The LSE Summer School 2003
Management Programme
MG106 - Organisation and Strategic Management
Seminar 11 – The US Airline Industy
Readings on the Discount Airlines Song and Starfish
A Sweet Song? Delta Aims at the Low-Fare Market
On April 15, 2003, a lime-green plane will depart New York City for Florida. On it ride the hopes of America’s third-largest carrier, as Delta’s new
subsidiary, Song, takes wing. With a new staff and new attitude, Delta is
hoping to break into the burgeoning low-fare air travel market to an extent that United, American and Continental haven’t been able to achieve.
For Song to succeed, it will have to fly in the face of 20 years of airlineindustry precedent. Major airlines have tried to spawn low-fare subsidiaries before: Continental had Cal Lite, United had Shuttle By United, US
Airways had MetroJet, and Delta itself is discarding Delta Express for its
new venture. All of these attempts have failed. “No sub-brand has ever
succeeded at any carrier anywhere in the world,” says airline consultant
and writer Joe Brancatelli.
Delta needs the boost. Although it’s in a stronger financial position than
United and US Airways (both of which are in Chapter 11) and American
Airlines (teetering on the edge of bankruptcy), the airline still lost $10.44
per share last year. At the beginning of February, the airline announced 810% pay cuts for all its top executives.
Song Sung Blue
Song’s first routes will be between New York’s JFK airport and south Florida, as the sub-carrier tries to stem the flow of business to JetBlue, the
trendy, three-year-old airline that has been a thorn in Delta’s side even as
it turns a profit in an unprofitable industry.
Wharton public policy professor Elizabeth Bailey, who has studied competition in the US airline industry, approves of Song’s initial choice of routes.
With their combination of business and vacation travelers, “they are the
densest routes,” she says.
Responding to JetBlue’s satellite TV and trendy blue potato chips, Song
will offer leather seats, seatback televisions and MP3 music, and various
branded food items for purchase on the plane. One of the key elements in
Song’s product strategy is ‘choice’ – flyers will get to vote on what sort of
food items will be offered over the long term, airline representatives say.
JetBlue isn’t fazed. In a typically gutsy move, the startup christened its
39th airliner “Song Sung Blue” – a direct poke at its new rival. And the
New York-based carrier has fended off big airlines before. In January,
American Airlines gave up on the JFK-Oakland, Calif., route that it started
in an attempt to choke JetBlue out of the Bay Area market.
“JetBlue’s success is due to our crew members and their dedication to
customer service. Delta can try to copy our product but they can’t match
our people,” JetBlue spokeswoman Fiona Morrisson says.
Low-Cost, Low-Fare
So what’s low-cost about Song? Fares will be lower and simpler than
mainline Delta flights, but that’s not going to make the unit profitable.
More crucially, Delta is committed to reducing costs by 23% per flight
with a combination of better utilization of equipment and lower labor
costs, Song executives say.
Delta starts with larger planes. Song will use Boeing 757s configured with
199 seats. Compared to the 119-seat Boeing 727-300s used by Delta Express, these planes will cost 30% more to fly but have 70% greater revenue potential, says Song spokeswoman Stacy Geagan.
To shorten the time planes spend at the gate, cleaning and catering crews
will work on one end of the plane while passengers board at the other
end. Flight attendants will help stow bags, speeding the boarding process,
and conveyor belts will be set up in cargo holds for the speedy unloading
of checked luggage.
And with point-to-point flights, Song won’t have to wait for connecting
passengers or deal with congestion at Delta’s Atlanta hub. Atlanta was the
world’s busiest passenger airport during the first 10 months of 2002, the
latest time period for which data is available, according to the Airports
Council International.
But the labor issue is the murkiest – and one of the most critical, according to Wharton management professor Peter Cappelli, director of Wharton’s Center for Human Resources. “Labor costs hover around 40% of total costs, but they are the most controllable costs, so they really matter,”
he says. Fortunately for Delta, it’s the least-unionized airline in the industry; only the company’s pilots are represented by a union.
