Flying on Thin Numbers

This week, Mesa Air Group released figures regarding go!’s performance during June. The Hawaii startup airline brought in approximately $1700 on each flight, needed about $2000 a flight to break even, and filled 82% of its seats. Go!’s competitors have been counting passengers on the new airline and claim that 75% of seats filled is a more accurate figure. In any event, we can distill some important data from these numbers. Go! brought in about $41 a seat in June and needs to bring in about $50 a seat if it fills 80% of its seats. If you believe the competitor’s figure of planes flying 75% full, the break-even ticket price rises to $53. This is an important concept to grasp, that as the planes fly less full, the break-even fare rises.

Mesa’s CEO went so far as to say that if go! can maintain the same load factors (percentage of seats filled) when it introduces larger jets next year, it will be breaking even. This is a taller order than it sounds. Let’s take a look.

Presently, go! provides about 8% of the interisland seats. Its expansion plans to larger jets would result in a nearly 300% addition to its current service, and this move would increase the total number of interisland seats by about 24%. How go! plans to keep its current load factor after flooding the market with airline seats remains a mystery.

Now, consider the effect of the high-speed ferry service which is coming next year. Let’s say the ferry captures 10% of inter-island traffic, not a particularly tough number to imagine. You therefore see a 10% drop in air passengers on inter-island routes, and a corresponding drop in percentage of seats filled. By the end of 2007, if you consider the effect of seats added to the market by go! and by the ferry, you could see inter-island jets flying with 60% load factors instead of the present 82%. This glut of seats would be devastating to all competitors.

We have witnessed a shrinking interisland market for several years now. The trend is likely to continue, but a fare war and good economic times may give us a temporary reprieve. Can we expect the same level of flying throughout this year that we’ve witnessed in June? Hardly. Summer is prime tourist season, and June was the first opportunity for islanders to take advantage of $19 and $39 fares. The $19 fares are gone now and some of the pent-up demand has dissipated with it. The rest of the year will provide more challenges for all three airlines.

Here in Hawaii, we’ve seen one other example of a startup airline introducing a large number of airline seats to the interisland market during a time of no growth. This was during the 1990s when Mahalo Airlines challenged Hawaiian and Aloha Airlines. The results were not surprising. Mahalo brought in several ATR-42 turboprops and took losses. Over a period of five years it tried high fares, low fares, and everything in between, but nothing brought profits. Eventually Mahalo folded its wings.

Hawaii’s interisland market is small enough so that additional seats provided by a new entrant become a major obstacle for that same competitor to ever achieve profitability. In other words, the seats added by the new entrant lower the load factors far enough so that the break-even fare climbs out of reach. If the airline raises fares, load-factor drops, and the break-even point remains elusive.

Go!’s expansion plans only make sense if Aloha or Hawaiian Airlines vanish from the interisland market. Otherwise, we’re looking at a market flooded with empty seats by the end of 2007 and lots of red ink to be shared by all three airlines.

Understanding Go!

Don’t try to figure out Hawaii’s newest interisland airline by examining that company under a microscope. To understand go!, you need to broaden your view and study its parent company, Mesa Air Group. That task completed, go!’s role becomes evident.

Mesa began as a regional airline in 1982, but at some point the business evolved into a less glamorous but considerably more profitable enterprise. It began providing regional aircraft, crews, and maintenance to large airlines such as Delta, United, and America West. The idea is that the big airlines sell the seats under their own names to take advantage of their marketing clout, but Mesa provides its services, taking advantage of a lower cost structure. The big airlines end up absorbing most of the risks: fuel price fluctuations, fare decisions, competition, etc. Mesa charges for its services by the flight-hour. Some 98% of its revenues last year came from agreements with such code-sharing partners.

What you need to realize is that Mesa Air Group provides services that it customers could perform for themselves. Accordingly, negotiations become a huge part of Mesa’s operation. It must keep aircraft leases and employee costs low enough so that it can tack on a profit and still offer these items at a price that is attractive to the big airlines. It needs to gain every advantage possible to convince big airlines to continue the agreements at suitable price points. Mesa sinks or swims according to the success of its negotiations.

Come 9/11, the U.S. airline industry went into a tailspin, losing more than $23 billion and not showing real signs of recovery until this past year. Such a dreadful business environment actually worked in Mesa’s favor. With demand for aircraft and personnel at a low, Mesa succeeded in keeping its costs comfortably below the rates it charges other airlines. As many airlines now show battle-damage from the past five years, Mesa is riding high. It has acquired several other regional airlines, expects a profit of $100 million this year, and it has access to nearly $300 million in cash.

