In the post de-regulation US airline industry, the single most recognizable words to the layman traveler have to be the “Southwest Effect” (though a case could be made for “Boeing 747”).Nominally the Southwest Effect is just a name pointing out that when low cost Southwest Airlines enters a market, fares tend to drop and market volume tends to increase.
For years, the “Southwest Effect” has been an incredible marketing tool – the term was used so widely that to the average customer the name Southwest Airlines was inextricably linked with low fares. Government antitrust action, most recently as seen in the Delta-US Airways slot swap, was specifically designed to favor Southwest Airlines with the Southwest Effect in mind.
But since the end of the global financial crisis in 2009, the Southwest Effect has increasingly lost sway. Once a no-frills, low-cost carrier focused exclusively on point to point (p2p) flights for leisure travelers, Southwest has evolved into a network carrier with large connecting complexes in several key US cities.
Its fares have rapidly risen to match those of legacy airlines like United and American, and its focus has shifted towards providing a competitive product for business travelers. And the traveling public is increasingly taking notice. USA Today ran an article in February of this year entitled, “Has the ‘Southwest Effect’ run its course?”
It is our view that it has – replaced by a new phenomenon that we’re calling the “Spirit Effect,” caused by the entry of Fort Lauderdale based Spirit Airlines into competitive markets.**
*Southwest Effect No Longer Valid?
*
The term “Southwest Effect” was first coined by Randall D. Bennett and James M. Craun in a paper they wrote for the US Department of Transportation’s Office of Aviation Analysis. The authors cited several intra-California routes such as Oakland to Ontario to prove the drop in fares and increase in volume.
Over the years, much additional research was published covering the Southwest Effect. In particular, research from Austan Goolsbee and Chad Syverson in 2004 concluded that Southwest need not provide nonstop service for a route to drive down fares, as existing carriers will adjust their pricing pre-emptively in response to Southwest:
…incumbents do indeed react to the threat of Southwest’s entry before actual entry takes place. Incumbents drop fares significantly in anticipation of entry. This is not simply due to airport-specific cost shocks because fares drop on threatened routes relative to incumbents’ fares on other routes from the same airports. The fare declines are accompanied by a sizable increase in the number of passengers flying the incumbents’ threatened routes. Southwest's 2004 route map, showing their route network at the time of the study. Note the lack of major congested airports in the Northeast, and the lack of any service at all to Denver, now one of the airline's largest hubs.
Even as recently as 2010, research by Jan K. Brueckner, Darin Lee, and Ethan Singer found that entry by Southwest into a market had a significant effect on fares:
Several broad conclusions emerge from the empirical analysis. First, the impact of LCC competition is dramatic. The presence of in-market, nonstop LCC competition reduces fares by as much as 34 percent in the nonstop markets, and adjacent LCC competition in these markets reduces fares by as much as 19 percent. The strongest effects come from Southwest, which is usually separated from other LCCs in the regressions.
Even the federal government cited the Southwest Effect as an important tool shaping its policy in recent years. Recent testimony by the US Government Accountability Office (GAO) before Congress on the competitive effects of the American/US Airways merger included the following statement:
Congressional action and DOT policy in subsequent years, especially in the award of operating rights called “slots” at congested airports like Washington Reagan and New York LaGuardia, favored new entrant airlines like Southwest. Similarly, DOJ cited the relinquishment of 36 slots by Continental to Southwest at Newark Liberty International Airport as alleviating its principle concerns in determining not to object to the United–Continental merger in 2010.
But it is our view that the Southwest Effect no longer holds water. The USA Today article noted that when Southwest Airlines entered the Atlanta market by virtue of its merger with LCC AirTran Airways, local consumers expected expansion and a large drop in fares. In fact, fares in the competitive Atlanta market stayed mostly flat, and Southwest Airlines pared back the once robust AirTran hub in Atlanta by nearly 20%.
This holds with the general pattern for Southwest Airlines over the past few years. Southwest Airlines may still have relatively low (but rapidly rising) costs, but it is no longer a low fare carrier. From a unit revenue perspective, Southwest actually had the third highest fares out of any US airline, with passenger revenue per available seat mile (PRASM) of 12.05 cents, higher than that of legacy carriers such as United, Alaska Airlines, and US Airways. The chart below shows Southwest’s fares in 2012 as compared to other US network carriers.
