Southwest is again taking the initiative in the US's most densely travelled market, while the performance of Shuttle by United remains unclear. Jane Levere reports. The fireworks that many expected to ignite in October 1994, when Shuttle by United first invaded Southwest's territory on the US west coast, have been a little late in exploding.

At the outset competition between the two major players in the intra-California and Pacific northwest to California markets was relatively placid. Fare activity was minimal, as United largely matched Southwest's fare structure, though both carriers' capacity grew considerably; Southwest's by 25 per cent and United's by over 200 per cent.

Consequently, though Shuttle by United has made a small dent in Southwest's market share over the past 12 months - Southwest's market share dropped 5.4 percentage points between the third quarter 1994 and the second quarter of 1995 - this was not significant enough to deny the Dallas-based carrier the breathing space it needed to consolidate its financial position. In September Southwest showed every sign of returning to the fray with an aggressive fare initiative that has both United and Alaska Air on the defensive.

With some 47 per cent of United's total revenue coming from passengers travelling to, from, or through a west coast city, the continued pressure being put on United's California presence by Southwest and others touches the heart of its operations. And, contrary to United chairman Gerald Greenwald's expectations of profitability in calendar 1995, reports suggest the shuttle is still a long way from making a profit.

In early September, Southwest raised the stakes by slashing unrestricted fares on routes between the Pacific northwest and California by almost 50 per cent. These deeply discounted fares, with yields up to three times lower than on other Southwest routes of comparable length, are a clear sign that Southwest is not happy with its Pacific northwest to California performance. The region was previously served by Morris Air which Southwest purchased in late 1993.

Southwest's fare initiative has unsettled rivals and been labelled by some sources as anti-competitive and possibly illegal under US antitrust regulations. At the very least, it will wreak havoc with progress in recent months by Alaska Air, the biggest player in the Pacific northwest to California markets, towards greater profitability.

Nor is it clear how well United's shuttle is doing, and United is seemingly keen for matters to remain that way: despite repeated requests for comment, the airline refused all interview requests.

Not that turmoil, or deep discounts, are strangers to the west coast. California has been a hotbed of competition ever since PSA, a San Diego-based regional carrier, invented the concept of low cost, low fare, high frequency service in the 1960s. PSA and Air Cal, a higher cost Orange County, Calfornia-based regional, were purchased by USAir and American respectively in 1987. Eventually USAir largely abandoned PSA's routes, mostly in the southern part of the state, while American turned the San Jose operation it had inherited from AirCal over to Reno Air.

Southwest began filling in the void in 1989. Starting with service between Oakland and Burbank, chosen over more congested San Francisco and Los Angeles, it gradually added more B737 flights in San Diego, San Jose and then other cities within the state, a market Southwest chief financial officer Gary Kelly calls 'well suited to Southwest's kind of service, low fares and frequent flights.' Today intra-California service represents 15 per cent of Southwest's total capacity, the same percentage as the airline's Texas operations, while 65 per cent of its ASMs are flown west of Texas.

Southwest was onto something: according to a report by Roberts, Roach & Associates, in 1993 the California corridor was the most heavily travelled market in the United States, with 12.3 million passengers. This was a 70 per cent increase over 1980, and represented 81 per cent more passengers than were then flying in the second largest US market, the northeast corridor. As of 1993, Southwest's share of the California market was 47 per cent and United's 26 per cent. Southwest's business had climbed to 57 per cent of the total by the time Shuttle by United was launched.

Southwest's encroachment on United's west coast business was threatening a vital part of United's operations. The solution, made possible largely by flexible pilot work rules negotiated in the July 1994 employee buyout, was to have been Shuttle by United, developed with the help of an employee team for launch in October 1994.

Shuttle by United began with 184 daily B737 frequencies, serving nine cities in California, Washington and Nevada. By December 1995, it will offer 384 daily B737 frequencies - approximately 4 per cent of United's total systemwide capacity - in 12 cities in California, Washington, Nevada, Arizona and Oregon. Shuttle competes directly with Southwest on only 40 per cent of its operation.

Since the shuttle start-up, United has increased daily service between San Francisco and Los Angeles (a route not served by Southwest) from 58 to 81 daily departures. Since last spring, Shuttle has added over 20 daily flights from San Francisco to Portland, eight to Phoenix and eight to San Diego; it has also added 12 daily flights between Los Angeles and Portland. Meanwhile Shuttle has cut service between Oakland (a Southwest stronghold) and Burbank from 22 to 15 flights daily, and between Oakland and Seattle from 10 to 6 flights daily. In addition, it has entirely eliminated service on the Oakland-Ontario route, where at one point it offered 14 flights daily.

United's fares in shuttle markets have generally matched those set by Southwest. But its product differs from the bare bones service of the Texas-based carrier: United has assigned seating, first-class and interline service on shuttle flights, and offers passengers the use of automated ticketing and boarding pass machines at selected airports.

But management of the shuttle has at best been erratic. Sky Magary, a former senior official at Pan Am and Northwest, was named Shuttle president right after its launch and left the company abruptly in late September. Sources familiar with the operation say he was given no decision- making autonomy. His replacement, Amos Kazzaz, a 12-year United veteran, was most recently in charge of flight attendant scheduling. Although his public title is Shuttle president, internally he is a vice president. This raises questions over his true decision-making powers and whether in fact control of the shuttle lies higher up in the organisation, according to sources.

