COVID-19 has hit the airline industry particularly hard. From a financial perspective, the first three months of the virus crisis involved airlines securing liquidity and petitioning for aid from the financial government based on the CARES Act. As the 2nd quarter of 2020 ended, airlines shifted their focus to developing plans for operations beyond September 30 when government grant money ends. The U.S. Treasury has approved loans for all U.S. airlines that requested them in amounts roughly equal to 10% of their 2019 expenses. Several airlines have recently released preliminary information on the number of employees that are taking early retirement or voluntary separation or extended time off programs with the hope that employee costs can be cut dramatically. With the trajectory for cost control defined, even if not achieved, airlines have turned their focus to their networks and revenue generation which have the greatest potential to reduce losses.
American’s Ticket Counter at its New LaGuardia Airport Terminal
Source: American Airlines
All airlines operate marginally profitable flights in the best of times; some new routes take time to reach profitability while others are considered “strategically necessary.” As I have noted in multiple Seeking Alpha articles, American Airlines (AAL) has operated large portions of its international network at a loss. Its transpacific system has lost billions of dollars on a cumulative basis over the past decade according to DOT data. Its continental European system drags down its European performance despite the strength of London Heathrow, one of the most profitable airports and where American has a joint venture with British Airways. American has also repeatedly noted that several of its hubs are considerably less profitable than others, holding out its New York City and Los Angeles (LAX) hubs among its low performers and its Dallas/Ft. Worth (DFW), Charlotte, and Washington National airport hubs as its most profitable, net-net leaving AAL’s net margins as the lowest in the industry for years. As the reality of COVID-19 continues to sink in, American is being forced to cut its low-performing routes and is doing so more aggressively than any other carrier has so far announced in the COVID-19 environment.
Source: American Airlines
American Airlines began its network restructuring by announcing that it would permanently drop a significant number of international routes including its flights from LAX to China and Hong Kong, a number of flights from Chicago and Philadelphia to Eastern Europe and N. Africa (most of which were to be operated on a seasonal basis) as well as flights from DFW and Charlotte to western Europe. After its international route announcements, AAL announced two new partnerships that will replace domestic American mainline or American regional carrier service on the west coast and in New York City and Boston. American’s first partnership announcement was an extension of previous announcements that American had made with Alaska Airlines (ALK) with which American has had a long-standing code-share and marketing relationship. In the latest announcement, American said that it will be shifting its long-haul west coast focus to Seattle where it plans to compete in the Seattle to Shanghai market; it previously said that it would add a new Seattle to London flight alongside partner British Airways and add a Seattle to Bangalore, India flight. American is also assisting Alaska’s application to the oneworld alliance. It intends to use its code-share with Alaska Airlines to provide domestic feed to American’s new international flights. However, American’s actual schedule filings show the true intentions of its moves at LAX. Even though American has been the most aggressive of the big 3 global carriers in restoring capacity, AAL’s domestic capacity at LAX is being restored at a much slower rate than other carriers. Although American has been the largest carrier at LAX for years, schedules for July and August show that Delta (DAL) is now the largest carrier at LAX based on flights and seats followed by Southwest (NYSE:LUV). American’s schedules through August show that it is either exiting or rebuilding its capacity from LAX to the western U.S. slower than other carriers as well as exiting a number of routes to other carriers strength markets such as Atlanta (Delta), Houston (United), and Nashville (Southwest) as well as to smaller cities in the west. Many of these routes within the west are operated by regional jets while American mainline (larger jets) operate longer flights. A similar trend is now emerging with American’s schedules in New York and Boston even after American’s aggressive redeployment of capacity in May and June. American recently withdrew schedules in the Boston to Los Angeles market, a top industry and historic American route.
