The Demise of Aloha Airlines- Part I

For all practical purposes, Hawaii’s second-largest interisland airline is dead. Rows of quiet 737 jets line the taxiway below the control tower at Honolulu International Airport, and the televised tears of once joyful employees tell the rest of the story.

Just how did such a tragic end come about? It began decades ago as Aloha Airlines lost its competitive edge over rival Hawaiian Air. Aloha President Joseph O’Gorman engineered Aloha’s most recent advantage in the marketplace by emphasizing no flight cancellations and great on-time performance. The addition of a first-class section on inter-island planes cemented Aloha’s lead. O'Gorman made a mistake, though. He brought old 737s back into the fleet and leased out the newer specimens, in an effort to combat Mid-Pacific’s low costs. One of these old jets was number 711, which lost the top of its forward fuselage in 1988 and resulted in the death of flight attendant C.B. Lansing. Aloha quickly recovered from the mishaps but carried a black eye that never completely faded.

O’Gorman’s replacement, Maury Myers, built upon O’Gorman’s tradition of quality and dependability. From the mid 1980s through the early 1990s, Aloha made more profits in the inter-island market than rival Hawaiian Air, and it often carried more passengers as well. The Myers years were good years indeed for Aloha and its employees.

Glenn Zander’s rein marked a turning point. Zander failed to recognize the importance of Aloha’s lead as the top-quality and dependable inter-island carrier. Hawaiian Airlines slowly took back the lead. Then came the turning point, Hawaiian’s introduction of new Boeing 717 jets into the inter-island market. Aloha needed to respond with a new jet as well, but it didn’t. Thus, Hawaiian gained a real advantage over rival Aloha, not from a cost standpoint, but from a revenue standpoint. Hawaiian’s plane flew with more of their seats full from this event forward.

Zander made a second mistake as well. Under his watch, Aloha was late joining the party of mainland to Hawaii flying. As other airlines started to fly directly to neighbor-island airports from the mainland, Aloha hesitated. Too soon it became clear that inter-island flying was decreasing and would continue to decrease. If Aloha wished to maintain a thriving business it needed to join the long-distance flying club. Here Zander made yet another mistake. He focused on modeling Aloha on the success of Southwest Airlines, and this model included using only one type of jet, the Boeing 737. Aloha leased 737-700 jets, which were just the right machine to fly between Orange County and Hawaii destinations, but came up short competitively on most other routes. The 737-700 only had two navigation sources for long-distance flying while the competition’s planes had three. If one navigation source became inoperative on the 737s, the airplane could not take off until it was fixed. The 737-700s were not really designed for such long flights over water, and their third source of electrical power, the APU, had to run all the time during flight, burning fuel but producing no thrust. For these reasons and because of greater size, operators with Boeing 757 or 767 aircraft enjoyed a cost and reliability advantage over 737-700 operators such as Aloha.

So, when the airline industry went into a tailspin after 911, Aloha lost money and headed for bankruptcy with everybody else, but did so with the wrong airplanes in the fleet.

David Banmiller came aboard as CEO and was soon tasked with saving Aloha from a dicey bankruptcy with only a few days of money in the bank. He pulled it off and should be congratulated for that effort. Something was wrong, though. Labor and Banmiller never grew to trust each other, largely because of labor’s impression that Banmiller was watching out for the “big money’s” concerns, not the long-range needs of the airline and employees. Such an impression hurt Banmiller’s effectiveness. Nonetheless, from the various bidders for Aloha one offer stood out, and that was an offer from Yucaipa, headed by Billionaire Ron Burkle. In September of 2005 Yucaipa was selected as the principle new owner. On the very day this announcement took place, an announcement by another bidder for Aloha raised eyebrows in Hawaii. This unsuccessful bidder would take it upon himself to ensure that the successful bidder found anything but success with Aloha in the years ahead.

To Be Continued.

Aloha Airlines Bankruptcy, Questions and Answers

Q. How can Aloha Airlines survive this current cash crunch?
A. It needs to either merge with another airline or find a white knight with enough funding to carry it through the fare war which go! has initiated and sustained. Either long run solution should include a plan to upgrade the interisland fleet. In the short term, Aloha needs to find funding sources which will allow it to explore these options.

Q. Mesa’s figures for go!’s break-even costs differ substantially from the same figures provided by Aloha and other sources. Why?
A. Both the Sabre Study and statements by Aloha’s CEO’s assume typical load factors for each competitor. The Sabre Study calculates that planes would fly 62% full, because that was a close approximation to what was actually taking place. Figures supplied by Mesa’s CEO appear to be based either upon completely full airplanes or airplanes with unrealistically-high load factors. If Aloha used the same percentage of seats full to compute their costs, the longtime Hawaii airline would still retain a 20% to 30% cost advantage over go!.

