Getting high on low
By David Carr
Canada’s lowest airfares are set to drop much lower. After years of being the only advanced economy without an ultra-low-cost carrier (ULCC), the sector is taking off. The trade-off will be added seats, less legroom and a sharp increase in ancillary fares.
By David Carr
In September, WestJet unveiled the name and a new purple on white colour scheme for its ULCC subsidiary: Swoop. “The name Swoop denotes exactly what we plan to do,” said Bob Cummings, WestJet’s executive vice-president of strategy, with special responsibilities to launch the ULCC. “It’s a powerful verb that demonstrates we plan to swoop in to the Canadian market with a new business model that will provide lower fares and greater opportunity for more Canadians to travel.”
It won’t be alone. After several false starts, Canada Jetlines plan to launch ultra-low fare service from Hamilton and Waterloo this summer, initially with two Boeing 737-800NG aircraft in a 189-seat all coach configuration for the first 90 days, with the fleet increasing to six airplanes by the end of November. Both carriers will join Flair Airlines, which picked up the pieces of sputtering NewLeaf Travel earlier this year, and recently celebrated one year of low-fare service in Canada.
The wild card in the deck will be Air Canada, which plans to counter the ULCC universe by offering lower fares on select routes and spreading more Rouge on routes across Canada. “The low-fare option that is now going to be at our disposal definitely is in our back pocket for strategic use,” Ben Smith, Air Canada’s president of passenger airlines told the Globe and Mail. “That is definitely going to be deployed strategically.”
Stan Gadek, chief executive of Canada Jetlines, pointed out it is a strategy that has failed in the past. “To be an ultra-low-cost carrier and offer those ultra-low fares, you have to have ultra-low costs,” he told Wings. “I know that at certain price points that are very low compared to what is out in the market today, I can make money. If the competition wants to match those prices, we will stimulate significant demand. They’ll fill up, we’ll fill up. The difference is they will lose money on every departure and I will make money.”
Gadek has considerable experience in the U.S. low-cost sector as chief financial officer during the transformation of Air Tran Airways before it was sold to Southwest Airlines, and more recently as chief executive and chief financial officer of Sun Country Airlines, a Minneapolis-St. Paul based low-cost carrier.
“The ULCC model has been one of the most successful in terms of profitability,” Gadek added. “But just having a model that works elsewhere does not ensure success. You have to be able to executive on that model with a plan of operations, and a value proposition. If a fare is only $50 below a mainline carrier’s fare, it is not really a compelling value proposition.” Especially when the mainline carriers still attach some perqs to the cost of a ticket, including loyalty points.
Of the four models, including Air Canada/Rouge, only Canada Jetlines presents a clean-sheet operation focused exclusively on the ULCC market. Swoop will leverage WestJet assets and Flair plans to continue to offer B2B charter services, which have been the roots of its operation. NewLeaf’s business model involved re-selling branded seats on aircraft flown by Flair.
“Once we got into it and started operating the program, it started producing some good solid business for us. NewLeaf ran into some issues – financing among other things. But it definitely was working and we see a huge opportunity in Canada. The public is screaming for a lower cost option for air travel,” said Chris Lapointe, vice president, commercial operations for Flair Airlines.
It has been a bumpy transition. “There is no doubt the transition from charter to becoming a scheduled carrier has lots of moving parts and lots of knees and elbows,” Lapointe pointed out. “Previously, we had several dozen customers every year. Now we have thousands on thousands of customers every month.”
Flair has moved off the vestiges of the NewLeaf business plan. Lapointe expects a full transition to be complete by early 2018, in time for the crowded summer period. A new schedule will be launched in December, primarily servicing the Greater Toronto Area, northern Alberta and Greater Vancouver from Abbotsford and Hamilton markets. Winnipeg will be added as a secondary market, and there will be seasonal service to Halifax and points east. “Some capacity will be put into primary markets like Vancouver and Toronto-Pearson, which are too large to ignore,” he said.
Flair plans to add three 737-800s to its existing fleet of four 737-400s by late winter/spring 2018, and grow to 12 airplanes shortly after that, although Lapointe won’t commit to a specific deadline. He does however envision a blended fleet of next generation and legacy 737s for the next three years.
“There is lots of life left in these [older] birds,” Lapointe insisted. “They are lower cost, and as long as fuel prices stay at the lower-end of the scale, we can compete.”
Both Flair and Canada Jetlines see Swoop as the formidable competitor, at least at the beginning. “I think what is going to evolve is Swoop will be WestJet’s take on Rouge, as opposed to being a pure ULCC,” Gadek said. “Rouge has been successful, but it is more a revenue generator than a low-cost. Rouge is putting more seats on the airplanes, but is not selling tickets at appreciable less money than the mainline carrier. Any way you slice it, Swoop is not going to have ultra-low costs. While they can rely on the parent company or mainline carrier for infrastructure to offset their costs, this is another iteration of the airline within an airline model.”
