Build It and They Will Come?

Go!, the Hawaii subsidiary of Mesa Airlines, plans to introduce up to a dozen large jets into the interisland market next year. The ten million dollar question is where will passengers come to fill the jets and allow a profit?

A CEO or marketing expert needs to know the relationship between the price of his product and consumer demand for it. In some cases, there’s not much change in demand as prices fluctuate. For example, ticket prices on the last flight off an island before a hurricane strikes are not likely to have much an effect upon the demand for that service. On the opposite extreme, if one airline offers tickets at a lower price than its competitors, that airline is likely to see a very significant increase in demand for its product.

Now, let’s look specifically at air travel. Underpricing your competition is not a realistic strategy because the competition is almost certain to match fares. Therefore, we need to instead look at the overall increase in demand for air travel on a route as fares decrease. The low-fare airline is counting on two mechanisms to increase available customers: generating more total travel on that route, and pulling traffic away from other forms of transportation. Southwest Airlines is renowned for increasing demand when it enters a market. Unfortunately, an airline is heading for trouble if its decision-makers expect a similar response to low prices here in Hawaii.

The answer to this disparity in consumer response is quite simple: nobody is currently driving their car from Honolulu to Maui. An interisland carrier cannot use the same strategy that works for Southwest on the mainland because there are no drivers to convert to air passengers. In fact, we’re likely to see just the opposite effect next summer as the high-speed ferry converts some flyers to travelers who bring their Dodge Neon along on the Maui trip.

Thus, an airline must generate more total travel on a route to fill up more of its seats, and this strategy has severe limitations. Hotel rooms priced at $200 a night put a damper on travel even if the interisland fares were $1 a ticket, and your auntie on Kauai will lose enthusiasm if you show up at her dinner table too often.

Go!’s CEO Jonathan Ornstein is quoted in news articles as saying that his airline could be profitable if its load factors and fares remain constant once it introduces its new jets. Unfortunately, the arrival of the new planes will increase the number of interisland seats by some 24%, and we can expect load factors to plunge accordingly. Can we realistically expect to see the fares and load factors of June throughout the year once a massive number of seats have been added to the interisland market? No way, not even close. Losses on interisland routes will be huge if this massive addition of seats ever takes place.

The Battle Ahead

So, how are we likely to see the inter-island airline battle shape up? Two months of competition give us a pretty good clue.

Of all the previous startups that took on Hawaiian and Aloha, the current battle most closely resembles the conflict brought about by Mahalo Airlines. The main reason for this parallel is that both Mahalo and go! entered the inter-island market during years of negative or slim growth in the market. In order to be competitive, the startup airline must offer a substantial number of flights to each destination. Therein lies the rub, for by expanding the number of seats in the market, load factors for all inter-island carriers drop and profits become difficult to achieve. Go! advertised heavily in June and offered fares as low as $19. These fares were matched by the competition and brought in enough extra travelers so that in June go! filled 82% of its seats and the other carriers flew with heavy loads as well.

Come July, some of the novelty of the new airline dissipated and go!’s load factor fell to 73%. With such loads, go! needs to bring in about $55 for each ticket sold in order to break even (it averaged about $41 per ticket in June). Keep in mind that this $55 figure does not include taxes and other fees tacked onto tickets. When these additional fees are considered, a customer must pay go! over $60 a ticket on average for go! to break even with a 73% load factor, and it’s hard to generate much excitement at such a price point.

Go!’s response was to offer a brief $29 fare sale. This tactic will help raise its load factor, but its average income per ticket falls. We once again see a repeat of the Mahalo years: efforts to raise ticket prices to profitable levels cause load factors to drop off, and efforts to raise load factors through fare wars cause the average ticket price to fall short of what’s necessary. It’s a frustrating seesaw for an airline trying to break into the market, and these are the robust summer months. Things get leaner once September arrives.

To remedy this seesaw effect, go! proposes to introduce 8-12 larger regional jets into the inter-island market by late 2007. The larger jets provide better economy per seat/mile, but they also greatly expand the number of empty seats flying between islands. The net result is that go! and its competitors fall even farther away from profits compared to the current competition.

