Low-cost survivors

CAROLE SHIFRIN WASHINGTON DC

After years of uncertain and even disastrous performances by new entrant carriers in the USA, some seem to be thriving and even beginning to report profits. Why did these start-ups survive where so many failed?

Accepted wisdom in the USA is that the fate of low-cost start-ups has been as predictable as it has been dismal since the ValuJet crash in Florida in 1996. But not all start-up business plans have ended up in the bankruptcy courts. For a handful of carriers, the low-fares business, against all odds, is turning into good business.

The list of hardy survivors includes Denver-based Frontier Airlines, a 1994 start-up that has carved a niche in one of United Airlines' key strongholds; Pro Air, a two-year-old carrier that has breathed new life into an airport close to downtown Detroit and attracted strong business support in Northwest Airlines' backyard; Kansas City-based Vanguard Airlines, which lost $70 million in its first three years, but has been totally rejuvenated by new management in the last two; and Spirit Airlines, which started out in the early 1980s as a tour operator and moved to scheduled services with a leisure-market focus in 1990.

Each airline has a different history, business plan, marketing approach and operating characteristics. But a look at these increasingly successful low-cost, low-fare carriers reveals nimble management with a willingness to admit mistakes and alter a business strategy when it seems to go awry.

These airlines also give the consumer "value for money", offering significant savings on leisure and unrestricted business travel and opportunities to travel without complicated restrictions. With the majors seeking to lower costs by putting more seats in aircraft and eliminating meals from all but the longest flights, the new entrants offer virtually the same or better onboard amenities. "Our peanuts are just as good as United's peanuts," says Robert "Rocky" Spane, president and chief executive of Vanguard.

The successful start-ups do not duplicate the majors' full range of services or extensive route systems, but have tried to carve their own niches and seem to be attracting a following that is willing - for price, flexibility, convenience or access to routes abandoned or ignored by the majors - to forego the majors' extensive frequent flier programmes.

Beating barriers

But it has not been easy. Each has faced, one way or another, barriers to entry, including difficulty in gaining airport gates, terminal facilities or take-off and landing slots. Despite operating for nine years at Detroit Metropolitan Airport, for example, Spirit is only now about to get its own gates. The new carriers have also had to deal with alleged predatory pricing and other practices by the established carriers. "We are the 'poster child' for predatory practices at the Department of Justice," says Vanguard's Spane, referring to the lawsuit charging American Airlines with anticompetitive practices against Vanguard and other start-ups.

One start-up official, noting the various "competitive elements" a major can use to undermine a new rival, such as increasing travel agency commission overrides, giving double and triple frequent flier miles only on the routes flown by new entrants, adding capacity on new entrants' routes and matching its lower fares until the start-up leaves the market, says with resignation: "If a major carrier with all its resources decides to go after a small carrier in today's climate, it's very difficult for the small carrier to survive."

Except for Spirit, which is avowedly a leisure-oriented carrier, the other start-ups have targeted the business traveller. Frontier and Vanguard have sought, through route development, scheduling and marketing, to attract travellers from small and medium-sized companies. Pro Air, despite its small size, has made major inroads with Fortune 500 companies in Detroit, once the sole domain of Northwest, at Detroit Metropolitan airport.

Pro Air began low-fare operations with two new Boeing 737-400s in July 1997, from Detroit City Airport, a facility with no commercial airline service close to downtown Detroit. The city was selected because of the high fares charged in the market, particularly for unrestricted tickets. The airport was chosen because it offered ease of operation, lower costs and less hassle, according to Pro Air president and chief operating officer Craig Belmondo. "Our aircraft taxi for a couple of minutes and take off," he says, "rather than wait in line for 20 or 30 minutes at more congested airports." The carrier has acquired only new aircraft to assure operating reliability and using Detroit City has helped keep usage high - about 10.5-11h a day - and seat kilometre costs down, Belmondo says.

The airline also instituted a simplified fares structure: one fare for first class and one for economy on each route, with no advance-purchase, round-trip or Saturday night stay-over requirements. The economy cabin, with a 800mm (32in) seat pitch, offers more legroom than those of many majors. Pro Air's unrestricted "walk-up" fares are about 80-85% lower than those of main rival Northwest.

Corporate deals

"The key is understanding what your marketplace needs are and coming up with ways to fulfill those needs," Belmondo says. "You have to carve out a niche." Within a year, Pro Air had pioneered creative arrangements with two big corporations in the Detroit area. General Motors (GM) and DaimlerChrysler signed five-year agreements providing for unlimited travel for their employees on Pro Air flights for fixed monthly rates for each market.

The unusual pacts guarantee Pro Air a revenue stream and lock in air travel costs for the companies. "It's very positive for the companies and for us," Belmondo says. GM expects the agreement, which was extended as Pro Air expanded, to reduce its corporate travel budget by more than $5 million a year. "Corporate customers are key to our growth plan," Belmondo adds. "We pay attention to their needs. It's why we think we've got off to a good start."