American also announced a partnership with JetBlue (JBLU). Potentially much larger than the American/Alaska partnership, the American/JetBlue partnership focuses on American’s underperformance in New York and proposes using JBLU’s domestic flights to provide feed for American’s remaining international flights, predominantly to the U.K., continental Europe, and S. America. As with the Alaska partnership, American and JetBlue will allow loyalty plan benefits to be accessed on a reciprocal basis by American and JetBlue passengers. Later phases of the partnership envision American leasing or sharing slots and gates at LaGuardia and/or JFK airports with JBLU, requiring that the deal be approved by the Department of Justice in addition to the usual approvals for code-share operations from the Dept. of Transportation. American also said it intends to launch new routes from JFK including to Athens and Tel Aviv.
JetBlue’s Network Strategy Source: JBLU earnings call
As of December 2019, American was the fourth-largest airline by passengers in the combined LaGuardia(LGA)/JFK/Newark market and the third-largest by revenue. However, American is the 2nd largest slot holder at LGA and operated about 30% of the flights at LGA in 2019 compared to Delta’s 45%. No other carrier operated more than 10% of flights at LGA. At JFK, Delta operated about 35% of the airport’s flights in 2019, compared to 26% for JBLU and 13% for American. Foreign carriers operated nearly 25% of flights at JFK. The AAL/JBLU partnership also envisions the two cooperating in Boston where JBLU is the largest carrier, followed by Delta and then American.
In order to understand the potential impact of these two partnerships not just on the three carriers involved but also on the industry, it is helpful to look at the last 20 years of the airline industry, specifically focused on the NYC and Los Angeles markets.
Two Decades of Major Market Declines
The U.S. domestic airline industry was deregulated in 1978 and was previously operated as a regulated utility, requiring that each airline had to request permission from the federal government to start and end routes as well as to price its offerings. The decade of the 80s saw multiple mergers in the industry. The early 1990s and the Gulf War created enormous distress for the airline industry and led to failures including of legends like Pan Am and Eastern. The late 1990s saw strong airline industry recovery with strong airline profits until the dot com bust followed by 9/11.
The nearly twenty years since 9/11 serve as an insightful guide as to how the legacy carriers have adapted to crisis. At the turn of the century, there were still seven legacy/international carriers left. Trans World Airlines returned to chapter 11 for the third time in April 2001 and was acquired by American Airlines which spent approximately $2 billion on the acquisition only to begin dismantling TWA within months after 9/11. The six remaining international legacy carriers each found a mate over the next 10 years, reducing the U.S. legacy carrier ranks to just three just over 30 years after deregulation.
American/TWA Hybrid Livery Source: Wikimedia
The legacy carriers that we have today began to emerge as the industry’s legacy survivors in the 1990s; American and United (UAL) were the only remaining airlines from the Spoils Conference, the 1930s era preferential airmail awards that were found to be influenced by government corruption and corporate bribery. American and United each had approximately 25% of the U.S. domestic market share in 1980 and each have risen to the top of the industry. Delta did not win access to the industry’s most valuable routes during the regulated era of the industry until after WWII but has repeatedly used successful mergers as well as deregulation to grow from its position as the sixth-largest U.S. airline in 1978 to the third-largest on 9/11 and then the largest based on revenue in 2019.
20 Very Different Years for the Big Four
From the year 2000, just prior to 9/11, until last year, American, Delta, and United each engaged in multiple mergers and asset acquisitions. During the first two decades of the new millennium, Southwest became one of the big 4 U.S. airlines with market share greater than United and comparable to American and Delta. However, considering the market share of all of the merger partners that each carrier engaged in, including Southwest, DOT data shows that American, Delta, and United all lost market share over the past two decades even though their revenues grew dramatically. The growth of new carriers including JetBlue as well as the growth of carriers such as Alaska and Spirit (NYSE:SAVE) that existed before the year 2000 left the three nationwide legacy carriers with a smaller share of the U.S. market. American’s market share, including its merger partners, dropped from 25% to 20%, Delta fell from 23% to 20%, and United retracted from 21% to 16%. Southwest’s share grew from 15% to 19%. While United and American each lost five percent of market share, Delta lost a smaller three percent, indicating that it was more competitive with low cost carrier growth than American and United.