Q. Shouldn’t our government stay out of the way and let competition determine who survives and who disappears?
A. In a properly-functioning free market, a company attracts customers by either offering a superior product or by being more efficient and offering the product at a lower price. The quality of Aloha’s product is certainly no less than the product offered by go!, as evidenced by go!’s inability to gain more than a small foothold in the market when Aloha and Hawaiian match fares. In terms of experienced pilots, comfort, on time arrivals, and schedule flexibility, Aloha’s product can be viewed as superior. Aloha’s cost structure has been 20%-30% below go!’s costs of offering the same product, according to the Sabre Study and recent comments from Aloha’s CEO. Thus, Aloha appears to be the superior competitor in a properly-functioning free market.

Unfortunately, Hawaii’s interisland market is anything but a properly-functioning free market. Mesa Air Group has sold its product well below its own cost of providing that product for the past year and a half. The free market model only works when companies actually seek profits. When one intentionally offers a product well below its cost, the competition becomes not survival of the fittest but instead survival of the wealthiest.

Q. Shouldn’t go! be subject to anti-trust prosecution, then?
A. Here we enter a grey area. The Airline Deregulation Act provided certain protections against prosecution for airlines which sell tickets below cost. A legitimate example of selling below cost includes sales during off-season to stimulate traffic, with the idea that the increase in travelers will more than compensate for the decrease in ticket price. Surely the architects of airline deregulation never envisioned the type of abuse which Mesa is currently employing, which is prolonged pricing at far below it’s break even point and the break even points of its competitors, as well.

At least two remedies are possible. First, Aloha could win a lawsuit against Mesa and establish a legal precedent which defines the limit of acceptable below-cost ticket sales in the airline business. If this solution is unsuccessful or cannot be accomplished quickly enough, the alternative is to refine the language in the Airline Deregulation Act so that legitimate below-cost pricing can continue but clearly anti-competitive abuse of this provision is prohibited.

Q. Has the U.S. government amended federal laws before because of abuse by an airline?
A. Yes, in the early 1980s Frank Lorenzo used federal bankruptcy laws to toss out the union contracts at Continental Airlines and slash pay in half. Such an abuse of the bankruptcy laws led to a revision of those laws which prohibited such actions unless the airline could persuade the judge that the contracts were a prime reason for the airline’s difficulties. A similar revision of laws may be warranted after a close examination of the Mesa vs. Aloha struggle.

Q. Couldn’t Hawaii just regulate airline fares within the state?
A. No. The federal government has deregulated airline pricing and does not allow states to overrule its methodology.

Q. What about asking the Justice Department to investigate this conflict?
A. That approach could be extremely important to Aloha’s survival. Mesa’s willingness to force prolonged losses is the 900 lb. gorilla in Aloha’s path to recovery. Defuse the fare war and 90% of Aloha’s troubles disappear. Suitors and lenders would respond appropriately.

Q. Aloha lost money after exiting bankruptcy and before go! entered the market. Isn’t this an indication that Aloha’s troubles are its own?
A. The amount of money Aloha lost prior to go!’s arrival was a manageable amount. Aloha’s new owners likely wanted to find a buyer for the airline and before tackling Aloha's weak point, which is its interisland fleet. Fleet changes are quite an expensive proposition, one to be avoided until the new owners are determined so that the fleet can match the purchasing airline’s fleet. Once go! entered the market with their $39, $29, $19, and $1 fares Aloha’s owners were stuck. No one but the largest airlines would want to take on Mesa with its “poison the waters” pricing, and the losses from the fare war with go! prevented Aloha from upgrading its interisland fleet to a more fuel-efficient type should Aloha wish to remain independent. Keep in mind that changing the interisland fleet affects not only the cost side of the equation but the revenue side, as well. Aloha’s load factors would increase if it introduced a newer interisland jet. This “new airplane” benefit to revenues is well-documented throughout the history of interisland flying. Unfortunately, go!’s fare war has prevented an interisland fleet upgrade by repelling potential suitors and by ensuring that Aloha does not have the cash needed to upgrade the fleet on its own. Since Aloha cannot shed its fuel inefficient fleet under the current pressure from Mesa, Mesa can be viewed as forcing Aloha to remain especially vulnerable to rising fuel costs.