In another step, Pro Air will soon add flights using three Saab 2000 turboprops operated by GM to shuttle its employees between facilities. GM is providing the aircraft to Pro Air, which will bring them on to its operating certificate and fly them. The two will decide where to operate the aircraft, but seats will also be sold to the public. "It's a win-win situation," Belmondo says. "The arrangement lowers GM's costs, takes an underused asset and puts it into commercial service and will contribute to Pro Air's profitability."

Pro Air operates four Boeing 737s to eight cities, but is nearing completion of a private offering of $20-30 million to be used to acquire additional aircraft. This will allow the airline to increase frequencies on existing routes, and add new cities to its network and build traffic. The private equity will be the last raised, Belmondo says, with future funding to come from an initial public offering. The three months to September were expected to deliver the airline's first profitable quarter. "We think the marketplace is large enough to carve a profitable niche and allow us to stay the course in Detroit," he adds.

Frontier's niche

Frontier, which started up in mid-1994, has also carved a niche using Denver International Airport, a strong United Airlines hub, as its base. Samuel Addoms, Frontier's president and chief executive, says that being able to admit mistakes and reverse course has been essential to the carrier's success after it started out with a business plan that did not work.

"We were going to bring passengers from mid-sized and smaller communities in places like Montana and North Dakota to connect to United in Denver," he says. By the end of the first year, it was clear that was not going to work. "We had been trying to avoid competing head-on with United," he says. "Now, we're a direct competitor, but we compete for the leisure flier and the small-business person, those not wedded to an airline mileage card." Addoms, who came to the airline industry after 34 years in banking, says attracting the small-business traveller was critical. This market segment now accounts for about 25% of Frontier's overall business and the carrier has signed up 2,300 business accounts eligible for travel discounts, most in the small company category.

Frontier operates 19, all-economy seating, 737s from Denver to 20 cities coast-to-coast. Its fares, well below United's, do not require a Saturday night stayover. The carrier also focuses on customer satisfaction. "We try to be nicer than people expect," Addoms says.

An additional marketing tool is that passengers can accrue mileage credit in the OnePass frequent flier programme of Continental Airlines, which was leaving the Denver market as Frontier was starting.

April to June was Frontier's fifth consecutive profitable quarter and Addoms think it is poised to continue growing profitably. But things did not look as bright two years ago, when Frontier was competing with low-cost Western Pacific Airlines and matching fares that Addoms says were "below what anyone could make money with". Since Western Pacific's demise, Frontier has raised its fares to what he calls "rational levels".

Along with strong traffic growth, the change in operating conditions has meant substantial increases in yield and revenue per available seat kilometre as well as an impressive 10 point year-on-year decline in Frontier's break-even load factor to 52% in the second quarter. Pre-tax margins are close to 15%.

Frontier expects to add three new aircraft this year. "We're on a growth path of about 20% a year and expect to stay on it for the foreseeable future," Addoms says. As more aircraft are delivered, new cities will be added - Orlando, Florida, came on line last month - and frequency in existing markets will be raised. "By growing modestly and developing a high quality service level, we can have a successful business," he adds.

Vanguard also seeks to attract travellers from small- and medium-sized companies and has tailored its route system, scheduling and marketing to that end. The strategy was instituted in mid-1997 after Rocky Spane, a retired naval officer, joined the airline. By then, Vanguard, which began flights in December 1994, had lost $70 million, was operating an unstructured point-to-point route system, flew short and long haul routes both to business and low-yield leisure destinations, and charged such low fares that its break-even load factor was 81% at one point.

Markets were cut, schedules were changed to optimise connections and the carrier looked for short-haul, 900-950km business markets that were largely unserved by the majors, such as Chicago Midway to Pittsburgh, Pennsylvania, and Buffalo, New York. "We brought discipline to the company," says Spane. His goal of introducing "more structure" applied to the external and internal workings of the airline.

On the marketing side, seats were removed from aircraft to provide extra legroom and assigned seating was introduced. With the help of a new yield management system, Vanguard revamped its pricing structure, keeping its lowest fares and raising the higher-end, less price-sensitive, unrestricted fares, but keeping them 50% below others' comparable fares. "As we raised the fares, people became more reassured; we weren't 'that cheap'," says Russell Winter, vice-president marketing and planning. "That's how we got unit revenues up 60%."

Vanguard also has a simple frequent flier programme offering a free round trip for every eight round trips flown. "It's not on a par with some other carriers' programmes," Spane says, "but, if you fly 600 miles [960km] and save $400, the fact that you don't get frequent flier miles is not as big an issue. We think we've found a niche: relatively short routes, half the price of the majors, extra legroom, seat assignments, frequency, and we're on time."

