Regional Airline and Small Community Air Service: It’s Time to Regionalize, Not Marginalize, the System

There are dark clouds looming around the regional airline industry that threaten small community air service and the regional airline industry as we know it.  This could be one hell of a storm.

On Wednesday I had the honor of moderating a panel at the Regional Airline Association’s 36^th Annual Convention in Nashville, TN.  The panel consisted of representatives of many diverse, yet critical, relationships to the industry’s regional sector.  Mike Ambrose of the European Regions Airline Association offered perspective and cited some of the differences/similarities between the US and European regional sectors; Greg Principato, long-time Washington aviation and political veteran and now head of the Airports Council International – North America provided the airport view of the importance of the regional carriers; and the current head of oneworld, Bruce Ashby, provided insight from the global alliance perspective as well as from his front row seat watching the US regional airline industry transform itself into what it is today.

The storm begins with fuel.  The equivalent price of a barrel of jet fuel is nearly $130 per barrel compared to $30 per barrel when the explosive growth of the US regional industry began in the late 1990s.  With regional economies around the US performing unevenly and demand down on top of soaring fuel prices and less capacity, it is no longer economically sound to fly to some markets.

As retirements of mechanics and pilots increase at the mainline carriers, talent is being plucked from the regional airlines to fill those vacancies.  Maintenance costs are escalating at rates that will test even the most optimistic and work to assure that current contracts between the mainline and the regional partners for 50-seat flying will likely not be renewed. 

All of these structural issues are compounded by the heavy hand of government regulation that will only increase costs to the regional sector.  This government intervention ensures that the regional sector will be smaller tomorrow than today, bringing economic carnage for affected communities.

Analysis of Large Hub Airports

The FAA defines an airport as a large hub if it accounts for at least one percent of all enplanements.  But an analysis by MIT graduate student Joe Jenkins that assesses individual airport’s domestic origin and destination (O&D) traffic reveals some interesting trends about air traffic, inflation-adjusted fares and the quality of individual airport access to the air transportation grid in the United States.

According to Jenkins’ analysis, between 2000 and 2010, the nation’s 29 large hub airports grew a paltry 1.1 percent. In terms of O&D, the fastest growing airports were New York – JFK, Charlotte, Denver, Ft. Lauderdale and Orlando.  Those losing the most domestic O&D traffic were Newark, Detroit, Los Angeles, Atlanta and Chicago.  In each case the trends are pretty clear:  Traffic declined at 15 of the 29 large hub airports over those ten years.

The main factors at play were capacity reductions by the network carriers, which depressed demand in hub markets, and a meaningful low cost carrier presence in the fastest growing markets.

In 1980 Orlando ranked 22nd among the large hub airports; in 2010 it ranked number 3.  Only Los Angeles and Las Vegas are larger in terms of local traffic.  On the opposite side of the scale, Miami ranked number 9 in 1980 and number 29 in 2010 (no doubt a function of the growth of Ft. Lauderdale, which ranked 24th in 1990 and 13th today.)

Jenkins also determines whether a market is experiencing improved access to the air transportation grid by looking at how much traffic is traveling nonstop versus connecting.  Only nine of 29 large hub airports saw decreases in access quality for each passenger.

Meanwhile, domestic fares fell on average 30 percent when adjusted for inflation between 2000 and 2010. Airports with the largest decreases in real fares during the period at Ft. Lauderdale, Denver, New York – JFK, Philadelphia, Boston and San Francisco.  Honolulu is the only one of the 29 large hub airports that realized an increase in real fares, which can be explained by the increase in longer distance flying between the US mainland and Hawaii and the liquidation of Aloha. 

Imagine that in the course of one decade, average real fares in the largest US domestic markets fell 30 percent.  And the regulators worry about too little competition? 

Analysis of Medium Hub Airports

At medium hub airports which handle between .25 percent and less than one percent of domestic enplanements, O&D traffic declined by an average of 6.2 percent over the 2000 - 2010 period.  Southwest is almost entirely responsible for the creation of medium hub airports.  During the carrier’s infancy (1980s - 1990’s), the “Southwest Effect” stimulated new demand by offering lower fares than were prevalent in the market before the LCC’s entry.  Today (2007 – present), the “Southwest Effect” diverts demand from surrounding airports more than creating new demand.  Maybe someday the regulators will understand this.  But I digress.

