The Boyd Group
Aviation Consulting & Forecasting
Aviation Insight & Perspectives
http://www.aviationplanning.com/
Hot Flash - July 5, 2004
United: Where From Here?
Now that the ATSB has finally closed the door on United for a loan
guarantee, the lemming-section of the media over the past week has
been casting lots to determine just where United will be cutting
service, selling off assets, and generally taking a knife to itself.
The Issue Is Cost v Revenue. Not Big v Small. Here's a concept that
many aviation reporters have missed: Who says that United will need to
significantly downsize to survive? Somehow, we can't find that extra
Commandment anywhere in all the stuff that Moses brought down from
Mount Sinai.
True, the airline is losing money, even after huge reductions in labor
costs, and cram-downs on many of its aircraft leases. True, United
needs to get costs down further. True, oil prices have spiked United's
fuel bill up by a reported $750 million. As a result, the usual
suspects in the media are speculating what United will sell-off,
close, or discontinue. This is because the assumption is that a cost
problem is solved by just getting smaller. Here's some news: the
cost/revenue equation is not necessarily fixed by downsizing.
No, They Don't Need To Match Southwest CASM. The contention that
United needs to get costs down further is completely correct. But to
survive, it's got to do a lot more. It must re-focus on the
extraordinary strengths United has in the areas of market position and
brand-equity. This is where the airline's real future lies, not in
just cost-cutting.
A common - and inaccurate - belief is that UA must have Southwest CASM
to survive. Wrong. Instead it must have a cost/revenue equation that
produces numbers that aren't in brackets at the bottom of the P&L.
What these compare-it-to-Southwest people miss is that United is a
different airline from Southwest or JetBlue, or AirTran. Different
route system, different revenue mix, and a different part of the air
transportation system.
If CASM alone were the Source Perrier of airline success, the skies
today would be black with airplanes operated by Vanguard, Pacific
Express, Northeastern, American International, Western Pacific,
Eastwind, Air South, and a whole gaggle of other Southwest wannabes.
They're gone, not because of cost issues, but revenue issues. Like,
they didn't have any. (And don't buy into the canard that the big guys
killed them off - that's mostly trendy lore.) The reason they went
glub-glub was because they had zero - or less - brand loyalty.
Brand loyalty, truth be known, is one of United's most potent
strengths.
Here's an airline with outstanding operational stats. On-time
performance. Schedule reliability. Employees that when dealing with
passengers display an attitude that some other airlines can't even get
close to. Customer service that is arguably among the best and most
professional in the industry. A route system that makes some sense,
including a fifth-freedom hub at Tokyo that's in the right place at
the right time to take advantage of what will be huge traffic growth
into China.
Conclusion: Yes, United needs to get their costs down. But they also
need to focus on their core strengths, which are excellence in product
delivery, and a strong brand identity. These are things absent from
United's loopy cartoon-style ads. It's also counter to the Ted concept
as well, which simply muddies the United brand. (We could also mention
the daily Martian Fire Drill, a.k.a the UAX operation on Concourse F
at O'Hare, which has raised the concept of total confusion to an art
form. But that can be easily fixed if somebody in the head office
would bother.)
Time For An Executive Search, Too. And that brings up the issue of
leadership. Maybe it's time to re-populate the front offices. To be
fair, running an airline, especially one in United's position, isn't
easy. Despite politically-correct populist rhetoric, nobody in their
right mind would take these top jobs unless the compensation, either
upfront or on the near-term come line, was in the respectable
seven-digit range. These people may go home at night, but the job
comes along with them.
But that much said, the executive track record so far at United is not
encouraging. United's employees have certainly come to the
save-the-airline dance party. But there's an open question whether the
trio at the top are in attendance. Despite some aggressively-placed
sunshine stories about the CEO in recent weeks, the fact is that the
whole plan at the top seems to have revolved around cutting labor
costs, re-negotiating aircraft leases, passing off a paint job (Ted)
as a low-cost carrier, and finally, financing it with a
government-guaranteed loan.
