The issue of community support for new air service took centre stage as the US industry got back down to some serious route development at this year's Network event in Sarasota

As yet, the US market may only be in the foothills of a long-awaited recovery, but if the optimistic mood at this year's Network route planning conference is anything to go by, then both airlines and airports are gearing up for new service. And as they do, debate over the relationship between carriers and the communities that they serve continues to take centre stage.

The issue of airports providing incentives, or even hard cash support, in order to win airline service is hardly new and has been a recurring theme at Network ever since it was launched by Airline Business four years ago, with the aim of bringing airport route developers and airline planners together to do face-to-face business. But as some 200 delegates gathered for the latest event in early March, hosted by Sarasota/Bradenton International Airport in the relaxed setting of Florida's Gulf Coast, there was evidence perhaps that the stakes have been rising for airlines and airports alike.

With a near-term recovery in traffic levels now looking like a more realistic hope, there is added incentive for communities, especially in small and mid-size cities, to lure in new carriers, often to replace or recapture service lost over the past two years of crisis.

Some 400 airports have lost service since September 2001 reckons Mike Miller, founder partner with the newly formed Velocity Group consultancy, adding that the new economic realities also mean that carriers now want a "domestic route to pay off from day one". The result has been a steady rise in the cash value of the support on offer. Miller estimates that some $40-50 million was made available in 2003 from airports and communities in incentives of one form or another.

On top of that there is an even larger slice of federal funding available in the form of the long-established Essential Air Services (EAS) programme. This uses a federal fund to subsidise service on rural routes deemed socially necessary but which will not support a commercial operation. The EAS has grown from $22.6 million in 1996 to $113 million annually today, says Miller, but warns that there are pressures from Congress to trim back on the budget this year. Proposals have also been aired to force communities to share the cost of subsidising an EAS route.

Airports can also apply for federal funding for a Small Community Air Service Grant, although competition is intense and funding thin. Sarasota, for example, tried for a grant last year and failed - only one city in Florida did succeed. Of 170 airports that applied nationwide, only 35 were selected in 2003.

The potential scale of the cash on offer from communities was demonstrated by Portland's bid to win European air service. The state of Oregon put in place an $11 million travel bank that helped tempt Lufthansa into launching a daily Frankfurt service in mid-2003. Under such an arrangement, a local community creates a bank account into which businesses and individuals pay to fly on the airline being supported. It is in effect a guarantee from the private sector to use the carrier. When flights are taken on the airline, the businesses draw down from their travel bank accounts.

Spending wisely

There are a host of other models on offer too, but Miller is not alone in warning that airports need to ensure that they spend their money wisely - backing services that are likely to stay and grow, rather than paying out the cash only to see the carrier depart or fail when it stops.

Tallahassee, Florida, and Wichita, Kansas, each spent heavily to attract low-cost AirTran Airways, but the Orlando-based airline has scaled back flights from Florida's capital city and is uncertain if it will stay in Wichita when its two-year agreement there ends in May. The Tallahassee plan was a travel bank not unlike the Portland scheme, while the Wichita plan was a guarantee to cover losses. At Wichita, in its second and final year of subsidies that were used to attract the low-fare carrier in 2002, AirTran has drawn $875,000 of the $1.5 million available to cover losses.

Miller warns that incentives need to be backed by some sound route analysis, adding that communities "should not give all their money to the first airline that comes along". He adds even darker warnings about the use of direct state aid to back new start-up carriers, such as the millions poured into the likes of Access Air, Air South and Great Plains in the 1990s. The operations ultimately failed, leaving their funding communities no better off. "Direct state aid has not worked for the most part in this country or in Europe," he says.

Airlines too warn that routes have to be viable without support at some point, although any incentive that "mitigates entry into the market" is helpful, adds Mark Kopczak, director market planning for Spirit Airlines.

JetBlue Airways, now among the hottest prospects for smaller communities after its order for Embraer 190 jets, says that it does not look for incentives but for viable economics. "We need to see the business case for a route, and are more interested in long-term airport costs and the need to make it work in the long-term," says route planning manager Adam Green.