Revenue growth provides even more insight. During the 19-year period between the years of 9/11 and COVID-19, American’s passenger revenues grew by 257%, Delta’s by 295%, Southwest’s by 331%, and United’s by 232%. American and United were less able to grow their revenues than Delta and Southwest, both of which entered the new century with smaller networks than they have today. Southwest became much more of a nationwide carrier while Delta became a much larger global carrier.
While domestic system data shows that American and United have been unable to use their mergers to protect their market share as effectively as Delta or to grow as Southwest has done, examination of city-specific data for New York City and Los Angeles shows that American and its merger partners have lost significant share in the U.S.’s largest and most influential markets. New York City is the largest air travel market in the world while Los Angeles International Airport is the richest airport in the United States for travel that originates or terminates at a single airport. LAX also handles a larger proportion of revenue of the region’s airports than do any of the big three New York City airports.
Including its merger and asset acquisition partners, American’s share at New York City’s three airports fell from 35 to 15% in the first 20 years of this millennium, United’s share is down from 32% to 27% but Delta’s share grew from 22% to 27%. JetBlue began service in 2000 and grew to 17% market share over 19 years. Southwest remains relatively small in the NYC market with just 4% share.
In Los Angeles, the share losses by American and United are similar to NYC. Including its merger partners, AAL’s passenger revenue share fell from 26% to 23% and UAL was down from 31% to 17%. As in NYC, Delta was up, growing from 14% to 19% while Southwest was down slightly from 18% to 17%. Seattle-based Alaska Airlines, a predominantly west coast airline, grew its share from 4% to 10% while JetBlue ended 2019 with 4% share at LAX.
Understanding these share shifts that took place over the first two decades of the 2000s explain why American is now looking to other domestic airlines to help shore up its market share positions in two of the nation’s top markets. While neither of American’s current partnership deals involve Chicago, American now only operates to a single longhaul international destination – London – from Chicago, after years of offering service to dozens of destinations across both the Atlantic and Pacific. United calls Chicago home and dominates the international travel market from Chicago. DOT data shows that American’s average fares in most of its longhaul international markets from JFK and Chicago to continental Europe, and Chicago and Los Angeles to Asia trailed Delta and United by double-digit percentages. It is not an exaggeration to say that American struggles mightily to compete with Delta and United in the largest and most competitive international markets from the United States.
Will It Work?
With American’s international presence failing in all three of the U.S.’s largest markets, the company has recognized it also does not need to maintain the size of its domestic operations and that is where its partnerships with ALK and JBLU come in. American has previously allocated a significant amount of domestic capacity to help feed its international flights. As it reduces its LAX international operations and decides that it will pull back on its domestic flights in NYC, the question arises if AAL’s strategy will now work when it hasn’t worked for nearly 20 years in these cities. American faces a number of daunting challenges in its attempt to salvage its shrinking presence in the United States’ largest markets:
- There is no guarantee of DOJ approval. While the Dept. of Transportation is certain to approve the code-sharing that AAL and JBLU propose, the DOJ part of the plan is more complex. While AAL and JBLU haven’t released details of what they are proposing, there is enough information available to know that AAL wants to be able to designate JBLU to use AAL gate and slot assets at New York LaGuardia and JFK airports as they become surplus to AAL. Of course, by choosing JBLU to use those assets, AAL is trying to obtain benefits as part of those asset transfers. It is certain that other carriers will assert that those slots and gates need to be made available to other carriers if AAL no longer wishes to use them. United Airlines has indicated for several years that it would like to be able to return to JFK airport but has been unable to do so because of a lack of slots throughout the day to build a marketable schedule; access to airport facilities might be problematic. At LaGuardia, Southwest is certain to seek additional slots in order to grow its presence there. Other airlines are certain to be interested in gaining access if they can.