In the few hazy public statements United has made about the shuttle, it claims operating costs in Shuttle markets went from 10.5 cents per available seat mile in October 1994 to 8 cents during the second quarter of this year. However critics charge the airline is improperly allocating some Shuttle operating costs to the larger United Airlines operation, making the shuttle seem more efficient than it actually is. United's investor relations department says operating gains so far have been achieved by greater utilisation of airport facilities; an increase in aircraft utilisation from 10.5 to 12 hours daily; speedier passenger boarding of planes, via the WILMA (window, middle, aisle seating) method; and adoption of automated ticketing and boarding systems.

United's goal, according to one investor relations official, is to reduce Shuttle operating costs to 7.4 cents per mile, closer to Southwest's 7.06 cents.

In a report on United Airlines issued in August, Moody's analyst Renee Shaker, says United estimates the shuttle produces about '$20 million in annual incremental feed revenue.' One senior official at a competing airline suggests profitability is 'not important (for the shuttle). As long as it keeps Southwest from eroding its market share [any] more, if it breaks even, it could be an extremely effective strategy. When you have the overall size and structure of United, and you're minting money like they are at Denver, it doesn't matter.' Yet another source estimates United is losing at least $50 million annually on the operation.

But according to Southwest's Kelly, before Shuttle by United began flying, Southwest's load factor on its western routes was 67 per cent, with a break even load factor between 55 per cent and 56 per cent. Since the shuttle's launch, Southwest's western load factor has dropped 'slightly below the system average of 65 per cent, but well above the break even. We fully expected it to come down. It's still very acceptable and profitable,' says Kelly. US Department of Transportation statistics indicate that Southwest's share of intra-California traffic dropped from 56.9 per cent at the end of 1994's third quarter to 51.5 per cent at the end of June, while United's increased from 21.3 per cent to 33.7 per cent.

During its first year of operations, United reduced service out of Oakland where it was overpowered by Southwest, and reallocated resources to San Francisco and Los Angeles, the third and fourth largest hubs on its system. According to PaineWebber analyst Sam Buttrick, United's greatest successes have been on routes originating in either San Francisco or Los Angeles, where it had a strong presence prior to the shuttle's start-up. Two thirds of the city pairs initially served by the shuttle were previously served by United Airlines and 10 per cent of the initial shuttle routes were entirely new markets. United subsequently dropped many of the latter. United's frequent flyer programme has also been a significant competitive advantage given that business travel accounts for some 50 per cent of traffic on intra-California routes.

Southwest is vulnerable in Pacific northwest-California markets in which it has gone from 31 to 57 flights since last October. The United shuttle added 22 daily flights between San Francisco and Portland in April, raising this to 24 in October. It has also increased San Francisco-Seattle service from 28 to 34 flights daily and added 12 new flights between Los Angeles and Portland. Alaska, meanwhile, has more than doubled service from Portland and Seattle to both the Los Angeles basin and the San Francisco Bay area, offering 49 daily departures to the former and 55 to the latter.

Buttrick believes South-west's action is aimed straight at Alaska rather than United, and 'suggests Alaska was starting to win the battle, and Southwest fought back with the only tool it understands, price.' Southwest used restraint during the first year of the shuttle, partially because of concern about its own financial position. But having gained greater confidence in its finances, and seen United begin to retreat, it has been emboldened to cut its Pacific northwest fares to the lowest levels ever, adds Buttrick. Alaska offers a full-service product on its west coast flights, including meals and frequent flyer ties with Northwest and others.

Alaska Airlines president John Kelly, who has continued the cost-cutting programme started by his predecessor Ray Vecci, reducing the carrier's operating costs from 8.3 cents last year to 7.5 cents in the second quarter of 1995, calls Southwest's latest fare filing 'uneconomical'. 'No new business will be generated. Only a minimal market share shift will occur. This is a fare war, not a sale, because business will not be stimulated. It will create losses for everybody.'

Alaska's Kelly, who matched Southwest's filing, vows to 'take whatever action is necessary' to compete against the Texas airline. Buttrick expects the fares will have 'a materially negative impact over the next several quarters on Alaska.' While Alaska has shown nice progress in restoring profitability in recent quarters, the Southwest fare initiative will meaningfully impair those efforts, says Buttrick. Alaska posted a net profit of $22.5 million last year and, boosted by its cost reduction programme, posted a net gain of $7 million in the second quarter and a record $27.4 million in the third.

Longer term, there will almost certainly be some downsizing and shifting of routes among airlines serving the region. Other than the three US majors, these also include Reno Airlines, a Nevada-based partner of American Airlines that operates MD-80s from Reno and San Jose to the western US, Anchorage, Vancouver and Chicago. Reno made a profit of $4.5 million in the third quarter and has reduced its operating costs to 7.6 cents.

Southwest's Kelly predicts it will be 'very difficult' for even three carriers to survive in the Pacific northwest, though he believes two to three could coexist in intra-California markets which are 'unique because of the dense population at both ends.' No carrier is willing to reveal where it might adjust capacity, though one analyst says at least a 15 per cent reduction in flights is needed.

For the moment, Southwest's growth plans appear to be directed towards Florida, where it will begin phasing in a 52-flight operation in January. But, with as many as 164 new aircraft slated for delivery by 2004, 'In the long run, I think they'll go head to head with Shuttle by United and clobber them,' says one competitor.

Meanwhile a big question mark remains over the financial viability of Shuttle by United and whether, as with Continental Lite, another US major's attempt to run a low cost, low fare, operation without truly embracing its basic philosophy is sooner or later likely to bite the California dust.

Source: Airline Business