After a dramatic takeoff in February that included the sale of 12,000 tickets in 120 hours, low-cost carrier Vision Airlines hit turbulence this week, announcing that it will end service to five of the 23 cities it serves on July 17.
While Vision is not by any means calling it quits, the privately held airline’s struggles point to a deeper challenge in the airline sector in general and with the low-cost carrier model in particular. Other low-cost carriers like Spirit Airlines (NASDAQ: SAVE), JetBlue (NASDAQ: JBLU), and Frontier (NASDAQ: RJET) could feel growing pressure to re-think their business models – particularly in light of the merger of Southwest (NYSE: LUV) and AirTran.
Vision officials said low demand was a key factor in the airline’s decision to cut service to Huntsville, AL; Savannah, GA; Greenburg/Spartanburg, SC; Baton Rouge, LA; and Columbia, SC. “There are a variety of factors that went into our decision,” Vision’s chief operating officer David Meers said. “But with high fuel prices, it is not prudent to continue to fly in markets that may take a very long time to develop.”
Still, the airline that cut its teeth on operating government charters into war zones like Afghanistan and Iraq is fighting back. On Wednesday, Spirit unveiled a new game plan for drumming up business: round-trip flights as low as $99 to Grand Bahama Island beginning in November.
The flights also will add three new mid-Atlantic cities to Vision’s routes: Baltimore/Washington, Richmond and Raleigh/Durham. Vision also inked a ticketing deal with global distribution system (GDS) provider Amadeus to get its fares in front of more potential passengers.
But while these initiatives aim to boost business, they will add cost and complexity to the airline’s operations. Low-cost carriers’ biggest edge over legacy competitors like Delta (NYSE: DAL), American (NYSE: AMR) and United Continental (NYSE: UAL) lies in their ability to control costs aggressively. Most effective tactics include: using a single aircraft class, focusing on direct sales instead of using online ticketing systems, focusing on domestic routes, charging premium fees for baggage, snacks and beverages.
Vision’s business model runs counter to that conventional wisdom. In addition to 737s, the airline operates a wide-body 767 and the turboprop Dornier 228 and 328 models. It offers complementary snacks, juice and sodas onboard and checked baggage fees are as low as $15. International expansion to the Caribbean will add costs, as will the new ticketing deal with Amadeus.
Vision faces significant headwinds as it struggles to find the right cruising altitude. But the airline’s story also illustrates challenges other airlines must grapple with to soar in a sector perennially plagued by high costs, slim margins and uncertainty. Here are three lessons other airlines should take note of:
- Fuel Price Volatility Is Still An Airline’s Bane. Airline stocks have been on a roller coaster this year, pitching and yawing in concert with the rise and fall of oil prices. While high fuel prices devour carriers’ earnings, price volatility is even worse because airlines don’t know how to plan for capacity.
- The Low-Cost Carrier Model Is Showing Its Age. Southwest’s pioneering low-cost carrier model revolutionized the airline industry and established LUV’s reputation as a big-time competitor. But even Southwest is leaving that model behind as it transforms its operations to compete nationally – and in the Caribbean. Other low-cost carriers like JetBlue and Spirit also are chasing that new strategy.
- Airlines Compete Best On Higher Value, Not Lower Price. In an industry saddled with such high fixed costs, competing solely on ticket prices is not enough. Vision launched with fares as low as $39, Spirit is offering $9 fares to launch its new service to Las Vegas. While those fares are enough to capture travelers’ attention, they are not enough to cement brand loyalty. Traditional airlines like Delta, United Continental and American are shifting their focus to where the money is: premium fare and business travelers.
Bottom Line: Low-cost carrier stocks traditionally have outperformed legacy airlines, but the tide is changing. As the industry evolves and the economy rebounds, carriers are gradually moving away from no-frills business models. But revising business models while still counting on price as the key value proposition is a risky bet, one that could threaten earnings – and stock valuations.
As of this writing, Susan J. Aluise did not hold a position in any of the stocks mentioned here.
