Troubled Skies – Why are budget airlines failing?

By now everyone reading this will be aware of the major announcement that Southwest made on Thursday 7/25.  The original version of this paper was written on Friday June 19^th, nearly a week before Southwest announced changes to its 53-year-old business model.

Airlines are always in the news and never for a good reason. The interconnected systems that allow us to traverse the world are subject to a variety of negative events all of which can cascade to system failure. The consequences of failure are heightened during peak travel periods when airlines are running at close to capacity.

We last reported data on the US domestic airline business in 2023 after Southwest Airlines experienced a system wide failure in December 2022 that stranded 2-million customers. This event cost Southwest close to $1Billion in lost revenue, fines, and compensation.

Domestic flights in the USA are back to pre-pandemic levels and the summer of 2023 was the busiest ever recorded. Our data shows that 6% more people would like to travel during the 2024 summer season. Readers of this blog will be aware that there has been a shift in demand for business travel and that level is still considerably less than pre-covid times. The demand that airlines are facing is coming from leisure travelers, people visiting friends and family plus vacation travel. This is the segment that low-cost carriers focused on so they should be doing well, but this is not the case. All the low-cost carriers; Allegiant, Frontier, JetBlue, Southwest and Spirit are struggling; meanwhile the legacy airlines are close to their historical profit margins.

This blog will explain what is going on, but it proves that Brand Love does not equate to a successful business model.

In 2023 we reported that consumer Preference for Southwest had reached a record high and that this was counter to our expectations, which was for Southwest preference to decline because of the December 2022 system meltdown.

 

 

It seems that any publicity is good publicity and Southwest Preference increased between 2022 and 2023. It increased again during H1 2024 to 23%, higher than any other US airline.

Southwest is a low-cost carrier, which does not mean that it charges lower prices, it means that its operating model results in lower cost per seat mile than the legacy carriers, and some of this is based onto the customer. In 2015, the low-cost carriers charging less than the Legacy carriers made excellent profit margins.

 

 

Low ticket prices are not the purpose of Southwest, but 69% of consumers’ who prefer Southwest say low ticket prices is one of the reasons, with 44% saying it is the primary reason. All the legacy carriers also have consumers saying low ticket prices are one of the reasons that they prefer them over the competition, but to a much lower extent.

 

Who Prefers Southwest?

• Aged 55+
• Live in the West
• Not in paid employment
• No child in household
• HH income less than $60K
• Education less than University Grad

Leisure travelers have been paying for Premium seating. This option is not available to Southwest or Allegiant because their planes are not configured that way, and their consumers can’t support it. However, JetBlue offers premium cabins, Frontier is starting to offer a premium product and Spirit offers two types of Economy seats.

What does Southwest offer customers:

• One cabin – Economy class (no Business, Premium economy, or Basic economy)
• No extra charge for oversize passengers who occupy two seats
• 2 checked bags for free
• Ability to change flights up to 10-minutes before departure without cost
• Free inflight beverages and complementary snacks (Alcoholic $6 or $7 a drink)
• Inflight internet for $8 a flight
• Cabin crew inflight announcements
• A unique boarding experience

Converting Preference into flights

Southwest generates the highest level of Preference in 2024: 23%, but not everyone who prefers a particular airline will fly that carrier.

 

 

Southwest Airlines is efficient (73%) in converting its Preference into flights, only American does better at 76% and the most profitable airline Delta achieves 67%.

Travelers have different reasons for switching from their preferred airline, but the primary reason is Route availability (Destination not served by airline), the top reason for Southwest (20% of switchers), JetBlue (20%) and American (17%).

The top reason for people who switched from Delta was promotional pricing from the competition. Travelers switched to American (32%), United (22%), Southwest (17%) and Spirit (11%).

United lost travelers because it was too expensive, with American (35%) taking more of these switchers than any other airline.

Business Outcome

When measured in terms of the number of passengers, Southwest is the largest US carrier with 22% share of domestic passengers during 2023. This demand should show improved profitability for Southwest, but this is not the case.

