Chase
Content
Survival of the Fittest: The Impact of Low-Fare Carriers on Competition
Embry-Riddle Aeronautical University Airline Economics Seminar
National Press Club ± Washington ± April 7th, 2004
Lehman Brothers Airlines Research
Gary Chase Winnie Clark (212) 526-5752 [email protected]
Please see analyst certification and important disclosures on slides 16 & 17.
Low-Fare Carriers Changing Pricing Dynamics
There is A New Breed of Category Killer Emerging
Low-fare carriers have learned from the past and have much more of a franchise focus than at any point in history
Network Presence
Airline Franchise Value City Strength Brand
They also are defying conventional wisdom about LCCs by flying longer-hauls, creating upscale brand images, and building their presence in core cities Perhaps most important of all, they are increasingly fearless and willing to defy the conventional wisdom referenced above
2
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Historical Revenue Premiums in Jeopardy
Our analysis suggests that historical revenue premiums for the major airlines are in jeopardy The network airlines are running out of non-competitive routes where they can outperform competitive routes The network airlines have also come to rely on generating increasingly large average fare premiums to the low-fare airlines on competitive routes to sustain their unit revenue premiums Airlines with greater frequency will likely always command a premium, but we suspect that premium will be lower in the future We believe that fare premium strategies are problematic for two major reasons Fare premiums appear to have been bloated by a strong economy and appear unsustainable at current levels The behavior pattern that generates fare premiums seems to accommodate rather than hinder low-fare airline growth. We believe that these fare premium strategies will do nothing to stop low-fare airline growth and erosion of network airline market share
3
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Network Airlines Have Generated Consistent Revenue Premiums To Low-fare Carriers
Systemwide RASM Premium Network vs. Low-Fare Airlines (Stage Length Adjusted) 50% 40% 30% 20% 10% 0% ¶91 ¶92 ¶93 ¶94 ¶95 ¶96 ¶97 ¶98 ¶99 ¶00 ¶01 ¶02
4
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
As Exposure To Low-fare Airlines Grows«
Network Carriers Historical Low-Fare Overlap
4 3 24 2
2
3
4
2
5
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Network Airlines Have Fewer Noncompetitive Opportunities«
Nonstop Yield Differential Markets Without Low-Fare Competition vs. Markets with Competition (1)
100 0 0 40 20 0 0-249 250-499 500- 49 50-999 1,000 ± 1,499 1,500 ± 1,999 2,000+
(1) Simple average of annual differentials, 1991 ± 2001.
6
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Forcing Them To Rely On Increasingly Large Overlap Fare Premiums«
Network Carriers Historical Low-Fare Premium 3 24
2
2
3
4
5
¶96
¶97
¶98
¶99
¶00
¶01
¶02
7
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Fare Premiums Hinge on a Few Passengers ± Majors Sell at Least as Many Low Fares
Fare Distribution ± BWI-CLE ± Continental vs. Southwest ± 3Q03 30 20 10 0
Continental ± Average Fare $95
300 280 260 240 220 200 180 160 140 120 100 80 CO 60 40 20 0
Southwest ± Average Fare $81
60
40
20
300 280 260 240 220 200 180 160 140 120 100 80 WN
8
60
40
20
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Fare Premiums Hinge on a Few Passengers ± Majors Sell at Least as Many Low Fares
Fare Distribution (Fares <$300) ± BWI-CLE ± Continental vs. Southwest ± 3Q03 60% 48% 36% 24 12 0 300 280 260 240 220 200 180 160 140 120 100 80 CO
9
60
40
20
WN
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
AIRLINES RESEARCH
Fare Premiums Hinge on a Few Passengers ± Majors Sell at Least as Many Low Fares
Fare Distribution ± JFK-SAN ± American vs. JetBlue ± 3Q03 20% 10% 0% 300 280 260 240 220 200 180 160 140 120 100 80 AA 20% 10% 0% 300 280 260 240 220 200 180 160 140 120 100 80 B6