Of the 35 airports medium hub airports, 20 experienced a traffic decline. While Ft. Myers and Milwaukee grew over the decade, San Jose, Reno, Cleveland, Hartford, Providence, Ontario, Cincinnati, Pittsburgh and St. Louis all lost traffic.

The economic troubles confronting the industry have not been solely relegated to the network carrier sector. The drawdown of network carrier hubs at Pittsburgh and St. Louis have been the subject of much discussion within the industry, as has Cincinnati, a hub for Delta.  But many medium hub markets were hurt much more than Cincinnati.  Jenkins’ analysis makes clear to this analyst that Delta is doing nothing more than rightsizing Cincinnati to meet local demand - a prudent business decision. 

Clearly, the loss of air service is problematic to any community, and no two markets were more affected that Pittsburgh and St. Louis.  But Pittsburgh and St. Louis were also among the airports that realized the largest decline in average fares, along with Milwaukee, Orange County, CA, Cincinnati, and San Jose.  Those experiencing the greatest increase in average fares between 2000 and 2010 were Dallas Love Field, Burbank, Reno and Houston Hobby which, interestingly, all are markets that Southwest calls home.

Analysis of Small Hub Airports

Only the small hub airports – those that handle less than .25 percent of traffic and more than .05 percent -- realized a significant increase in traffic between 2000 and 2010.  The airports with the biggest gains were Orlando Sanford, Long Beach, Newport News, White Plains and Akron/Canton.  Of the 63 small hub airports, one-third of the airports enjoyed a double digit increase in traffic despite the most difficult decade for US airlines ever.   The worst performers in the group were Greensboro, Tallahassee, Colorado Springs, Corpus Christi and Stewart Airport in New York.  With the exception of Corpus Christi, there is no meaningful LCC presence in this group.

Among the 36 of 63 small hub airports with improved access to the national air transportation grid most were Springfield – Branson, Akron/Canton, Stewart (despite seeing below normal traffic growth), Flint and Long Beach. The airports realizing their quality of access declining the most were Gulfport-Biloxi, Tallahassee, Santa Barbara, Fresno and Syracuse.

Only the large hub airports realized a fare decrease between 2000 and 2010 more than the small hub airports.  This will certainly come as a surprise to those that claim smaller airport markets have not shared in consumer benefits brought on by competition.  Average fares declined the most in White Plains, Allentown, Long Beach, Richmond, Atlantic City and Wichita, in part because of the influence of AirTran. The merger Southwest and AirTran makes even more sense to me now as Southwest’s 72-point network is significantly augmented by a network of small hub markets.  But what happens in catchment areas like Akron/Canton and Cleveland? There are many of these shared catchment areas when the merged route maps of Southwest and AirTran are examined. Only time will tell.

Analysis of Non-Hub Airports

Where the rubber hits the road in the next few years is at the very small, non-hub airports.  

Here, those most successful in generating traffic were Ft. Collins and Laughlin, AZ.  Among the worst performing were Pocatello, Sioux City, Toledo, Muskegon and Lansing.

Among these mostly small communities, some did gain better access to the US air transportation grid, including Hot Springs, Rockford, Western Nebraska, Laramie, Peoria and Toledo. But others are losing service, with Pocatello, Klamath Falls, Elko and Columbia, SC atop that list.

All the discussion of Essential Air Service in Washington underscores the importance of revenue economics in this sector.  When I looked at the traffic performance relative to the trajectory of the inflation adjusted fare line, only one non-hub really shined: Aspen Eagle.  This explains the relative levels of new service being started there.  Of the low performing airports not yet closed, Toledo and Muskegon, MI are the worst.

As a significant number of regional contracts expire through 2016, the real question will be whether it is economical for airlines to continue to serve some of these markets. The prospects are not good. In addition to punishing regulation and fuel prices, the regional sector already suffers from a pilot and mechanic shortage sure to be compounded by a coming wave of retirements at the network carriers. Further compounding manpower issues for the nation’s regional airlines is the dubious impact of new legislation that mandates 1,500 hours of qualifying flying time for regional pilots.