Accessing new funds

Who pays for incentives, and how, has become a hotly debated topic within the US airports community, and the Sarasota Manatee Airport Authority has raised the heat further. As an airport authority it comes under strict FAA regulations that prevent it from using reserves to pay airline incentives. However, it complains that rival airports, which are run directly by their city, can look to local government coffers for community support.

Sarasota, for example, has long tried to lure AirTran to fill in the service the community wants, says airport director Fred Piccolo. And airport officials say they could raise some $2 million for AirTran by dipping into the airport's reserves, but are currently prevented from doing so. Therefore, late last year the airport authority asked federal authorities to change those rules, and ignited a debate.

Major airlines, unsurprisingly, oppose the plan, which would fundamentally alter the US approach to policies on airport charging and economics. American Airlines, for one, says the Sarasota plan would raise costs for any carriers not receiving an incentive at an airport, and so be discriminatory. Others caution that the plan opens the potential for an ill-advised airport spending itself into insolvency, or at least a risky fiscal position.

And though the major airport lobby, Airports Council International-North America and the American Association of Airport Executives, support it as a way to rethink policy, some other airports also oppose the plan. Raleigh-Durham airport, for instance, says that the subsidies could be "very well be temporary in nature and authorisation for the payments would be at the whim of various local political bodies that may or may not have the same interest, enthusiasm or financial wherewithal to support them from year to year".

However, Piccolo has submitted a detailed plan that would keep the incentive plans from becoming a discriminatory force against carriers at an airport, and the airport authority hopes for a ruling by late this year.

Policy disconnect

Miller notes an important element of the incentive dilemma: "Airport boards put a lot of pressure on airport management to add service. But there is a disconnect," he says. "Boards may introduce incentives to bring in new passengers, but there is not always an understanding of how that process works."

This is a common theme. "More communities understand what air service brings to them, but the vast majority are not willing to put risk into developing service," says Brad DiFiore, specialist-network analysis new market implementation at Delta Air Lines. Delta routinely asks for revenue guarantees from communities that no longer have service on certain routes, says DiFiore. "In this market you are lucky if you can make new regional jet service make money in year two," he says.

All carriers agree that obtaining community buy-in is essential - whether or not it is in the form of hard cash or alternatively in marketing support. "Revenue guarantees are not subsidies," says John Kirby, director network planning at AirTran Airways. "They ensure buy-in from the community and form a partnership with the community." AirTran has successfully launched service from its Atlanta hub to Flint in Michigan with the backing of such guarantees. However, AirTran expects to move away from this type of support, and from launching additional service to smaller cities, says Kirby. "The reality is that when you come into a marketplace the majors match your low fares. This makes it very difficult to go into small and medium-sized communities."

Independence Air, the former Atlantic Coast Airlines that is relaunching itself on the east coast as a low-fares carrier, is less interested in financial incentives like revenue guarantees, which may add complexity in management terms. It is more interested in a partnership approach. "Our goal is in marketing dollars and in marketing time" from the airport, says Jeff Pollack, senior director of market planning.

Independence wants to begin operations by mid-year from its Washington Dulles hub. "We have met with close to 90 airports in the last four months," says Pollack, in between meetings with communities hungry for service.

US optimism returns but regionals feel the pinch

The buzz around the halls at Network 2004 gave further evidence, if it were needed, that the airline market is finally turning up. After two painful years, the US mainline carriers seemed more optimistic, and their low-cost counterparts also show no signs of slowing down.

Overall, the US airline industry is "gaining strength", according to Michael Boyd, the outspoken airline consultant, and the situation is brighter than it looks. "Although the industry will not get back to 2000 levels for another two years, in revenue terms, it has survived," he says. The system is running with some $18-20 billion less in revenue than before, but "still no big airlines have gone bust", he says, adding that it would not necessarily be wise to bet on one doing so either.

