Question: Will AirTran continue to be successful in this highly competitive industry?
Case:
Internet Mini Case #11
AirTran Holdings, Inc.
Maryanne M. Rouse
AirTran Airways? ability to grow, in what has arguably been the worst environment in years for airlines, adds an unexpected new chapter to one of the most unlikely turnaround stories in the airline industry. In 1996, when the carrier was known as ValuJet, it grounded all flights for three months after the crash of its Flight 592 in the Everglades killed all 110 people on board. Fortu-nately, the carrier had floated a package of $150 million in junk bonds just prior to the Ever-glades crash, and these cash resources proved critical as the company addressed safety concerns during the shutdown and the 11 successive loss quarters that followed. In 1997, ValuJet merged with AirTran Airways Corporation to form AirTran Holdings, Inc. (AAI).
At the end of December 2004, AirTran operated 508 daily flights to 48 destinations, primarily in the eastern United States, making it the second-largest ?affordable-fare? scheduled airline in the United States in terms of departures (just behind Southwest).
Although the company moved its headquarters from Atlanta to Orlando, Florida, after the 1996 crash, it still flies most of its flights to and from Atlanta, providing both point-to-point and one-stop flights through its Hartsfield hub. AirTran offers a business class any business can afford, all-assigned seating, a generous frequent flier program, and a corporate program dubbed ?A2B?; unlike its competitors, the carrier never requires a round-trip purchase or a Saturday night stay.
The company?s regional jet operation, AirTran JetConnect, operated by joint-venture partner Air Wisconsin, flies 50-seat Canadair Regional jets in short-haul markets to and from the airline?s hub at Hartsfield Atlanta International Airport. AirTran JetConnect serves Greensboro, North Carolina; Pensacola, Florida; and Savannah, Georgia?all of which were previously served by AirTran. The new service will allow the company to redeploy its 717s to increase frequencies in longer-haul, more profitable markets and facilitate growth in larger markets not currently served. In addition, AirTran JetConnect will allow the airline to expand into other short-haul markets as well as increase frequencies in underserved markets.
______________________________________________________________________________
This case was prepared by Professor Maryanne M. Rouse, MBA, CPA, University of South Florida, as the basis for classroom discussion. Copyright ? 2005 by Maryanne M. Rouse. This case cannot be reproduced in any form with-out written permission of the copyright holder, Maryanne M. Rouse. Reprint permission is solely granted to the pub-lisher, Prentice Hall, for the books, Strategic Management and Business Policy?10th and 11th Editions (and the In-ternational version of this book) and Cases in Strategic Management and Business Policy?10th and 11th Editions by the copyright holder, Maryanne M. Rouse. This case was edited for SMBP and Cases in SMBP?11th Edition. The copyright holder is solely responsible for case content. Any other publication of the case (translation, any form of electronics or other media) or sold (any form of partnership) to another publisher will be in violation of copyright law, unless Maryanne M. Rouse has granted an additional written reprint permission.
MARKETING AND OPERATIONS
AirTran?s marketing strategy is to develop an innovative brand identity that sets it apart from its low-fare and full-service competitors. The company targets two primary segments: price-sensitive business travelers and leisure travelers, primarily in the eastern United States. To attract business travelers, the carrier launched a business class product that is, in terms of comfort, the equivalent of the first class service offered by its full-service rivals. The business class cabin is configured with 2 ? 2-foot oversized seats, providing considerably more leg and seat room than a typical coach cabin. Targeted to the price-sensitive business flier, upgrades to business class from coach are just $25.
AirTran offers a range of fares based on advance purchases of 14 days, 7 days, 3 days, and ?walk-up? fares. All fares are one-way, and most are nonrefundable; however, reservations can be changed prior to departure, with a service charge.
The company also offers a popular frequent flier program, A+ Rewards, that allows members to earn free travel more quickly than its competitors and, for twice the number of flight credits, will even buy members a free domestic ticket on any major carrier. The A+ Rewards program offers a number of ways to earn free travel, including the use of the AirTran Visa card, Hertz car rent-als, and bonus earnings for Business Class.
In spring 2003, AirTran introduced a new standby program targeted broadly to young travelers (and specifically to college students) between the ages of 18 and 22. Dubbed the X-Fares Standby Program (www.xfares.com), this marketing initiative allows those who are eligible to fly standby to almost any AirTran destination for $55 per segment ($75 per ?long-haul? seg-ment).