10
JetBlue ± Average Fare $163 American ± Average Fare $199
60
40
20
60
40
20
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Fare Premiums Hinge on a Few Passengers ± Majors Sell at Least as Many Low Fares
Fare Distribution (Fares <$300) ± JFK-SAN ± American vs. JetBlue ± 3Q03 20% 16% 12% 8% 4% 0% 300 280 260 240 220 200 180 160 140 120 100 80 AA
11
60
40
20
B6
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
AIRLINES RESEARCH
S-Curve Suggests Carriers With Frequency Advantages Can Sustain Premiums
S-Curve Analysis ± Frequency vs. Revenue Share ± United Chicago O¶Hare ± 1995 100% 80% 60% 40% 20% 0% 0% 20% 40% 60% 80% 100%
12
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
S-Curve Suggests Carriers With Frequency Advantages Can Sustain Premiums
S-Curve Analysis ± Frequency vs. Revenue Share ± United Chicago O¶Hare ± 1999 100% 80% 60% 40% 20% 0% 0% 20% 40% 60% 80% 100%
13
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
S-Curve Suggests Carriers With Frequency Advantages Can Sustain Premiums
S-Curve Analysis ± Frequency vs. Revenue Share ± United Chicago O¶Hare ± 2003 100% 80% 60% 40% 20% 0% 0% 20% 40% 60% 80% 100%
14
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Low-Fare Growth May Threaten Scope Advantages ± Southwest Chicago Example
Metric Cities Served > 1x per Day 1 3 BNA BWI CLE CMH DET DTW IND MCI SDF STL 1 6 BHM BNA BWI CLE CMH DTW IND LIT MCI OMA PVD SDF STL 1 BHM BNA BWI CLE CMH DTW HOU IND ISP JAN LAS LIT MCI MHT OMA PHX PVD RDU SDF STL ABQ BDL BHM BNA BWI CLE CMH DTW FLL HOU 2002 IND ISP JAN LAS LAX LIT MCI MCO MHT OAK OMA PHX PVD RDU SAN SDF SEA STL TPA
Total Markets Served % Chicago Revenue 8.2%
13 .7%
20 15.4%
2 43.1%
15
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Historical Revenue Premiums in Jeopardy
Our analysis suggests that historical revenue premiums for the major airlines are in jeopardy The network airlines are running out of non-competitive routes where they can outperform competitive routes The network airlines have also come to rely on generating increasingly large average fare premiums to the low-fare airlines on competitive routes to sustain their unit revenue premiums Airlines with greater frequency will likely always command a premium, but we suspect that premium will be lower in the future We believe that fare premium strategies are problematic for two major reasons Fare premiums appear to have been bloated by a strong economy and appear unsustainable at current levels The behavior pattern that generates fare premiums seems to accommodate rather than hinder low-fare airline growth. We believe that these fare premium strategies will do nothing to stop low-fare airline growth and erosion of network airline market share
16
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Risk Disclosure
Investing in airline stocks is very risky. Airline stocks have historically underperformed broader market averages by significant margins when measured over long periods of time. Our recommendations are based on historical trading patterns and our profit expectations, which are subject to a high degree of risk. Our profit expectations for individual companies hinge on our revenue assumptions, which depend entirely on assumptions we make regarding economic growth, the demand for leisure and business travel, the impact of competition from low-fare carriers, and industrywide aircraft capacity decisions. Our profit expectations also depend on assumptions we make about the cost of jet fuel (historically a volatile commodity), the impact on revenue and expenses of potential labor disruptions, and the impact of any number of geopolitical events and terrorism risks on the demand for air travel, among other things. The combination of heavy operating and financial leverage along with the volatile nature of the underlying assumptions means that our profit expectations, targets, and ratings are subject to rapid, frequent, and material change.
