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From Startup to Upstart: A position report on Porter Airlines

An Industry Under Siege
It has become frighteningly obvious that record high fuel prices are challenging the business models of all air carriers. Since the start of April, several airlines have ceased operations. These include Aloha, ATA, Eos, Oasis Hong Kong, Silverjet and Skybus. Most of those companies were relatively young and all had employed a discounted-fare strategy to attract travellers. Major North American carriers have announced plans to downsize network capacity through reduced frequencies or route cancellations. Revenue enhancement schemes using fare increases and service fees have also been introduced to ease the financial pain. If high fuel prices remain, we are likely to see less passenger traffic, smaller fleets and shrinking industry employment.

Given the ugly environment, it is only reasonable to ask if any young Canadian airlines might be susceptible to the same contagion. While we have witnessed the creation of a number of Canadian carriers in recent years, such as Zoom and Sunwing, the one that has attracted the most controversy and media attention is Porter Airlines of Toronto. Despite vocal opposition by some local residents and government decisions to build a new ferry system in lieu of a bridge to link the Toronto City Centre Airport (YTZ) with the mainland (only 400 feet away), company founder Robert Deluce has prevailed.

Today he and his team have brought to fruition a dream that began years ago. Although there is more work to be done to meet the full potential of the company as outlined in its original plans, an impressive startup has been achieved. The fact that Porter has been described as an “upstart” by industry observers supports the thesis that it is a small, but growing, force to be dealt with. The question that remains is: How will it fare in the current environment?” Before we attempt to answer that, a brief review of its history is in order.

That Was Then …
Incorporated as City Centre Airlines in April 2005, it was renamed Porter Airlines in January 2006 when it was still a “paper airline.”  Later that month, Porter’s parent company, REGCO Holdings, raised approximately $125 million through a private placement of equity to a handful of investors. Impressively, it was the second-largest equity raise by a new carrier in North American airline history; JetBlue Airways had raised $158 million US in 2002. Soon thereafter, REGCO ordered ten Bombardier Q400s and took up options on another ten aircraft.

Jazz Air, Air Canada’s regional affiliate, withdrew from YTZ on March 1, 2006 after it was evicted by its new landlord (Porter FBO). At that time, Jazz only operated the YTZ-Ottawa route, although it had previously provided scheduled services to Montreal, Newark and London, Ont. from “the island.”

In late June 2006, Porter announced that Ottawa would be its first destination and scheduled service on that route began on October 23, 2006 using its two Q400s. Almost two months later, on December 11, 2006, service began on the YTZ-Montreal route, as the fleet had doubled. Six months later, on June 29, 2007, Porter initiated service to Halifax from Ottawa and Montreal. Seasonal service to Mont Tremblant from YTZ began three days before Christmas that year.

This past March, Porter ordered an additional two Q400s, bringing its firm order up to a dozen aircraft with eight options yet to be exercised. On the last day of March, Porter began service to Newark, N.J. from YTZ, its first transborder route. Most recently, on June 27, the company initiated the YTZ-Quebec-Halifax route within its summer schedule that runs until September.

…This Is Now
Today, Porter operates half a dozen Q400s primarily on nonstop routes within 500 miles of Toronto. The carrier’s strategy has been focused on providing convenience, comfort and speed to differentiate itself from its competition. Convenience is provided by operating its hub out of Toronto City Centre Airport, a ten-minute ride from the downtown core aboard a complimentary Porter shuttle bus. Further convenience is enabled by its website for ticketing, seat selection, flight status information and online check-in. Porter’s terminal at YTZ has self-serve electronic kiosks to issue boarding passes.

Porter’s hub terminal provides a stylish lounge that serves refreshments and features wireless internet access and a business centre. Onboard its aircraft, Porter serves complimentary wine, beer and premium snacks to its passengers in leather seats that have a 34-inch pitch.