The real issue at stake is whether the DOJ will allow an airline to control the disbursal of its own assets at limited access airports such as LGA and JFK, two of the three remaining FAA slot-controlled airports in the country. The DOJ has repeatedly used asset transfers involving slot-controlled airports as an opportunity to inject additional competition into the markets. It is also possible that the DOJ could encourage the FAA – which is responsible for slot controls for safety and capacity rather than economic reasons – to relax slot controls at JFK and LGA. No airport is operating at capacity right now, so slots are not being fully used, although approval for the proposed AAL/JBLU deal could take months or more. The FAA relaxed slot restrictions at both LGA and JFK airports post 9/11 and there was a massive influx of capacity, much of which was grandfathered in when slot controls returned. However, the FAA also removed slot controls at Newark airport several years ago because United was not fully utilizing its slots; a rush of new capacity came into the market and the FAA has had to require that airlines coordinate schedules with them but has not re-implemented slot controls. While LaGuardia might be the last airport to have slot controls eliminated, JFK might be a good candidate to follow Newark with the elimination of slot controls. If that happens, then the value of the deal to AAL/JBLU might be less than expected.
The only other FAA slot-controlled airport in the U.S. is Washington National where American is the largest slot holder with a higher percentage of slots than any carrier has at LGA or JFK. If slot controls are relaxed in New York – which is far more delay-prone – there is certain to be calls to relax slot controls at Washington National.
Mike Linenberg (Deutsche Bank)
Hey. Good morning, everyone. Joanna, a question for you just on the American agreement, you did talk about code-sharing connections and the like. I know it’s been reported in the press that there was also the transaction would include a slot swap, and there’s been sort of differing reports out there about what that actually entails. I’m not sure if that’s LaGuardia and Kennedy or if that’s space at Newark. Any color that you can share on it?
Scott Laurence (JetBlue Head of Revenue and Planning)
So thanks for the question. So as we continue to work through this, we’ve talked a bit about what we’re going to do. I think the first part of this is there’s — obviously, for us, we’re excited about this because there’s a ton of benefit, right? There’s low fares, there’s great service. That’s going to come to new markets.
And as we look at slots and we look at how we move forward, American has talked about things like LaGuardia, where they’re going to be removing airplanes. That creates some room for JetBlue at LaGuardia slots are freed up. There’s also potential for us to look at other opportunities.
Certainly, in the afternoon at JFK, not only does that allow our transcon network to come in and arrive and feed American’s long-haul network, but it also brings competition to some of those long-haul markets.
JBLU executive comments regarding AAL NYC slots
Source: JBLU earnings call transcript
- The greatest risk American faces is believing that it can shrink to profitability in highly competitive markets when that strategy has never worked for any other airline. By cutting capacity in the two largest markets, American risks further loss of its significance as a global carrier. American, fundamentally, believes that it can become smaller in the nation’s three largest markets – including Chicago – and continue to be relevant as a global competitor to Delta and United. The last 20 years show that has not been the case; AAL’s relevance in the global marketplace is less than it was 20 years ago. Delta has spent the last 15 years “pushing up” from its interior U.S. hubs which are in medium-sized cities – Delta and Northwest’s historic strengths – to larger markets, including New York City and Los Angeles. American and United have historically been stronger in large markets; American is now shifting its focus to its interior U.S. hubs where it has higher market share while United is trying to grow its hubs in the middle of the country to match its historic strengths on the coasts. Strategically, American is going in the opposite direction of Delta and United. Given that the justification of the last round of consolidation was for the big three legacy carriers to become nationwide and worldwide carriers – all three are among the top ten airlines in the world regardless of the metric – American’s move is unlike what any other airline that has survived has done by shrinking its network in the largest and most competitive markets.