The results of a quick touch-screen survey, carried out among a sample of the 200 airline and airport delegates at Network, underline the optimism. Some 40% said their operation had seen a moderate growth in passenger traffic last year, with 25% at the same level as 2002. This year is likely to be significantly better, with 70% expecting at least moderate growth and 15% expecting strong growth. However, there is still some way to go before airlines and airports return to the peak traffic levels of 2000. A third believe the peak will be reached this year, while another third say it will be next year, with the balance believing it will not be until 2006.

As the major carriers successfully shift costs, slow growth is returning, says Boyd, predicting a 2.3-2.7% rise in traffic over the next couple of years. Boyd sees three types of carrier emerging: the network airline system; opportunistic low-fare "cherry pickers", and small jet providers, or what used to be called regional carriers, he says.

While he is cautiously optimistic about the prospects for majors, Boyd's prognosis for regional airlines is grim. "The age of the 50-seat regional jet is coming to a close," he predicts. The deteriorating economics of operations at this scale compared with larger jets will "drive mega-carriers to need fewer 50-seaters later this decade". This will lead to a shake-out of the regional players that Boyd calls small-jet providers. Boyd notes increasing consumer resistance to long flights on 50-seat size jets.

Robert Ashcroft, UBS Investment Research analyst specialising in regionals, is somewhat less pessimistic, although he does believe that in the long term the regional airline business will be a bad one for investors. "It is becoming a commodity business," he says. "The barriers to entry are low. Over time, margins will drop and you will see business flow to the low-cost guys."

For the next couple of years, though, Ashcroft sees continuing growth for the sector, with significant numbers of regional jets delivered. "The majors like having a lot of regionals competing for this business, so we do not necessarily believe there will be a shake-out," he says. However, the arrival of the 98-108 seat Embraer 190, which can make money serving smaller communities that would be uneconomic for 150-seaters, "will tend to reduce the profitability of 50-seat service". Change will start in 2005, when JetBlue Airways takes delivery of its first 190s. JetBlue says it can use its 190s to connect mid-sized cities in the west with the large eastern cities it serves such as New York. Columbus, Ohio, and San Antonio, Texas, are possible western candidates.

North of the US border, Canadian low-fares carrier WestJet will soon announce the transborder routes it will operate from October, says Mark Hill, vice-president strategic planning at the carrier. Its focus will be on leisure and sun destinations such as Florida, California, Hawaii and the US desert regions. The transborder market was estimated to be worth some $4 billion in 2002, almost as much as the $4.5 billion Canadian domestic market.

By the end of this year, WestJet will be operating a fleet of 54 Boeing 737s, and could reach as many as 94 by 2008 if it exercises all of its 737 options.

Network briefs

Network Planning Forum

On the eve of the Network event, Airline Business, in partnership with OAG, launched the the concept of the Network Planning Forum - designed as a platform for airline route planners to come together and discuss common key themes. Details of how this mainly US-based group will work are being finalised, but an early target is to campaign for airports and communities to better understand the airline planning process. Any airline planner interested in finding out more should contact:

Santo Domingo nets JetBlue

On the opening day of Network, JetBlue Airways announced its first service to the Dominican Republic, building on a contact made at the event two years earlier. Daily services from New York to Santo Domingo and twice-daily to Santiago will now be launched in mid-June, alongside another Caribbean route to Aguadilla in Puerto Rico. The first contact for the Santo Domingo route came at Network in 2002. The keynote speaker for that event was JetBlue chief David Neeleman. After speaking, Neeleman rushed to make his connection back to New York. As Neeleman walked for the exit, Santo Domingo airport commercial director Ken Hassard pursued him to push the virtues of his airport. Contact with Delta Air Lines was also made at the same event resulting in new service.

Positive Latin groove

Although more than a third of his member airlines are in "technical bankruptcy", Alex de Gunten, executive director of the International Association of Latin American Airlines, said that there is significant growth ahead for the region. Other characteristics of the region are strong competition from US carriers, and more co-operation and consolidation between Latin carriers.

Flyblu's Florida launch

A new participant in Network was UK-based start-up Flyblu, aiming to begin flights from Birmingham in the UK to Florida in June. It will operate Boeing 767-300s with a premium economy-style service to Orlando Sanford, Fort Lauderdale and St Petersburg.


Source: Airline Business