In keeping with Tennessee vernacular:  In coming years it will be difficult to “perfume the pig”. 

The Southwest Catchment Area and the Impact on Small Airport Markets

Let’s face it: the enemy of the small airport is the high cost of oil, a poor local economy and, yes, the presence of Southwest Airlines within a two hour drive.  Consider the facts.

With service to Pittsburgh do we really need service to Latrobe, Youngstown, Morgantown, Franklin, Akron, Johnstown, Clarksburg, DuBois, Altoona, Parkersburg, Cleveland and Erie?  For some of these markets the highway is already the first mode of access to the air transportation system.

With ample service to Raleigh/Durham, do Pinehurst, Fayetteville, Greensboro (remember their bad traffic performance), Kinston, Greenville, NC, Winston-Salem, and Jacksonville, NC need their own airports? Raleigh/Durham has been shown to be outperforming most in their peer group of airports.  The catalyst for that outperformance is because the best service in the “air service region” is offered at RDU.  Jacksonville and Greenville will never be able to offer passengers the air service menu that is available in Raleigh/Durham no matter the number of frequencies or the number of hubs served.

Some of these airports are, simply put, ripe for closure.  But some should also be candidates as tomorrow’s “essential.”  Bills doing away with the Essential Air Service Program as defined in 1978 are unfortunate.  What’s needed instead is legislation that better defines “essential” in today’s airline revenue system.  Secretary LaHood visited the Regional Airline Association Convention on Tuesday.  He said that no Reauthorization bill will exclude Essential Air Service as we know it.   And that’s a mistake.

It is high time that we begin talking about the regionalization of air service.  The market is already causing that to happen in places like Bloomington, IL.  With no replacement airframes in the pipeline to replace the flying done with 50-seat and smaller aircraft, we need to talk about air service regions.  But no one in Washington will have the guts to say that the local airport should close even if its customers would fare better (pun intended) by driving to a better performing airport in the region to access the system.  We should be investing in infrastructure at the best performing airports within regions rather than building monuments to Congressmen and local politicians that will not add value to the overall system.

There is much more to write, and I will.

[Note:  Thanks to MIT graduate student Joe Jenkins for his excellent analysis of domestic air service contained in this blog.  Mr. Jenkins plans to complete his analysis and thesis of airport network access in August 2011.]

Pithy Ramblings On The Past 24 Days

In the 24 days since I last wrote, I have given multiple lectures, participated on a panel at the EU Forum on Transatlantic Competitiveness, prepared to present at Atlantic Southeast Airlines' Spring Leadership Conference and am working with two MIT students, Kari Hernandez and Joe Jenkins, on what I believe will be an insightful and important study on airline industry efficiencies and community access to the nation’s air transportation grid.

The worst NCAA national championship game in history ended three painful weeks made more so by my abysmal picks for the tournament.  And the Master’s golf tournament began and ended with no American at the top of the world ranking, just as no US airline can be said to be atop of the global airline industry.

With earnings and proxy season in full swing, it’s clear that most airlines are scrapping their way to respectable results even as high fuel costs depress their performance and executives continue to get paid executive salaries even at the sharp objections of unions.

And with so many union contracts still under negotiation, labor disputes continue to dog the industry, here and at airlines around the world.  I looked with hope to the pilot negotiations at Air Canada, where it appeared that the union was willing to consider less onerous restrictions on domestic flying in recognition of economic difficulties in the domestic Canadian market.  But rather than put an agreement out to vote, the union instead recalled its Chairman, doing little to strengthen the airline for the future. In response, the Centre for Pacific Aviation said it best: “That Air Canada needs something dramatic to make it sustainable is as obvious as the maple leaf on the national flag.”

