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:: September 2002 Newsletter ::

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Dear Fellow Cheap Seat Occupants,

Ever see The French Connection? Well, if Hollywood has taught me anything, it’s that heroin addiction is something to avoid. It seems addicts need more and more heroin to feel good again. They get dependent, and it ultimately destroys them.

If you’re expecting a concise metaphor out of this, you may be disappointed. I was thinking something along the lines of comparing heroin with business fares on major carriers. And waddya know, it works. These airlines have been getting diminishing returns on high price tickets, for the simple reason that in these price-sensitive times, fewer people will pay for them. And the resulting changes airlines make will have consequences for the type of aircraft that get built.

In pursuit of people who will pay any damn price, ticket pricing has bifurcated. Unable to make money with the typical passenger, airlines have cranked up fares at the high end, to take advantage of those who are willing to pay for convenience. As a result, airlines now offer $200 or $2,000 fares for the same seat, with little in between, and the pool of people willing to pay $2,000 is drying up. John Walsh calls this “mad pricing disease.” But you can understand the airlines’ position: “Look at the margins! We can’t give those $2,000 seats up! We need these fares to compensate for all those $200 fares!” And meanwhile, more and more business travelers are fleeing to the cheap seats, or to the dreaded discount carriers.

As an example, let’s use a typical guy. He is a 39 year old aviation industry analyst. A few times a year, he goes to Texas to see a client, mid week, for one day. Thanks to the new insane pricing, he (or rather, the client) is now asked to pay $1,800, economy class (as it is so amusingly called). But the client, like most other businesses, suddenly gets cost-conscious, and no longer sanctions that kind of expense. The typical guy has a choice: he either pays out of his own pocket, or he makes a few sacrifices and, aided by internet cheap fare search engines, saves $1,500.

It isn’t easy abandoning a pricing structure with $2,000 seats, even if you’re getting fewer takers. Again, it’s just like heroin. But gradually, the majors are heading to the aviation equivalent of the Betty Ford Clinic. American has led the way, with its August announcement that it would radically reshape its hub and spoke route network, using a frequency-oriented “rolling” hub instead of the traditional “pulsing” hub. More importantly, AMR has announced an ambitious cost-cutting program, with lowered aircraft turnaround times and an emphasis on fleet simplicity (no more Fokker 100s—drat!).

Hopefully, this cost reduction will allow a simplified fare structure, one that will sacrifice those dwindling $2,000 fares in exchange for a greater number of $600 fares. After all, a much greater number of folks will be willing to pay a modest premium for greater flexibility (or comfort). Most won’t pay a 1,000% premium, but many would pay a 300% premium. AMR, in pursuit of this goal, will look more like the discount carriers, with the addition of greater service options.

With all this airline talk, it seems like I’m neglecting my day job (drinking coffee, analyzing aircraft markets, pestering co-workers). But it can’t be overemphasized—the airline industry is changing, and this has ramifications for aircraft manufacturers.

The biggest change is a clear preference for aircraft commonality. This means that niche machines get hurt by aircraft families. The 737-600/700/800/900 and A318/319/320/321 families prosper. The 717 and 757, which have nothing in common with other domestic-use narrowbodies, get clobbered. The extreme example of this trend: Southwest eschews larger 737s, because they have an extra exit row. Meanwhile, to keep those rolling hubs rolling, the domestic market prefers smaller planes. Again, this hurts the 757, and pretty much all widebodies that may have once been used for domestic “trunk” routes. And all pretense of comfort goes away, so the slightly wider A320 series is now at a disadvantage to the 737. So far, the A320 has only scored with one discounter, jetBlue. The upcoming easyJet order may prove to be make or break for the A320’s low-cost credentials.

Can this discount trend go international? Right now, the international arena remains a goofy wonderland of silly bilaterals and curious flag carriers. But if it becomes a free and open cash-driven industry, there could be some big changes. The demise of Sabena and Swissair certainly suggests that change might be coming. If we do see the return of Peoples Express or Laker Airways (first incarnation), with resulting changes in majors’ international operations, then both A380 and Sonic Cruiser could be big losers. After all, the premium market will cease to exist (again, this has already started), which would kill Boeing’s Great Fast Hope. And international discounters would promote fragmentation and rolling hubs that emphasize frequency. This would make the large capacity A380 hopelessly irrelevant.

The winners, of course, would be smaller, low-cost planes, preferably with two engines. The 777 and A330 would prosper. Unless the 767 gets an enhancement, it’s in trouble. The A340-300 would remain marginalized as a slow and expensive quadjet, although the –500/600 may prove themselves.

I’ll offer a ray of hope to the jetliner primes. Sure, regional jets have prevailed in North America, but Europe is another story. The cheap and cheerful discount carrier trend could clobber those European regional (and charter) guys. In fact, the Euros have kind of been in denial about the impact of easyJet, Ryanair, and the others. The discount carriers have only had about 4% market penetration in Europe (as opposed to about 14% in the US). But the carrier formerly known as Crossair has felt it, and Lufthansa’s regional operations are feeling it too. So, in a twist of fate, 737s and A320s could wind up hitting back at the CRJs and ERJs. Notice, for example, that Lufthansa hasn’t rushed out to shop for replacements for their now-dead Fairchild Dornier 728 order?

There’s a lot in this supplement. The F-22 is holding steady, and the C-17 looks great. There’s yet another negative A400M report. The 767 seems to be floundering. And join us again next month when there’ll be updates of the Rafale, Citation, 717, C-5, and others. Let me know your priorities. And if you are European, I hope you had a good summer vacation.

Yours, ‘Til They Give Out The Pulitzer For Market Analyses,

Richard Aboulafia
(703) 385-1992 ext. 103 (office)
raboulafia@tealgroup.com

 

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