The death of the Southwest Effect is a direct result of the airline’s slow strategic evolution over the past decade. From its inception until roughly 2000, Southwest Airlines pursued a path of aggressive p2p expansion. From its Texas roots, Southwest expanded throughout the nation, gaining an especially strong foothold in the short haul markets of the Western United States. The expansion pattern followed by Southwest in each of its new markets was similar. It would enter a major US market with a minimum of 10 daily flights to several nonstop destinations, offer extremely low fares to stimulate demand and capture market share, and slowly add p2p flights as its name brand grew in the market.
Low costs were maintained through a relentless focus on productivity (the famed 20 minute turnarounds between deplaning and boarding at an airport), as well as continuous expansion, which allowed Southwest to spread its relatively stable fixed costs over an increasing number of available seat miles (ASMs). Southwest operated flights into a mix of large airports with little operational pressure (such as Phoenix and Las Vegas), as well as alternate airports in metro areas where the primary airports suffered from congestion and delays (think Manchester/Providence in metro Boston, and Islip for NYC). This was intended to preserve Southwest’s legendary on time performance and productivity, and had the ancillary benefit of naturally forcing Southwest to keep fares low as consumers usually pay a premium for flights from primary airports.
The low fares continued throughout the early 2000s as did the growth, but the underlying factor had changed.
Throughout the 80s and 90s, Southwest had signed a succession of ever more lucrative contracts with its workers, trading off labor peace for increased costs over time.
Certainly this strategy was and remains a major factor in the legendary relationship between management and labor at Southwest.
Southwest front-line employees are the happiest of those at any major airline, which helps drive their passion for quirky and superior service. But by the early 2000s Southwest’s workforce and fleet of 737-300 jets was aging driving up non-fuel costs. But Southwest was able to shrug off these increased fuel costs thanks to a series of smart fuel hedges it placed in the late 1990s. These hedges, made when oil was dirt-cheap in the late 1990s, meant that Southwest had by far the lowest fuel costs in the nation, keeping its overall unit costs low. So Southwest continued its explosive growth through the first part of the decade.
But around 2006, the strategy shifted. Southwest’s fuel hedges had expired, meaning that their costs rapidly rose to converge with those of legacy carriers (helped on the other end by the legacy carriers entering Chapter 11 bankruptcy and shedding costly labor contracts and defined benefit pension plans). It also ran out of “low hanging fruit” from a growth perspective. By and large, the markets that could handle Southwest service under the existing model were being served: every major US market that wasn’t a mid-size legacy stronghold (e.g. Cincinnati, Salt Lake City, Memphis) or a congested primary airport (Washington Reagan, Newark, et. al). Southwest quickly realized that it had to improve revenues, or risk massive losses. And so began a shift in business strategy that is probably one of the best kept secrets in the airline world; Southwest became a network carrier.
It started with entrance into the sort of congested markets it had previously avoided; Boston, New York La Guardia, and Philadelphia were quickly added, and Southwest created large new focus cities in Philadelphia and Denver. This of course had an adverse impact on its cost structure by affecting productivity, causing it to continually chase higher and higher revenue. As it was ushered into competitive airports like Washington Reagan and Newark via federal antitrust action, Southwest quietly began moving its product away from the p2p leisure markets. It built large connecting complexes at airports like Chicago Midway and Baltimore Washington; today more than 40% of passengers carried by Southwest are connecting – a far cry from days past.
As business travel became more important to Southwest, the airline began quietly to move away from its no-frills identity; a new, enhanced Rapid Rewards frequent flyer program, as well as an enhanced BusinessSelect product were used to lure travelers. Investments were made into in flight entertainment and connectivity (IFEC) – Southwest became one of the first flights to expand into offering wi-fi, and recently began offering passengers 15 free channels of Dish Network satellite TV streamed over WiFi. For a carrier that once prided itself on being no-frills, Southwest has certainly added many a frill over the last five years, and its little wonder that the Southwest Effect (at least on base fares) has all but died out.
A Southwest spokesperson responded to our analysis with the following:
To discount the relationship today between Southwest and low fares is akin to discounting the relationship between freedom and democracy. You can’t have one without the other. We are a low fare airline, but we haven’t forgotten that we’re in the customer service business. We offer lower fares than the legacy airlines; better customer service than all airlines; and more value and friendlier policies than the ultra low fare airlines…. Once you factor in the variety of fees the other airlines charge, you’ll come to one conclusion: More often than not, Southwest fares are the lowest, especially when customers check a bag. A recent survey of O&D data that shows actual final flown average fares in a market shows that industry average fares are almost are far less in markets served by Southwest (nonstop or connecting service) than in markets without any Southwest service, proving that the Southwest Effect is still alive and well.