17
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
This material has been prepared and/or issued by Lehman Brothers Inc., member SIPC, and/or one of its affiliates (³Lehman Brothers´) and has been approved by Lehman Brothers International (Europe), authorized and regulated by the Financial Services Authority, in connection with its distribution in the European Economic Area. This material is distributed in Japan by Lehman Brothers Japan Inc., and in Hong Kong by Lehman Brothers Asia Limited. This material is distributed in Australia by Lehman Brothers Australia Pty Limited, and in Singapore by Lehman Brothers Inc., Singapore Branch. This material is distributed in Korea by Lehman Brothers International (Europe) Seoul Branch. This document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy the securities or other instruments mentioned in it. No part of this document may be reproduced in any manner without the written permission of Lehman Brothers. We do not represent that this information, including any third party information, is accurate or complete and it should not be relied upon as such. It is provided with the understanding that Lehman Brothers is not acting in a fiduciary capacity. Opinions expressed herein reflect the opinion of Lehman Brothers and are subject to change without notice. The products mentioned in this document may not be eligible for sale in some states or countries, and they may not be suitable for all types of investors. If an investor has any doubts about product suitability, he should consult his Lehman Brothers representative. The value of and the income produced by products may fluctuate, so that an investor may get back less than he invested. Value and income may be adversely affected by exchange rates, interest rates, or other factors. Past performance is not necessarily indicative of future results. If a product is income producing, part of the capital invested may be used to pay that income. Lehman Brothers may, from time to time, perform investment banking or other services for, or solicit investment banking or other business from any company mentioned in this document. © 2004 Lehman Brothers. All rights reserved. Additional information is available on request. Please contact a Lehman Brothers¶ entity in your home jurisdiction. Complete disclosure information on companies covered by Lehman Brothers Analysts is available at www.lehman.com/disclosures.
Analyst Certification: I, Gary Chase, hereby certify (1) that the views expressed in this research note accurately reflect my personal views about any or all of the subject securities or issuers referred to in this note and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this note.
18
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Survival of the Fittest: The Impact of Low-Fare Carriers on Competition
Embry-Riddle Aeronautical University Airline Economics Seminar
National Press Club ± Washington ± April 7th, 2004
Lehman Brothers Airlines Research
Gary Chase Winnie Clark (212) 526-5752 [email protected]
Embry-Riddle Aeronautical University Airline Economics Seminar
National Press Club ± Washington ± April 7th, 2004
Lehman Brothers Airlines Research
Gary Chase Winnie Clark (212) 526-5752 [email protected]
Please see analyst certification and important disclosures on slides 16 & 17.
Low-Fare Carriers Changing Pricing Dynamics
There is A New Breed of Category Killer Emerging
Low-fare carriers have learned from the past and have much more of a franchise focus than at any point in history
Network Presence
Airline Franchise Value City Strength Brand
They also are defying conventional wisdom about LCCs by flying longer-hauls, creating upscale brand images, and building their presence in core cities Perhaps most important of all, they are increasingly fearless and willing to defy the conventional wisdom referenced above
2
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Historical Revenue Premiums in Jeopardy
Our analysis suggests that historical revenue premiums for the major airlines are in jeopardy The network airlines are running out of non-competitive routes where they can outperform competitive routes The network airlines have also come to rely on generating increasingly large average fare premiums to the low-fare airlines on competitive routes to sustain their unit revenue premiums Airlines with greater frequency will likely always command a premium, but we suspect that premium will be lower in the future We believe that fare premium strategies are problematic for two major reasons Fare premiums appear to have been bloated by a strong economy and appear unsustainable at current levels The behavior pattern that generates fare premiums seems to accommodate rather than hinder low-fare airline growth. We believe that these fare premium strategies will do nothing to stop low-fare airline growth and erosion of network airline market share
3
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Network Airlines Have Generated Consistent Revenue Premiums To Low-fare Carriers
Systemwide RASM Premium Network vs. Low-Fare Airlines (Stage Length Adjusted) 50% 40% 30% 20% 10% 0% ¶91 ¶92 ¶93 ¶94 ¶95 ¶96 ¶97 ¶98 ¶99 ¶00 ¶01 ¶02
4
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
As Exposure To Low-fare Airlines Grows«
Network Carriers Historical Low-Fare Overlap
4 3 24 2
2
3
4
2
5
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Network Airlines Have Fewer Noncompetitive Opportunities«
Nonstop Yield Differential Markets Without Low-Fare Competition vs. Markets with Competition (1)
100 0 0 40 20 0 0-249 250-499 500- 49 50-999 1,000 ± 1,499 1,500 ± 1,999 2,000+
(1) Simple average of annual differentials, 1991 ± 2001.