In order to come up with a combination of load factor and income that prevents losses, go! must find some way to fill a higher percentage of its seats than the competition. Such a feat is not easily accomplished. Let’s look at particulars…

Aircraft- The advantage here goes to Aloha and Hawaiian. Both fly jets with plenty of room for luggage and decent seat-space for each passenger. Go!’s 50-passenger regional jets fall significantly short in both areas. Larger 90 or 110 seat regional jets would be an improvement over the 50 seaters, but the new jets still would not provide an equivalent experience to Boeing 717s and 737s.

Service- Likely a draw. With its smaller jets, go! may indeed get the baggage to the customers faster. Is this enough? Both Aloha and Hawaiian are operating reliable airlines at the present time. Hawaiian holds the nation’s on-time record for more than 30 months in a row, and Aloha recently received accolades for the lowest complaint record in the country. These are tough airlines to out-serve.

Mileage Programs- Aloha and Hawaiian lead here. Aloha has teamed up with First Hawaiian Bank on a VISA card which provides Aloha miles, and Hawaiian has a similar agreement with Bank of Hawaii. The incumbent airlines hold an advantage here because participants would rather fly for free on credit card miles than buy a ticket.

Contracts- Wild card. Will go! capture a significant number of inter-island contracts with large travel groups? This scenario is unlikely until after spring of 2007, due to litigation filed by Hawaiian Airlines which has the potential to halt go!’s service for a prolonged period of time. Most observers believe it is not a frivolous lawsuit and has a chance of success. Travel companies do not like to take chances with such matters.

Price- A dead end. As go! offers more cheap tickets, so do its competitors. The overall increase in traveler does not make up for the decrease in revenue per ticket sold.

So, how can go! succeed in profitably penetrating Hawaii’s inter-island market? It’s primarily a matter of staking its claim to become heir-apparent to a piece of the market should one of the incumbent carriers falter. Go! then helps these competitors falter by carrying on a prolonged interisland fare war.

The inter-island competition really depends upon the overall health of each company. Keep in mind that go!’s parent company Mesa Airlines makes the vast majority of its income from contracts with other airlines rather than from airline operations itself. If fuel prices go through the ceiling, if a Hawaii-to-the-mainland fare war erupts, or if passengers travel less because of a terrorism disaster, Hawaiian and Aloha take a significant hit, but Mesa does not. These are scenarios in which go! stands the greatest chance of replacing one of Hawaii’s traditional carriers.

Similarly, Mesa has its vulnerabilities. Its profits may fall well short of the projected $100 million this year due to problems with a Delta Airlines deal and other surprises. As profits drop at Mesa, the stockholders become less tolerant of a Hawaii subsidiary which shows no promise for profits anytime soon. To understand this interisland battle, you need to keep your eyes on the broader health of the parent companies. This is a war of attrition.

How is the battle likely to change over time? Previous interisland startups found their best success early on, as consumers equate inexpensive tickets with that startup company. Over time, the consumers become accustomed to all interisland airlines offering the same low fares, and that link lessens. The consumer is then likely to choose the airline he prefers to fly on, rather than the airline which brought the fare wars in the first place.

If the startup airline threatens to bring financial ruin to one of the traditional airlines, expect to see the target airline’s labor groups jump into the fray. Airline management is positively pleasant to deal with compared to the barbs that labor can throw. Most likely, you would see the pilots of a traditional airline buy newspaper space pointing out the downside of flying on a startup airline. The startup pays less for pilots and can operate less expensively for this reason, but what are the costs? Since traditional airlines pay double the startup’s captain’s wages and more than triple the copilot wages, we can expect that the startup’s crewmembers will be far less experienced than crews at the traditional airlines since the startup airline is used by many pilots as an experience-building transitory job, rather than as a career. Pilots of the traditional airline will emphasize this difference in experience levels and the implications towards flight safety. They're also not shy about bringing up issues such as near accidents, Mesa's flight cancellation rate on the mainland, and Mesa's mainland ticket pricing. Labor is a tough customer to deal with.

In conclusion, when a startup airline enters the interisland market during times when the market is not growing, its arrival creates a surplus of seats in the market, which leads to lower load factors and losses for all parties. These lower load factors can temporarily be addressed through deep fare wars, but the dismal income from each ticket sold does not allow profits. The game becomes one of displacing an incumbent airline, rather than peaceful coexistence. Don’t underestimate the staying power of the incumbent airlines. This is a life-or-death struggle for them, and they’re not likely to go away quickly.