Where Delta Express cut pilots’ salaries but made no changes to other
crew costs, Song is taking the opposite approach. Song’s 771 flight at2
tendants and 86 dedicated ground crew will be offered new, more “flexible” compensation packages, Geagan says. Pilots and some other ground
crew members will stay on their Delta compensation plans.
Possibly more importantly, Song will use as few staff as possible. Check-in
will be handled by one gate agent instead of Delta’s two, and four flight
attendants will handle 199 passengers – the absolute minimum mandated
by the FAA. “That’s a significant cost savings,” Geagan says.
The Right Attitude
According to Wharton business and public policy professor W. Bruce Allen,
Delta faces a challenge more intangible than cutting labor or equipment
costs: Can Song employees infuse the new airline with the sort of effervescent cheer that has made Southwest and JetBlue fun to fly?
“Southwest and JetBlue have a real can-do attitude,” Allen says. “Song
has to divorce itself from the culture of the larger airlines. That’s the
tricky business.” The attitude shift is about more than making passengers
feel good, he adds. More positive attitudes mean higher productivity, faster turnaround times for planes and lower costs. “The employees [at large
airlines] are these old, grizzled veterans, and they’re set in their ways.
[Song] has to get productivity up from these guys, and that involves a real cultural change,” Allen points out.
The new sub-carrier is being run as a wholly-owned subsidiary, rather
than as a brand within the main company, to make sure cultural changes
can take hold, Song representatives say. But the new airline will still share
pilots and some ground crew with Delta.
Bailey suggests that the ongoing air travel recession may prove to Song’s
advantage. In a tough economy, people are willing to do harder work for
less. “It does strike me that there are an awful lot of people who would be
very happy to have something as opposed to nothing,” she says.
Delta’s staff seems ready for the challenge. On a Delta Express flight on
Feb. 7 from JFK to Palm Beach – the exact flight that’s going to be replaced by Song’s first offering – a flight attendant who asked not to be
identified said he was “interested” enough in Song’s terms to interview
with the new subsidiary. To show Song he’s got the right attitude, he
plans to ride from his Florida home up to Song’s Atlanta headquarters by
motorcycle. “I’m going to wear my leather,” he said.
A Delta pilot who also asked not to be identified said pilots are willing to
pitch in to keep their carrier afloat. “I don’t mind giving them some concessions. I look at United where [pilots] have just taken a 29% pay cut
and [the airline] may not survive.” Delta isn’t at that point yet, he added,
“and I don’t want to get there.”
3
Will Song Fly?
Several Wall Street analysts are giving thumbs-ups to Song’s plan. “We …
applaud management for being proactive with respect to responding to
low fare competition,” Deutsche Bank Securities analyst Susan D’onofrio
says. Lehman Brothers analyst Gary Chase calls Song “a step that Delta
needed to take … and a clear improvement over Delta Express.”
Independent analysts and investors, on the other hand, are not quite as
enthusiastic. Delta’s stock languished at $9.38 on Feb. 10, affected far
more by worries over terrorism, fuel prices and war in Iraq than by the
Song announcement. And airline analyst Bob Mann points out that Song
faces major challenges in its very structure.
“It’s almost impossible for big companies to manage entrepreneurial,
new-entrant startups without imposing big-company overheads, processes, points of view and other costs. That’s one of the reasons none of these
entities works particularly well,” Mann says.
Allen is also skeptical. Song’s got great plans, he says; the test will be in
the execution. “Can these guys do it? They can say [they will lower costs],
and they have said it before with not very impressive results. They’re going to have to show me.”
Published: February 12, 2003
Airlines
Delta's Song Could Rock JetBlue
Lisa DiCarlo, 29 January 2003
It took Delta Air Lines more than three years to answer JetBlue Airways' assault on
its business in the busy Northeast-to-Florida corridor, but now its hand has finally
been forced. Delta's discount carrier, called Song, will launch in April, but will JetBlue
be singing the blues?
The new Delta subsidiary will mimic JetBlue in that it will fly single-class planes direct
from the Northeast to several cities in Florida. According to Song spokesperson Stacy Geagan, Delta will "gut and rebuild" existing 757s, "so they look and feel like new."
