated internally or externally.
16:55Much has been made of Elliott’s investment into
the airline—experts have warned that the firm’s
17:00focus on short-term gains may harm the company’s
long term future. Industry insiders have pointed
17:05out that Elliott may fundamentally misunderstand
what’s made Southwest Southwest for the past five
17:11decades. But what all can seemingly agree on is
that the company has been slow to change for too
17:17long. And in a current environment so unfriendly
to low-cost and ultra-low-cost carriers,
17:22for those in C-suite positions, it’s time
to adapt or start updating the resume.
17:28There is a genuine question to be asked as
to whether the low-cost carrier business
17:32model is viable long-term in the US. It thrives in
Europe, but Europe is far more densely populated,
17:39meaning people don’t tend to travel as physically
far from home for vacation or business. The US is
17:45vast—cities are far, far apart—and the fundamental
basis of the low-cost carrier business model is to
17:51find ways to optimize and reduce operating costs
relative to the legacy carriers. Carriers can do
17:56this by minimizing time on the ground, flying to
secondary airports, paying their employees less,
18:01packing in seats more densely, but what they can’t
do is pay less for fuel. Fuel costs what fuel
18:08costs, and so Spirit is paying just about as much
as United to buy the fuel to fly from New York to
18:14LA. But with such a long, five-hour flight, that
fuel cost represents a far higher proportion of
18:21overall costs, meaning the other costs, that they
could minimize, represent a smaller portion. So
18:27today, in 2024, there’s a perfect storm
of higher fuel costs meeting a collection
18:32of outside factors making it harder for low-cost
carriers to optimize costs overall. Essentially,
18:38low-cost carriers just can’t be low-cost in the
US anymore, and without that, well, what are they?
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