Kerry Skeen: Independence day

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Kerry Skeen is leading an ambitious plan to free his airline from its role as a United Airlines feeder and reinvent it as a low-cost carrier flying regional jets. Can this unconventional vision succeed?

When Kerry Skeen chose a logo for his planned carrier Independence Air, he ended up with a circle enclosing an off-centre "I", one that, in his words, "is decidedly eccentric". That is fitting, given the decidedly off-centre approach Skeen has taken in his attempt, the first anywhere, to create a full-grown low-fares airline starting out with regional jets. He is defying conventional wisdom that 50-seat regional aircraft just cannot work in a low-cost operation, especially in a region that is rapidly facing low-fare airline saturation. These are all tough considerations, but Skeen insists that Independence Air can succeed; "not because we're smart and have such great ideas but because we are smart enough to recognise that the time is right and that the stars are aligned". That is a phrase heard often at Skeen's offices not far from Washington Dulles International airport.

Timing is the defining factor. In its current incarnation - Atlantic Coast Airlines - the company had chafed for years under the restraints of its United Express feeder pact, and Skeen was thinking back in 1999 that the company had limited growth prospects. Indeed, it has the same constraints as most US regionals that operate under a fee-per-departure contract. United did all of the scheduling, all of the marketing and took all the fare decisions. The lack of freedom was, to Skeen, bad enough, but the utter lack of growth prospects was worse, he says.

Skeen had been operating flights up and down the East Coast from Dulles since 1989, when he came east to set up a United Express feeder operation for WestAir. The company, renamed Atlantic Coast, went public in 1993, but its fortunes were tied closely to United. As United's financial woes mounted, it tried to renegotiate its contract with Atlantic Coast to a lower fee-for-departure agreement. Skeen refused. Many in the industry thought Skeen was bluffing, since United provided 85% of Atlantic Coast's revenues. But Skeen objected, and not just because of the tough deal United was pushing. He worried about tying his airline's fate to that of a bankrupt airline because "history says that airlines that go into bankruptcy go into bankruptcy again. We viewed staying with United as a considerable risk."

So Atlantic Coast decided to strike out on its own, renaming itself FLYi Inc, and operating a low-cost airline to be called Independence. The carrier is larger than any other new entrant in recent history, and its philosophy and operating plan are different in its reliance on regional jets. Skeen is challenging the received orthodoxy on starting a low-fares carrier, which takes its gospel from the testament of Southwest Airlines, where heresy is likely to be fatal.

Challenging convention
Doug Abbey, regional airline consultant with the Velocity Group, sees the Independence effort as the first modern regional airline to "morph" into a national airline. "Its entry will redefine the equity, scale and market requirements for all domestic start-ups going forward. The airline could produce profitability on a scale that rivals the largest low-fare carriers in the USA," he argues. Independence has the chance to do for regional carriers what Southwest did for major airlines - break the myths of the past."

But Abbey and others agree that the extraordinarily ambitious effort relies on fundamentals that are at least unique and often simply unproven. Chief among these is the reliance on regional jets for most of the carrier's capacity. Although Independence will later add small Airbus narrowbodies, it will rely on the 50-seaters for the majority of its route network and capacity. Another monumental question mark comes in the form of the unpredictable and possibly overwhelming competitive response of estranged partner United and of other low-fare carriers.

Skeen has an answer for all these questions. Atlantic Coast has a long-term lease on 50 gates at Dulles, unusual for a regional carrier, more than $400 million in the bank and ownership of 87 jets. Regional jets are "a natural progression as low-fare carriers turn to smaller markets where yield premiums still exist", says Skeen. At about $1,500 an hour to fly, regional jets are inherently higher cost aircraft than other types, but high utilisation will help keep down trip costs. Skeen sees utilisation at 11.8 hours a day, about 30% over the majors' average of nine hours. He thinks that the carrier will get about 15 hours a day of flying out of its Airbus A319s, a 50% advantage over the majors. Seat costs, he says, will be competitive with low fares carriers, falling to as low as ¢5 per available seat mile (¢3 per km) on stage lengths of 1,000 miles (1,600km), about ¢4 below network carrier costs.

But it is in the terminal infrastructure that Indepen-dence sees the greatest inherent advantages. "We have the terminal space. We're the only regional in the country which controls its own gates. That was a major advantage in letting us take an aggressive posture with United when we were debating staying with them," says Skeen. By January, United had committed some $22 million to building a United Express terminal at Dulles, even before the Atlantic Coast split was final, and that decision acknowledged that Independence would have its own facilities. "We're far along in our discussions with the airport and we anticipate having our narrowbody gates right across from the regional jet gates so all of our gates will be contiguous."

