Note to Virgin America: Successful Startups Make Money Fast

Cranky is on vacation, but I’ve lined up some excellent guest bloggers for you while I’m gone. Today I have a guest who prefers to go only by “The Cardinal.” The Cardinal doesn’t pull punches, so hopefully this will generate some good discussion on both sides.

We take as our point of inspiration (or exasperation) Ted Reed’s recent article on Virgin America from The There are a lot of annoying things about this article, such as the idea that what Virgin America is doing amounts to innovation. What a crock that is. But that’s not what this blog entry is about. We’ll get to that after a bit of history.

The list of stupid airline startups since US deregulation in 1979 is very, very long, but Virgin America surely ranks high on that list.

Start with Richard Branson’s alleged brilliance as an airline entrepreneur. The man’s record is uneven at best. The flagship Virgin Atlantic airline is certainly high profile, but a look at its financials (the company is private but provides some summary data at the end of this document) shows it to be not excitingly profitable. And note this is an airline that for much of its history was one of only four airlines that was permitted to fly from London’s Heathrow airport to the US — you would think that would be a license to mint money.

But then think of the late, unlamented Virgin Express, Branson’s flop of a European low cost carrier. Among Branson’s mistakes: picking a Belgian carrier as the foundation of Virgin Express (Belgium has some of the highest social charges and toughest labor laws in Europe) and putting Mesa’s Jonathan Ornstein in charge of it (whatever Jonathan’s virtues, he’s a distinctly American phenomenon who was out of place in Europe). It’s no surprise that Branson ultimately threw in the towel in 2004.

But what about Australia’s Virgin Blue? Clearly a success, no? Well, yes, but it’s actually a great example of how it’s better to be lucky than smart.

Virgin Blue started flying roughly a year before Australian carrier Ansett collapsed (for complex reasons but related to the financial trouble of its then partial parent, Air New Zealand. As a rough guide as to the approximate effect that had on the Australian air travel market, imagine if American Airlines and United suddenly went out of business — not just bankrupt, but completely out of business. How difficult would it be for any US air carrier to make money in the wake of such an event? It would be cake. Heck, even Spirit, Mesa and Frontier would make money in large quantities in such an event. So yeah, Virgin Blue was successful, it would have been very difficult for them not to be very profitable in the wake of Ansett’s collapse.

You have to hand it to Branson, he has a reality distortion field around him that rivals that of Steve Jobs. Let’s think about Virgin America. What exactly is the unfilled niche that Virgin occupies in the US?

Virgin America is largely going after long-haul domestic flying between major US cities. Is there a lack of capacity in such markets? No. In fact there’s even an existing not-quite-a-startup that does many of the same things, JetBlue, on many of the same routes. Arguably JetBlue is better at it than Virgin. JetBlue doesn’t have the mood lighting that Virgin has, and JetBlue’s IFE isn’t quite as snazzy as that of Virgin America’s, but JetBlue’s seat-pitch is a heck of a lot better than that of Virgin America (at least Virgin America’s economy-class pitch — JetBlue obviously doesn’t do a first class, but then its single class product is already pretty dang comfy) and JetBlue’s in-flight service is really quite good.

Yet Branson convinced a bunch of financiers to throw money at him to start Virgin America. Chalk it up, perhaps, to a minor moment of wretched excess — minor at least relative to the rest of the financial crisis. Yeah, so a bunch of financiers ponied up some hundreds of millions for a dumb airline concept. Big deal. This was at the same time that Swiss bank UBS was doing real estate deals that ultimately cost it $38bn in writeoffs. So much, much dumber things were being done at the same time. It could have been worse. And the Virgin America backers weren’t alone — there were the folks who lost their shirts with Skybus at about the same time.

Just how poor was Virgin Amerca’s concept is apparent from its appalling financial results. Cranky did a good job covering their dismal historic financials here and Ted Reed covers the 4th quarter of 2008 in his piece referred to above.

And now we’re getting to what this blog entry is about. The most exasperating thing in Ted Reed’s piece is the ill-advised statement by Virgin America CEO David Cush at the end:

“We are not profitable, and you would not expect a new airline to be profitable,” he said. “But we have no debt to be renegotiated, no need to go to the capital markets and we continue to believe we will be profitable in 2011.”

[The Ted Reed story initially said 2011, which I know because I saved a copy. Checking it recently, it now says 2010, but there’s no notice of a change, which is poor practice on the part of Ted and The Street — the kind of thing the media is not supposed to do. It doesn’t matter much whether it’s 2010 or 2011, the same point applies, but don’t be surprised when you click thru and see 2010 rather than 2011.]

Huh? I suppose you can chalk some of Cush’s nonchalance up to the fact that he previously worked for American Airlines. With that background he probably thinks that you wouldn’t expect any airline to be profitable, period. But Virgin America started flying, finally (after a year or two of delay) in 2007 — it’s highly unlikely Virgin America’s long-suffering investors were sold this puppy on the basis of no profits until 2011. Over five years from investment to break-even? That’s a joke.

Yeah, lots of startups are unprofitable — but then most startups fail, and they primarily fail because . . . they don’t make money. Whereas successful startups do the opposite. They make money (what a concept). JetBlue started in 2000 — it was profitable in 2001, and that, as you will recall, was a really bad year for airlines. Then-tiny (and still, today, small) Allegiant came out of bankruptcy in 2002 — in 2003 it was profitable (and has not had an unprofitable year since). ValuJet (now AirTran) was immediately and spectacularly profitable, going public within a year of startup in 1994. In other words, there’s a strong record of good airline startups making money more or less out of the box.

About the only two startups that weren’t immediately successful that are still on the scene are Frontier and Spirit. Frontier limped along for years before making money, and of course is now bankrupt. Spirit has absorbed (in the form of awesome losses) hundreds of millions of dollars in private equity over the last five or more years and may finally become profitable this year. Neither Spirit nor Frontier have evolved in a manner an investor would appreciate.

There’s no worse position to be in than to be a startup airline with cash remaining and a concept that doesn’t work. Skybus found itself in the same position about a year ago, and to the great credit of its board, they had the sense to shut it down. They didn’t have to, they could have kept floundering around and for all we know they might still be with us today (airlines being notoriously hard to kill). But in an all-too-rare (in the airline biz) moment of responsibility, they faced reality squarely in the face and did the right thing.

Unfortunately there are a lot of big egos on the line at Virgin America, and big egos are highly susceptible to believing their own bullsh*t. There’s a good chance that the unfilled market niche Virgin America is really in is that of stroking the aforementioned egos.

The Cardinal is a long time industry observer, who is currently a [redacted] at [redacted]. Prior to working at [redacted], he worked at [redacted], [redacted] and [redacted]. He resides in [redacted] and in his spare time enjoys [redacted with extreme prejudice].

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