The test, according to Gadek will be the summer peak season, and whether the mainline carriers and their subsidiaries can resist the temptation to jack up fares. “Demand in Canada in August is very strong,” he said. “It will be very challenging for Swoop or Rouge to maintain ultra-low fares when they can up the fare and take advantage of demand.
“If you are a ULCC, you have to be disciplined enough to not leverage revenue when demand is strong and always offer the lowest fare on the market because that is your product. The first time a customer comes to your website and they don’t see an ultra-low fare, you’ve lost them. You have to stay true to the model.”
Which is why customers should not expect a premium cabin on Canada Jetlines’ flights any time soon. “As we evolve that is a possibility,” Gadek said. “We had an iteration of that at Air Tran. But people who seek out this model do not seek out the bigger seat. We did not get the uptake from it.”
Heading in the opposite direction and introducing “seat only” fares recently introduced by American, Delta and United to compete against ULCCs like Frontier and Spirit could be a low-cost option for Air Canada. The strategy has had the unintended consequence of luring customers to spend more.
According to the CarTrawler Yearbook of ancillary revenue, “recent comments by Scott Kirby, the president of United, reveal 60 to 70 per cent of passengers buy a higher fare when presented with the basic economy option.” American has experienced comparable results, with 50 per cent of customers opting for the main cabin.
What customers can expect onboard the ULCC’s is a more aggressive American-Euro approach to raising ancillary revenues, where “extras” contribute up to 46 per cent of total revenue. WestJet and Air Canada’s (including Rouge) ancillary programs hover around 10 per cent. Are Canadians ready for a heightened sales pitch? Flair’s Lapointe thinks so.
“More and more Canadians are getting experience with ancillary fares. On the mainline products of Air Canada and WestJet there has been a significant unbundling of the product over the years. The consumer is getting used to having the option of choosing certain services and not choosing others. They understand that it is going to be taken a bit further and there will be options, I think they can adapt. The public has asked for lower airfares. You have to deliver that some way. Purchase options are the key way of doing that.”
Lapointe estimates that ancillary sales account for approximately 27 per cent of the airline’s total revenue. He plans to increase that to 30 per cent. A new web site was rolled out in October, which will include a more user-friendly way of pushing out ancillary products.
Canada Jetlines will charge for basics such as checked baggage as well as baggage that enters the cabin, seat assignment, beverage and other a la carte services. Gadek will not disclose ancillary revenue targets, but insisted that, “the accumulative total of the typical ancillary services that you would purchase as a customer is going to be substantially lower than what the mainline carriers are selling their unbundled products for.”
Gadek is also promising totally digital distribution, with ticket sales exclusively over the Internet. That is a key cost savings relative to mainline carriers that rely on global distribution system providers such as Amadeus and Sabre, who charge for every transaction.
“All those systems are expensive from an airline standpoint,” he said. “It’s about $8 to $18 a booking based on the itinerary. In the ULCC world, with the systems that are available to us, you can get your bookings for as low as 35 cents a transaction.”
It is clear to both new entrants that you can no longer launch a ULCC with just two airplanes and stay in the game for the long-term. If all pieces remain in the air for the next 12-months there should be at least 13 airplanes going head-to-head against Swoop and Air Canada.
“We believe that we definitely have a lower cost base than the two major air carriers. The $64,000 question is; how long can they dump capacity on the market and keep their shareholders happy,” asked Lapointe.
Air Canada and WestJet control 92 per cent of the Canadian domestic market. To try to equal the playing field and give new entrants more staying power, the Trudeau government will introduce legislation next year to lift the ceiling on foreign ownership to 49 per cent from the current 25 per cent. In reality, it is catching up to industry practice. Air Canada channels foreign ownership above 25 per cent through ACE Aviation Holdings, and Sunwing is already 49 per cent by German leisure group Tui.
“Lower cost of capital lowers your cost as a business. For those airlines to come into being or expand, they need access to capital,” Bill Morrison, an associated professor at Wilfred Laurier University, told the CBC last year. “Foreign ownership is just international capital.”
In the interim, the government has issued temporary exemptions on foreign ownership. Canada Jetlines, which is reported to have raised $27 million in startup capital was granted an exemption. “The barriers to competition are so great,” Gadek said. “Opening up foreign ownership allows us to access that additional capital in order to compete.”
It is also something that Flair is “definitely looking at” but has concerns that until the legislation is passed, exempted carriers might be considered foreign airlines, which could disrupt plans to open up routes to U.S. sun destinations this winter.
ULCC’s will stimulate new markets and encourage existing travellers to fly more. Even so, WestJet’s Cummings believes there is room for only one ULCC. Lapointe thinks even that might be a bit optimistic. “The Canadian market is not like the U.S. or Europe,” he said. “I think it really has to be a hybrid. We are going to be different from the competition. We are going to maintain a bit of diversification with our service offering with the charter and contract flying for other airlines. Wherever it makes sense.”
Not surprising, Gadek, who was involved in the launch of CALite while at Continental Airlines, believes a ULCC operator must pick a lane. “You have the big airline mindset and you have the ultra-low-cost mindset. There is no way you can just flip a switch and turn off one mindset and adopt the other in either direction.”