Q. What about the rise in fuel costs? Isn’t that just as big a problem to Aloha as the go! fare war?
A. No. In a properly-functioning free market, airlines can raise their ticket prices to pass most of the fuel price increase to their customers. Not so in Hawaii’s interisland market, where go! is maintaining ticket prices that are well below the costs of all three competitors.

Q. Why are you so confident that Mesa intends to drive Aloha out of business?
A. For two reasons: Mesa’s words and its actions. When Hawaiian Airlines researched a recent lawsuit against Mesa, attorneys uncovered an email exchange between then-Mesa CFO Peter Murnane and Hawaii-based advisor Mo Garfinkle. Garfinkle stated that he believed Mesa’s go! Airlines would be unprofitable if Aloha remained in the market. Murnane responded that Mesa should enter the market anyway and give Aloha “the final push”. Emails between the two also indicated that Mesa planned to raise ticket prices once Aloha disappeared. These comments clearly indicate Mesa’s intentions in Hawaii, but its actions speak louder than words.

Let’s look at those actions. This past summer, during the busiest part of the travel season, Mesa unleashed $1 ticket sales at go!, and following this financial carnage with widespread sale of $19 tickets. Such sales make absolutely no economic sense any time of year, but especially during summer vacation. The fares were clearly designed to place the maximum financial burden possible upon go!’s competitors. Even go!’s $39 fares fell far short of the $67 which the Sabre Study indicated go! needed to charge if it wished to break even. Go! failed to test the waters and see how reasonable fares would be received by Hawaii’s traveling public. Go! surely would lose less money if it raised ticket prices, but it is reluctant to do so, because the airline wishes to provide the illusion that it can profitably offer these incredibly-low prices. If go! were to raise prices, it would lose less money in the interisland market. Since go! places punishing the competition as a higher priority than minimizing its own losses, it appears clear to me that go!’s actions accurately reflect its stated position of entering the market to give Aloha “the final push”.

Q. So, to wrap it all up, what must Aloha do to survive?
Short term financing is necessary, and a long-term owner or partner is needed to facilitate Aloha’s transition to an efficient interisland fleet. The biggest obstacle remains the interisland market’s unrealistically-low fares offered by go!. Should go! be forced or persuaded to discontinue this anti-competitive behavior, then Aloha’s chances of survival would improve dramatically. Perhaps we’ll see on March 31 what potential suitors are out there for Aloha. Stay tuned.

We Wouldn't Tolerate This Behavior with our Gas Stations

Imagine the following scenario. A big mainland oil company has just lowered its gas prices in Hawaii to $2.00 a gallon, even though a selling price of at least $3.20 a gallon is needed to break even. The oil company has kept its mainland prices well above $3.00 a gallon and Aloha Gas station owners in Hawaii are screaming “foul!” At times the big oil company offers a “special” on gas and charges as little as 5 cents a gallon. Aloha Gas is in trouble and losing money fast. The big oil company’s CEO is quoted as saying “Aloha Gas need not match our prices. Their demise is their own doing.”

Shortly thereafter, Hawaii newspapers publish an article about emails intercepted between a top executive with the big oil company and a Hawaii advisor in which the two discussed “Giving Aloha Gas the final push” and then raising gas prices statewide once the competitor is knocked out of business.

Now, substitute “Mesa Air Group” for “big oil company” and “Aloha Airlines for “Aloha Gas” and the story is, for all practical purposes, the same. The primary difference is that in the gasoline price example, government officials would cry “Anti-trust violations” and remedy the situation immediately. Not so in the airline scenario, however.

Why the difference in the public’s and the government’s attitudes? For one, the public has become accustomed to long-distance flying at remarkably low prices. It cannot fathom that short range flying in recent years has not realized the same efficiencies as long-distance flights, but that’s indeed the case. As for the government’s response, wording in the airline deregulation act provides some immunity from prosecution for airlines which sell tickets at below cost prices. Surely the architects of that law never envisioned this wording being abused in the manner that Mesa Airlines is currently employing, but so it goes.

Thus, the fare war we’re seeing here in Hawaii is actually a classic case of anti-competitive behavior which is only tolerated by the government because of flawed language in the airline deregulation act. Should that wording be corrected to allow legitimate uses of below-cost ticket sales but prohibit the type of sustained anti-competitive behaviors exhibited by Mesa Air Group, the survival prospects of Aloha Airlines would improve dramatically.