The planes will have a mixture of paid and free digital services such as satellite television, MP3 audio, video-on-demand and videogames. JetBlue heavily promotes its
free satellite television and leather seats; Delta will have both.
4
The two most important factors for the target audience of leisure travelers are price
and convenience--in that order. Song's flights will run from $79 to $299 each way, on
par with JetBlue. It's possible that Delta might have an edge in the convenience department, since it will fly out of all three New York airports, whereas JetBlue only flies
only out of JFK International. Furthermore, JetBlue has no presence in Boston and
offers service to only one Florida city from Washington, D.C. Song plans to offer service to Florida from both Boston and Washington.
JetBlue was able to snag market share on the Northeast-to-Southeast routes by offering lower prices. But it also benefited when Delta cut back flights to Florida and
other cities after the terror attacks of Sept. 11, 2001. For example, Delta had replaced some direct routes to Florida with flights that inconveniently stopped at its
massive Atlanta hub.
From a cost standpoint, JetBlue still has the edge. Because it was launched only
three years ago, JetBlue does not have the long-standing inefficiencies of its larger
competitors. For instance, most of JetBlue's ticket sales are made directly over the
Internet, and it has always issued electronic tickets only.
Like every other airline, labor is the biggest expense for JetBlue, but its pilots and
machinists do not belong to a national union. For 2002, labor costs represented more
than 40% of sales at Delta, compared with about 25% of sales through the first nine
months of the year at JetBlue. Delta will not pay lower salaries to pilots of its new
subsidiary, leading some to wonder whether Song can really be competitive on costs.
"They're going to use senior Delta pilots because they don't want to alienate their unions," says Ray Neidl of Blaylock and Partners.
"We are a subsidiary of Delta, and we will respect our contract with Delta pilots," says
Geagan. "They're the best in the industry."
Neidl says that if any company can succeed with a discount "airline within an airline,"
it is Delta. "They're giving [Song] a separate identity and already have had a moderately successful experience with Delta Express."
Delta will spend about $65 million to launch Song, which will eventually replace Delta
Express. Song will indeed have a separate identity from its parent. For starters,
Song's Web site looks more like JetBlue's--that is, they're both uncluttered, with lots
of white space and large, bright lettering.
JetBlue executives will no doubt be asked about how they plan to combat Song,
when they report the company's fourth-quarter numbers tomorrow. JetBlue, which
went public in April, is expected to report earnings per share of 20 cents, up 2 cents
sequentially.
If Delta is to succeed, Song must be noticeably different, and it already appears to be
on that path. But the changes inside the airplane's cabin should be more than esthetic. Stand in line at any JetBlue terminal and you're likely to hear people actually complimenting the airline on its service and generally friendly attitude of its workers.
5
Rebuilding planes and offering direct flights will be the easy part. Rebuilding the total
customer experience is what could make Song sing.
FEBRUARY 7, 2003
COMMENTARY
By Michael Arndt
Little Lift from United's Discount Airline
UAL says a low-cost service is key to its rebound. More likely, it'll rile unions, confuse
customers, and eat into mainline sales
Two months after taking UAL Corp. (UAL) into Chapter 11 bankruptcy, Chairman and
Chief Executive Glenn Tilton has begun laying out his plan to restructure the airline
by mid-2004. The centerpiece: a new low-cost service that would offer bargain fares
coast-to-coast and complement UAL's mainline brand, United Airlines.
On paper, the move seems sound. Though details are still being worked out, the new
subsidiary, code-named Starfish for now, would look a lot like Southwest Airlines
(LUV), featuring only one type of aircraft, no-frills cabins, and flights to vacation markets such as Orlando and Las Vegas. It would be staffed with lower-paid employees
who likely would be reassigned from United's payroll, says Douglas Hacker, UAL's
executive vice-president for strategy.
In theory, Starfish should finally blunt Southwest and other cheap-seat carriers that
now compete with United on 70% of its routes and are stealing ever-more business.
The airline would start next autumn with service from Chicago, Denver, San Francisco, and United's other hubs and could soon account for about a third of United's
1,700 daily flights.