This is not to say that Southwest’s evolution hasn’t benefited travelers. As legacy carriers shrunk away from mid-sized markets to consolidate at larger hubs, Southwest stepped up to fill a profitable void. In markets like St. Louis, Austin, Nashville, Oakland, Milwaukee, Kansas City, and the like; Southwest ensures that business travelers have access to a much wider portfolio of convenient nonstop destinations than they would otherwise. This has helped stimulate and retain businesses for such communities. Southwest still provides an excellent on-board product that retains much of the quirky individuality it has had for the past 40-plus years. And in a somewhat ironic twist; Southwest offers perhaps the least unbundled economy class product in the sky today.
A Southwest spokesperson added the following:
It’s true we are evolving our business to adapt to the changing landscape—flying longer routes as short-haul travel is diminishing significantly, and we’re equipping Southwest to fly internationally. We’ve revamped our Rapid Reward program to reward Customers based on how much they spend with us; we’re bringing onboard larger planes (Boeing 737 -800) that are better equipped for longer flights and near-international destinations; and we’re integrating with AirTran to grow profitably at a time when we otherwise couldn’t and bring on new, key markets (ATL, DCA, international). But at the end of the day, we still hang our hat on low fares, legendary customer service, and a convenient flight schedule—just as we always have.
Southwest is a highly successful airline with a well thought out strategy and excellent future ahead of it. But its role has evolved from that of an upstart low cost carrier stimulating markets with low fares, to that of a thoughtful network carrier focused on growing connectivity and revenues. It is our view that the Southwest Effect, in so far as it affects base fares, has been all but eliminated; and market stimulation, where it still persists, has been dampened significantly.
*Enter Spirit Airlines*
Fort Lauderdale based Spirit Airlines traces its origins back to the Clipper Trucking Company, a Michigan corporation founded in 1964. Its airline service began in 1983 in Macomb County, Michigan as Charter One, a charter tour operator that provided travel packages to leisure destinations like Atlantic City and Las Vegas. In 1990, the airline began scheduled services between Atlantic City and Boston and Providence.
On 29^th, May 1992, Charter One added McDonnell Douglas MD-80 jet equipment to the fleet and changed its name to Spirit Airlines, adding scheduled service to Detroit. Over the course of the 1990s, Spirit continued to expand out of Detroit in the vein of Sun Country Airlines at Minneapolis, adding service to leisure destinations like Fort Lauderdale, Myrtle Beach, New York, West Palm Beach, Orlando, Tampa, Fort Myers, and Los Angeles. Fort Lauderdale in particular, became a key focus city for Spirit, and the airline re-located its headquarters to nearby Miramar, Florida in 1999.
By the early 2000s, Spirit had evolved into a dual focus city strategy in Detroit and Fort Lauderdale, adding service to Las Vegas, Washington – Reagan, Denver, and San Juan. It inaugurated its first international service to Santo Domingo in 2004 and slowly shifted strategy yet again; turning into a hybrid low cost carrier (LCC) focused on connecting Fort Lauderdale and the Caribbean. Between 2005 and 2007, Spirit added service to the Bahamas, Jamaica, the US Virgin Islands, Haiti, Aruba, and Saint Maarten.
Spirit’s growth really took off, however, in 2007 when the carrier decided to shift its business model to the ultra low cost carrier (ULCC) model pioneered by Ryanair in Europe.
Spirit first brought its ULCC business model to the large and price-sensitive market between South Florida and Latin America, adding service between 2008 and 2013 to Colombia, Peru, Panama, Nicaragua, Guatemala, El Salvador, Costa Rica, and Jamaica.
Coincident with its shift to an ULCC business model, Spirit retired the 14 frame strong MD-80 fleet that had been its fleet’s backbone since 1992, centering on the Airbus A320 family of aircraft as replacement; operating 3 of the 4 variants in the family (all except the Airbus A318).
After testing its ULCC model in Latin America, Spirit began taking the ULCC model nationwide into the domestic US market. Unlike fellow ULCC Allegiant Air, Spirit began to expand aggressively into major airports such as Chicago O’Hare and Dallas Fort-Worth. Since its domestic expansion period began in 2011, Spirit has jumped onto several heavily trafficked, high-fare city pairs such as Dallas Fort Worth – Boston, Chicago-Minneapolis, and Las Vegas Portland. In each of these markets, Spirit is the lowest fare offering by far.