All is not smooth flying at Mesa, however. The big airlines have extracted significant cost savings from their employees, to the tune of 30% and higher. These giants are now more capable of profitably operating 100-seat aircraft themselves. They also have laid-off employees wanting to get back to work. Mesa has a tougher job ahead when it comes to negotiating sweet deals with the big airlines. On the labor front, the Air Line Pilots Association now represents Mesa pilots, and there’s pressure to raise pay rates on Mesa’s property. While it’s new Hawaii airline go! may eventually turn a profit, in the short run go! addresses Mesa’s needs in the negotiations department.

Take its negotiations with big airlines, for instance. Mesa Air Group’s announcement to begin interisland service came within hours of Aloha’s announcement that it had chosen other partners with which to exit Chapter 11. This timing indicates that Mesa was some type of player in Aloha’s bankruptcy dealings. If Mesa could enter the Hawaii market and prevail over Aloha, this action would serve notice to other airlines that there are consequences to turning Mesa down. The ability to recover from a failed negotiation by entering that market and eventually dominating it would give Mesa an ace up its sleeve in future negotiations. Notice that Hawaii’s newest airline go! has a name which can be used anywhere in the country. Perhaps what we’re seeing here in Hawaii is Mesa’s blueprint for dealing with unsuccessful negotiations it might encounter on the mainland as well. This may be the reason why Mesa is announcing a massive increase in go!’s capacity well before it has had time to properly assess whether such an expansion will be profitable.

Go!’s arrival in Hawaii also addresses Mesa’s cost side of the equation. When negotiations for a new pilot contract begin again, Mesa will want to have as many pilots as possible in the “don’t rock the boat” frame of mind. To do this, Mesa needs to show its pilots that life is pretty good at the airline even without significant pay increases. Keep in mind that a second year copilot on a 50-seat regional jet makes only about $2300 a month. For a pilot with a 4-year college degree plus years spent gaining flight credentials and experience, this is a tough pill to swallow. Mesa wants its copilots to see plenty of expansion ahead and look beyond the dismal pay at the prospects for upgrading to captain. Captains make more than double what the copilots make, and the experience gained in the left seat of a regional jet makes a Mesa captain quite marketable with major airlines once they start hiring again. Also, many pilots like the idea of flying from Hawaii, and this is yet another reason not to rock the boat.

What happens if Mesa stops growing? There will be upward pressure on pilot wages because advancement will be greatly slowed, and the copilots become interested in making a livable wage if they’re going to spend a substantial amount of time in that position. An increase in wages decreases Mesa’s ability to cut a deal with larger airlines, and the whole business model is threatened. The “young airline growing quickly” honeymoon is a phenomenon we’ve seen before at many airlines, and once it’s over the employees demand higher wages. In the case of Mesa, higher wages present a greater than normal threat to the company’s ability to flourish.

So, if you want to understand go!, realize that it is a subsidiary of a company that’s all about cutting the deal. Mesa realizes nearly all of its revenues selling the components of airline travel to airlines. That’s a tricky business and the parent company may make decisions which are inconsistent with your expectations about a startup airline. The interactions between go!, Hawaiian, and Aloha Airlines are sure to be anything but dull.

The Predatory Skies

To call an airline “predatory” is a bold accusation. Nonetheless, it’s difficult to reach any other conclusion regarding Hawaii’s newest interisland airline, go!. The actions of this newcomer don’t tell the whole story. One must also consider the timing of those actions.

First, let’s look at go!’s announcement to enter the interisland market. It came while Aloha Airlines was involved in delicate negotiations with potential investors aiming to bring the airline out of Chapter 11. This timing was, of course, more than coincidence. Go! took on the job of spoiler, the villain intent on scaring away investors and then profiting from Aloha’s demise. The tactic didn’t work, and Aloha’s financial backing came through anyway. Go! chose to make good on its threat and it entered the market quickly thereafter.

Next, consider the $45 fares ($39 plus fees and taxes) which go! has brought to the interisland market. Airline analysts agree that neither go! nor its competitors can break even with such low fares. It is reasonable for a new entrant to come into a market with a low fare to capture the media’s attention and build a customer base. At some point, however, the airline needs to move on and make a profit. Go!’s insistence that these low fares remain is an indication that a prolonged period of losses will plague Hawaii’s interisland carriers.

