A Tale of Two Airlines

Where did America West Airlines go wrong? What has Alaska Airlines done right? Why would two carriers with such common beginnings face such uncommon futures today? The tale of America West and Alaska is the story of two different ways to run an airline. It could be an object lesson for aspiring carriers anywhere in the world particularly Australia.

America West started in Phoenix; Alaska Airlines in Seattle – recognised capitals of the Southwest and Northwest respectively. Both airlines were darlings of deregulation -living proof that independent carriers could make it. America West started four years after deregulation; Alaska was around from the old days, but changed so much after deregulation that it also seemed new.

At first both airlines grew cautiously. America West confined its routes to California and underserved cities in the Rockies and Great Plains. Before deregulation, Alaska had flown only within the state of Alaska and south from there to Seattle. With deregulation, it started a cautious expansion south along the Pacific coast.

One difference quickly emerged. America West was willing to discount fares to gain market share. Alaska Airlines was not. Bruce Kennedy, Alaska’s CEO at the time, decided to compete only on the basis of service. United, Delta, and Northwest also flew to Alaska. They had the resources to wage fare wars. Kennedy knew “they could drive us out of business in fairly short time if they put their minds to it. ” So he concluded that the best way to capture market share was with quality service. “Because we don’t have clout,” he said, “we have to use finesse. ”

Finesse meant inflight services that became a hallmark of Alaska Airlines. After deregulation, when competitors cut costs, Kennedy cut the number of seats, and added cabin attendants and frills. Hot meals on every flight over an hour and a half and complimentary wine are now standard. “We’re a high cost airline,” Kennedy conceded. “Our cost per available seat mile is probably the highest in the industry. ”

America West had less to fear from megacarriers, but more to fear from another post deregulation regional: Southwest Airlines. Southwest was a non union, low cost carrier who flew Texas to California with stops in Phoenix. That encouraged America West to adopt the same low cost, non union, low fare style.

From 1988 through 1991, costs for both America West and Alaska grew US1. 5 cents per seat mile, mostly due to fuel prices. But America West started that period at US6 cents, while Alaska started at 9. 5. Southwest remains the only US carrier with lower unit costs; no one started higher than Alaska and only USAir’s costs are as high today.

Yet, Alaska Airlines was consistently able to show a profit because higher fares and better yield produced unit revenues that always exceeded unit costs. By contrast, America West produced a slim positive margin only from mid 1988 through mid 1990. It could not sustain a profit. As costs passed revenue, the gap grew.

It is hard to distinguish cause and effect, but the slim economics at America West may have accounted for other differences in management philosophy. One of the most obvious differences was the strategy on route expansion.

Alaska has found a niche and grown cautiously from it. Alaska’s share of the market is about the same today as when deregulation started. Of course, the market has mushroomed and many airlines of Alaska’s size have since become history.

With deregulation, Kennedy cautiously began to extend routes south of Seattle, first, to Portland, and then, more dangerously, to San Francisco. The latter, a major hub for United Airlines, woke the sleeping giant. United reacted by launching its own flights to Alaska in head-to-head competition.

Kennedy’s position was precarious. He faced the prospect of a fate similar to Wein Air Alaska, which had also pushed southward, only to be taken over by a larger airline when Wein invaded its territory. But the war with United Airlines never happened, partly because Kennedy found a way to minimise the confrontation. He focussed his southward push on city pairs that posed less threat to United and the other big airlines. Kennedy recognised that Alaska’s survival amid Goliaths required it to remain “a fairly benign competitor. ” So, in the San Francisco Bay area, he emphasised Oakland over SFO. In Los Angeles, he concentrated on suburban airports which were under served or not served at all by the majors.

Today, Alaska flies all the available seats from Seattle and Portland south into the LA suburbs of Ontario, Burbank, and Long Beach, and over half the seats into Oakland, Orange County, and San Diego. Only on the trunk routes to SFO and LAX does Alaska Air’s share drop to about 40%. This seems to maintain a balance, albeit delicate, between a respectable market share and a confrontation with the Goliaths.