What's missing? The customer has been left out of the equation.
United's management has oozed out buzz-terms like "compelling
customer/value proposition" and "reconstituting margins" and "pressure
testing routes" and other unintelligible utterings that are telltale
signs that they don't really have a clue.
Meanwhile, take a look at how United is posturing itself to the
customer. Ads that look more like an attempt to win a Cleo award than
get passengers on airplanes, with the tag line, "it's time to fly."
But nothing suggests why United should be the choice, except the
inference that they fly to a lot of places. Big deal, so does
Aeroflot. And the funky stuff with this Ted concept is clear evidence
that United's top executives have wandered way off into the planning
swamp. It's time to tell the customer why they should fly United
instead of the competition. In short, strategically, United is
drifting.
This is in spite of the presence of phalanxes of Tiffany-priced
"advisors" reportedly working for the airline. In one case, news
stories indicated that the airline was spending a million bucks a
month for advice on how to re-structure the United Express system.
Whether that's still the case or not, it begs the question: who's
running the store?
Likely: More Requests For Labor Give-Backs. And, Downsizing. The fact
remains that even with huge employee concessions, United isn't making
any money. That means something has to give. Add to that the track
record in the executive offices, which seems to be more show than go
when it comes to hard forward strategy, and the media pundits will
probably be proven right. Downsizing may well be the new non-strategy.
Maybe the Tokyo operation goes on the block. Maybe some additional
Heathrow slots will be put up for auction. Maybe there will be demands
to let small jet providers take over more of the United route system.
Maybe a lot of things. But if the revenues drop as fast as the cuts,
the result is simply a downsized Titanic. Maybe.
And that's just the crux of the United problem. It seems when it comes
to forward-thinking strategy, everything's a "maybe."
================
The Seat Excess Is Real. The Solution Isn't So Obvious.
The Over-Capacity Myth
Well, it's not really a myth. There clearly is over-capacity in the
industry. It's obvious - just look at all those seats chasing too few
passengers, most of which aren't willing to pay what it costs to carry
them.
But the oft-mentioned "solution" - i.e., let a couple of legacy
carriers go bust, is a myth, because that wouldn't do diddly to
engender an environment that would be yield-friendly. The reason is
simple - it wouldn't do much to reduce capacity in the biggest
markets.
Counter To Ambient Thinking. But, We Think, Accurate. We'll be
covering this in detail at our Annual Forecast Conference in October,
but we thought we'd note a couple of highlights.
The Boyd Group has run a number of airline-failure scenarios through
our traffic demand model. What we've found, a la Economics 101, is
that capital and assets chase the highest and best returns. In
virtually every reasonable scenario, when the dust settles, the
following is the general competitive picture:
Reductions In Major Markets Would Be Flow-Driven. Take Philadelphia,
for example. If US Airways failed, the top twenty PHL O&D markets
would merely see shifting of market shares. The loss of the US Airways
capacity in such markets that was being subsidized by contributory hub
flows would tend to represent a temporary reduction in capacity. But
at PHL such flow traffic is relatively limited, and the remaining
capacity in the top 20 markets would likely still represent levels
that make yield increases very difficult.
Mid-Size & Small Markets Would Take The Hit. The "incremental
contribution model" - also known in cocktail party repartee as the
hub-and-spoke system - is based on the feed that can be generated from
many cities, including relatively small ones, into the hub.
Here's a flash: the loss of, say, United or US Airways, would result
in capacity being reduced in mid-size and smaller markets which are
supported and made economically viable by the power of the connecting
hub operation. Simply put, without the hubbing operation, the local
O&D to the hub city is not supportable. Try the US Airways service
between Ithaca and Philadelphia. Like, there isn't enough local O&D in
that market to fill a VW Microbus. Eliminate the US Airways hub at
PHL, and, voila! - instant capacity reduction. Except it's not in the
markets where the real competition and over-capacity are.