Go!’s announced plans to acquire 8-12 large (90 seats or more) jets for the Hawaii market is noteworthy for a couple reasons. First, the startup airline has only been in business for a month and a half during the busiest tourist season, giving it no real opportunity to properly assess the potential for profitability. Second, go!’s announcement came just a few days after Israel’s invasion of Lebanon. Why in the world would an airline announce a major investment in aircraft immediately after news that unsettles financial markets and drives oil to new highs? The answer can only be that the purpose of the announcement was to undermine one or more of its competitors.

Keep in mind that Hawaii’s interisland market has been shrinking for years now. The reasons are obvious. Airlines have increased direct flights to neighbor islands and thereby eliminated many connection flights. Medical and shopping facilities on neighbor islands now eliminate many needed trips to Honolulu. As for Oahu residents taking vacations on other islands, island hotel room rates exceeding $200 a night put the kibosh on many such plans, even if air fares are reasonable. With low airfares to the mainland, a week in Las Vegas is noticeably less expensive than a week on Maui. Why then is go! planning to add an enormous number of seats to the interisland market? Such a plan only makes sense if at least one of its competitors is eliminated, and go! appears hell-bent on making this happen. Stay tuned.

What’s Different This Time Around?

A subsidiary of Mesa Airlines named go! has entered interisland competition against Hawaiian and Aloha Airlines. Can we expect a replay of past conflicts with would-be third carriers? Certainly there will be similarities. All newcomers announce their arrival with a stunning fare war. A few days before the new airline begins operations, it’s not uncommon for a brief super-far war to take place. Mahalo offered $10 fares to ensure that its planes had plenty of passengers on them for the media coverage and for minimizing losses during the first month of service. Go! used a $19 fare for the same purpose but was trumped by Aloha’s surprise free-ticket giveaway.

Nonetheless, what lies before Hawaiian and Aloha is a battle like they’ve never before encountered. For one thing, go!’s parent company Mesa is the first mainland company to enter the market. The interisland market is a minor percentage of the parent company’s overall operation, and Mesa has over $300 million at its disposal. Thus, Hawaiian and Aloha will need to outmaneuver Go!-- they cannot depend upon a war of attrition.

Probably the greatest difference between go! and previous contenders is the aim of the newcomer. Go! has taken a predatory stance right from the start. More so than any conflict that Hawaii’s long-standing interisland airlines have faced before, this is a battle for survival. This doesn’t mean that Mesa will be willing to spend $300 million to capture a place in the market. It means that Hawaiian and Aloha must convince the decision makers at Mesa that the cost of entering this market exceeds the benefit. This is a challenge which will test the resolve and resourcefulness of Hawaii's longstanding airlines.

Previous Interisland Air Wars

Hawaii’s two longtime interisland carriers, Hawaiian and Aloha Airlines, have battled startup air carriers before. Each skirmish brought unique lessons.

A renegade airline named Skybus challenged Hawaiian and Aloha Airlines during the summer of 1963 by employing a single, tired DC-4 transport. The plane was a flying dinosaur by the standards of the day, but it’s owner, a longtime pilot named Walton Wood, proved that islanders would fly on just about anything if it was big and the price was right. A combined effort of the FAA and CAB clipped the wings of Skybus.

When Mid Pacific Air became airborne in 1981, the two incumbent airlines gave in and allowed the newcomer to enjoy a $5 price advantage after a bruising fare war brought standby ticket prices as low as $10.95. It was a huge mistake. Mid Pacific climbed into the catbird’s seat and expanded at will. As Aloha’s Maury Myers later explained, “You can match the competitor’s price cuts and lose money, or you can resist the cuts and lose even more money.” Mid Pacific was finally brought under control after Aloha and Hawaiian matched fares and found other methods of leveling the playing field.

Discovery Airways rekindled the air war in 1991with four-engined BAe146 jets. This time, the startup met its end when Aloha and Hawaiian discovered that a majority of the new airline’s ownership belonged to a foreigner. Laws prohibited such an arrangement, and the battle was won by attorneys and political pressure. Never again would this defense be ignored.

In 1993, Robert Iwamoto (of Roberts Hawaii) and other investors brought Mahalo Airlines into existence. Although its ATR-42 turboprops were efficient, they couldn’t provide the speed and aura of safety that jet aircraft offered. Aloha and Hawaiian matched Mahalo’s ticket prices, and eventually won a slow war of attrition. If the competition offered a less attractive plane again, the incumbent carriers knew how to neutralize the threat.

During challenges by third carriers, the established interisland airlines tightened their belts and devised creative tactics in order to survive. Quick-thinking management and a healthy relationship between management and labor is essential for each established airline to maximize its chances of surviving the ordeal.