Spirit’s pricing model relies on offering these extremely low base fares – separating out things like fees and taxes; both directly, and through innovations such as the so-called $9 fare club, a variation on the frequent traveler loyalty programs offered by most other airlines. Research has shown that customer psychology when purchasing airline tickets is primarily driven by advertised fares. The DOT forced a slight shift in Spirit’s business model when it began requiring airlines to advertise so-called “all-in” pricing, combining base fares with all fees. Even so, Spirit still offers extremely low base fares, because so much of its product is unbundled.
Turning to Spirit’s route network, the following is Spirit’s most recently published route map, showing the coast-coast expansion pursued by the carrier.
Turning to a focus city by focus city view, Fort Lauderdale remains the largest operation, with 59 peak day departures. The operation in Fort Lauderdale is still heavily focused heavily on connectivity with Latin America, and is Spirit’s only true connecting complex.
Meanwhile, Dallas-Fort Worth, of all places, has rapidly risen up to become Spirit’s second largest operation, with 33 peak day departures, despite only receiving its first flight in 2011. Taking advantage of the immense difference between American Airlines’ premium product and higher costs, as well as rising fares and the constraints of the Wright Amendment at Southwest, Spirit has quickly built up a strong O&D p2p operation in Dallas, focused on providing an alternative to full service carriers on business traffic heavy routes like DFW – Atlanta.
Its next two largest operations are in Chicago O’Hare and Las Vegas, both of which are focused, like Dallas-Fort Worth, on providing tail end service in markets dominated by network carriers focused on business traffic.
And Spirit does still maintain a large presence in its traditional strongholds of Detroit, Atlantic City, and Myrtle Beach (it is the only carrier serving ACY, and the largest carrier in Myrtle Beach), though Detroit has been de-emphasized relative to some of the newer focus cities in the network.
Spirit Airlines is now a major player in the US aviation market. It carried more than 10.4 million passengers in 2012, with a fleet that now includes 50 Airbus A320 family jet aircraft (29 A319s, 19 A320s, and 2 A321s) with 135 more on order (7 A319s, 53 A320s, 45 A320neos, and 30 A321s). It services 52 destinations in 18 countries spread across North America, South America, Central America, and the Caribbean, and much of this scale has been achieved in the last 3 years. Since the start of 2011, Spirit has added new nonstop service on 63 different city pairs, adding 581 new weekly flights or the equivalent of 83 extra flights each day. It now operates more than 280 flights per day, and has taken delivery of 15 Airbus A320s over the timeframe mentioned above.
From a financial perspective, Spirit is remarkably successful as well. In 2012, Spirit reported record operating revenue of $1.32 billion, up 23.1% year over year. Its net profit was $103.2 million, for a superb 9.1% net margin, and operating margin of 9.7%, and an industry leading return on invested capital (ROIC) of 26.%. And these figures were artificially deflated by the adverse impact of Hurricane Sandy and the resultant disruption.
In many of the new markets started after 2011, empirically, Spirit appears to play the same role that Southwest once did; stimulating the market and driving down fares, both directly, and by forcing competitors to match its base pricing.
*Is There A Spirit Effect?*
Our table (see the full thing here) displays every new route started by Spirit between the first quarter of 2011 (when the current strategic shift began) and the third quarter of 2012 (the last quarter with average fare and market size data available from the Department of Transportation is the 4^th quarter of 2012).
For the 44 markets that fit the criteria (63-65 new daily flights), we measured market size and average yield for the first full quarter after the date of inauguration, as well as the same period for the year prior (e.g. for a route that started in the 3^rd quarter of 2011 we collected the market data for the 4^th quarters of 2010 and 2011).
We then compared these two metrics year over year. The following tables display the aggregate results sorted first by the reduction in fares, and then by increase in market size.
Out of all the markets surveyed, Portland to Las Vegas perhaps best exemplifies the non-existence of the former Southwest Effect, and the current stimulating role played by Spirit Airlines, a.k.a the Spirit Effect. Prior to Spirit’s entry into the market on September 22^nd, 2011 with two flights per day, Portland-Las Vegas was dominated by Southwest. In the 4^th quarter of 2010, the market was 1096 passengers per day in each direction (PDEW), with an average fare of $151.97, translating to a yield (average fare/distance – basically a way of comparing fares for flights of different lengths) of 19.9 cents.