- American says that it is trying to serve as a niche carrier in New York City and its cuts make it more of a niche carrier. One of the major principles of airline pricing strength is that carriers with high market share are better able to price their services higher. American has not proven that its niche market strategy works in large markets and it will be under even more pressure to deliver on a goal it has not achieved as it cuts many key domestic routes. There is no evidence from airline history (including American’s previous partnerships with ALK and JBLU) that simple code-shares have any meaningful impact to revenue; companies and travelers value integrated networks. American and Alaska and JetBlue cannot coordinate schedules or prices or jointly plan capacity even if the DOJ grants approval to their deal. They are legally required to remain competitors.
- Service differences between American and JetBlue are more significant than with Alaska. JBLU only has a premium cabin on its Mint flights, largely used on selected transcontinental flights. Premium cabins provide powerful incentives to business travelers that might be able to get upgrades in return for their loyalty. American is generally perceived to have weaker customer service than either Alaska or JetBlue and DOT statistics confirm those trends. Therefore, the intended reciprocity of the deals might not materialize. Further, at both New York City airports, AAL and JBLU operate from separate terminals, minimizing the schedule display benefits compared to Delta that operates all service from a single although large terminal.
- Related to the market share issue is that American is outsourcing domestic connecting flights, many of which are served on small regional jets, to Alaska and JetBlue while trying to retain much of its international flights despite the fact that its underperformance in Los Angeles to Asia and New York City to continental Europe is in the local international market, i.e. Los Angeles to Shanghai and Beijing and New York City to Paris and Milan. As of February 2020, American operated 50 passenger or smaller regional jets on approximately 40 flights/day from LGA and JFK, or about 20% of its flights. Interestingly, American operated no 50 passenger regional jets at LAX but still wants to cut flights. Adding more connecting traffic can’t make up for the lack of ability to successfully compete in the NYC and LA international markets. AAL will be cutting costs from some of its lowest performing domestic routes from LA and NYC but isn’t addressing its financial underperformance in key international markets. In fact, American is doubling down by adding new international routes from JFK and Seattle (as part of its partnership with Alaska) even though it hasn’t demonstrated above average fares than Delta or United in comparable markets. It also is not clear how far American is willing to go in pulling out of routes it operates and then buy seats via code-shares on other domestic carriers but it is certain that as American’s ability to negotiate corporate contracts diminishes, its need to exit more routes will grow.
- One of the unique challenges that American faces is that it is linking its network strategy with two carriers, one on each coast, and Alaska and JetBlue both aggressively compete against each other, including on transcontinental U.S. routes. In fact, much of JBLU’s growth in the transcon markets came at Virgin America’s expense and later from Alaska as acquirer of Virgin America. American has had relationships with both carriers previously, terminating the JBLU relationship several years ago and scaling back the Alaska relationship. While the details behind those older relationships aren’t known, it is certain that American wound them down because they weren’t financially feasible. It is doubtful that the economics have changed other than that American is dangling access to its gates and slots on both coasts as an incentive for Alaska and JetBlue to cut the seat prices that they will charge American for flights American wants ALK and JBLU to operate on behalf of AAL. Add in that Alaska and JetBlue are competing with each other in some of the nation’s largest markets and the likelihood that American’s partnership deals fail as they did before is very real again. An example of the internal network overlap between American, Alaska, and JetBlue is the JFK to Los Angeles and San Francisco markets – which each of the three serves on their own aircraft. Years ago, American replaced its 767-200 aircraft on those routes with A321s in a configuration with a high ratio of premium seats and few coach seats (internally called American’s A321Ts), in part because American was not successful competing against the growth of Virgin America and JetBlue. Shortly after American announced its A321T strategy, JetBlue announced its Mint configuration which is an A321 with 16 premium lie flat seats essentially added in front of the same size coach cabin on its smaller A320s. JBLU’s Mint strategy has been successful because it involves minimal incremental cost but offers significant incremental revenue. However, it was Virgin America that initiated the premium, low cost transcon product by offering a smaller premium cabin on its A320s with recliners, a strategy that Alaska chose not to continue after during its merger, offering instead only a standard domestic first class cabin. Alaska’s share has shrunk, its average fares are the lowest in the transcon markets where JetBlue offers its Mint product while American’s share has shrunk but it has the highest average fares, but very likely not sufficient to cover the higher unit costs of its service. Delta has become the largest carrier by revenue in both the JFK to LAX and SFO markets, uses 767s on some flights (which allows Delta to carry cargo) and has average fares second only to American but very likely sufficient to generate profit margins comparable to or higher than JBLU given that the average number of seats per flight on Delta’s transcon flights is the highest in the market. American says JBLU’s Mint product will complement its own transcon product but the chances are high that Delta and JetBlue will continue to grow their share while Alaska’s share falls due to low unit revenues and American’s due to high unit costs. Still, American is pitting its two partners increasingly against each other.
