Delta, UA Try, Try Again: Struggling Full-Service Carriers Resurrect Low-Cost Strategy

The low-cost carrier-within-a-carrier concept once again is in vogue in the U.S. aviation industry—despite doubts by analysts and other observers stemming from several failures during the past decade. Both Delta Air Lines and United Airlines in the past two weeks announced plans to operate subsidiaries offering lower airfares in an attempt to protect marketshare from prosperous low-cost competition, if they can get labor union support.

The trend had sputtered in the United States following the Sept. 11, 2001 attacks when Delta, United and US Airways each disbanded or sharply reduced poorly performing, in-house, low-fare operations. Recently terminated attempts by foreign carriers also discredit the model. Nevertheless, U.S. majors again are crafting alternatives to mainline service.

At the same time, some carriers are accelerating service transitions to smaller jets operated by regional partners, which offer more flexible scheduling as part of a larger effort to achieve operational efficiency while sustaining hub dominance.

This evolution away from mainline service in many domestic markets is a direct result of the growth of Southwest, JetBlue and AirTran airlines, which have proven that the flying public, including many business travelers and their managers, is satisfied with lower-price products.

"There is a new aviation model unfolding as it relates to corporate air programs," said Chris Staal, vice president of strategic sourcing for Thomson Corp. in Stamford, Conn. "Changes, such as the ability of low-cost airlines to deliver a high level of service into business markets, begs reevaluation of how corporations have sourced their spend for air travel."

National Business Travel Association president Kevin Iwamoto said the trends may lead to just a couple of airlines running full-service operations with the rest classified as low-fare carriers. "The good news is that costs can go down, which may encourage a few more trips. The bad news is that travel process and experience will still be onerous," he said, adding that a "core group of corporations" with expansive travel needs still would support full-service carriers.

"Other than the top 25 or so long-haul markets, do you need full, mainline service?" asked John Smith, president of Tower Travel Management. "Some would say yes, I would say no."

Delta is staking its future on Song, a low-cost, East Coast subsidiary set to take flight in April. It appears unlikely that Song services will include point-of-sale corporate discounts, but Delta officials would not comment on how Song services would be integrated into corporate contracts, if at all. Some travel managers already are wondering if bookings on Song will count toward their contracted Delta goals. A Song spokesperson said only that the low-cost unit and the mainline parent will "cross-utilize" corporate sales resources.

A clear reaction to JetBlue's penetration, Song will try to raise the bar for inflight service while capping one-way fares at $299, initially between the Northeast and Florida. The inflight entertainment system to be deployed aboard Song's dedicated fleet of 199-seat Boeing 757s will mimic that of JetBlue's, and ultimately could surpass it if the system works as advertised.

Song's predecessor, Delta Express, failed to prevent AirTran, JetBlue and Southwest from invading Delta's East Coast turf. "On the one hand, some may ask, 'You tried this before, so why is it different now?' " said Michael Boult, COO of Eclipse Advisors, a Rosenbluth International technology unit. "On the other hand, the airlines may not have a choice, so maybe it simply has to be different. If it doesn't happen in this environment, then I give up and Chapter 11 must be the corporate strategy."

Song is eyeing cost savings through lower-cost distribution, including voice recognition rather than traditional reservations offices, and higher aircraft utilization rates. Its Web site, the main focus of the sales effort, will solicit customer feedback leading to service and amenity modifications. "We're introducing choices back into the experience," said Song president John Selvaggio.

Delta CEO Leo Mullin said the primary key to success is a clear distinction, both internally and externally, between Delta mainline and Song services, an element Delta Express lacks. But leaders of Song's competitors expressed no concerns. "It's the same old song, second verse," quipped Southwest CEO Jim Parker. "All these airlines within an airline have withered. Song is looking for lower seat mile costs by flying larger airplanes, but there are a limited number of U.S. markets where you can do that successfully. I don't see how these airlines can reinvent themselves to close that gap in productivity in any material way."

At JetBlue, CEO David Neeleman is "skeptical" Delta can outfit Song airplanes by October with the announced inflight entertainment system, which Delta said will include live television, on-demand audio programming and pay-per-view movies. "They certainly will never get down to our costs," Neeleman added, "and it is even more clear they won't get to our level of customer service when they are laying off employees and lowering salaries."

For its part, no-frills champion Southwest has no plans to bring inflight entertainment systems to its fleet. "Our flight attendants are our inflight entertainment," Parker said. "Why would we want to do anything to diminish that?"

Analysts are divided on Song's chances. J.P. Morgan Securities analyst Jamie Baker, for one, said Delta's child will bring competition that "will inevitably result in a modest level of spill/defection from JetBlue."

"Delta had to do something to get costs down, but I wonder if it can truly make it low cost with senior, high-paid pilots flying the airplanes," said Ray Niedl, analyst with Blaylock & Partners.

Rolfe Shellenberger, an independent consultant in Palm Desert, Calif., said Delta, in deciding to "overwhelm JetBlue with schedule and service," disregarded the real issues of pilot pay and traveler preference. "The mentality of the big airlines is that they have to protect their turf from interlopers," he said. "Instead, they should be talking to the public and focusing on what is needed."

United's plan thus far is more vague and potentially problematic in the context of labor-management relations. In an employee hotline message last week, the company said its new carrier would "learn from the industry's past mistakes" and could be developed as "a separate entity with its own management and employee workforce." Statements from certain labor leaders suggested the process will be difficult. "There is no magic cure for United or any other airline," said Capt. Paul Whiteford, chairman of the United Master Executive Council of the Air Line Pilots Association.

United provided no other details of its low-cost unit strategy, but CEO Glenn Tilton said, "We will not—we cannot—walk away from a significant and growing market that is important in its own right and an important element of our total network proposition."

Meanwhile, several carriers overseas in recent years have tried the airline-within-an-airline concept, with varying results. British Airways last year sold Go to rival EasyJet and KLM Royal Dutch Airlines just last month sold Buzz to Ryanair. More recent low-fare entries outside the United States include BMIBaby from BMI British Midland and Qantas Airways' Australian Airlines. Air Canada, meanwhile, operates a regional subsidiary, a western Canada operation and no-frills discount carrier in addition to mainline service.

Citing Air Canada's need for cash and recent service reductions by low-fare unit Tango in eastern Canada, Sam Andraos, president of Toronto-based consultancy Aim International Management, said Air Canada may have "cut itself too thin," despite its monopoly position in the market. "I think the majors should focus on their core business," Andraos said.

Late last week, in fact, Air Canada said it "is reviewing alternatives" related to selling all or part of Jazz, its regional operation.

Stateside, major U.S. carriers also are transitioning certain services to regional partners, including Delta, which recently announced a reconfiguration of its Dallas/Ft. Worth operation. That trend is likely to accelerate as carriers seek to align supply and demand by deploying small regional jets. United's reorganization plan, for example, includes expanding United Express operations.

Still, Southwest's Parker said hub-and-spoke carriers won't fully evolve any time soon. "They still have strong market positions in their hubs, and are difficult to compete against in those hubs," he said. "We'll see them focusing on markets where they can be profitable—including international—but they are not positioned to compete on point-to-point service."

Blaylock & Partners' Niedl agreed, expressing doubt that airlines-within-airlines will work as planned. "But if by some chance they do work, they will be the blueprint for domestic service."