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The future of US regional airlines: big changes imminent

17-Dec-2009

A small, seemingly inconsequential, press release touting a new partnership between AirTran and SkyWest, which operates as Delta Connection and United Express, was published recently. While most would view it as just another code-sharing relationship, the two airlines describe it as a "ground-breaking partnership". It aims to fortify AirTran’s Milwaukee territory, now that Southwest has entered the market and Midwest Airlines is on the road to recovery, thanks to its acquisition and reorganisation by SkyWest rival Republic Airways Holdings (RJET).

This is the first in a series by Kathryn B. Creedy of the changing airline business models resulting from the recession and inherent changes within the global airline industry.

The airlines have secured a new marketing partnership to operate five 50-seat Bombardier CRJ200 aircraft between Milwaukee’s General Mitchell International Airport and six destinations. That means that the five aircraft, shed from either Delta or United’s network, are now back not only competing with the majors but to making money for the company rather than continuing to be a drag on the books.

While retaining profitability, regionals have been hit hard by the recession as their major partners shed not only mainline, but regional, capacity to cut costs. Regionals have been cut below their major/regional contract minima. That has left many hundreds of 50-seat jets lying fallow. It is doubtful that much of this capacity will be restored as the economy improves. It matters little whether it is or not, however. The regionals cannot wait out the recovery, they must find new ways to grow and put their jets back in the skies if they are to maintain their legendary profitability.

SkyWest, which had grown becoming a Midwest Connection in one of the first LCC/regional relationship, suffered its loss with the deterioration of Midwest Airlines. For AirTran, SkyWest Airlines will offer new nonstop service from Milwaukee to Akron/Canton, Ohio; Des Moines, Iowa; and Omaha, Neb.; and will add frequency from Milwaukee to Indianapolis, Ind.; Pittsburgh, Pa.; and St. Louis, Mo. SkyWest Airlines launched its first flights carrying the AirTran Airways’ code from Milwaukee to Pittsburgh and St. Louis, recently abandoned by American Airlines, on December 4.

SkyWest’s regional jet service between Milwaukee and six destinations will be sold in conjunction with AirTran jet service with revenue shared on a pro-rated basis. The aircraft will be placed into service in between December 2009 and February 2010. Interestingly, unlike its major partner contracts, SkyWest Airlines will control local availability, authorization levels and use of all seat inventory for the aircraft used by AirTran. SkyWest Airlines will assume fuel cost and will maintain all revenue and pricing responsibility for these routes.

“Under this new partnership, SkyWest’s Milwaukee passengers will have flights to more destinations with all the benefits of AirTran’s vast route network and A+ Rewards program,” said SkyWest Airlines President and COO Chip Childs.

“This unique partnership and expanded service is an exciting next step for our Milwaukee focus city,” said Kevin Healy, senior vice president, marketing and planning, AirTran Airways. “We are delighted to make new and interesting destinations available to our customers and now offer more choices than ever to, from, and through Milwaukee to the rest of the country.”

Milwaukee as a battle ground is not surprising since it has been the focus of an AirTran/Midwest struggle for a few years now. Air Tran entered Midwest’s home turf and later tried to acquire the Milwaukee-based carrier. Its efforts were stymied by a Northwest/TPG acquisition of Midwest. RJET came to Midwest’s rescue, first lending it money, then acquiring the carrier, absorbing it into its holding company, adding it to its stable of Republic Airlines, Shuttle America, Chautauqua and, most recently, Frontier Airlines.

The SkyWest/Air Tran deal is pivotal since competition in the city now includes new service by Southwest, against Republic/Midwest/Frontier and Delta/Northwest. It must feel good to be a Milwaukeean. Just think of the fare wars. For airlines, however, it inevitably means losses as noted by Republic CEO Bryan Bedford when he outlined his strategy for consolidating Frontier and Midwest.

What this all means

In the past decade, regional networks have grown at least 10% as they replaced mainline service in the post-9/11 period under very lucrative contracts with their major partners which saw 8%+ operating marginss. Majors were lucky to eek out a 3% margin even in the best of times.

The Regional Airline Association (RAA) reports regionals carry one in four domestic passengers and account for more than half of all U.S. departures. Through their regionals, majors capture the feed from nearly every airport with scheduled service while only serving a handful of hub airports themselves, significantly reducing costs. Indeed, the only way to make money on many of these routes was for mainline carriers to abandon them in favor of their regional partners.

