Get-rich regional players are in the driving seat as their mainline contemporaries get bogged down with restructuring and cost-cutting

Regional carriers long were servants if not outright vassals of their mainline partners, but that world is now turned upside down. As regionals amass a solid record of earnings and field some of the industry's strongest management, they are far more in control of their own futures and are increasingly in the driving seat as their legacy partners get bogged down in restructuring.

And in a period of reinvention and a desperate search for new models by the majors, regional carriers have done this by keeping to the tried and true, staying with the basic model that has defined them. Indeed, in the last year a closely watched experiment by a strong and well-entrenched feeder to nourish itself and become the first self-supporting US low-cost regional has proved that the old way is likely to remain the new way. That effort by Atlantic Coast Airlines management to become Independence Air has come close to outright failure and is at best struggling. It is carriers such as Continental's ExpressJet and Pinnacle that are solid and it is their model that remains all but unassailable. Velocity Group regional consultant Doug Abbey notes: "Isn't it ironic that they are the ones with the money?"

MergeGlobal consultant George Hamlin points out that United Airlines was the catalyst for the changes throughout the regional sector; it was United that pushed Atlantic Coast into its declaration of independence and it was United's thirst for lower costs that drove Air Wisconsin to cast its lot elsewhere. As United continued to work through its bankruptcy, now nearing its 30th month, it demanded renegotiations from all of its Express providers to give it lower costs. Atlantic Coast, the provider at United's Washington Dulles hub refused and said it would go its own way under the rubric of Independence Air. Others took a different path. Air Wisconsin bought itself a place in the US Airways system, followed by Republic Airways a few weeks later.

Hamlin says: "Increasingly, we're seeing a blurring of the lines between regionals and majors as you see stronger financial positions and management at regionals. When the smoke and dust settles, the regional may very well be the one left standing." As the industry undergoes changes like the overall loosening of restrictive scope clauses and the possible sale of such major players as Delta Air Lines' Atlantic Southeast or Comair units, it is not that managers are changing the basic operating model but that they are putting it somewhere they can protect it.

Radical move

The Independence experiment is a seminal lesson to any contemplating a radical rewriting of the regional business model. As it ended its United relationship, Atlantic Coast said it would take its Bombardier CRJ fleet and draw on the wealthy traffic base of northern Virginia near its Washington Dulles hub to fill the 50-seaters on routes throughout the eastern half of the country. Renaming itself Independence and renaming its parent company Flyi, it would eventually add Airbuses to the regional jet fleet. Because it would eschew the global distribution systems (GDS) and the travel agents, Independence would be a low-fare platter.

Things did not work out quite as planned, and with fuel prices rising and the competitive response fiercer than it had imagined, the company lost more than $160 million in its first six months of operation. Some analysts had predicted a Chapter 11 filing by January. In February, Flyi announced it had completed a financial restructuring plan, backed by General Electric. It sold some jets, returned others to creditors and scaled back service from Dulles to cities such as Columbus and Charleston and dropped others like Norfolk entirely.

But the carrier, which has now placed itself in all four of the major GDSs, has also reverted to a more traditional approach. It is relying on the Airbus A319s that it had ordered to attract travellers to traditional holiday routes such as the Florida markets and major western destinations. As it added the larger aircraft, taken regional jets out of the fleet, and dropped destinations, the Independence load factor rose to an all time high of 70.7% in March, up from 62.9% in February and way above the 40% levels that it had set in its first few months. Gone are the boldest elements of the plan, although scepticism about the airline's long-term viability remains.

Hamlin says of Independence: "Don't count them out totally." Flyi management realised that that creating a new model would be more difficult than ever given the fuel crisis; instead of reverting to the guaranteed fees of the basic regional structure, it has migrated toward another proven approach: low-fares in large aircraft to places with palm trees, sun and sand. Similarly, other regionals, rather than radically rewriting the pay to play or fee per departure approach, are modifying it by allying themselves even more intimately with a major.

Consider the case of two of the US Airways Express feeders, Air Wisconsin and the Wexford Group's Republic Airways. After United demanded that Air Wisconsin accept lower fees, the regional carrier was forced to consider its options. JP Morgan analyst Jamie Baker thinks that United demanded a 30% cut in fees. Previously owned by United but privately held since 1993, the company had learned it could serve other masters in its brief experience as AirTran Jet Connect, a feeder arrangement that ended as AirTran Airways expanded its own fleet.

In February "AirWis" surprised the entire aviation industry by becoming the first regional to prop up a faltering major in a big and direct way. Air Wisconsin affiliate Eastshore Aviation put $125 million into US Airways and said Air Wisconsin might fly up to 70 Bombardier CRJ-200s and possibly some 90-seat CRJ-900s for the legacy carrier. But the US Airways deal gives AirWis a place to grow, Baker says. Velocity Group's Abbey says of the demands United made of Air Wisconsin: "It's just another example of United eating its young."

Within weeks of the Air Wisconsin investment, a second highly regarded regional, Indianapolis-based Republic, pledged another $125 million to US Airways. By pledging $250 million collectively, Republic and Air Wisconsin stand to end up with large stakes in US Airways. The agreements give each carrier the right to own 19-25% of US Airways stock and three seats each on the board of directors. AirWis got what it wanted, a home for its future, while Republic positioned itself for strategic growth.

Buying into US Airways

By locking up an agreement to fly US Airways jets and buy some of its assets for as much as $110 million, Republic won itself a place in US Airways network and could also end up running MidAtlantic Airways, the corporation that US Airways created in 2002 to operate the larger regional jets it saw as the key to its future. Republic could purchase the entire MidAtlantic fleet, all 28 of US Airways' Embraer 170s, and fly them under the US Airways Express label. It also could build a heavy maintenance facility for MidAtlantic.

It therefore has bought itself two items of value: a guaranteed chunk of flying and assets to own and hold regardless of the fate of US Airways. Abbey thinks the investments are desperation moves because of US Airways' situation, but is certain that Air Wisconsin and Wexford are survivors even if US Airways is not. Hamlin is even more emphatic about the strength of regional managements. He says: "Air Wisconsin could well outlast United given the management. One has a clear plan and the other doesn't." While that is perhaps hyperbole, it speaks to the virtues of the underlying regional model, tweaks and all.

This model is undergoing tweaking elsewhere. United will stay with one partner, SkyWest and add another, GoJet, created for United Express service by Trans States. They will change things with multi-class regional jets. SkyWest will fly 66-seat CRJ-700s in two classes and GoJet is taking the class act even further, planning on CRJ-700s with three-class seating including United's trademark Economy Plus mid-class.

As US Airways gains two new partners, many wonder what will happen to the 59 50-seat regional jets and eight turboprops that Mesa Air Group operates for the major. Some had speculated that Mesa's chief executive Jonathan Ornstein would invest in US Airways, but Baker of JP Morgan thinks that Mesa, the acknowledged master of the basic regional model, can call the shots.

He says: "Cash is king. Mesa has it and others need it." The regional tail again wags the major dog, and perhaps rightly so.


Source: Airline Business