It wasn’t all that long ago that airlines raced to get their airplanes out of the US as fast as possible. Flights within the US just weren’t earning their keep, and besides, there was a lucrative market beyond our borders just brimming with opportunity. But the tables have turned. Now, the domestic US market has become one of the best markets in the world for airlines.
To get an idea of just how good things are, you need to look no further than second quarter financial results. Those airlines that skew domestic did very well. Alaska posted an 18.3 percent operating margin. Southwest reported in with 16.3 percent. And even Virgin America just announced it had a very solid 11.4 percent margin during the quarter. The legacy carriers noted it as well, showing great gains in the domestic market.
Meanwhile, the international arena is seeing weakness. Delta has said it is bringing down capacity, and in fact, announced it would pull 4 fully-renovated 747s out of service. American has cut its international capacity growth plans toward the end of this year. All airlines are taking a hard look to see what makes sense. So how did this change so dramatically? In short, it’s just basic economics. There’s a lot of demand and airlines have resisted the urge to add supply.
The chart above tells quite the tale. The number of domestic departures stayed flat from 2004 through 2007 while international departures grew significantly as airlines saw opportunity. But beginning in 2008, fuel prices spiked, the economy tanked, and fortunes changed dramatically. International departures first went flat and then plunged in 2009. Domestic departures started shrinking in 2008. By 2010, international departures were on the rebound while domestic departures actually never did. But this doesn’t tell the whole capacity story. When we look at available seat miles, things look a bit different.
This chart doesn’t show nearly the same level of fall-off in domestic capacity after 2009 that we see when we look at the number of flights. Why is that? It’s because airlines are flying fewer airplanes, and they’re adding seats to the ones they still have. On the one hand, airlines are simply pulling regional flights out of the system. Many have become unprofitable since the rise in fuel prices, and that has led to route cuts and hub closings (eg Memphis, and very recently, Cleveland). In some cases, regional jets have been replaced with larger airplanes, so that offsets the decline. But there’s more than that.
On the mainline side, airlines have raced to add seats. Some of that is through simply using larger airplanes. US Airways, for example, has been replacing its 144-seat 737-400s with 187-seat A321s. The rest is from airlines adding seats to the airplanes that they have, often thanks to new thinner “slimline” seats. Southwest added a row to its 737s. United has added seats to its A319/A320 fleet. Delta is doing the same on several aircraft types. And American has big plans for that as well. In short, the number of flights has gone down but the number of seats has stayed relatively flat. That means the cost of producing each seat has gone down as well.
While this is going on, think about what the economy has been doing. Things have been steadily improving for awhile now, and the demand for air travel has picked up dramatically. We don’t have international fare data here, but take a look at the cumulative change in domestic fares since 2004.
After some serious weakness in 2009 and 2010, fares have rebounded with a vengeance. While it should be noted that adjusting for inflation, fares have only increased 1.3 percent in that time… fares have actually kept pace with inflation! Consider that a victory in the airline world since fares have done nothing but drop since deregulation.
While fares have gone up, flights have also become more full. The change in domestic travel has been more pronounced than internationally since airlines have begun to vary their schedules better to match passenger demand.
All of this adds up to good times for airlines flying domestically. Seats are being produced for less, and they’re being filled at record levels. Meanwhile, fares are going up. But are the times too good? When airlines start turning in great margins like this, others begin to prey. Spirit and Frontier already see blood in the water. Spirit in particular is growing and sees plenty of opportunity. When the fare canopy gets this high, it opens up opportunity for others to come in underneath and make a nice living.
We haven’t seen many start-ups lately but it wouldn’t shock me to see more in the works. Whether they actually get airborne is a whole different story, since by the time that happens, we’ll probably be in another down cycle. But in the domestic market, times are really good right now. Let’s see how long it stays that way.
