July 23, 2013 Why United Airlines is Going to Go Bankrupt Again.
United Airlines is bleeding and current changes in market conditions will make it likely that United Airlines will go bankrupt again.
Before I get into my argument I want to posit that there are four groups of flyers out there. These groups will be referred to in the main body as follows:
Low spend, low frequency: The leisure flyer, price (referred to as LL)
Low spend, high frequency: The mileage runner, rewards (referred to as LH)
High Spend, low frequency: The premium passenger, service (referred to as HL)
High Spend, high frequency: The road warrior, service & reliability (referred to as HH)
My argument in one sentence is that, the Japanese auto industry is to Detroit as Southwest is to United.
When the Japanese car makers came to the US in the early 1970’s their cars were ugly, small and poorly equipped. However, they were fuel efficient and during the gas crunches of the 1970’s that was all they needed. Over the years, Japanese car makers slowly branched out from the efficient compact car to make SUVs, trucks, large sedans, and luxury cars. They did all of that resting using their fuel efficient compact as their advantage. The end result was that Honda made record profits and GM and Chrysler both went bankrupt.
The same thing is happening with US Airlines. Southwest entered the market in the 1970’s and over the years ran several airlines into the ground. JetBlue entered the NYC market in the 1990’s and has been very successful while other airlines were going bankrupt. Looking at their history, both Southwest and JetBlue said they were going to be the market leaders on price. From the very beginning their entire business model was built on being cheap. Now today they are not necessarily the cheapest carrier. But look at what the other airlines have had to do to get to their level, they charge for seat assignments, checked-bags, and they don’t have any snacks. So while the legacy airlines may similar pricing to the low cost carriers there is less product. This is exactly the same as Japanese versus US cars. The models cost the same, but because the US models cost so much more to make they are not as reliable or as well equipped as the Japanese equivalents.
US carriers have been willing to put up with this because even though the LL market went straight to the low cost carriers (referred to as LCCs), the LCCs haven’t been able to compete in the other markets. That’s starting to change. Southwest has created “Business Select,” providing a free drink and early boarding to their high fare passengers, JetBlue has suggested and FAA filings have apparently confirmed that JetBlue will be introducing suites on their transcon markets. These moves are designed to pick up the HLs and HHs, giving them a huge amount of market share.
The legacy carriers have responded in two different ways. Delta has responded by improving their product, while United has responded by cutting theirs. Delta has been investing in both their soft and hard products, while their hard product leaves much to be desired, they probably have the best soft product of the US legacy carriers. United has improved the hard product, mostly by forcing through the retrofits that were designed years ago. However, United in a bid to cut costs has been cutting their soft product to the bone and it shows. Just today a rumor started that United Airlines is going to be removing some of their more popular buy on board meals with less expensive options.
United’s cost cutting puts them in the exact same place as Detroit when they confronted Japan. Sure the Taurus and Accord cost the same, but the Taurus was so much “cheaper” on the inside. With JetBlue setting themselves up to take over premium transcontinental business, United will start losing the HLs, and HHs to them. This will be the beginning of the end for this version of United Airlines. Eventually LCCs like JetBlue and Southwest will start moving into the final bastion of the legacy carrier, long haul routes. Previous LCC long haul carriers haven’t been that successful in the long haul market. But these carriers, Oasis Hong Kong, Air Asia X, and People’s Express to go way back hadn’t had the core product to build on. New entrants such as Norwegian and Condor are already successful in their original markets which provides serious resources which allows them to compete and be successful in the long haul markets. In fact SAS has already had to increase investment in its soft product to compete with Norwegian, which so far SAS has not been that successful at.
Even if Southwest and JetBlue are not successful with their entries into the legacy markets, they will keep the pressure on the legacy carriers. United Airlines has reported losses above estimates and a lower return on capital expenditures. These moves will continue to erode United’s market share. The decline in market share will result in increase fixed costs as United trims marginal costs where it can, it will also result in decreased revenue as passengers move to other airlines. Reading and listening to United’s shareholder guidance, I just don’t see how United plans to innovate and respond other than business as usual which so far hasn’t been working. It didn’t work for Detroit and it’s not going to work for United. Thus, there is a very real possibility for United Airlines to go bankrupt again.