As for speed, Porter’s Q400s provide near-jet block times. There is also the quick boarding and deplaning that comes
with a 70-seater, compared with larger aircraft. This is a service-oriented business model not previously seen with a single-class short-haul airline. To attain a better understanding of any business model and therefore appreciate how a company may perform in the future, it is useful to perform a so-called S.W.O.T. analysis (Strengths, Weaknesses, Opportunities and Threats). Doing so with Porter provides the following insights:

S.W.O.T. Analysis of Porter Airlines

STRENGTHS:
Hub Airport – Toronto City Centre Airport is very close to the core of Canada’s largest city and its financial capital. User fees (landing fees, terminal costs, hangar rents, etc.) at YTZ compare very favourably to those at Toronto’s main airport (Pearson). This is a significant advantage, since YTZ handles almost half of Porter’s daily movements.

Fleet Makeup – focusing on a single aircraft type provides cost savings related to maintenance, training and the inventories of parts and rotables.

Aircraft Type – the Bombardier Q400 turboprops have a direct operating cost per seat mile flown that is approximately 30 per cent less than that of a similar sized regional jet. Porter is getting about eight hours of block time per day from each of its aircraft and is looking to increase that to nine hours. As well, Porter is achieving a 99.6 per cent dispatch reliability, the best among all Q400
operators.

Employees – a youthful, energetic team of approximately 350 that is keen on the company’s culture and is non-union. Team spirit is enhanced by all employees’ participation in the company’s profit-sharing program. Furthermore, managers are participants in Porter’s Employee Equity Incentive Program.

Strong Brand – with the assistance of an aggressive multi-media advertising campaign, Porter has created a buzz with its unique Toronto location and its premium service features both in the air and on the ground. Full page multi-colour advertisements in major newspapers are unlike anything the Canadian airline industry has seen in decades.

User-Friendly Website – not only is it convenient, it is a very cost-effective distribution tool. Today, approximately 75 per cent of Porter’s tickets are booked via the internet, with the balance being handled by its call centre

WEAKNESSES:
No Interlining at Its Hub – Since there are no other scheduled carriers operating into YTZ, there are no interline opportunities for Porter at its hub.

U.S. Profile – Like any other Canadian carrier operating transborder, it is far easier to attract Canadians flying south than it is get U.S. passengers heading north.  Developing brand awareness in U.S. markets takes time and money.

Lack of U.S. Pre-Clearance – U.S. Immigration authorities have not yet established a presence at YTZ, therefore U.S.-bound passengers must clear U.S. Customs upon arrival. Depending on the destination and the time of day, there can be some delays. Porter is hopeful that within 18-24 months, as its transborder traffic builds, pre-clearance will be provided at its hub.

Higher Fuel Price = Higher B/E LF – According to Bombardier’s published numbers, a 70-seat configured Q400 covers its direct operating costs with a 35-per cent passenger load factor. The assumptions used with that example include a full service carrier’s cost base, a premium yield and a fuel price of  $2.50 US per gallon. Assuming that Porter has a  much lower cost base, competitive yields and recognizing that the spot price for jet fuel is closer to $3.75 US per gallon, Porter’s operating breakeven is more likely around 40 per cent. That is still quite competitive in today’s environment.

Opportunities
Customer Loyalty – In June the VIPorter frequent-flyer program was introduced. It is a straightforward program that rewards customers with free travel aboard Porter after achieving various thresholds of air travel, depending on the fare category paid for that travel. The Aeroplan frequent flyer program, created by Air Canada, has approximately four million members. Around 125,000 of those are the highly coveted Prestige, Elite and Super Elite members – the most frequent of flyers.  Given its relatively limited route network, it seems unlikely that Porter could tempt these folks to swap their Aeroplan membership for one with VIPorter. However, in light of the special-purpose nature of the VIPorter program, there could well be an opportunity to coax many senior Aeroplan members into adding another card to their wallets.

Market Share Growth – Continuing high fuel prices may cause Porter’s competitors to reduce seat capacity on domestic and transborder routes. In light of its small footprint, Porter would be positioned to pick up market share in that case.

The following table outlines the competitive seat capacity situation that exists on the two heaviest travelled city-pairs in Canada:
While Porter uses 70-seat Q400s between Toronto-Montreal and WestJet utilizes 136-seat 737-700s, Air Canada operates the route with seven aircraft types ranging from 73-seat Embraer 175s to 349-seat 777-300ERs.