This same philosophy extends to routes within California -the market where small angels clearly should fear to tread. Alaska Air avoids the hotly contested SFO/LAX corridor altogether. Instead, it skirts around from Oakland to Long Beach and San Diego, where competition is lighter and more passengers pay full fare. Alaska Airlines has found a niche in the California suburbs. The company lapsed only once from this careful approach. Five years ago it bought Jet America, a low cost carrier with an coast-to-coast network. Kennedy had hopes of using it to extend Alaska Air eastward. But those plans were soon scuttled. “We got hammered right away by United and American,” he recalls.

Kennedy made the best of a bad deal by selling Jet America’s slots at Chicago, Washington, and New York. He redeployed its MD-80s on Alaska’s north-south routes, boosting capacity 31% in a year when demand and fares were both up. As a result, operating income more than doubled.

That was the one and only time Alaska Airlines tried to extend east. Since then it has relied on arrangements with other airlines. It maintains an intertie with American Airlines on routes from Dallas, Houston, Chicago, and Washington. It is also a frequent flyer partner with Northwest and TWA, and coordinates schedules with them to offer Minneapolis, St Louis, and New York passengers one stop service to the state of Alaska.

The north-south niche has helped hedge against ups and downs in the state of Alaska’s economy, and help smooth out its seasonal roller coaster. When the airline was only flying to and within the state of Alaska, summer was always a boom and winter a bust. Now that routes extend down the Pacific coast as far as Mexico, southbound winter traffic has grown. Mexican markets are counter seasonal to Alaska’s northern markets.

Numbers reflect the success of Alaska’s southern expansion.

In 1983, two thirds of its revenue passenger miles were flown north of Seattle. Six years later, two thirds were generated on flights south of Seattle down the West Coast and to Mexico. Mexico alone now accounts for 12% of the airline’s traffic.

America West started with a comparable niche philosophy. For three years it developed routes throughout the West from its Phoenix and Las Vegas hubs. Many of these were new routes,

America West Facts

History: Launched in August 1983, America West was first praised as a “darling of deregulation” for its strategy of building a network in the west half of the US centered on its twin hubs in Phoenix and LasVegas. But it was unwilling to confine itself to the West. In 1987 the airline doubled in size, flying into the teeth of intense competition with new services to Chicago, New York, and Baltimore. By 1989, with revenues

approaching $US1bn, America West became the only US post deregulation carrier classified as a “major” airline. Growth continued at a breakneck pace as the carrier added aircraft and destinations. At the same time,it was losing traffic and yield to fare discounting by rival Southwest Airlines, a low cost regional carrier. By 1990, America West had operating revenues of $US1. 3bn, but a net loss of nearly $US80m. Saddled with debt, in June 1991 it sought relief from its creditors under Chapter 11 bankruptcy protection.

Network: When it filed bankruptcy, America West served 56 US destination in 20 states plus Calgary and Edmonton, Canada and Nagoya, Japan. Since then, under court supervision, its route system has shrunk dramatically. It has dropped all flights to Canada, New York’s La Guardia, and a host of regional cities. At press time the US Department of Transportation seemed on the verge of approving a sale of the Nagoya route to Northwest for $US15m.

Ownership: America West is 28% owned by its 12,000 employees, 26% by Transpacific Enterprises (an Ansett affiliate)and about 10% by management. The remainder is publicly traded. Shortly before the airline filed for bankruptcy protection, Ansett’s affiliate increased its stake from 20 to 26% with an injection of some $US1. 4m.

Fleet: When it filed for bankruptcy, America West operated 108 aircraft as follows: 3 A320-200, 4 747-200, 11 757-200, 44 737-300, 33 737-200, 1 737-100, 12 DHC Dash 8. It also had orders and options for $US8bn in nearly 200 additional aircraft, mostly A320s. Of the 80 leased aircraft it was operating before bankruptcy, it has since returned about 10.