Southwest’s average fare and yield were $150.51 and 19.8 cents respectively, almost exactly the same as the market average. The days of Southwest offering disruptive lower fares to stimulate local markets are over; nowadays Southwest is a network carrier that prices at the same level as its legacy competitors; it controlled 48.4% of the market. Spirit on the other hand, is a disruptor.
In the 4^th quarter of 2011, the first full quarter after Spirit’s entry into the market, the average fare on Portland-Las Vegas plummeted 20.1% to $121.40 and a yield of 15.9 cents. The market had grown over 32.3% to 1451 passengers PDEW, and Spirit held 16.7% of the market and the average fare its customers paid was $82.71 for a yield of 10.8 cents. Spirit’s business model of offering low base fares and charging extra for each and every additional service not only stimulated the market by generating new passengers, but by pulling down fares for every player in the market. In Q4 2011, Southwest still controlled 40.5% of the market. But its average fare was just $123.33, for a yield of 16.2 cents. While non ULCC competitors don’t necessarily have to match Spirit’s pricing in a given market, they do have to lower fares to some degree in order to maintain competitiveness in terms of overall cost of travel with Spirit.
Spirit’s effect on pricing is somewhat diluted in larger business markets. The passenger mix on Portland-Las Vegas skews towards leisure travelers, who are more price sensitive. In larger business markets, there are more inelastic passengers (passengers who will still purchase tickets despite price increases), who value the legacy product more, partly because of the extra bundled services, but more because of the frequent flyer benefits, network strength and connectivity, and schedules. Taking a look at such a market, Spirit added double daily (up to thrice daily seasonally) flights between Dallas Fort Worth and Chicago O’Hare on August 18^th, 2011. Even in business heavy markets like Chicago – Dallas/Ft. Worth, Spirit still has a significant effect.
In the 4^th quarter of 2010, the market was measured at 2789 passengers PDEW with an average fare of $217.39 and yields of 27.1 cents. The largest carrier in the market, American Airlines, who has a hub on both ends of the route, held a 67.4% of the market, and charged an average fare and yield of $223.99 and 27.9 cents. In the first full quarter following Spirit’s entry, average fares declined 13.3% to $188.95 (yield – 23.6 cents) and the market grew by 21.9% to 3399 passengers PDEW. Spirit held 11.3% of the market, and charged an average fare of $85.91, yields of 10.7 cents. Now once again, the other players in the market didn’t drop all the way to match Spirit, American Airlines was still the market leader with 63.4% of the market and average fare and yield of $197.68 and 24.6 cents. Even in a business market, other airlines are forced to reduce prices in order to keep Spirit Airlines at bay.
The following chart shows the top 10 new Spirit markets by market stimulation:
And the following chart summarizes the top 10 new Spirit markets by reduction in fares.
Of the 44 markets, 3 were smaller than 10 passengers PDEW before Spirit’s entry, so for these markets only a lower bound for the percentage market stimulation (i.e. the minimum amount that the market size could have grown post-Spirit) was calculated with percentage change in yields marked as N/A. For the 41 remaining markets, the average market grew 20% after Spirit’s entry, with fares falling on average 8.3%. Now clearly there is a high degree of variability in the survey, change in market sized varied from -16.1% on the low side to 360.9% on the high side while change in fares varied from 17.6% to -47%. And we’d like to survey more markets (especially those added in the 4^th quarter of 2012 and beyond) to get a more robust statistical sample.
However, the list contains a wide variety of market sizes from 79 to 10,209 passengers PDEW. Additionally, the median change in market size was 7.8% and the median change in fares was -7.9%. And we performed a statistical test of significance on the change in market size and yield data, which told us that the true mean change in yield and market size were close to the median figures. So we can conclude that based on statistical evidence from 2011-12, the “Spirit Effect” of lower fares and market stimulation does in fact exist. The figures are especially telling given that the average fare paid by US consumers actually increased 5.2% from the 1^st quarter of 2011 to the 4^th quarter of 2012. Spirit is an important force in driving down base fares for US domestic markets.