Stand-alone hub
Independence now plans on using each of its 36 gates for 8.3 daily departures, more than double the industry average of four turns a day. The terminal advantage leads Skeen to note another significant difference between Independence and other low- fare start-ups: "We believe in hubs. We will be building connectivity. Our hub will let us serve more than 1,200 city pairs with regional jet connections, with six or more daily round trip connecting opportunities for most city pairs. And 55% of the East Coast connecting markets that Independence will serve do not currently have low-fares service." The hub will be a stand-alone entity. "We will have no - repeat none whatsoever - interlining agreements," Skeen insists.

It is in the reliance on regional jets that Skeen is defying the conventional wisdom the most and raising the sharpest doubts. Regional analyst Jim Parker of investment bankers Raymond James & Associates says even with higher utilisation and without the extra profit margin that major airlines have to pay on regional jet costs, Independence Air's average fare would have to be as much as $20 higher than that of Southwest or "at the upper end of the low-fare range". Independence Air's marketing vice-president Eric Nordling says that right now each regional jet trip will have a $2,728 cost, based on an average trip of 341 miles; that means that an average fare of $78 would let the operation break even at 35 seats or a 70% load factor. With fuel increases and the like coming along, even an $8 ticket surcharge would cover the extra costs.

Skeen notes that the carrier's pilots have already reached a tentative agreement to reduce regional jet rates. They have also agreed to low rates on the Airbus A319s that Independence will begin accepting late this year, which it will use for long flights to Florida and the West Coast. They made their concessions when Mesa Air Group, and its high-profile boss Jonathan Ornstein, was mounting a hostile bid for Atlantic Coast, and conditioned them on the carrier's continuing independence. "They didn't want to work for Mesa or Jonathan. That was a great motivator," Skeen says.

Competitive costs
Skeen adds that even if regional jets are not the lowest- cost equipment, Independence fares will be low, and offers these examples: between Dulles and Syracuse, New York, fares will range between $64 and $114 each way, while between Dulles and Orlando, the Florida low-fares Mecca, the range will be $63 to $152, compared to a range of $60-$154 on Southwest from Baltimore/Washington International (BWI). On a 341-mile trip, he sees regional jet unit seat costs at about ¢15.8, versus ¢22.5 for a United Express trip. Station costs will be ¢2.8, compared to ¢4.1, because of the higher utilisation. Crew costs will be marginally lower, at ¢2.4 versus ¢3 for United, while distribution costs will be dramatically lower, at ¢1.1 versus ¢3.1. "We will have no GDS participation at all and a high percentage of reservations will be on line," he says. He will not participate in either the OAG or the airline tariff publishers, saving costs on two more expense items. Skeen anticipates booking costs of about ¢50 per ticket by using the Navitaire Open Skies system, also used by JetBlue Airways among others. The carrier will also make heavy use of IBM self-service check-in kiosks at its Dulles hub.

Looking at the details, UBS securities analyst Robert Ashcroft says that he is "probably more sceptical than most (analysts) about the plan's chances, but less sceptical than I was at first. They have given it a great deal of thought, but it is not a slam dunk." Like other observers, he thinks that the addition of the A319s reduces Independence's exposure to regional jet risks.

Skeen accepts Parker's estimate of a needed fare premium of about $20: "When you look at the drive from northern Virginia over to Baltimore, we think that $20 and more flights to choose from at Dulles is a pretty good value proposition...the ground congestion in the DC area works in our favour; most of it is on the northern side, the side between Dulles and BWI. You certainly aren't going to buy a non-refundable ticket and get in the car and risk missing it because of congestion. We're not saying we're going to get all that BWI traffic but we are going to capture a lot of that traffic for $20 more, and our promotional fares will be equal or close to Southwest levels."

The drive between the Northern Virginia suburbs of Washington is about 45 miles, but the contrast is greater: Dulles is surrounded by counties in which the household income is $100,000 and over, and adjacent to counties where it is over $150,000, while Baltimore is in the middle of less wealthy households, says Nordling. The Dulles area is the fifth-largest US local air traffic market, with almost 42 million annual passengers. Only New York (75 million origin and destination), Los Angeles (63.4 million), San Francisco (45.5 million) and Chicago (43.8 million) are larger, says Nordling. It has the third highest median household buying power after metropolitan New York and Los Angeles/Long Beach.

The North Virginia area is hungry for low fares, says Tulinda Larsen, vice-president of the BACK Aviation Solutions consultancy. "Few areas are home to so wealthy a population, and few are as thirsty for low-fare air service. And, Kerry knows that market, better than almost anyone. He has been serving it for almost two decades and has made very few mistakes. Still, he is going to have to deploy his fleet quickly and overcome the fact that Atlantic Coast doesn't have a name in the market. His plan may be too optimistic in its assumptions about asset utilisations, and some routes may just be scheduled with too many frequencies. I don't know that Syracuse can support six daily frequencies," she says.