In addition to targeting individual business travelers, AirTran has focused on developing travel partnerships with companies of all sizes, from one- and two-person small businesses to such large corporations as BellSouth, State Farm, and John Deere. Under the terms of its A2B corpo-rate travel program, employees of registered companies get free confirmed upgrades to business class when paying full coach fares, fee waivers for ticket refunds or changes, and advance seat assignment. Unlike rival Southwest, AirTranhas established interline ticketing and baggage agreements with Delta, United, US Airways, and American Trans Air and has ticketing arrange-ments with major online travel services such as Orbitz, Priceline, Expedia, and Travelocity.
AirTran has been aggressive in lining up corporate and community support via public?private partnerships that allow the carrier to shift more of the risk of expansion to communities and businesses expected to benefit from overall lower fares in their markets. The ?public? part com-prises revenue guarantees by cities, counties, or other municipal entities to protect AirTran against losses during the initial phase of operations; the ?private? part builds ?travel banks? in which businesses pledge to spend a specified amount on tickets. Both elements help to build a loyal following and serve as a cushion against the early losses of expanding into a new city and the invariable backlash from bigger competitors, which often respond by slashing their own fares and expanding service. Because AirTran?s arrival in a market typically drives down fares by as much as 50%, both cities and businesses view the partnership guarantees as money well spent. For example, when AirTran began service to Wichita, Kansas, in May 2002, the average full fare on the Wichita?Washington, DC, flight dropped from $1,667 to $460. Wichita, which was com-peting with other cities to lure AirTran, estimates that the entry of the low-fare carrier could lead to annual airfare savings of $43 million for business and leisure travelers.
In December 2004, AirTran lost a bidding war to buy leases on 14 gates at Midway Airport in Chicago from ATA Holdings, a company now in bankruptcy. The company, which added seven daily flights from Midway to Florida destinations in January 2004, had planned to create a Mid-western hub and diversify its route system by adding more east?west flights. Despite the disap-pointing loss of gates to Southwest, AirTran believes it can grow profits by adding new destina-tions?Sarasota, Indianapolis, and three unnamed cities?and by adding flights to connect cities already in its system.
Named ?Best Low-Fare Airline? for 2001 and 2002 by Entrepreneur magazine, AirTran?scost structure is among the lowest in the domestic airline industry in terms of cost per Average Seat Miles (ASM). The company?s low-cost position is supported by an emphasis on cost controls, lower distribution costs (reservations, ticketing), and high employee productivity. The compa-ny?s labor costs are equivalent to approximately 25% of revenue?the same percentage as Fron-tier and JetBlue?below Southwest?s 30% and significantly below the full-service carriers? 40+%. An award-winning web site that makes it easy to book flights online has helped AirTran shift 52.5% of its sales to the site?one of the highest percentages in the industry?with an addi-tional 13% of bookings coming from other travel sites. The company estimates its cost per book-ing online at less than $1?a significant saving over the $8.50 average cost of booking through a travel agent.
In September 1999, the company became the launch customer for the new Boeing 717, an inno-vative, cost-efficient, and environmentally friendly commercial aircraft that has reduced the higher fuel and maintenance costs associated with the DC-9s with which it had begun operations. (The company?s current fleet comprises 77 Boeing 717-200s and 5 Boeing 737-700s.) AirTran has also forged close ties with Boeing and Boeing Capital Corporation, a full-service provider of financial services, including asset-based lending and leasing. Boeing Capital, an indirect wholly owned subsidiary of the Boeing Company, refinanced $201 million of AirTran?s junk bonds in 2001 (and also agreed to finance the 20 Boeing 717s to be delivered in 2002, 22 used and 1 new 717 in 2003, and 5 737-700s delivered through June 2004), enabling AirTran to continue its rap-id fleet modernization.
FINANCE
AirTran was one of the few domestic airlines to report profitable operations for the year ended December 31, 2003, recording operating income of $86.3 million and net income of $100.5 mil-lion. The company also strengthened its balance sheet by issuing $145.9 million in common stock and $125.0 million of convertible debt at 7% while paying down $76.5 million of long-term debt at 11.27%, paying down $12.7 million of long-term debt at 13%, and converting $5.5 million of 7.75% convertible debt to equity, all of which greatly improved AirTran?s debt-to-equity ratio.
Despite a sea of red ink, overcapacity, and threatened bankruptcies in the industry, the company overcame intense fare wars and weak October bookings to eke out a profit of $1.1 million, or 1 cent per share for fourth quarter 2004. Although this was down from $21.7 million or 24 cents a share in fourth quarter 2003, AirTran beat analysts? consensus estimate of a 9 cent loss. Both domestic fare wars and escalating fuel costs hurt the company?s profit yield. (The company re-ported a 70.3% increase in fuel costs.) AirTran?s load factor for the period declined 0.5%, to 69.3, compared with fourth quarter 2003; however, revenue passenger miles increased 22.6% as capacity rose 23.4%.
