United head’s plan may spur lower airfares

Bloomberg

Scott Kirby has a very specific view about how the three US hub-and-spoke airlines work best, having managed two of them. In his
current job as president of United Airlines, Kirby’s role is to oversee a major overhaul of how the carrier operates, beginning with a broad restructuring of its three domestic-focussed hubs in Chicago, Denver and Houston.
By United’s math, this trio has profit margins that are 10 percent below the inland domestic hubs operated by American Airlines Group Inc. and Delta Air Lines Inc. That gap is one big reason for United’s third-place finish among the three in recent years.
The troubles, Kirby explained, began shortly after United swallowed up Continental back in 2010. United’s post-merger decision to shrink, forced by investor demands that the carrier curb capacity to bolster fares and profits, was a weak choice, he said. United cut seat growth domestically by 8 percent over the next six years, while Delta and American grew 8 percent and 3 percent, respectively, according to United. That growth by its rivals put United on the defensive as they made inroads into its Middle America hubs.
Almost halfway through his second year as CEO of United, Kirby, 50, wants to reverse this trend.
“Our growth and strengthening our hubs is absolutely the critical, essential element to driving higher … margins at United,” Kirby recently said. “I’m absolutely certain about it.”
Analysts and investors largely agree with his diagnosis of United’s ills, if not his prescription—sustained growth. Annual capacity expansion of as high as 6 percent until 2021, or “nearly the equivalent of another Spirit-sized airline,” JPMorgan analyst Jamie Baker said in a client note, has sparked deep discomfort in some quarters.
Such an aggressive move by a mature US airline is a throwback to the 1990s, when major carriers were more than happy to throw elbows in a bid for supremacy. These days, it’s not done in polite aviation company. “United is, to some degree, ripping up the airline economics playbook from the past decade,” said Seth Kaplan, managing partner of Airline Weekly.
Kirby’s expansion comes at a time when the overall industry is already adding capacity. In 2018, an uptick of about 5 percent is expected despite steadily rising Brent crude oil prices that have already climbed 30 percent in the past six months.
While airlines still think they can boost profits in this climate, it’s possible fares may end up falling, leaving consumers the winner. Kirby’s strategy has several underlying principles, which United said it will use to track its progress.

Hub strength
Airport hubs are the key and represent the heart of a network airline’s profits. But critical to this premise is that the hub’s dominant carrier must truly dominate—and United lags markedly in this area compared with Delta in Atlanta and Detroit, or with American in Charlotte and Dallas. “Arguably, United has no choice but to either shrink drastically or to pursue this path, and Scott Kirby wasn’t hired to shrink anything,” Wolfe Research analyst Hunter Keay wrote in a Jan. 23 client note.
Today, United has fewer connections, departures and destinations from Chicago, Denver and Houston compared with what American and Delta offer from their similar hubs. “A hub-and-spoke airline is really a manufacturing company and it is about manufacturing connections,” Kirby told analysts, calling these transfers “the magic elixir that makes hubs successful.”
In Airlines 101, connections correlate to profit because much of that traffic is starting or ending a trip at an airport with less competition, where fares are higher, or what the industry calls “high-yield flow traffic.” As part of its strategy, United is boosting connections in its three mid-continent hubs by an average of 17 percent by adjusting its flight schedules, a process it’s completed in Houston and will commence in Chicago next month.

Small cities
United’s domestic shrinkage involved retreats from the smaller cities where people usually pay a premium to fly, burgs such as Champaign, Illinois, Elmira, New York, North Carolina. These “high-yield” cities have gained even greater importance in an era when many routes have seen fares drop due to low-cost competition.
United has fewer small-city routes from which to glean these profits than Delta and American; 26 percent of its passengers are from large cities—where the yield is roughly 5 cents per mile below small ones—compared with 30 percent for American and Delta. So to fix that, United is adding 31 new regional jets to its fleet this year to help penetrate smaller markets.
United is a far more seasonal airline than American, Delta, and even Southwest Airlines Co. in terms of how much flying it does in August, the peak, versus January, the slowest month. Given the same employees, gates and airplanes on the books all year, this low-season schedule posture is a drag on costs. Increasing “asset efficiency” through greater employee productivity, more daily flying time and boosting gate use is key, CFO
Andrew Levy said.
While Kirby puts his troops in motion, his two rivals aren’t sitting still. American, the largest airline, has announced similar moves this year with new routes from its hubs, flights such as Philadelphia-Oklahoma City and Dallas-Fort Worth-Panama City, Florida. Its growth involves 52 new nonstop routes, including international. What remains to be seen is whether United directors have the stomach for its managers’ multi-year curatives. Investors demand returns now, Bloomberg Intelligence analyst George Ferguson said.