Corporate Business – Porter has already opened accounts with a number of leading Canadian companies. If it continues to offer competitive fares (inclusive of fuel surcharges) and reasonable frequencies on key business routes, Porter should be able to increase its patronage from large corporations.

THREATS:
Competitors’ Aggression – While Porter currently has a relatively small share of the weekday seat capacity on Canada’s two busiest routes, the two larger players may wish to become more aggressive through fare discounting and/or frequent-flyer incentives.

Civic Politics – Toronto’s government would prefer to see YTZ turned into parkland. Although at present it seems highly unlikely, should the federal government and the Toronto Port Authority ever support the city on that idea, Porter would stand to lose its low-cost fortress. It should be noted, however, that Porter’s agreement with the Toronto Port Authority gives it access to YTZ until 2033.

Attracting Additional Capital – Airlines are notoriously capital-intensive and even the most successful carriers can have trouble attracting capital when financial markets are in a less than charitable mood. As it is a private company, Porter’s financial performance is a mystery to outsiders. Key metrics (such as traffic, passenger load factor, yield, RASM and CASM) that are normally used to monitor an airline’s progress are not publicly available. Whetting the appetites of potential investors, while maintaining commercial confidentiality by not divulging too much information, is no easy task for a private concern.  Nonetheless, it might prove to be useful to stimulate the investment industry’s interest by sharing some basic data such as the system-wide traffic and load factor.

Legal Action – Since Jazz Air was evicted from the terminal at YTZ by Porter’s FBO subsidiary, Jazz and Porter have been in a legal tango. Given that such proceedings tend to get dragged out over time and that both companies have more pressing issues to deal with, it seems unlikely that any resolution of this issue will be reached in the near term.

What Does This All Mean?
Porter has a unique business model, in that it provides a unique service package and operates from a hub in a unique location. It is also unique in that its fleet did not have to evolve in the traditional manner of a Canadian regional airline – start with Cessna 402s and gradually move up through Beech 1900s and Dash 8s to the Q400. Because it began as a well-funded venture, Porter was able to select the optimum aircraft type for its operations from the get-go.

What is not unique about Porter is that it is up against tough competition on most of its routes, and that probably won’t change as it adds destinations to its network. If it continues to provide the standard of service that it has offered since its beginning, maintain a user-friendly level of frequencies on its business-oriented routes, continue to attract customers who have long-established allegiances to other carriers and maintain a customer-focused culture among its employees, Porter should not only survive the current turbulence, but fly into a prosperous future as well.

What Does The Future Hold?
Very simply, more aircraft and more destinations. The next two aircraft are due this fall, followed by another four early next year. That would result in a fleet of 12 aircraft by March 2009 – double the current fleet. Another eight Q400s are scheduled to be delivered during the subsequent year. If all goes as planned, Porter would be operating 20 aircraft to 17 North American destinations in March 2010. Among potential destinations, Boston’s Logan and Chicago’s Midway are high-priority airfields in Porter’s flight plan.

This growth profile is reminiscent of an extremely successful Western jet airline and, therefore, begs the question of how it should be managed.  When asked what are the most critical issues facing Porter, Bob Deluce responds succinctly: “People and growth.” Regarding the employees, he says that it is a matter of “attracting and retaining good people and maintaining the culture.” As far as the rate of growth is concerned, Deluce wants Porter’s to be “steady and measured. Not going too far, too fast.”

Conclusion
Porter Airlines has had an impressive run since its first flight less than two years ago. Of course, there remain skeptics who continue to question its traffic levels and crow that the party can’t go on forever. When asked if his employer might one day operate Q400s, a Jazz Dash 8 driver responded, “Yes, when we get Porter’s fleet.” Such is the subtlety of competitive-spirited banter. Like its mascot, the wily and self-sufficient raccoon Mr. Porter, the airline has so far managed to survive in a challenging environment and appears to be positioned to ride out the current crisis that is wreaking havoc on the global airline industry.