- Alaska and JetBlue have also expanded their networks outside of the partnership routes, in some cases directly competitive with American. JBLU is adding flights from American’s Philadelphia hub to Florida and Puerto Rico while Alaska is adding flights in the western U.S. where JBLU is also trying to expand. Both Alaska and JetBlue are growing at LAX, likely using assets that have become available as AAL shrinks. Just as in NYC, gate assets at LAX are very valuable.
- American risks a strong competitive response to the partnership. JBLU recently announced that it is adding numerous flights from Newark including to Los Angeles and San Francisco, top system markets for United. By partnering with JBLU, American is opening itself to increased competition from United. By the same token, United is committed to getting back into JFK which would very likely result in Delta adding Newark to California flights, negatively impacting American since Delta and United already have a much larger presence from JFK and Newark, respectively. Delta has built new hubs in Boston, a major market for JBLU, and Seattle, Alaska’s largest hub, making part of American’s motivation to help ALK and JBLU compete against Delta; since there are still a number of markets which Delta does not serve from Boston and Seattle, including to American strength markets, the chances are high that Delta will simply expand its own network into more high-profile industry markets where American has traditionally been strong. Because the AAL partnerships will require DOJ approval in order to transfer assets, other carriers can quickly start their own new competitive service with their own assets.
- From a macro perspective, one of the biggest concerns about AAL’s partnership deals is that it does nothing to reduce AAL’s industry-topping debt and actually shrinks American’s own network while ALK and JBLU will be given the opportunity to grow without servicing AAL’s debt. Airlines simply cannot shrink their way to profitability outside of bankruptcy. While removing high unit cost regional jets will lower AAL’s systemwide unit costs, AAL ended 2019 with the highest unit costs in the U.S. airline industry despite being the most recent large airline out of chapter 11. Much of AAL’s high unit costs can be attributed to its high employment numbers which American could reduce after September 30 but they risk employee dissatisfaction and service challenges as American mainline and regional employees see their jobs being eliminated while American outsources flying to other airlines. American’s most recent schedule changes show that it is at least temporarily suspending service in highly competitive markets such as Boston to Los Angeles which are flown by American’s own aircraft, making it harder for American to sell its partnerships to its employees who are certain to face layoffs as they watch their employer exit long-standing company markets.
American’s Fleeting Global and Nationwide Relevance
American might turn around its 20-year-long decline in the nation’s top markets via its partnerships with other carriers but, at best, it appears to be set to dangle some of its best assets in those cities- gates and slots – in front of Alaska and JetBlue in order to try to increase its presence in domestic markets where it has done poorly while hoping to connect more passengers to international flights where it has not been able to produce revenues compared to Delta and United. American is taking a high risk in further reducing its size in competitive industry top markets, something no other airline has ever successfully done. In fact, airlines like Pan Am, Eastern, and TWA all were forced over time to reduce their presence in major markets in order to slow losses, ultimately leading to their downfall. Like American, each of those carriers had financial situations that were worse than industry average. American might succeed at altering its trajectory in the wake of COVID-19, but American’s most recent financial results, its own track record of competing in the industry’s top markets, and airline industry history show that the chances of American’s success in these latest initiatives are low and will likely accelerate American’s demise.
Disclosure: I am/we are long DAL LUV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.