The four hurricanes that struck the state of Florida in 2004 have had and will continue to have a major economic impact on the state in the affected area, which represents about 51% of the air-line?s normal traffic flows and seriously disrupted flights over the normally busy Labor Day hol-iday. Both the company?s Orlando headquarters and its aircraft hangar in Orlando suffered dam-age that further hampered operations. The impact of the hurricanes, coupled with a weak revenue environment and record high fuel costs, affected AirTran?s financial results for both the third and fourth quarters.
For the full year, AirTran reported a profit of $12.3 million, or 14 cents per share, to become one of only two U.S. airlines (the other was Southwest) to post an overall profit for the year.
Complete annual and quarterly financial information is available from the company?s web site (www.airtran.com), The Wall Street Journal (www.wsj.com), and FreeEdgar.
THE INDUSTRY
On the morning of September 11, 2001, terrorist attacks shut down the U.S. airline industry. The Federal Aviation Administration (FAA) suspended all commercial flights within hours after the attacks on the World Trade Center?s Twin Towers and the Pentagon and, although some flights resumed three days later, on September 14, the industry still had not recovered nine months later. Continuing concerns about the safety of flying, a weaker-than-expected economic recovery, and delays resulting both from tighter security and fewer flights led to a passenger traffic year-over-year decline of approximately 12% among the nine major U.S. airlines in the first three quarters of 2002.
Major airlines, many of which deferred or cancelled new aircraft deliveries, pared down flight schedules, and furloughed employees in the wake of 9/11, have been slow to increase capacity to previous levels. Some majors have permanently retired up to 5% of their total capacity, mostly large, older, gas-guzzling planes such as DC-10s and 727s. And, while analysts and airline finan-cial officers agree that retiring inefficient aircraft is a positive step toward profitability in an in-dustry that had suffered from overcapacity, a great deal of that capacity is being replaced by low-fare startups, most of which are still growing, and by small-jet regional carriers. For example, New York?based JetBlue Airways, while still small (500 million revenue passenger miles in April 2002, about 10% of what Continental carried in the same period), has won over a signifi-cant number of business travelers on the long-haul routes that have been the province of big, full-service carriers for years. JetBlue is strongly capitalized and well run, and analysts predict that it can grow at an aggressive 25% per year for the next five years by taking market share from the majors. Similarly, both Frontier Airlines and American Trans Air have made traffic gains at the expense of United Airlines in Denver and other western cities.
The airline industry is highly competitive in terms of fares, frequent flier benefits, routes, and service. Profit levels in the industry are highly sensitive to changes in operating and capital costs and the extent to which competitors attempt to match each other?s fares and services, as well as to general economic trends. Energy prices continue to be unpredictable: Favorable prices in the first quarter of 2002 were followed by sharp increases in April and May. The airlines have racked up higher costs for the security tax assessed on tickets; for the monthly security fees paid to the Department of Transportation (DOT); for a war-risk insurance premium; for implementing federally mandated directives such as stronger cockpit doors; and for the first class seats dedicat-ed to federal air marshals. Recently testifying before a Congressional committee, airline execu-tives noted that if the United States does strike Iraq, the results will be disastrous for the industry because travel, particularly international travel, will fall off sharply at the same time that oil pric-es surge.
Of increasing concern to carriers is the number of business travelers who are practicing what one industry analyst calls ?Airline Avoidance.? Poor service and complex pricing, further exacerbat-ed by arcane rules, regulations, and restrictions on reservation changes, have created an envi-ronment in which companies and individuals are purchasing planes, purchasing fractional owner-ship in planes, or choosing to drive. So many travelers are choosing the latter that Delta Air Lines (DAL) launched a fare sale at the end of March 2002 specifically to provide additional customer incentive to fly rather than drive. The short-haul market is crucial to profitability for full-service carriers because, in general, travelers pay more per mile to fly short trips.
Increasing numbers of travelers are using web sites to book airline tickets, hotel rooms, and car rentals. According to the Internet analysis group Jupiter Media Metrix, consumers were expected to spend about $36.8 billion on travel sites in 2004, up from $24 billion in 2001. Concerned about prices and practices of online travel services, Congress created a nine-member commission to investigate the pricing, practices, and exclusive marketing agreements of various airline and independent sites.
The industry is subject to regulation by a number of federal, state, and local departments and agencies. The DOT has regulatory jurisdiction over passenger airlines, with the FAA regulating aircraft maintenance and operations, including equipment, ground facilities, licensing, and com-munications. The Aviation and Transportation Security Act of 2001 established a new Transpor-tation Security Administration (within the DOT) with responsibility for aviation security func-tions including passenger and baggage screening
