Every time I hear airlines talk about capacity constraint, my mind drifts to small town England. It’s not a real small town, actually. It’s the fictional small town of Sandford from the movie Hot Fuzz. The local Neighbourhood Watch Alliance there is a secret society that does despicable things all to support (say it with me) the greater good. (If you haven’t seen it, you really should. And don’t stop there, watch the whole Cornetto trilogy.) For the last few years, the US carriers, while not actually having done anything truly despicable, have acted in a similar way in trying to create a healthy industry. But if they aren’t careful, this is going to bite them hard.
The mantra of capacity constraint has been in full force for nearly a decade. The old saying goes that you’re only as smart as your dumbest competitor. And there were plenty of dumb competitors out there who threw a ton of capacity into a market only to make everyone unprofitable. The end result was a sea of red ink and a lot of airline disappearances. But in the last decade, we’ve seen very few airlines start. (Virgin America is the only high profile startup in the US that’s really done anything.) At the same time, we’ve seen consolidation which has helped weed out those dumbest of dumb competitors.
Today, we have the remaining big carriers in the US all having found religion. And that religion says that these capacity-dumping market share-grabs generally don’t make sense. Do not add seats for the sake of growth. Be conservative and slow it all down.
This has been true for American (only since the US Airways merger), Delta, United, and yes, even Southwest. Southwest used to be an airline that grew like a weed. That’s no longer the case. JetBlue has slowed itself down dramatically since the explosive growth days of David Neeleman. Even Virgin America has paused its growth. With the economy doing well, this has allowed airlines to get healthy. Fares have gone up and margins have actually approached that of a normal business. (Shock! Horror!) With this kind of stability, workers are getting back some of the money they gave up during the dark times after the turn of the century. At the same time, US airlines are investing more in their products than they have in years. Sounds great, right?
The problem is that this mantra of capacity constraint can only last for so long. At some point, opportunity arises. So far, the big moves we’ve seen with the big carriers are more strategic than anything. You see Delta trying to build its hub in Seattle. And you have American and Delta slugging it out in LA. In the scheme of things, those are minor turf wars.
What should be more troubling to these airlines is the rise of the ultra low cost carrier. If you’re looking for growth in the US industry, that’s where you should look. Spirit, Allegiant, and now Frontier are the airlines that are adding seats at a rapid pace. With costs as low as they are and fares on other carriers so high, the sky appears to be the limit for these airlines. Travelers love cheap fares, and nobody is delivering cheap fares like these guys.
But they are also offering a different product than the other carriers. While everyone is using a la carte fees, none of the traditional US carriers have taken it as far as these guys by charging from everything from water to a carry on bag. In general, their operational integrity is worse than the traditional airlines. (Spirit is notorious for never canceling but delaying quite often.) And the general view that there is no customer service available at all from these carriers has kept some people away. That’s fine. This experience should be primarily for the price-sensitive. There is room for competitors using different models.
For that reason, the other carriers have been watching closely but they haven’t seemed all that scared. Perhaps they should be considering how many flights are being added by ultra low cost carriers, but so far, it’s more about providing new low fare options to cheap travelers than it is about stealing market share. So the big guys watch and react in different ways.
The problem for the traditional carriers, however, is that they’re all playing it very conservatively. More than one airline said in the last earnings call that they were going to continue to run their airlines as if oil were at $100 a barrel even though it’s at half that.
That sounds prudent since oil has been prone to spikes over the last decade. But the fundamentals right now show a relentless Saudi government that has no problem flooding the market with cheap oil. Some people are expecting years of oil at these lower prices.
The more confident people become that oil will stay within a lower range, the bigger the opportunity for another airline to come in and profitably add capacity. A lot of capacity. Could it be an existing airline like JetBlue or Virgin America? Virgin America still seems to be messing around with silly ideas like Austin to Dallas, but maybe there’s more coming.
Or could it be that money will start flowing back into start-up airlines that think they can take advantage of the opportunity? We all know how that usually turns out. The traditional carriers will fight back with fire if they feel threatened. But the bigger the opportunity appears, the more determined others will be to take advantage.
At some point, the traditional carriers are going to have to start adding capacity and bringing fares down or someone else is going to do it. That is, unless oil goes back up to $100 a barrel again…. But do they really want to play that game and hope?