I made the same suggestion in my presentation to the FAA's 35th Annual Aviation Forecast Conference.  But in doing so I often feel much like the Chairman of the Air Canada pilots union with plenty of readers who want to recall me when I look economic reality in the eye and recommend dramatic change.  One reader warns of a looming pilot shortage citing the law of supply and demand.  But that law will apply only by depressing the demand for pilots as the industry in the US will get smaller yet before it gets bigger.

At most of the US network carriers, cost structures are still too high to continue domestic flying at current levels.  And those high cost structures make it hard to justify investment in the hundreds of new narrowbodies necessary to replace fleets performing domestic flying today, particularly if today’s managers are truly serious about achieving a return on capital that actually exceeds the cost of capital.

Speaking at a CERA Conference in March, United-Continental Holdings CEO Jeff Smisek acknowledged that United-Continental, the product of the merger of United and Continental, will shrink in the U.S.  “We'll have the domestic [operations] sized solely to feed the international traffic," Smisek said.

Warring words between pilots and management have been increasing in volume in Australia too. Qantas had it relatively easy domestically once Ansett, the largely domestic carrier, was liquidated in 2002. When Virgin Blue grew to replace Ansett, Qantas responded by forming Jetstar, an airline within an airline.  But then came Tiger Airways Australia which now leads pricing in the Australian domestic market.  So legacy Qantas, with a cost structure once supported by a near monopoly in its domestic market, has now lost its competitive way.  Add to that pressure from the Middle East carriers internationally, a route system that is nothing more than a spoke to the world’s hubs is under challenge from all directions.

We can expect to hear similar noise from union halls in Germany, France, the Netherlands and the United Kingdom.  This is a region with social cost structures that look more like that of the state bureaucracy in Wisconsin than what will be needed to compete for tomorrow's global traffic.  I increasingly believe that what is being built in the Middle East will challenge the competitive integrity of each of the three global alliances.  Given that these alliances are nothing more than Band-Aid solutions to maneuver around archaic rules and regulations governing air transport, the bandages will begin to lose their adhesion one by one.  Global airlines built organically, particularly through cross-border mergers that build a brand, will begin to win the day. 

Not surprisingly, the response to the Middle East carriers from Canada, Germany, France and elsewhere has been protectionist at best. First the world wanted to open the skies.  Now that the skies are largely open for some, the talk has turned to restricting access to markets from new, innovative and vibrant competition.  I agree that the new competition should not be allowed to access cheap capital that is not available to all.  But to limit access because of presumed subsidy, cheap fuel, little or no airport costs and whatever other excuse to limit the growth of Middle East carriers is just plain wrong. Until a forensic accounting of Middle East carrier finances is available, it is all heresay to me.  Even Willie Walsh speaking at the EU Forum said he sees nothing abnormal in the numbers being reported today.  

In my mind, the US network carriers already have faced this type of competitive challenge to their domestic operations from upstart airlines with a labor cost advantage, new, more efficient aircraft and a cost structure that reflects the realities of today’s market in part by doing things like outsourcing ground services.  Why was it OK for the low cost carriers in the US to take 20 points of domestic market share away from incumbents and it is not OK for more efficient operations in other parts of the world to challenge incumbents in Europe and Canada?  Let’s not forget that one of the benefits of LCCs in the US was stimulating new demand that filled airplanes painted with new and old liveries. 

Finally, a few words on the battle between American Airlines and the global distribution systems/online travel agencies. We cannot talk about the airline ticket distribution system without mentioning the Business Travel Coalition – the advocacy group that tells the world it is all about protecting consumers when it is doing nothing more than to ensure the sustainability of its business with cash flows from the distribution duopoly.  In the past month alone, the BTC News Wire put out communications that, among other things, suggested that airlines are lying to Congress, railing against airline fees and urging consumers to write Congress in protest.

As I wrote 24 days ago,  despite the rhetoric from BTC and the constituents it represents, the coalition is doing more to protect an outdated mode of operation and stifle innovation than support a strong airline industry.  The GDS duopoly cannot move fast enough for an industry that sells “time saved” no matter how painful it is for the BTC and the online travel agencies to have the revenue tap turned off.  It’s time for the GDS to recognize they can’t support interests other than their ultimate customer – the airlines that actually do serve the air travel customer.

Much more to come.