Financial: Operating revenue climbed steadily from the airline’s inception almost until it filed for bankruptcy. The airline showed modest profits in four of its eight pre-bankruptcy years, but lost $US75m in the last one. In 1989, 85% of its capitalisation was debt. That ratio rose to 94% by the third quarter of 1990. In the months preceding bankruptcy, America West offered seats at 50% discount in a desperate attempt to raise cash. The bankruptcy court has approved $US78m in debtor-in-possession financing from Guiness Peat Aviation, Kawasaki Leasing, and Northwest Airlines. That plus $US108m in deferred aircraft payments and $US100m from an annualised cost reduction program recently led an America West official to predict that the airline will successfully emerge from bankruptcy by the northern 1992 summer.

serving regional centres in Colorado, Kansas, Nebraska, and New Mexico. But in 1987 it forsook the west by launching ser-· vices to Chicago, and then to Baltimore and New York on the east coast. Over the next two years it added Minneapolis, Newark, Boston, Washington, and Honolulu. All were well beyond any regional network. Even since its bankruptcy filing, the company has tried to develop a hub in Columbus, Ohio.

Geography and competition may have given Alaska Airlines an advantage. America West could not develop a linear niche across the southern west because Southwest Airlines was already there. America West might have offered one stop flights between the east and west coasts, but the megacarriers already flew those transcontinental routes non stop. The company’s best bet might have been east-west routes between some of the smaller eastern cities and California, with a stop in Phoenix or Las Vegas. But America West did not have Alaska’s niche philosophy; it wanted to mix with the biggest and the best. On international routes this difference was even more stark.

Alaska’s growth into Mexico was a natural extension of its northsouth flights long the Pacific coast. Mexico also met both of Alaska’s expansion principles: grow from strength and avoid unnecessary confrontations. Last year’s launch of a Los Angeles/ Toronto service did not fit Alaska’s typical linear growth, but the US route authority lay dormant until Alaska asked to exercise it. The airline’s expansion last year into the Soviet Far East seems more exotic, but fit the pattern more closely.

The airline already went as close to Siberia as any US carrier could fly. Alaskans were keen to establish contacts with their neighbors across the Bering Sea. New flights could reconnect Eskimo communities cut off since the Cold War. Alaska Airlines seemed the logical instrument to bring that about, and no other US carrier wanted the route. Now, Alaska Airlines would like to extend its Magadan/Khabarovsk flights on to the port city of Vladivostok and, ultimately, to China. It fits a familiar Alaska Airlines pattern-follow the Pacific coast in either direction.

By contrast, America West’s approach to international routes seemed opportunistic. Instead of using the Southwest as a base for flights into Latin America, a neighbouring region with ethnic ties, America West applied in 1988 for authority to serve Australia. Ansett’s stake in the carrier might have justified that request, but it hardly explains the applications in 1989 and 1990 for Tokyo, Taipei, and Hong Kong. The most likely rationale is that America West saw Asia-Pacific as a growth region, and wanted in on the action.

The US Department of Transportation awarded America West the Honolulu/Nagoya route in 1990. Since few Americans fly to Nagoya, and even fewer via Hawaii, it seemed from the outset as an improbable route for an airline based in the American Southwest. Correctly, the company understood that 95% of its traffic would have to come from Japan, where it would compete with All Nippon, Japan’s largest domestic carrier. Incorrectly, management was willing to bet the expense of daily 7 4 7 flights on proving they could do it.

The simultaneous launch of Desert Storm and America West’s Nagoya flights offers an excuse for why they did so poorly. However, the real reasons have more to do with Alaska’s route expansion principles that America West chose to ignore. Route and growth philosophies are intertwined. Hence, it is no surprise that the two airlines approached growth differently.

When Bruce Kennedy and his partner took over Alaska Airlines in 1972, they turned a flamboyant airline with a gambler’s style into what a Wall Street analyst for Kidder, Peabody & Company called “probably the best managed airlinein the business. ” Instead of operating losses and a shareholder equity of negative $US2m when Kennedy took over, Alaska Air today sports a positive equity of around $US350m.