Listening for Dings

A friend of mine who wrote a controversial book about dating taught me the concept of the ding. He said if the lady is not the person she's expressing to you, sooner or later she's going to say something that makes no sense. He calls this a ding. Never overlook a ding, because it gives you a glimpse into the active undercurrents.

In my previous posting, I mentioned that go!'s raising it's lowest price to $49 was a very significant development in the air war story. I continue to hold that opinion. My belief was that this fare increase showed that Mesa's CEO was under enough pressure to finally bow to the competition and raise fares as an act of damage control. This is certainly a possible explanation, but the more thought I give this matter, the more uneasy I feel with this explanation.

I regard Mesa's CEO Jonathan Ornstein as a person who views business as a chess game. His goal is to win, and he moves his pieces to exert pressure until he reaches his goals or is forced into defeat. He's a calculator much like Russsia's president Putin. What bothers me about the fare increase is that it takes most of the financial pressure off Aloha Airlines, yet it falls far short of relieving go! airlines of its losses. In other words, go! loses more than it gains with this move. I believe Ornstein is a better chess player than this, so I note ding number 1.

Do you remember go!'s pledge that its lowest fare will always be no higher than $39? It may be reasonable for go! to raise average prices, but by eliminating $39 fares on even the toughest flights to sell, it has reneged on its pledge to customers and in so doing loses credibility at a time it cannot afford to lose credibility. Ding number 2.

So, I believe there are undercurrents at work here, and I cannot tell you what they are. As more dings appear, I'll be listening though. Change is in the air.

Someone Just Blinked

So, what’s the big deal about go! raising its interisland ticket prices from $39 to $49? More than you might realize.

We’ve been watching a game of chicken in the Hawaiian skies during the past year and a half. Go!’s parent company set a well-below-cost ticket price which was matched by Hawaiian and Aloha Airlines. In time, the battle would force one of the competitors to swerve in order to avoid total annihilation. Guess who just swerved?

When go! entered Hawaii’s interisland market in the summer of 2006, they did so with a cost disadvantage. The Sabre study suggested that at a 62% load factor, Aloha needed $50 a ticket to break even, Hawaiian needed $55 a ticket, and go! needed about $67 a ticket to pay for the basic costs. Fuel prices have gone up since then, and by now the break-even prices are likely closer to $55, $60, and $70. What’s important is to take a look at the difference between the cost of a ticket and the revenue.

Aloha took a beating at $39 fares. If their costs are about $55 a ticket, then they were losing about $16 for every passenger carried. Some sources figured that Aloha was losing $6 million a month. With tickets at $49, though, the loss is more like $6 for every passenger carried. Thus, nearly two-thirds of Aloha’s losses disappear with the fare increase.

Let’s look at go!, though. They were losing about $31 a ticket in months with 62% load factors (December was about 65%), and with the higher fares they’re only losing about $21 per passenger. So, approximately a third of their losses disappear with the fare increase. That’s an improvement, but only half the improvement that Aloha realizes through the fare increase.

A fare of $49 is still a money loser, and Mesa is keeping the financial pressure on Aloha. Hawaiian is feeling far less pain, however, since the airline’s high systemwide load factors suggest that they’re filling more of their inter-island seats than either competitor. Go!’s parent company has kept some bargaining ability with this price, and the logical use of that bargaining ability would be to negotiate go!’s departure in return for a reduction in legal liability. Don’t hold your breath for logical behavior in this contest, however.

Besides the fare increase, go! has also reduced the number of flights it offers in Hawaii. Maui only sees seven go! round trips a day, for a total of 350 seats between HNL and OGG each day, each way. Thus, the superferry’s single roundtrip potentially makes it nearly double the player in this market than go!.

What does the future hold? If Hawaiian’s court victory stands, that airline can return to court in another year or two and request additional damages. Thus, Mesa may be liable for both go!’s losses and Hawaiian’s losses in the future. If Aloha is successful with their case, then Mesa could be liable for the losses of all three airlines. Such a burden would force Mesa into bankruptcy. Mesa’s core business showed disappointing results in the past year, even without the Hawaiian Airlines judgment. And now, go! has shifted its fare strategy from one of "victory at any cost" to one of damage control. Such changes often signal a significant shift in such a corporate war.

Schoolyard Bully

Mesa’s critics have previously used the analogy of a schoolyard bully to describe the company’s tactics in assaulting the Hawaii interisland market with its startup airline go! Little did I expect this comparison to play out so colorfully in the recent Hawaiian vs. Mesa trial.