*Analysis And Implications*
The ULCC business model utilized by Spirit is predicated on unbundling the airline ticket purchase. Passengers pay a base fare that guarantees them a seat on the flight. Everything else, things like online check in, printed boarded passes, and checked baggage require passengers to pay an additional fee. As Spirit CEO Ben Baldanza put it in an interview with Peter Greenberg:
We think of it as creating more ‘optionality’ for customers… What we do is we strip out all of the things that can be a decision point for the customer — like whether you take bags or not, or if you want to pick where you sit on the plane, or whether you’re going to eat on the plane or not.
And when asked whether Spirit was a no-frills airline, he said:
Sometimes we get called a no-frills airline. That’s wrong. We’re a very high-frills airline. We just charge incrementally for each of the frills. And the advantage of that to the consumer is they pay for what they care about and they save on what they don’t use. So they only pay for what they want.
As an example, Spirit still offers a premium seating option, called “Big Front Seats” ($12-$200 depending on when purchased) at the front of its aircraft for an extra fee; perhaps because the airline operates several long, red-eye overnight flights to Latin America on which customers are willing to pay for the additional comfort (and better sleep).
An overview of Spirit’s unbundled product offering can be found in the info-graphic below.
All of these excess non-ticket revenues mean that the final out-of-pocket cost of traveling on Spirit Airlines is much closer to that when traveling on legacy carriers. Spirit’s total PRASM of 11.62 cents is actually quite similar to that off the network carriers.
The business model is also heavily reliant on Spirit’s low costs; which are driven through a relentless focus on productivity and keeping costs low. Their reduced seat pitch allows for more seats in the same amount of space (driving down cost per available seat mile, or unit costs). Their non-unionized workforce is young, so labor and benefit costs are low, and on a per available seat mile (ASM) basis, they have the fewest number of employees – thus the highest productivity. This focus on cost-cutting employs even the most mundane of strategies; at Spirit’s headquarters in Miramar, there is no janitorial staff; the employees take out the trash themselves. And all of these savings add up; Spirit has the lowest unit costs in the industry at 10.02 cents; lower even, than fellow ULCCs Allegiant Air and Frontier Airlines.
Analyst Henry Harteveldt of Hudson Crossing had this to say about Spirit’s business model:
The business model has proven to be a smart one for Spirit, because it has helped Spirit earn substantial profits on a sustained basis. I won’t be surprised to see this model expand into other airlines, though I believe we will see airlines adjust their “go to market” execution of the model to be appropriate for their brands and relevant to the types of customers they serve.
On the flip side, Spirit Airlines does not necessarily rate well from a customer perspective; it has had trouble winning repeat business from customers who discover that they dislike the unbundled product with its myriad fees. Part of the success of the Southwest Effect was driven by the repeat business won by Southwest’s exemplary service; it remains to be seen whether Spirit can win the repeat business necessary to give the Spirit Effect long term staying power.
To this effect, Spirit CEO Ben Baldanza has been very outspoken in admitting that Spirit is “not for everyone.” He was quoted in the same Greenberg interview as saying:
At Spirit, we are an airline that is focused first on the lowest-price way to get from A to B. So we’ve built our airline so we can have the lowest possible prices. And with that, we want to have an on-time flight, a really friendly travel experience, but at the lowest price possible, and to that end, we sort of create an option versus what the rest of the industry’s doing.
He compares his airline to McDonalds in the restaurant industry.
You don’t go into McDonald’s and act surprised when you don’t see filet mignon on the menu at McDonald’s, right? You go in and you know what you’re getting–a clean restaurant, good service, a fair price…. You’ve got it all over the map. But consumers do better when they have choices at multiple price points. You’re wearing a very nice watch, right? You can go by a $29 Timex. You can spend tens of thousand dollars on a watch if you want. And at Spirit, we create a choice that without us wouldn’t be there. A number of our customers we think– or we should say we know, wouldn’t even be able to afford their travel if we didn’t fly in the market.
The Dallas-Fort Worth – Chicago O’hare market in particular provides an interesting case study as to the sustainability of the Spirit Effect. In the past, legacy carriers would typically respond to a new entrant competitor by dropping fares to unsustainably low levels temporarily to kill off the competitor, before raising fares back to normal levels. The post-deregulation US airline market is littered with examples of such examples of predatory pricing through smart usage of revenue management systems; most notably Continental nearly killing off People Express at Newark in the 1980s (before, ironically, merging with them in 1986), Northwest Airlines with its so-called “Heartland Strategy” in the Midwest, and American Airlines actually re-configuring a small sub-fleet of Fokker F100s with 56 seats just to kill off upstart Legend Airlines – who had bypassed the Wright Amendment and started operations throughout the US with a fleet of 56 seat Douglas DC 9s.