“We’ve never taken on more than we can absorb into the overall corporate strategy without maintaining a strong corporate profit for that year,” Kennedy said. “We’ve never been able to understand people who keep preparing for future years of profitability. ” By contrast, America West’s philosophy was recently described by William Becker, Avmark’s Seattle representative: “They grew so fast they blew the roof off, and then it started to rain. ”

One measure of growth strategies was in aircraft acquisitions.

In 1990 Alaska Airlines placed the biggest order in its history – $US2. 5bn for up to 64 MD-90-30s and 737-400s. Simultaneously, Alaska leased out three 727s to oil companies in a move to reduce its fleet to only two aircraft types – the 737 and MD-80/90. Alaska Airlines was using its acquisitions t6 replace older, less efficient aircraft and reach a high degree of equipment commonality. It bought the MD-80/90s for high frequency passenger services and leased the 737s for routes with big cargo loads, typically in and out of Alaska.

While Alaska Air was enlarging its fleet at an average rate of three aircraft a year, America West was adding fifteen. Underscoring their dissimilarity, America West also placed its biggest order in 1990. For $US6. 5bn it bought four 7 47-400s, 15 737s, 10 757s, and 74 Airbus A320s with options on 44 more. The order was two and a half times larger than Alaska’s. By 1990 America West had already enlarged its fleet family to include 737s, 757s, 747s, A320’s and de Havilland Dash 8s-five aircraft types.

While Alaska Airlines was tailoring its fleet to its needs, America West was proliferating aircraft types without much apparent idea of what aircraft would fit which routes. That pattern may have peaked in 1990, but it had been part of America West’s strategy almost from the start. It averaged seven new cities on its network every year for seven years. Starting with 13 destinations in 1983, it reached 69 before it filed for bankruptcy.

In the four years preceding bankruptcy, America West’s traffic grew by a phenomenal annual average of 38. 5% compared to Alaska’s 12%. Imagineif America West had successfully bought the PanAm shuttle and some of Eastern’s routes and gates, as it tried. Imagine what might have been if Carl Icahn had carried through his threat to sell TWl’l. s domestic routes and hubs to America West. In only seven years, America West had already become the ninth biggest US carrier in market share.

But it was like a pyramid scheme. Lease aircraft for quick growth; add routes and cut fares to grab market share; order more planes and then look for a place to fly them. One analyst described such frantic growth as “helter skelter. ” William Becker observed, America West followed the pattern of People Express

Alaska Facts

History: Alaska Airlines traces its roots to a bush airline that launched service between Anchorage and Bristol Bay, Alaska in 1932 with a single engine float plane. Over the years, mergers and acquisitions produced name changes and expanded business through the state of Alaska and south to the Lower 48. The carrier took the name Alaska Airlines in 1944. Before deregulation in 1979, the airline served 10 Alaskan cities and Seattle. Deregulation sparked the airline’s transformation with a carefully planned expansion of routes south from Seattle to California and Mexico. Alaska Airlines’ holding company, Alaska Air Group, also owns Horizon Air, a Seattle based regional carrier. The company bought Jet America Airlines in 1986, based in Long Beach, California, and merged it into Alaska Airlines the following year. Network: The airline serves 38 cities along the Pacific coast stretching from Alaska to Washington, Idaho, Oregon, California, Arizona, and Mexico. Seattle is a major hub; Anchorage and Oakland are supplementary hubs. Last year Alaska Airlines launched seasonal flights to the Russian Far East cities of Magadan and Khabarovsk. It also started flights between Los Angeles and Toronto.

Ownership: Alaska Airlines is a wholly owned subsidiary of the Alaska Air Group. The holding company shares are publicly traded. Twenty percent of the voting stock is held in an employee stock ownership plan and by International Lease Finance Corporation. Both moves were designed to discourage takeovers.