 

 

Delta is the best managed airline in the USA and has been the most profitable for several years, even though it has a far more complicated operation than the low-cost carriers.

Something is clearly wrong with Southwest. Its costs have expanded as its volume has improved. The same is true for most other low-cost carriers.

 

 

All low-cost airlines are in an untenable situation, and something must change for them to survive. Each management team has presented the reasons for their problems (never the management team) and their plans to ensure a profitable future.

So, what is going on?

Low-cost carriers have lower operating costs than legacy airlines for five main reasons: More intensive use of aircraft, higher passenger density, use of secondary airports (with lower landing fees), paying staff less, using one type of aircraft.

When examining the cost per available seat mile (CASM) we see that cost have risen from 8¢ in 2015 to 11.67¢ in 2022. The low-cost airlines pay the same for fuel costs as the Legacy carriers, and between 2021 and 2022 the cost of aviation fuel increased by 47%.

 

 

Source: Bureau of Transport

 

The price of Jet Fuel has declined from its peak in 2022 but is well above its historic price.

Given the different business models, fuel price inflation affected the total operating cost of low-cost carriers more than legacy airlines.

Excluding the cost of fuel and the CASM for various low-cost airlines shows divergent trends between 2021 and 2022.

 

 

Examining the reasons for low-cost carrier price structures

1. Aircraft used more intensely (more flying hours per day).

Low-cost carriers used to average 12 flying hours per day during the summer season, but last year only achieved 10.6 hours per aircraft. The reasons for this are Weather affecting Florida, a lack of Air Traffic Control staff (affecting Florida more than other states). It has become much harder to operate an on-time airline and without this there is a need for slack (additional aircraft and crews at hubs to ensure that the system flows). This is practically impossible for Southwest since they don’t use a hub system.

2. They pack more people inside the same aircraft – no change.

Frontier reducing the number of seats to introduce a premium product.

3. They fly to cheaper secondary airports – no change.

JetBlue significantly changing their routes and cities served.

4. They pay their staff less.

This might have been true in the past but current salaries (excluding regional airlines) are similar across the aviation industry.

 

 

5. They simplify their operations by flying fewer aircraft types.

This reduces costs for Training Pilots, Cabin Cleaning, and Maintenance.

Southwest only flies B737s and most use the LEAP engines from CFM. It incurred higher maintenance costs and operational distributions because of Boeing’s problems.

JetBlue, Spirit, and Frontier all use Pratt & Whitney PW1100G engines and have incurred higher maintenance costs due to metal fatigue in the turbine.

6. Catering costs are much lower.

Southwest does not offer meals or perishable foods onboard; therefore, there is no need for refrigerated trucks to deliver drinks and food to planes. It’s a simpler operation than all other low-cost carriers who tend to charge for everything.

Twilight of the Gods – the future of low-cost carriers

This is the end of the classic low-cost airline business model in the USA, unless…

1. On-schedule predictability returns but this is outside the control of the carriers

• FCC recruited more ATC last year but still needs 3,000 more
• The weather becomes less volatile
• Maintenance issues are resolved

2. The price of Jet Fuel returns to $2.00 per gallon from its current $2.83. This is unlikely to happen as global air travel is expected to double by 2040.

All low-cost carriers have explained how they intend to return to profitability.

Allegiant plans to boost seat availability by 6% by reactivating older jets and is opening a series of new routes. Part of its business model includes earning commissions by selling passengers ancillary items like rental cars, hotel rooms, tickets to events, amusement park passes, and other add-ons. Additionally, Allegiant is expanding beyond travel with the Sunseeker Resort. The first opened in Charlotte County, Florida in December 2023.

Frontier has simplified their route structure and condensed operations to 13 hubs. Additionally, they are abandoning their low-cost structure, with bundled prices and the introduction of service classes. More is to come.

JetBlue is already changing with the introduction of their transatlantic flights. During the winter months these planes with their first-class suits are being used on domestic flights. Additionally, JetBlue is changing its route structure and building San Juan (PR) as a hub. JetBlue abandoned its plans to buy Spirit in March.