But, according Abbey, the Velocity Group consultant, traffic stimulation from surrounding areas should help push local originating traffic past predictions. "While you may not see that many people driving to Greenville, South Carolina, from a big hub like Charlotte, North Carolina, to get a low-fare flight, you will see it from other small cities like Asheville, North Carolina, or Knoxville, Tennessee. With the Dulles and BWI situation, you'll see "reverse leakage", with people staying at the Dulles hub instead of driving to BWI." He adds that just four frequencies a day in a market with a 50-seat regional jet adds almost 150,000 seats a year, but Independence's large and sole presence in secondary markets will give it "abnormal pricing control and substantial profitability" down the road.

But Abbey says the competitive response is a wildcard. If United or US Airways do something irrational in response, "well, it would be the Wild West in the East, a real shoot out". His Velocity Group partner Mike Miller sees United "just dumping capacity" to fend off the new rival, but agrees that the Independence plan of high frequencies can dull that response. Merrill Lynch's Mike Linenberg says an aggressive fare war at Dulles could easily cost United over $100 million and could disrupt its emergence from bankruptcy later this year.

Larsen thinks it unlikely that JetBlue would ramp up its limited Dulles schedule of seven daily departures a day to Florida and the West Coast in response to Independence, but instead will concentrate on building its new 100-seat Embraer 190 network starting next year. AirTran Airways is likely to build at Dallas/Fort Worth and other "focus cities" rather than adding significantly to its five daily Dulles departures to Atlanta. And Southwest, with 161 daily departures at BWI, is busy with its new operation at Philadelphia, making the reaction of "punch drunk" US Airways a smaller, unpredictable response, says Abbey.

Cash reserves
Independence has enough cash on hand - about $425 million as of early April, including $125 million from a convertible bond offering early this year - to ride out a competitive reaction. It may need it. Skeen and other Independence executives say they expect to turn a loss of $8-10 million in the second quarter, and to lose $45 million in the second half of the year. Late last year, they were predicting a loss of $25-30 million in the second half of this year. But the transition out of United Express will cost more than anticipated, and Skeen concedes that he will need to spend more on advertising and marketing than first planned, doubling his $15 million budget. He admits that establishing the name will be difficult after decades of doing business under someone else's brands.

And even though the Airbus will enjoy lower operating costs than the regional jets, they will expose Independence to the fiercest competitors of all, the low-cost and the legacy carriers battling for transcontinental markets. Airline consultant Mike Levine, the former Northwest Airlines executive who now teaches at Yale Law School, says: "They may well soon find themselves wishing they weren't independent. When somebody else is your master, at least they toss a fish or a piece of meat into the cage from time to time."

 

Five steps to freedom

The Independence Air fleet will grow in five stages in its transition from Atlantic Coast:   

June The withdrawal of 30 CRJ-200ERs from Atlantic Coast's service as United Express;

July The withdrawal of 30 more regional jets;

August The final 26 CRJs will be withdrawn. They will all be refitted with larger, all- leather seats from B/E Aerospace.

ACA, by now flying as Independence Air, will have retired its 22 BAE Systems Jetstream 41 turboprops;

November First flights of leased 132-seat Independence Airbus A319s, with live television at each seat, begin. November Delivery of the 22 leased and owned A319s and five 156-seat A320s, with IAE V2500 engines, will be completed by early 2006.

 

Regional flyer

Kerry Skeen, founder of Independence Air, is a regional airline man through and through. His first airline job was custodial work for Delta Air Lines. In 1983 he became director, marketing and development of the carrier's regional arm Delta Connection.

From1987-9 he served at independent regional WestAir, initially as vice-president, marketing and sales and then as senior vice-president. For the next two years he held the post of president Atlantic Coast division of WestAir. In 1991 he was made executive vice-president of Atlantic Coast Airlines rising to become president of the carrier just a year later. He led the company throughout the rest of the decade, before taking the position of chairman of the board of directors in 2000. In 2003 he was appointed chairman, chief executive, and director of FLYi Inc, parent of Independence Air.

Born in Atlanta, Georgia, Skeen was educated at West Georgia State university, gaining a degree in business administration. His hobbies are sports, especially basketball

On his career path, Skeen jokes about how he ended up in the airline business: "In Atlanta, you either work for Coca-Cola or Delta. And I had the travel bug, so it was Delta." He has a straight- forward manner and wants his airline to be the same: "We want people to be themselves, not to be comedians or pretend to be someone they're not. That is the way we build integrity as a core Independence value."

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