Fleet: 7 737-200C; 24 727-200; 1 727-100; 32 MD-80. Three other 727-100s are on lease to two oil companies in Alaska. In 1990 the airline ordered 20 MD-90-30s and optioned 20 more. It also committed to lease 20 737-400s from International Lease Finance Corporation with options on 4 more. The total purchase/lease package was $US2. 5bn. The 737s are slated for delivery between now and December 1994. At that time, the first of the new MD-90s are scheduled to arrive. Finance: Alaska Airlines has reported a profit for 19 consecutive years, although profit margins have declined sharply in the last two years. While operating revenues rose from $US900m in 1989 to $US1. 1bn in 1991, profits fell from $US42m (1989)to $US17. 2m (1990)to $US10. 3m in 1991. Revenue passenger miles have hovered around 4. 5 billion for the last five years, ranking Alaska Airlines as the 11th largest US carrier on that basis.

They had the same non union crews, the same high esprit de corps, the same fare discounting, the same fast growth strategy, and the same high load, low yield operations. It was as if no one had paid any attention to what happened to People Express and they were destined to do it again. ”

Inevitably, the result was mounting debt. In 1989, 85% of America West’s capitalisation was debt. That rose to 94% by the third quarter of 1990. Aircraft lease payments, which do not show on balance sheets even though they are functionally long term debt, would have made it even higher. America West faced an estimated $US50m annually in new lease payments alone on aircraft delivered last year. The observation by Philip Baggaley, senior vice president of Standard & Poor’s CreditWatch was proving true. He had warned the Wall Street Journal, “Their eyes are always bigger than their pocketbooks. ”

What does the future hold for these disparate airlines? With new directors imposed on America West by its lenders, will it emerge from bankruptcy and adopt an ideology more like Alaska’s? How much longer can Alaska Airlines continue its own low profile, yet profitable growth before it is challenged?

Opinions differ on America West’s chances of survival. For starters, the precedents are not encouraging. Eastern, PanAm, and Midway all obtained debtor-in-possession financing and tried to reorganise. All three failed.

America West has improved its cash position with debtor-in-possession loans from its lessors, GPA and Kawasaki, and Northwest Airlines, but some of that money is committed to lease obligations. Hence, there is less working capital than there might seem. The airline reported a staggering $US214m loss for 1991, far from the kind of turnaround it needs.

Wisely, America West is trying to sell its Nagoya route. At press time, the Department of Transportation seemed on the verge of approving its sale to Northwest for $US15m. But domestic route restructuring is also a priority. And so long as low cost Southwest Airlines is a rival, America West has a problem. Showing his frustration with that rival, Edward Beauvais, America West’s chairman told a Washington audience, “If we could figure out how to take their head off tomorrow, we would. ” That may explain why America West is busy building a hub in Columbus, moving into part of the vacuum left by Midway, far from its Phoenix base and Southwest Airlines. Whether an Arizona airline can adapt to Ohio, however, remains uncertain.

Alaska Airlines also faces new challenges. In November it faced a new Southwest of its own in the form of MarkAir, an intra-Alaskan carrier who decided to try the profitable Anchorage/ Seattle route. Undercutting Alaska’s fares, MarkAir also plans to compete on other routes within and beyond the state. This is developing into a nasty fight, with each side suing the other over a code sharing agreement and various trade practice claims.

Because of its own Alaskan background, MarkAir has a better chance of gaining a viable market share on Alaska/Seattle routes than other airlines who have tried. They learned the hard way about poor Alaskan flying conditions and the strong loyalty of Alaskan passengers. But winter was a bad time to launch a challenge when traffic is down. If MarkAir survives till the northern summer, Alaska Airlines could be in for a fight.

It has already felt the recent impact of competition from low cost charters between the Northwest and Mexico. Over its objections, in October the US Department of Transportation granted Delta a Los Angeles/Mexico City route that will divert some southbound traffic. Even without this competition, the California/Mexico routes are lower yield than Alaska’s other markets.

Alaska Airlines may well have reached the outer limits of its niche. When costs start exceeding yields, no one is immune.

There is a lesson in that for everyone