But even strong mid-size markets will get capacity-zapped, too. The
fact is that at places like Bangor, Grand Junction, and Albany, the
majority of the O&D traffic is from markets that, each taken alone,
represent less than 1% of the airport's total. Take out a hubbing
carrier, and the "incremental" passengers from dozens of places that
make up the majority of the traffic base will find it tougher to get
to and from places like BGR.
Yes, some will say, but other carriers will pick up the slack. Sounds
good, but it ain't necessarily so. First, staying with the BGR
example, the loss of US Airways' PHL hub would eliminate the most
direct connectivity to dozens of markets in the Mid-Atlantic and in
the South. Some traffic could get re-flowed over CVG or maybe DTW, but
if you're heading to Orlando, that's a long way around just so the
kids can ride Dumbo. If you're coming from Savannah, intent on a
romantic lobster dinner on the Penobscot, you now have the choice of
taking the round-about scenic route, or maybe even the thrill of a
double-connection, which could kill anybody's appetite. (Good news for
the crustacean. Bad news for Bangor.)
And even here, we find another potential barrier: paradoxically, it's
capacity. See, hubbing carriers serve mid-size markets such as BGR
(and ALB, and LAN, and so on) to meet their banks. Adding additional
flights that are off-bank makes no sense. Very often, upgrading
capacity isn't an option, either. Take Northwest's pattern between
Bangor and its Detroit hub. They can upgrade from 50-seaters to
69-seat ARJs. But the airline has a limited number of these aircraft.
The capacity issue here is also affected by available fleet mix.
Between 70-seats and roughly 125 seats, there's a very real aircraft
gap, particularly when viewed in terms of sector costs.
Other Issues. Sure, some will posture that in the event of a major
airline failure, low fare carriers will jump in. They certainly will.
But only in the biggest and most competitive markets. Keep in mind
that the economics of the "low cost model" increasingly are
gravitating toward larger, not smaller, markets. (And don't fall for
the "JetBlue is getting regional jets" nonsense. The 100-seat E-190s
they've ordered are miles from being regional jets. Anybody who's seen
the E-190 prototype up close and personal, as we have, understands
this.)
Aviation Consulting & Forecasting
Aviation Insight & Perspectives
http://www.aviationplanning.com/
Hot Flash - July 5, 2004
United: Where From Here?
Now that the ATSB has finally closed the door on United for a loan
guarantee, the lemming-section of the media over the past week has
been casting lots to determine just where United will be cutting
service, selling off assets, and generally taking a knife to itself.
The Issue Is Cost v Revenue. Not Big v Small. Here's a concept that
many aviation reporters have missed: Who says that United will need to
significantly downsize to survive? Somehow, we can't find that extra
Commandment anywhere in all the stuff that Moses brought down from
Mount Sinai.
True, the airline is losing money, even after huge reductions in labor
costs, and cram-downs on many of its aircraft leases. True, United
needs to get costs down further. True, oil prices have spiked United's
fuel bill up by a reported $750 million. As a result, the usual
suspects in the media are speculating what United will sell-off,
close, or discontinue. This is because the assumption is that a cost
problem is solved by just getting smaller. Here's some news: the
cost/revenue equation is not necessarily fixed by downsizing.
No, They Don't Need To Match Southwest CASM. The contention that
United needs to get costs down further is completely correct. But to
survive, it's got to do a lot more. It must re-focus on the
extraordinary strengths United has in the areas of market position and
brand-equity. This is where the airline's real future lies, not in
just cost-cutting.
A common - and inaccurate - belief is that UA must have Southwest CASM
to survive. Wrong. Instead it must have a cost/revenue equation that
produces numbers that aren't in brackets at the bottom of the P&L.
What these compare-it-to-Southwest people miss is that United is a
different airline from Southwest or JetBlue, or AirTran. Different
route system, different revenue mix, and a different part of the air
transportation system.
If CASM alone were the Source Perrier of airline success, the skies
today would be black with airplanes operated by Vanguard, Pacific
Express, Northeastern, American International, Western Pacific,
Eastwind, Air South, and a whole gaggle of other Southwest wannabes.