Still, that did not mean profitability for their major partners, which, collectively, have lost $4.4 billion in the last year compared to a $785 million profit for the top 20 regionals who serve the vast majority of regional passengers. It also means that regionals are the only service to 442 airports, or 70%, of the 500 airports With U.S. with scheduled service.

The two airlines are right that it is groundbreaking in that it signals a new trend in how regional airlines are transforming themselves in the post-recession environment. The deal means that tentative moves by low-cost carriers (LCCs) to partner with regionals to increase ridership and grow their networks have become a full-blown reality.

Regional/LCC partnerships are not new but have been largely unsuccessful in the past. It was tried by Frontier first with Alaska Airlines subsidiary Horizon Airlines which was replaced by Republic before Frontier launched its own regional with Lynx Airlines.

Part of this new trend includes RJET’s acquisition of Midwest Airlines and Frontier Airlines. RJET immediately switched out Midwest’s Boeing 717 aircraft for lower-cost Embraer ERJ 190 jets substituting its own lower-cost crews to operate the Midwest routes after furloughing all of Midwest’s higher-cost pilots. Its strategy for Frontier continues to unfold and it remains to be seen whether these new relationships will be successful. However, if the JetBlue/Cape Air relationship, which has become a successful, growing partnership, is any guide, the prospects look good, albeit risky for some of the contenders.

New regional prospects for growth

The SkyWest/AirTran move also means that regionals, long overly dependent on their major carrier partners, are finding new clients for what they call their production (flying aircraft for others) at a time when their profitable relationships with the majors are changing – and not for the better.

Who cares? Wall Street cares because regional carriers have been consistently raking in profits while their major carrier partners swim in read ink. Regional carriers have remained profitable in all business cycles while their partners roll with the steady drumbeat of failure as the business cycle ebbs and flows.

Like SkyWest, Republic Airways Holdings (RJET) is always on Wall Street’s radar screens, as a consistently profitable carrier. As their fortunes declined with the recession, Wall Street analysts expressed concern about how they will grow their businesses as their major partner’s contracted. For SkyWest it was finding a new partner in Midwest which did not work out. For RJET it was acquiring brands – Midwest and, most recently, Frontier, in its empire building and putting its lower-cost stamp on the end product.

What has become known as the legacy carriers – those in business before deregulation – the likes of Delta, American, Continental, United and US Airways come to mind – have never had a business model that makes money. Yes, there are good times when they actually managed profitability, the exception not the rule, but that profitability is soon overwhelmed by the losses that come in the down cycles.

For the first time, we now have a crop of CEOs and CFOs that hail from the financial side of the business, breaking from the traditional practice of plucking CEOs from the operational ranks. With their laser focus on the financial side, they are very mindful of their dismal track record and are  actively seeking a new business model that will help them not only gain profitability, but sustained profitability in both down and up cycles. Part of that evolving business model is transferring its code-sharing practices to international networks in the growing number of alliances that are developing worldwide. The top three are Star Alliance, SkyTeam and oneworld.

Who else cares?

Medium-sized communities also care. The new LCC/regional partnerships may mean that communities that have lost air service in the latest recession may have an opportunity to regain or grow vital air service once these new LCC/regional airline relationships solidify and the economy recovers. Given the fact that LCCs have successfully tapped these abandoned or underserved markets in the past, their relationships with the regionals can go after these second-tier markets using the regionals that have even lower costs that the low-cost carriers.

The LCC/regional airline relationship also puts a new dynamic in play. It remains to be seen what the regionals’ legacy partners will do about this. Given the legacy’s expectations that regionals must take on more risk sharing in the next iteration of their code-sharing partnerships, they may not be able to dictate whether or not regionals can compete with them. Partnership exclusivity in which regionals were not allowed to partner with anyone else, a major part of early contracts, has eroded over the last decade with the changing marketplace so it is largely gone now anyway.

Moves by SkyWest Airlines Inc and Republic Airways Holdings are just a small part of the changing airline landscape. Coupled with other changes afoot with majors, low-cost carriers and regionals and the growing role of business aviation, the industry will likely look far different than it does today and that will be a very, very good thing.

Kathryn Creedy is a veteran aviation journalist with 30 years experience in covering commercial and business aviation. She contributes to CAPA's America Airline Daily publication.


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