BURNED ONCE. It would be a radical departure for the world's No. 2 airline, but
given UAL's financial straits -- the Elk Grove Township (Ill.) company lost $3.2 billion
in 2002, after a $2.1 billion loss in 2001 -- Tilton argues there's no other way. "Every
one of us knows that we cannot fix our business as it is currently structured," he told
employees in a recorded message before management presented his plan to union
chiefs on Feb. 4. "We must establish an alternative to the low-cost carriers that will
appeal to the customers in this market segment."
In reality, however, Tilton's transformation may be only another dead-end. Indeed,
UAL attempted a discount carrier once before, Shuttle by United, which began in California in 1994. It was folded into the mainline in 2001, after unions pushed labor expenses back up to United's levels, rendering it uneconomical.
And UAL's wasn't the only failure. Every hub-and-spoke carrier that has started a discount subsidiary -- from Continental Airlines' (CAL) Continental Lite and US Airways'
6
(UAWGQ) MetroJet to Delta's (DAL) Delta Express -- has flopped as costs ballooned
and single-minded rivals like Southwest or JetBlue Airways (JBLU) expanded.
LABOR REBELS. "I'm skeptical an 'airline within an airline' can ever work," says Michael Levine, a Yale University law professor and former airline exec. He predicts
that at best UAL would simply trim its losses by creating a second airline, rather than
actually make money.
Things aren't likely to be different with United in Chapter 11. United's labor unions,
fearing steep wage cuts at Starfish and the loss of more jobs, are vowing a fight to
the finish to keep Tilton from launching the low-cost service. Paul Whiteford Jr.,
chairman of the 8,600-member Air Line Pilots Assn. at United, predicts the plan
would lead to a piecemeal sale of United. "There's no recipe out there that says this
is a good idea," he says.
Adds Gregory Davidowitch, president of the Association of Flight Attendants at United: "This strategy could not be worse." Granted, the unions may not be able to do
much more than complain: At the end of the day, Bankruptcy Court Judge Eugene
Wedoff could impose contract terms on labor allowing UAL to proceed.
LOST EDGE? Even if Starfish takes off, however, industry consultants and analysts
warn that it probably won't get very far. When the new contracts come up for renewal,
unions undoubtedly will push to lift pay scales and workplace rules to mainline levels,
just as they have done at every other airline that has ever imposed a two-tier wage
structure. Once that happens, the new unit no longer will have the edge needed to go
head-to-head with low-cost rivals.
Plus, United will incur another cost: surly employees who feel they've been relegated
to second-class status, especially if their pay rates were crammed down their throats
by the judge.
That's not all. By operating from the same airports with tickets issued by the same
company, the twin airlines could easily confuse and rile passengers -- particularly
business travelers, who may find themselves stuffed in a one-size-fits-all plane instead of a roomier United jet.
PROFIT-EATER. UAL aims to create a discount airline that would be self-sufficient,
but some analysts predict it may be forced to subsidize its bargain prices on Starfish
with cash from high-priced tickets on its mainline flights. That's what Delta appears
set to do with its new Song discount airline, a 36-plane operation that will launch in
April with service between the Northeast and Florida.
United isn't the only network airline getting blown away by discount rivals. As bankruptcy chatter grows louder, American Airlines parent AMR Corp. (AMR) is telling unions it must slash labor costs by $1.8 billion a year to return to avoid UAL's fate.
The upshot: The more Starfish expands, the more it could eat into mainline sales and
the less money UAL would have to funnel into its startup or its own pockets. "This
plan is something they could lose the airline over," observes Darryl Jenkins, director
of George Washington University's Aviation Institute and an industry consultant. "In
all candor, they should forget it."
7
READY TO CHANGE. Tilton concedes his transformation plan is still evolving.
UAL's creditors committee, for instance, hasn't yet been briefed on the restructuring.
Once that happens, Hacker says, management will take feedback from all stakeholders and modify the scheme if necessary.
Still, it looks like Tilton's goal of saving UAL might be better served by transforming
all of United Airlines into a money-maker, not just a piece of it.
8