Spirit Airlines is preparing shifts to its merchandising strategy that will be geared toward higher-end flyers. It must appeal to travelers that fall outside of its core discount base to adapt to evolving customer preferences. Plans will be revealed in August.

Southwest is the company that originated the low-cost model that has been copied successfully around the world. However, they appear to be the company that has done the least to prepare for the future. Their plans call for a hiring freeze with the intention of reducing staff numbers by 2,000.

Clearly consumers like the current Southwest.

 

 

It has near universal awareness.

52% of those aware have tried Southwest.

61% of those who have tried have been retained in the brand either as a Loyal user or someone who says it is one of the airlines they use.

It is attractive to those who have not tried, this is mainly tied to route availability.

Very easy to understand why management is reluctant to change the “winning” formula.

A Southwest comparison vs. the leading airlines is informative. Its trial rate is only marginally less than legacy carriers. Retention is in line with the majors. It is Attracting the right number of people who have never flown Southwest and importantly its Loyalty rate among current users is best in class.

 

 

However, change is coming – Elliot Investment Management have bought an 11% stake. They want to replace the senior management, to make changes to operations that will enable Southwest to achieve the profit margins being delivered by legacy carriers. Effectively they will convert Southwest to the business model used by legacy carriers.

Update 7/25/2024: Earlier today Southwest announced three major changes to its customer experience:

1. Assigned seats

• Southwest has had an open seating policy since 1971. Data presented by Southwest indicates that 4 out of 5 Southwest customers would prefer to have assigned seats.

2. A Premium Cabinet

• Southwest has had one economy cabinet since it started. Its economy is superior to the economy provided by the ultra-low-cost carriers, providing free beverages and snacks, plus two checked bags.  The price of alcoholic beverages and Wi-Fi is lower than other low-cost carriers.
• JetBlue explained that 25% of customers prefer to pay for a premium seat.
• MSW has seen the growth of Divergent economy with some consumers willing to pay for luxury experiences and other searching value. The old middle is giving way, and legacy carriers have catered for this with four classes of service on the same plane: First or Business, Premium Economy, Regular Economy and Basic Economy.  Southwest are taking the first step to offer a more premium experience.

3. Overnight flights, from Las Vegas to the East coast.

• Implementation is planned for Valentine’s Day 2025.
• There is demand for overnight flights from the West coast to the East coast, but the driving factor was probably the possibility of using equipment for more hours per day. Additionally, storms and other adverse conditions tend to be higher in the mid-afternoon after the land has warmed up.

Sometimes when looking at the results from survey data, we see something that makes us say ‘huh?’ or ‘that doesn’t look right’. When the odd results persist after verifying the data were processed correctly (always a good practice), there is typically still a logical answer that can be uncovered after doing some digging. Sometimes the answer lies with something that we will call ‘unusual statistical phenomena.’  This is part 2 of a series that will look at some of these interesting – or confounding – effects that do pop up now and then in real survey research data.

This time we will look at an unusual phenomenon that can occur when doing something typically considered fairly mundane – testing for statistical significance between percentages. An example will help to illustrate this phenomenon which periodically causes us to question stat testing results.

Let’s say we have fielded the same survey for two different brands. One part of the survey collects respondent opinions of the test brand using a battery of attribute statements with a 5-point agreement scale. The base size for each survey was 300.

Stat testing was conducted between results for the two brands for Top Box percentages on each of the attribute statements. However, some of the results are questionable. Specifically, for the attribute “Is Unique and Different” Brand B’s score was higher than Brand A’s by 4 percentage points, which was statistically significant at the 90% confidence level (denoted by the “A” in the chart below); while for the attribute “Is a Brand I Can Trust” Brand B’s score was higher than Brand A’s by 6 percentage points, which was NOT statistically significant at the 90% confidence level. How could this be!

How can a difference of 4 points be statistically significant while a difference of 6 points is not, even with the same base sizes? To understand how this can happen, let’s first look at the basics of how a statistical test for comparing percentages works.