They're gone, not because of cost issues, but revenue issues. Like,
they didn't have any. (And don't buy into the canard that the big guys
killed them off - that's mostly trendy lore.) The reason they went
glub-glub was because they had zero - or less - brand loyalty.
Brand loyalty, truth be known, is one of United's most potent
strengths.
Here's an airline with outstanding operational stats. On-time
performance. Schedule reliability. Employees that when dealing with
passengers display an attitude that some other airlines can't even get
close to. Customer service that is arguably among the best and most
professional in the industry. A route system that makes some sense,
including a fifth-freedom hub at Tokyo that's in the right place at
the right time to take advantage of what will be huge traffic growth
into China.
Conclusion: Yes, United needs to get their costs down. But they also
need to focus on their core strengths, which are excellence in product
delivery, and a strong brand identity. These are things absent from
United's loopy cartoon-style ads. It's also counter to the Ted concept
as well, which simply muddies the United brand. (We could also mention
the daily Martian Fire Drill, a.k.a the UAX operation on Concourse F
at O'Hare, which has raised the concept of total confusion to an art
form. But that can be easily fixed if somebody in the head office
would bother.)
Time For An Executive Search, Too. And that brings up the issue of
leadership. Maybe it's time to re-populate the front offices. To be
fair, running an airline, especially one in United's position, isn't
easy. Despite politically-correct populist rhetoric, nobody in their
right mind would take these top jobs unless the compensation, either
upfront or on the near-term come line, was in the respectable
seven-digit range. These people may go home at night, but the job
comes along with them.
But that much said, the executive track record so far at United is not
encouraging. United's employees have certainly come to the
save-the-airline dance party. But there's an open question whether the
trio at the top are in attendance. Despite some aggressively-placed
sunshine stories about the CEO in recent weeks, the fact is that the
whole plan at the top seems to have revolved around cutting labor
costs, re-negotiating aircraft leases, passing off a paint job (Ted)
as a low-cost carrier, and finally, financing it with a
government-guaranteed loan.
What's missing? The customer has been left out of the equation.
United's management has oozed out buzz-terms like "compelling
customer/value proposition" and "reconstituting margins" and "pressure
testing routes" and other unintelligible utterings that are telltale
signs that they don't really have a clue.
Meanwhile, take a look at how United is posturing itself to the
customer. Ads that look more like an attempt to win a Cleo award than
get passengers on airplanes, with the tag line, "it's time to fly."
But nothing suggests why United should be the choice, except the
inference that they fly to a lot of places. Big deal, so does
Aeroflot. And the funky stuff with this Ted concept is clear evidence
that United's top executives have wandered way off into the planning
swamp. It's time to tell the customer why they should fly United
instead of the competition. In short, strategically, United is
drifting.
This is in spite of the presence of phalanxes of Tiffany-priced
"advisors" reportedly working for the airline. In one case, news
stories indicated that the airline was spending a million bucks a
month for advice on how to re-structure the United Express system.
Whether that's still the case or not, it begs the question: who's
running the store?
Likely: More Requests For Labor Give-Backs. And, Downsizing. The fact
remains that even with huge employee concessions, United isn't making
any money. That means something has to give. Add to that the track
record in the executive offices, which seems to be more show than go
when it comes to hard forward strategy, and the media pundits will
probably be proven right. Downsizing may well be the new non-strategy.
Maybe the Tokyo operation goes on the block. Maybe some additional
Heathrow slots will be put up for auction. Maybe there will be demands
to let small jet providers take over more of the United route system.
Maybe a lot of things. But if the revenues drop as fast as the cuts,
the result is simply a downsized Titanic. Maybe.
And that's just the crux of the United problem. It seems when it comes
to forward-thinking strategy, everything's a "maybe."
================
The Seat Excess Is Real. The Solution Isn't So Obvious.
The Over-Capacity Myth
Well, it's not really a myth. There clearly is over-capacity in the
industry. It's obvious - just look at all those seats chasing too few
passengers, most of which aren't willing to pay what it costs to carry
them.