The primary target for Mesa’s cut-rate entry into the market was Aloha Airlines, according to email statements brought into court as evidence. One communication stated that Mesa planned to finish off Aloha Airlines within 24 months and then raise fares to 105% of the pre-go! fares. According to the author, Mesa’s operation would be unfeasible if Aloha remained in the market.

Mesa’s attorney argued against any conspiracy to sink Aloha and claimed that the statements about Aloha were but one scenario in planning. He stated that Mesa also planned what would happen if Aloha remained in the market. Hmm, Mesa had two plans to choose from: one feasible and one unfeasible. Which do you think they’d pursue?

During closing arguments on the trial’s final day, Mesa’s attorney felt the need to explain the advantages gained by Mesa from its entry into the Hawaii market. According to Max Blecher, Mesa negotiates with large airlines for whom it supplies aircraft, crews, and other services. If Mesa can show these big airlines that it has the ability to take over these routes and operate them itself, then it gains a negotiating advantage. One problem with this argument is that Mesa never provided such a service for Aloha. Another problem is that what Blecher is actually doing is explaining the philosophy of the schoolyard bully (If I rough up a kid from time to time it’ll keep the other kids in line). For a supplier of airline services to demonstrate that it will turn against its host airline and inflict financial pain should negotiations go badly is not a smart tactic, Mesa.

Comments made so far in newspaper editorials suggest that go! has already taken quite a PR beating from this trial. Go! may choose to resort to its old tactic of giving tickets away for a small fraction of their cost once the judge issues his ruling. Such a tactic by Mesa will only highlight its willingness to trash the economics of the interisland market to punish its competitors. Once again, not a smart move, for the eyes of Hawaii’s residents have been opened wider than usual by this trial.

Hawaiian's Day in Court

Hawaiian Airlines has reached it's court date with archrival Mesa Airlines. After just three days of pretrial motions, Hawaiian has prevailed on most issues. The only two issues remaining to be resolved by the court are 1) whether the thousands of pages of data provided by Hawaiian Airlines contain any confidential information and 2) what the damages will be in this matter. It's a safe bet that Hawaiian will indeed prove that the thousands of pages do indeed contain confidential information. Thus, the real issue before the judge is how much to award Hawaiian for Mesa's illegal and unethical behavior.

Hawaiian Airlines is asking for $173 Million in damages, plus interest, attorney's fees, and other considerations. An earlier report claims that Hawaiian also wishes to restrict Mesa's ticket sales at go! for a one year period. What are we likely to see? If Hawaiian receives a large cash award, the judge is likely to rule that this amount compensates Hawaiian for the losses due to Mesa's misuse of data. A large award and a one year restriction on Mesa's ticket sales are not likely to both transpire. So then, what is likely?

Mesa has competent legal representation, who will argue on enough areas of contention that the award is likely to be noticeably less than the $173 million asked for. The real drama will be answering the question, “How much less?”

Should Hawaiian be awarded a particularly large amount, It is quite possible that Mesa and Hawaiian may haggle on a settlement. In return for forgiveness on a certain amount of cash payment, Hawaiian could see Mesa pull up and leave the islands. In the long run, this approach makes more sense for both airlines than a prolonged fare war. Mesa may very well negotiate with Aloha for an end to its legal action as a prerequisite for go!'s departure, as well.

The amount awarded to Hawaiian may have a significant impact upon CEO Jonathan Ornstein and his management team. The activities of Mesa in this court issue showed blatant disregard for the law and for ethical conduct. At some point, shareholders at Mesa may recognize that such a management team is more liability than asset. Aloha's day in court is scheduled for April, and a victory by Aloha would bankrupt Mesa. There is little rationale for Mesa's foray into Hawaii's interisland market when you consider the cost versus likely payback.

A victory by Hawaiian is a further wakeup call to Hawaii residents regarding the truthfulness of statements made by Mesa officials. Mesa knows how to work the media for maximum spin factor, but such tricks don't work in a courtroom. Let me correct myself, they don't make any difference with the judge. Today in court I witnessed an interesting strategy by Mesa's attorney. He introduced snide statements about the intentions of Hawaiian Airlines which had absolutely no relevance to the matter under consideration. Why? I believe he is carrying out Mr. Ornstein's wish to continue the propaganda war. He's hoping that the newspaper reporters in the crowd will pick up on the comments and salt them into their articles. One can only get away with such strategies when one is spending tons of money on newspaper advertising (which Mesa is doing). It'll be interesting to see if the strategy works.

One thing is for certain, however. No matter how guilty the courts find Mesa to be, its CEO Jonathan Ornstein will continue to claim that Mesa is the victim.