United Airlines has declared war on twice-bankrupt Spirit Airlines adding 15 new destinations to drive them out of markets, including the famous infamous route they used to fly – Newark to Columbia, South Carolina, the route that turned out to be a payoff to the former Chairman of the Port Authority of New York New Jersey who was convicted of accepting flights as a bribe (United’s former CEO Jeff Smisek was forced out in the scandal).

United’s CEO Says Spirit Is Going Out Of Business “Because I’m Good At Math”

CEO Scott Kirby has long maintained that the ultra-low cost carrier business is not sustainable. He said that when they were the most profitable airlines. So now that Spirit is in Chapter 22 and Frontier is underperforming, he’s having a moment.

Kirby tells The Airline Observer‘s Brian Sumers (well worth the subscription) that Spirit is toast – going out of business.

I asked him what really will happen next at Spirit, and he was very clear. “Off the cliff they go,” he said. I responded by citing Spirit’s turnaround plan, asking Kirby why he was so sure. “Because I’m good at math,” he said.

As for United’s announced routes into Spirit markets? “We’re not trying to bully them or do anything mean,” he said. “We don’t think they’re going to be flying by then, so we waited until after they would not be flying anymore to add the seats.” Put another way, based on new route timing, Kirby expects Spirit to be out of business by end of the year.

United Says They Won’t Pick Spirit’s Bones

Spirit still has assets: an order book of new Airbus narrowbody aircraft, gates and slots at congested airports, and a Fort Lauderdale operation. If Spirit goes out of business, Kirby predicts,

“I think Florida is going to be a bit of a bloodbath,” he said. “There’s going to be at least three airlines trying to establish a No. 1 position in Fort Lauderdale.”

He confirms what I wrote last year, that United wanted a Florida hub, but says that United wouldn’t be a buyer of assets. I’m skeptical – I wouldn’t be surprised to see him go after Spirit gates in Fort Lauderdale.

“We don’t engage in battles where we have the losing hand.” During the pandemic, he asked a team to evaluate new possible hubs where United might expand once he accepts the hundreds of airplanes it has on order and fills out the schedule at its existing hubs. He said the team looked at Fort Lauderdale. (He declined to name the other options some of which, presumably, remain possible.)

“The problem with Fort Lauderdale is: not enough gates and not enough runways,” he said. “You need at least, probably, 35 or 40 gates to make a South Florida hub work. There’s not enough there. We looked at that [and said], ‘oh, that would be cool.’ But then you go look [again] and say, ‘well, it wouldn’t work.’“

Kirby told me he expects United will remain on the sidelines and not bid on Spirit’s assets.

Saying he couldn’t build a Fort Lauderdale hub without Spirit assets is not the same thing as saying he wouldn’t buy their assets – I read him as actually saying he wouldn’t go full throttle into Fort Lauderdale without those.

Here’s Why Low Cost Carriers Are Struggling

The low cost carriers have faced several headwinds:

• They’ve become less low cost. They pay the same for fuel as everyone else. Labor has gotten more expensive.

• Consumer preferences have skewed more premium. They haven’t had the products people have wanted to buy. Even where they’ve been able to sell their seats, it’s been at a discount, while other airlines have earned a premium.

• People have wanted to travel abroad. Where low cost carriers do international, it’s to Mexico, Caribbean, and close-in Latin America.

• They also don’t earn loyalty revenue to the same degree. And it’s loyalty revenue that supports United’s margins and American’s and Delta’s also (even though American is barely profitable).

  In 2017 Kirby spelled out his thesis that the airline schedules drive credit card profitability, and this is why he was re-banking hubs and improving domestic connectivity to gain more relevance in each local market. Kirby explained how he thinks re-banking hubs helps sell credit cards. If schedules don’t work for a passenger, the credit card is off the table. So United has spent the past 8 years optimizing for this.

In addiiton to these factors, Kirby has offered that government airports and government-run air traffic control are too inefficient and create problems for the low cost model. They prevent efficient operations, drive up costs, and erode the cost advantage.

Airport costs in major cities are high. But that’s not the only high cost of flying in the Northeast. Congested airports mean greater taxi time, and congested airspace also means that flights take longer. You cannot operate as many flights with an aircraft in the Northeast as you can a similar-distance route elsewhere in the country, and you can’t turn planes around on the ground as fast either.

How Major Airlines Fought Back Against Their More Profitable Small Rivals

Kirby has been arguing that low cost airlines can’t compete successfully since before the pandemic. At the time they were doing better than his United was. So in fairness, this is a belief he’s held for awhile. And now they aren’t doing as well. Some of that is major carriers getting better at competition. Some of that is a shift in consumer preferences and wage inflation driven by the pandemic (that he couldn’t really have predicted in 2019).