But the oft-mentioned "solution" - i.e., let a couple of legacy
carriers go bust, is a myth, because that wouldn't do diddly to
engender an environment that would be yield-friendly. The reason is
simple - it wouldn't do much to reduce capacity in the biggest
markets.
Counter To Ambient Thinking. But, We Think, Accurate. We'll be
covering this in detail at our Annual Forecast Conference in October,
but we thought we'd note a couple of highlights.
The Boyd Group has run a number of airline-failure scenarios through
our traffic demand model. What we've found, a la Economics 101, is
that capital and assets chase the highest and best returns. In
virtually every reasonable scenario, when the dust settles, the
following is the general competitive picture:
Reductions In Major Markets Would Be Flow-Driven. Take Philadelphia,
for example. If US Airways failed, the top twenty PHL O&D markets
would merely see shifting of market shares. The loss of the US Airways
capacity in such markets that was being subsidized by contributory hub
flows would tend to represent a temporary reduction in capacity. But
at PHL such flow traffic is relatively limited, and the remaining
capacity in the top 20 markets would likely still represent levels
that make yield increases very difficult.
Mid-Size & Small Markets Would Take The Hit. The "incremental
contribution model" - also known in cocktail party repartee as the
hub-and-spoke system - is based on the feed that can be generated from
many cities, including relatively small ones, into the hub.
Here's a flash: the loss of, say, United or US Airways, would result
in capacity being reduced in mid-size and smaller markets which are
supported and made economically viable by the power of the connecting
hub operation. Simply put, without the hubbing operation, the local
O&D to the hub city is not supportable. Try the US Airways service
between Ithaca and Philadelphia. Like, there isn't enough local O&D in
that market to fill a VW Microbus. Eliminate the US Airways hub at
PHL, and, voila! - instant capacity reduction. Except it's not in the
markets where the real competition and over-capacity are.
But even strong mid-size markets will get capacity-zapped, too. The
fact is that at places like Bangor, Grand Junction, and Albany, the
majority of the O&D traffic is from markets that, each taken alone,
represent less than 1% of the airport's total. Take out a hubbing
carrier, and the "incremental" passengers from dozens of places that
make up the majority of the traffic base will find it tougher to get
to and from places like BGR.
Yes, some will say, but other carriers will pick up the slack. Sounds
good, but it ain't necessarily so. First, staying with the BGR
example, the loss of US Airways' PHL hub would eliminate the most
direct connectivity to dozens of markets in the Mid-Atlantic and in
the South. Some traffic could get re-flowed over CVG or maybe DTW, but
if you're heading to Orlando, that's a long way around just so the
kids can ride Dumbo. If you're coming from Savannah, intent on a
romantic lobster dinner on the Penobscot, you now have the choice of
taking the round-about scenic route, or maybe even the thrill of a
double-connection, which could kill anybody's appetite. (Good news for
the crustacean. Bad news for Bangor.)
And even here, we find another potential barrier: paradoxically, it's
capacity. See, hubbing carriers serve mid-size markets such as BGR
(and ALB, and LAN, and so on) to meet their banks. Adding additional
flights that are off-bank makes no sense. Very often, upgrading
capacity isn't an option, either. Take Northwest's pattern between
Bangor and its Detroit hub. They can upgrade from 50-seaters to
69-seat ARJs. But the airline has a limited number of these aircraft.
The capacity issue here is also affected by available fleet mix.
Between 70-seats and roughly 125 seats, there's a very real aircraft
gap, particularly when viewed in terms of sector costs.
Other Issues. Sure, some will posture that in the event of a major
airline failure, low fare carriers will jump in. They certainly will.
But only in the biggest and most competitive markets. Keep in mind
that the economics of the "low cost model" increasingly are
gravitating toward larger, not smaller, markets. (And don't fall for
the "JetBlue is getting regional jets" nonsense. The 100-seat E-190s
they've ordered are miles from being regional jets. Anybody who's seen
the E-190 prototype up close and personal, as we have, understands
this.)
----------------