Vanguard's route map includes 10 cities, mostly from Kansas City and Chicago, and expansion of the network and the fleet - to 18 737s next year - are planned. After reporting its first profit in March last year, Spane took 5% of the company's stock as options and distributed it to employees "to give something back to them for what they have done to make the company a success". Spane says Vanguard is willing to take business risks, and can because it is small and nimble. "But, if you change too often, people lose confidence that you'll be around," he adds. "You want to change strategy carefully."

Spirit targets leisure

In contrast to the others, Spirit's operations are oriented toward leisure travellers, who account for about 90% of its traffic. But it too is seeking niches - the underserved markets such as Myrtle Beach, South Carolina, and Melbourne, Florida - as well as the traveller who does not want to book a trip 30 days in advance to get a low fare. Spirits fares are non-refundable but have no round trip, minimum-stay or advance-purchase requirements.

The airline serves 15 destinations, all but one in the eastern third of the USA. This summer it added flights between Detroit and Los Angeles. Although Spirit has no direct competitor in 60% of its markets, it also serves some large origination-and-destination markets such as Detroit-Florida. But its schedules - one to three departures a day - are not designed for the business traveller. "Our existence doesn't put pressure on major carriers," says president and founder Edward "Ned" Homfeld. "We seek to expand the market, not steal others' passengers."

Homfeld attributes some of Spirit's success to the discipline it learned when operating charters. "Our original mindset is to fill aeroplanes," he says. The carrier uses computerised capacity-controlled pricing, adjusting fares depending on expected load factors and the time left before a flight.

Spirit plans to increase capacity by 20% a year, by raising its Boeing MD-80 fleet from 11 to 15 by the end of next year. It operates the MD-80s alongside nine McDonnell Douglas DC-9s (shortly to be cut to six). Homfeld says Spirit will look for new niches, in some cases "connecting the dots" between existing cities on its network, but will expand carefully. "We are a very conservatively run airline," he adds.

Consistently operating at high load factors, Spirit, owned by Homfeld and two minority partners, has been profitable in all but two quarters in the past 10 years. Homfeld expects both revenues and passenger count to rise about 80% this year.

Although each of the four start-ups is profitable or on the verge, Frontier's Addoms says his advice to would-be entrants remains: don't start! "If you look at the odds, it's one in 20 that will succeed; even the restaurant business is better than the airline business," he says.

For those who ignore that counsel, he cautions: "My advice would be not to fall in love with your business plan. Plan to the infinite detail, but don't fall in love." Any new business makes mistakes, and management has to be willing to admit that a plan element or strategy is wrong and alter it, says Addoms, adding: "If we had not changed, we would not be here."

US low-cost airline fleet details
Carrier	Base	Start-up	Aircraft	Fleet	Employees
Frontier Airlines	Denver, CO	Jul-94	19	Boeing 737-200/300	725
ProAir	Seattle, WA	Jul-97	4	Boeing 737-300/400	380
Spirit Airlines	Michigan	1990	20	MD-82, DC-9	450
Vanguard Airlines	Mission, Kansas	Dec-94	13	Boeing 737	937

US Independent airline group financial results - year 1998
Group/airline	Revenues		Op result	Operating margin		Net Margin
	1998	% change	1998	1998 %	1997 %	1998 %	1997 %
Amtram/ATA	919	17.4	75	8.2	1.7	40	2
Airtran	440	118.9	-19	-4.2	-38.3	-41	-97
Frontier	221	49.9	25	11.2	-12.6	25	-18
Spirit	131	61.0	8	5.9	2.3	7	1
Vanguard	104	28.1	1	1.4	-31.2	-1	-28
TOTAL	2,336	24.8	131	5.6	-2.3	35	-102

Note: Results from preliminary published accounts, compared against the same quarter a year ago **Amtran group includes charter operations $344.5 million (-4.1%) and scheduled ATA revenues $511.3 million (+37.%%) Frontier results for year to March 1999.

US low-cost carriers net profits $m
Carrier	1994	1995	1996	1997	1998	*1999
AirTran Airways	na	-3.5	1.2	-7.0	-29.4	18.0
American Trans Air	15.4	4.2	-21.9	11.2	57.4	41.7
Carnival Air	1.5	3.0	-16.0	-76.7	-0.5
Frontier Airlines	-5.0	-8.2	0.0	-18.9	10.7	25.4
Kiwi International	-18.1	-0.8	-12.9	-19.9	-20.6	0.0
Pan American	na	na	-27.5	-31.0	na	na
Reno Air	-14.0	1.8	2.0	-11.6	-1.5	0.9
Spirit Airlines	na	2.7	-4.8	0.9	6.7	3.7
Valujet	na	67.7	-41.5	-86.8	-11.1	na
Vanguard	na	-12.2	-25.8	-28.2	-1.5	2.0
Western Pacific	na	-6.2	-23.7	-82.0	na	na
Total	-20.3	48.5	-171.0	-350.1	10.3	91.8

Note: *1999 year to June. Figures from DoT Form 41 BACK Information and Company accounts. Valujet acquired AirTran in Jul 1997 and results merged in following year.

Source: Airline Business