But the biggest claim Kirby makes today is that major airlines figured out how to compete with low cost carriers – their hero is ‘basic economy’. When they used to match price, their high fare customers would just pay the lower prices. Now they offer stripped down experiences at the lower price, segmenting customers so that high fare customers keep paying those high fares while they fill empty seats at those low fares offered by the discounters.

This is not a new idea! In fact, it’s the current manifestation of 14-day advance purchase tickets and Saturday night stays. And that really is an idea that dates back at least 40 years to American Airlines.

Prior to deregulation the Civil Aeronautics Board ‘experimented’ with the idea of price competition. That’s the story of how Southwest Airlines became the largest liquor distributor in Texas through fare segmentation. Faced for the first time with fares lower than their own, they segmented customers: matching $13 fares between Dallas and Houston offered by major competitors, while continuing to sell $26 flights to expense account business travelers who would be able to take home a bottle of booze from the flight.

In 1977, American Airlines introduced the Super Saver fare. Initially on New York – California routes, it was expanded across their domestic route network in 1978 and the airline introduced ‘Ultimate Super Saver’ in 1985, discounting up to 70% to compete against new lower cost carriers that launched after deregulation.

The American Airlines insight was that they could beat low cost carriers at their own game through revenue management. They could be a high fare business airline and a low fare airline by offering different prices to different customers. And they would use the same planes to do both. Using restrictions such as advance purchase requirements, change penalties, and Saturday night stay requirements they made cheap fares available to price sensitive travelers and still retained their margins on business customers who booked the most convenient flights at the last minute.

This gave American a competitive advantage because they had no marginal cost to run their low fare airline. Other carriers quickly copied, of course.

Copyright: boarding1now / 123RF Stock Photo

There Are Problems With Kirby’s Thesis

There are a few problems with Kirby’s model.

• There actually are profitable low cost carriers. Sun Country and Allegiant are doing just fine! Excluding the Sunseeker Resort which is finally coming off their books, Allegiant’s opreating margin last quarter was nearly 9%. Three quarters ago that hit more than 13%.

• The latest version of segmentation – basic economy erodes United’s advantages. United and other airlines were already matching fares of low cost carriers. This did not begin with the introduction of Basic Economy, which hasn’t meant lower fares for customers but rather new restrictions on the existing lowest fares.

  Basic economy fares mean giving customers less than before, eroding the product advantage that major airlines had over low cost rivals. It used to make all the sense in the world to choose a legacy airline over Frontier or Spirit at the same price because of the mileage program or advance seat assignments.

  Spirit offers better wifi and better operational reliability than United does today, but the airline has a toxic brand. Spirit has less legroom in standard coach, and no seat back TVs. So there’s still some product differentiation even with basic economy. You still get a complimentary soft drink on United flights that are long enough, and maybe a stroopwafel.

• Low cost carriers better merchandise their fees with Frontier now earning 61% of its revenue outside the fare. So Frontier, with still lower costs, can also generate more revenue at the same low fares than United can. This doesn’t work as well at United’s high cost hubs, but it does in most markets.

• Kirby’s argument isn’t recession-tested. Historically low cost carriers have done relatively better in challenging economic conditions. Customers trade down. Kirby thinks he’ll have empty seats and just match Spirit and Frontier fares. He calls them ‘spill carriers’ and says they get to keep whatever traffic he allows to ‘spill’ over to them. But he flies planes and has those empty seats in back because he’s capturing premium revenue. That premium revenue may decline in a recession, United would likely pull back capacity, and have fewer of those seats to sell too.

Will Low Cost Airlines Survive?

Ultimately much of the advantage United actually has is loyalty revenue. They have an aspirational product and global route network that tempts customers to spend on their credit card, and Spirit and Frontier cannot match it (although Frontier is adding loyalty benefits and first class seats for this reason).

At the same time, low cost carriers outgrow their low cost model. They fly a handful of routes that largely airlines ignored, or they undercut those larger airlines on price with a handful of flights on routes where they compete directly. But there are only so many unexploited opportunities and eventually they find they’ve tapped all of those as they grow. And as they age, their workforces unionize.

In order to keep growing, these same low cost carriers need to try to appeal to different customers with different products. They need a more complicated fleet to serve more markets, which means higher maintenance, training, and staffing costs. Each of these changes entails higher costs, eroding the cost advantage.

Low cost carriers need to avoid expensive, congested airports. They need a simple fleet with low maintenance costs. And the newest airlines are best-positioned to have the lowest labor costs. In Europe, they outsource cabin crews to staffing companies. And they need to aggressively merchandise. Maybe the best at this is Europe’s Volotea.