First, a t-value is computed according to this formula:

Then this t-value is compared to a critical value. If the t-value exceeds the critical value then we say that the difference between the percentages is statistically significant.  The critical value is based on the chosen confidence level and the base sizes of the samples from which the percentages were derived.

In our example, we chose the 90% confidence level for both statistical tests and the base sizes are the same, so the critical value for both tests is the same. We also know the difference between the percentages (the numerator of our equation) is what appears anomalous as the difference of 4 led to a t-value that exceeded the critical value, while the difference of 6 did not exceed the critical value. Therefore, the issue must lie with the Standard Error of the Difference.

Let’s next examine what a Standard Error represents. Our surveys were fielded among a sample of the overall population. If we sample among women 18 to 49 in the United States, we will infer that our results are representative of the entire population of interest, which is all women 18 to 49 in the United States. However, it is unlikely that the measures we compute from the sample (such as the percentage that say Brand A “is a brand I can trust”) will be exactly the same as the percentage would be if we could ask everyone in the entire population of interest.  There is some uncertainty in the result because we are asking it of only a subset of the population. The Standard Error is a measure of the size of this uncertainty for a given metric.

In our equation, the denominator is the Standard Error of the Difference between the percentages. While not precisely correct, the Standard Error of the Difference can be thought of as the sum of the individual Standard Errors for the two percentages being subtracted (the actual value will be somewhat less due to taking squares and square roots). As the graph below illustrates, the Standard Error for a percentage is a function not only of the sample size, but also of the size of the percentage itself.

Specifically, for any given sample size the Standard Error is largest for values around 50% and decreases as values approach either 0% or 100%. For a base size of 100 (the dark blue line), the Standard Error is close to 5 for percentages near 50%, but decreases close to 2 for very small or very large percentages.  You can think about this as it being harder to estimate the percent incidence of a characteristic of a population when around half the population has that characteristic versus when almost all (or almost none) of the population has that characteristic.

In our example, the percentages for Is a Brand I Can Trust are close to 50%, so at a base size of 300 the individual Standard Errors would each be a little under 3. In contrast the percentages for Is Unique and Different are around 10%, so at a base size of 300 the Standard Errors would each be around 1.5.  That’s a big difference!

It follows that the Standard Error of the Difference for Is a Brand I Can Trust would be much larger than for Is Unique and Different. In fact, the actual values are 4.08 for Is a Brand I Can Trust and 2.34 for Is Unique and Different. Again, a big difference. If we divide the differences in the percentages by these values for Standard Error of the Difference, we get t-values of 1.47 and 1.71, respectively. Given the critical value is approximately 1.65, we see that the t-value for the difference of 6 is below the critical value (hence not statistically significant); while the t-value for the difference of 4 is above the critical value (hence is statistically significant).

Hopefully this takes some of the mystery out of stat testing and helps in understanding why what can appear to be anomalous results may actually be correct.

The Journal of Advertising Research just published a terrific paper that MSW was proud to participate in, titled…

Effectiveness and Efficiency of TV’s Brand-Building Power: A Historical Review – Why the Persuasion Rating Point (PRP) Is a More Accurate Metric than the GRP
Frank Findley, Kelly Johnson, Douglas Crang, David W. Stewart
DOI: 10.2501/JAR-2020-011 Published 1 June 2020

ABSTRACT
This article examines the effectiveness of television advertising and changes in television-audience response in the United States since the 1980s. It concludes that television remains one of the most effective platforms for advertising, despite the rise of digital media and new technological developments. On a single, quality exposure basis, television advertising continues to be highly effective, although the rate of delivery of advertising selling power per gross rating point (GRP) has declined, but the decline is mitigated by the increasing number of households in the United States. Television advertising remains effective despite the potential increase in distracted viewing, but advertisers need to manage the quality of their messages and the media weight of their advertising more carefully than in the past. The persuasion rating point (PRP) offers an accurate measure of that effectiveness.

Contact us for a full reprint of the article.