US regionals are again reshaping themselves, becoming multiple franchises and the major buyers of aircraft, but the business basics are the same as always

Regional airlines find that every few years they must reinvent themselves. What is different from the rest of the US industry is that unlike others, they can do so. Now, as the legacy carriers struggle to redefine their business model at the edges, the regionals are poised again to reaffirm their basics. As Doug Abbey, an authority on the regional industry and a Velocity group consultant puts it: “The challenges come along every few years, from the advent of the regional jet to the current crisis. We see attempts at a new model that fail utterly, yet the industry continues. The basic model is sound; they do it because they can.”

At its heart, the regional airline industry is profoundly about plain, bare-bones basics: simply flying, usually back and forth between points A and B and sometimes, on Sundays and holidays, Point C. It is about concentrating on the fundamentals of operating. It is not based on marketing, nor flair, or on any personality. It is dependability, not charm, that makes a regional strong.

In a sense, the future of regionals is in their past, with a return to basics. The emerging changes – the growth of large regional management firms with multiple brands and multiple partners, the burgeoning fiscal strength and bulging jet-order books of the regional carriers that own their aircraft – are evolutionary, not radical.

Indeed, last year saw the failure of a radical attempt at an entirely new concept: the small regional jet as a low-fares contender. The would-be pioneer, Independence Air, chafed at the one element of the regional model that has remained the defining constant: control. Like other regionals, the former Atlantic Coast had seen its daily business defined by its master, in this case United Airlines, and as United demanded control at lower costs, the regional rebelled. It took its aircraft away from the service of United and said it would leverage its Washington Dulles hub into a low-cost Mecca.

It may have succeeded in doing that at the cost of its own existence. Drawn by Independence’s low, low, below-cost fares, flyers flocked to Dulles. The airline never came close to breaking even and was out of business by the first week of 2006, strangled by its inability to reconcile the inherent high cost of operating 50-seat regional jets with the realities of a low-cost market.

In a further irony, the Independence experiment proved, as Abbey says, that the basic concept is enduring. There will always be a master.

New opening

By creating a vacancy in the regional industry, Independence gave an opening to a beleaguered legacy master that was in the middle of reshaping its regional relationships – Northwest Airlines. One of the two US majors in bankruptcy reorganisation, Northwest is establishing one of the two major directions in which legacy carriers are taking their regional relationships. Delta Air Lines, which entered bankruptcy court protection on the same day as Northwest last September, is showing the other.

Northwest parent NWAC bought the air operator’s certificate of Independence, using it to hasten the inauguration of a new regional unit in June. That unit, Compass, could only be created after a new pilot contract compromise representing a victory of sorts for both pilots and management. Northwest succeeded in expanding the scope of its regional network while the pilots maintained their right to fly narrowbody jets certified to carry more than 76 passengers. Furloughed Northwest pilots would also win first rights to all flying created by the new regional subsidiary.

Under the deal, the new regional airline could fly as many as 90 jets. However, for each aircraft it assigns to the unit, Northwest would have to place an aircraft with 77 or more seats in the mainline fleet, to be flown by Northwest pilots. This represents a small win: ALPA negotiator Rich Haase says it promises a resolution to the Northwest McDonnell Douglas DC-9 dilemma by guaranteeing that this ageing fleet will be replaced.

Northwest said in a Transportation Department filing that it would make a decision shortly between the Bombardier CRJ900 and the Embraer 175 for the fleet, although it will begin service in June, probably between Washington Dulles and Minneapolis/St Paul, with a single leased CRJ200. JP Morgan’s Jamie Baker thinks Compass would fly some 50 dual-class, 76-seat CRJ900s and that Northwest will replace its DC-9s with Embraer 190s for mainline routes.

The Compass idea, one of the most significant new-entrant proposals among the many in various stages of development, comes as Northwest has, in effect, launched a series of beauty contests seeking new contracts from independent regional partners. Continental Airlines, for instance, put its feeder ExpressJet, a former subsidiary, on notice that it may take away some of its flying and shift it to Chautauqua, a Republic subsidiary. Northwest has asked its regional Airlink partners, Pinnacle and bankrupt Mesaba Airlines, to rebid for their business. They will have to compete with any and all comers – including the brand new Compass.

Baker thinks that “Northwest will substantially favour its subsidiary over Pinnacle” and other Airlinks. If this is supposed to terrify the incumbent Airlink partners is has failed to do so. At Pinnacle, chief executive Phil Trenary says he takes seriously the Northwest moves but believes that Pinnacle’s record of dependability and reliability will keep it in the Northwest fold. “We will likely see a move toward more risk sharing, possibly exposing the regionals to more vulnerability in areas such as fuel costs, but there is a lot of flying to be done,” he says. The majors will doubtless be able to get lower margins on flying, but so long as the carrier keeps its costs down, it will survive.

In contrast to Northwest’s hardball tactics, Delta’s approach has been two-pronged: it sold the regional it could find a buyer for at a loss, and then proceeded to confrontation with the unions at the other regional subsidiary, Comair. At Comair, which Delta could not sell, Delta faced a mid-April strike. But its sale of ASA, the former Atlantic Southeast Airlines, helped create another powerhouse within the industry, spurring the trend in which a well-regarded operator controls multiple brands and has multiple relationships.

The pioneer of this multiplicity approach has been Mesa Air Group, a company that moves quickly as an agile opportunist. However, in recent years, Republic Air Holdings has adopted the approach, and now SkyWest has too, with its $425 million purchase of ASA in August, just weeks before Delta’s Chapter 11 reorganisation.

For SkyWest, always a conservatively managed and well-run company with accountants in the top management, the ASA deal was extraordinary. It got itself an airline that bankrupt Delta had bought in 1999 for $700 million. Now, in the SkyWest family, it is poised to operate the single largest stable of larger Bombardier regional jets, 77 CRJ700s and as many as 102 more Canadian-built aircraft in the 70- to 90-seat range. SkyWest itself is bidding for more carrier contracts. Officials refuse to identify the companies, but Cathay Financial’s Susan Donofrio is confident that SkyWest will win contract flying from Continental and from Northwest, thus becoming an ever larger multiple player.

Stronger players

This is the way forward, says Ray Neidl, the Calyon Securities analyst. He believes that “the industry will evolve into three or four strong regional carriers bidding for the business from multiple legacy carriers”. Perhaps the centre of financial strength will shift from struggling majors to vigorous regionals such as Mesa, Republic or SkyWest.

Mesa Air Group chairman and chief executive Jonathan Ornstein says: “It’s become harder to finance aircraft and it costs money, and there are fewer and fewer of us who can do it. If anything, I’m wondering which way the leverage is going.”

Mesa, for one, has a large enough fleet that it will risk a stand-alone start-up in the already crowded Hawaiian inter-island market. It will also likely win new flying from another major, drawn by Mesa’s low operating costs of about $1,990 a block hour, estimates Benchmark Group’s Helane Becker. The Republic group, at about $1,600 a block hour, is the lowest, she says.

Abbey concludes that the lower a regional’s costs, the larger the regional’s aircraft portfolio and the stronger its willingness to engage in multiple partnerships, the more apparent are the virtues of regional agnosticism, and of not being tied to one or another major carrier as a sole master. That is, he adds, as long as the regional reaffirms the basics of the model. In that sense, the regional past is an omen for its future. ■

“This is your mess, fix it” labour arbitrator Richard Bloch told Delta and its pilots as strike action loomed, read more on our blogs.


Source: Airline Business