6
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Forcing Them To Rely On Increasingly Large Overlap Fare Premiums«
Network Carriers Historical Low-Fare Premium 3 24
2
2
3
4
5
¶96
¶97
¶98
¶99
¶00
¶01
¶02
7
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Fare Premiums Hinge on a Few Passengers ± Majors Sell at Least as Many Low Fares
Fare Distribution ± BWI-CLE ± Continental vs. Southwest ± 3Q03 30 20 10 0
Continental ± Average Fare $95
300 280 260 240 220 200 180 160 140 120 100 80 CO 60 40 20 0
Southwest ± Average Fare $81
60
40
20
300 280 260 240 220 200 180 160 140 120 100 80 WN
8
60
40
20
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Fare Premiums Hinge on a Few Passengers ± Majors Sell at Least as Many Low Fares
Fare Distribution (Fares <$300) ± BWI-CLE ± Continental vs. Southwest ± 3Q03 60% 48% 36% 24 12 0 300 280 260 240 220 200 180 160 140 120 100 80 CO
9
60
40
20
WN
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
AIRLINES RESEARCH
Fare Premiums Hinge on a Few Passengers ± Majors Sell at Least as Many Low Fares
Fare Distribution ± JFK-SAN ± American vs. JetBlue ± 3Q03 20% 10% 0% 300 280 260 240 220 200 180 160 140 120 100 80 AA 20% 10% 0% 300 280 260 240 220 200 180 160 140 120 100 80 B6
10
JetBlue ± Average Fare $163 American ± Average Fare $199
60
40
20
60
40
20
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Fare Premiums Hinge on a Few Passengers ± Majors Sell at Least as Many Low Fares
Fare Distribution (Fares <$300) ± JFK-SAN ± American vs. JetBlue ± 3Q03 20% 16% 12% 8% 4% 0% 300 280 260 240 220 200 180 160 140 120 100 80 AA
11
60
40
20
B6
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
AIRLINES RESEARCH
S-Curve Suggests Carriers With Frequency Advantages Can Sustain Premiums
S-Curve Analysis ± Frequency vs. Revenue Share ± United Chicago O¶Hare ± 1995 100% 80% 60% 40% 20% 0% 0% 20% 40% 60% 80% 100%
12
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
S-Curve Suggests Carriers With Frequency Advantages Can Sustain Premiums
S-Curve Analysis ± Frequency vs. Revenue Share ± United Chicago O¶Hare ± 1999 100% 80% 60% 40% 20% 0% 0% 20% 40% 60% 80% 100%
13
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
S-Curve Suggests Carriers With Frequency Advantages Can Sustain Premiums
S-Curve Analysis ± Frequency vs. Revenue Share ± United Chicago O¶Hare ± 2003 100% 80% 60% 40% 20% 0% 0% 20% 40% 60% 80% 100%
14
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Low-Fare Growth May Threaten Scope Advantages ± Southwest Chicago Example
Metric Cities Served > 1x per Day 1 3 BNA BWI CLE CMH DET DTW IND MCI SDF STL 1 6 BHM BNA BWI CLE CMH DTW IND LIT MCI OMA PVD SDF STL 1 BHM BNA BWI CLE CMH DTW HOU IND ISP JAN LAS LIT MCI MHT OMA PHX PVD RDU SDF STL ABQ BDL BHM BNA BWI CLE CMH DTW FLL HOU 2002 IND ISP JAN LAS LAX LIT MCI MCO MHT OAK OMA PHX PVD RDU SAN SDF SEA STL TPA
Total Markets Served % Chicago Revenue 8.2%
13 .7%
20 15.4%
2 43.1%
15
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Historical Revenue Premiums in Jeopardy
Our analysis suggests that historical revenue premiums for the major airlines are in jeopardy The network airlines are running out of non-competitive routes where they can outperform competitive routes The network airlines have also come to rely on generating increasingly large average fare premiums to the low-fare airlines on competitive routes to sustain their unit revenue premiums Airlines with greater frequency will likely always command a premium, but we suspect that premium will be lower in the future We believe that fare premium strategies are problematic for two major reasons Fare premiums appear to have been bloated by a strong economy and appear unsustainable at current levels The behavior pattern that generates fare premiums seems to accommodate rather than hinder low-fare airline growth. We believe that these fare premium strategies will do nothing to stop low-fare airline growth and erosion of network airline market share
16
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Risk Disclosure