Southwest was largely able to get around this (and still does to some degree), by operating from secondary airports in many major cities (Chicago Midway vs. O’Hare, Houston Hobby vs. Bush Intercontinental, Oakland vs. San Francisco, and Dallas Love vs. Dallas Ft. Worth; to name just a few). But what Spirit has done, armed with a sizable cost advantage (its CASM, at 10.02 cents, is lower than that of every major legacy by anywhere from 3.23 [US Airways] to 4.24 [American] cents), is come into these major airports and offer a product that is so distinct and different from that of the legacy carriers, that the legacy carriers no longer drop their fares so low as to kill off Spirit’s service; only low enough to ensure that their own planes remain full. This strategy of serving major airports (with limited exceptions like Latrobe for Pittsburgh, or Phoenix Mesa for Sky Harbor) contrasts with that of other ULCCs like Allegiant Air and Frontier Airlines, who still largely operate un-competed with from secondary and tertiary airports.
Harteveldt had this to say about Spirit’s effect on markets:
As we’ve seen since the advent of deregulation, the entrance of a low-fare airline can often contribute to lower prices becoming more widely available. Some airlines match Spirit’s fares, usually on a flight-specific basis, and always subject to capacity controls. Delta created a unique fare and product that it offered between its Detroit hub and a few cities in Florida where the airline competed against Spirit.
Spirit is certainly not the first airline to try a ULCC business model. People Express Airlines in the 1980s and Skybus in the early 2000s both tried the model, and failed. People Express in particular, was an investor and industry darling, but if fell afoul of legacy carriers thanks to over-expansion, and as sophisticated revenue management systems emerged at the legacies, fell into abject unprofitability. Spirit has pursued a more sustainable and distributed growth strategy (so-far avoiding the ire of a legacy carrier at its hub) and has a much more significant product gulf with the legacy carriers. Skybus on the other hand, suffered from poor choice in focus cities; small markets like Columbus and Greensboro didn’t offer enough demand to fill their planes, and when fuel spiked in 2007-8, Skybus collapsed. During the same period, Spirit was still profitable. As Baldanza pointed out in the Greenberg interview:
When oil went to $147 in 2008, we still made money. In 2008, our CFO at the time used to joke that we outperformed the industry by $10.1 billion. Because the industry lost $10 billion and we made $0.1 [billion].
However, it is also important to point out that another factor in People Express’ demise was that it grew too quickly and collapsed under its own weight operationally. And there is some evidence that Spirit may be suffering from operational pressure due to too much growth. According to FlightStats.com, Spirit’s on time performance for June was just 43.47%, with 38.6% of those flights being categorized as excessively delayed. By comparison, its nearest competitor, ULCC Allegiant, had an on time performance of 71.63% for the month, and the airline with the next greatest percentage of excessively delayed flights was regional provider GoJet, at 20.12%. Spirit has to grow thoughtfully, or it risks turning off passengers due to operational unreliability.
So does any of this change the existence of the Spirit Effect?
No. As we mentioned above, customer ticket purchasing behavior (for leisure and VFR, visiting family and relatives traffic) is driven primarily but the up-front price, not by total out of pocket travel cost. Other airlines know this, and as we showed above, are forced to bring down their prices in response to Spirit’s advertised prices. In most of those large markets, Spirit controls 10-15% of the market, and yet is responsible for driving down the base fare charged by every player in the market. So the unbundled product does not negate the overall “Spirit Effect”
The implications of this conclusion are profound. A major usage lies in federal antitrust action. For example, in order to gain DOT and Federal Aviation Administration (FAA) approval for their merger, American and US Airways will likely be forced to divest a portion of their slots at Washington’s Reagan National Airport, where they will hold a dominant market share post-merger. The DOT’s conventional wisdom would hold that the divestment should be allotted to Southwest Airlines. However, as we have shown, the divested slots should instead be allocated to Spirit and its ULCC peers like Allegiant and Frontier – airlines who will truly stimulate demand and drive down fares for consumers.
Note: Spirit Airlines was offered an opportunity to comment on this story and did not respond at press-time.
*SEE ALSO: Tour The Gulfstream G650, The Best Private Jet $65 Million Can Buy*
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Reported by Business Insider 4 hours ago.