Investing in airline stocks is very risky. Airline stocks have historically underperformed broader market averages by significant margins when measured over long periods of time. Our recommendations are based on historical trading patterns and our profit expectations, which are subject to a high degree of risk. Our profit expectations for individual companies hinge on our revenue assumptions, which depend entirely on assumptions we make regarding economic growth, the demand for leisure and business travel, the impact of competition from low-fare carriers, and industrywide aircraft capacity decisions. Our profit expectations also depend on assumptions we make about the cost of jet fuel (historically a volatile commodity), the impact on revenue and expenses of potential labor disruptions, and the impact of any number of geopolitical events and terrorism risks on the demand for air travel, among other things. The combination of heavy operating and financial leverage along with the volatile nature of the underlying assumptions means that our profit expectations, targets, and ratings are subject to rapid, frequent, and material change.
17
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
This material has been prepared and/or issued by Lehman Brothers Inc., member SIPC, and/or one of its affiliates (³Lehman Brothers´) and has been approved by Lehman Brothers International (Europe), authorized and regulated by the Financial Services Authority, in connection with its distribution in the European Economic Area. This material is distributed in Japan by Lehman Brothers Japan Inc., and in Hong Kong by Lehman Brothers Asia Limited. This material is distributed in Australia by Lehman Brothers Australia Pty Limited, and in Singapore by Lehman Brothers Inc., Singapore Branch. This material is distributed in Korea by Lehman Brothers International (Europe) Seoul Branch. This document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy the securities or other instruments mentioned in it. No part of this document may be reproduced in any manner without the written permission of Lehman Brothers. We do not represent that this information, including any third party information, is accurate or complete and it should not be relied upon as such. It is provided with the understanding that Lehman Brothers is not acting in a fiduciary capacity. Opinions expressed herein reflect the opinion of Lehman Brothers and are subject to change without notice. The products mentioned in this document may not be eligible for sale in some states or countries, and they may not be suitable for all types of investors. If an investor has any doubts about product suitability, he should consult his Lehman Brothers representative. The value of and the income produced by products may fluctuate, so that an investor may get back less than he invested. Value and income may be adversely affected by exchange rates, interest rates, or other factors. Past performance is not necessarily indicative of future results. If a product is income producing, part of the capital invested may be used to pay that income. Lehman Brothers may, from time to time, perform investment banking or other services for, or solicit investment banking or other business from any company mentioned in this document. © 2004 Lehman Brothers. All rights reserved. Additional information is available on request. Please contact a Lehman Brothers¶ entity in your home jurisdiction. Complete disclosure information on companies covered by Lehman Brothers Analysts is available at www.lehman.com/disclosures.
Analyst Certification: I, Gary Chase, hereby certify (1) that the views expressed in this research note accurately reflect my personal views about any or all of the subject securities or issuers referred to in this note and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this note.
18
AIRLINES RESEARCH
Airlines Research ± Gary Chase ± Winnie Clark (212) 526-5752 [email protected]
Survival of the Fittest: The Impact of Low-Fare Carriers on Competition
Embry-Riddle Aeronautical University Airline Economics Seminar
National Press Club ± Washington ± April 7th, 2004
Lehman Brothers Airlines Research
Gary Chase Winnie Clark (212) 526-5752 [email protected]
