Low Cost Carriers in the U.S.:Shifting Strategies Required for the Next Growth Phase

William S SwelbarEclat Consulting

3rd Annual MIT Airline Industry Conference“Winds of Change: The Airline Industry in 2004 April 15, 2004

Topics to Be CoveredTopics to Be Covered

The LCC Growth Cycle Matures

Measuring the Levels of LCC Exposure

The Myth of Market Stimulation

Is the Current “Regional Armada” the Right Artillery?

Rethink the Architecture, or Else?

LCCs: This Growth Cycle Matures

The Next Phase of LCC Growth Will Require a Different Mindset About Market SizeThe Next Phase of LCC Growth Will Require a Different Mindset About Market Size

LCC Markets Entered

Total City Pairs

Large Hub Airportsto/from

Large Hub Medium Hub Small Hub

Medium Hub Airportsto/from

Medium Hub Small Hub

Small Hub Airportsto/from

Small Hub

% of Total

Cumulative% of Total

33.0% 47.1%

80.1%

11.1%

91.2%

6.5%

97.7%

2.0%

99.7%

3.0%

100%

35444565157555324

397

199419951996199719981999200020012002Total

38

12151920202410

131

--3023262026312110

187

--34995464

44

--124116--2--

26

--1142--------8

------1----------1

LCC Penetration of Top CMSA Markets —The Battle Rages East LCC Penetration of Top CMSA Markets —The Battle Rages East

Total Los Angeles

40%

Total San Francisco

32%

Total Dallas/Ft. Worth

21%

Total Chicago

17%

Total Washington

19%

Total New York

10%

Total Boston

10%

Total Houston

28%

Large Hub

Medium HubSmall Hub

Total Atlanta

14%

Total Philadelphia

5%

Total Denver

15%

Total Miami19%

Los Angeles 28%

Long Beach 76%

Orange County 33%

Oakland61%

San Jose43%

San Francisco

6%Chicago (ORD)

1%

Chicago (MDW) 75%

Houston (IAH) 4%

Houston (HOU) 74%

Dallas/Ft. Worth (DFW) 4% Dallas/Ft. Worth (DAL)

88%

Washington (BWI) 49%

Newark3%

New York (JFK) 31New York (LGA) 5%

Westchester County

Islip48%

Providence20%

Boston 6%

Manchester 19%

Ontario 64%

Burbank 70%

Washington (IAD) 3% Washington (DCA) 3%

Denver (DEN) 15%

Ft. Lauderdale (FLL) 33%

Miami (MIA) 4%

Atlanta (ATL) 14%

Philadelphia (PHL)5%

March 2004

%

Only 232 City Pairs Are Seen as LikelyNew Candidates for LCC ExpansionOnly 232 City Pairs Are Seen as LikelyNew Candidates for LCC Expansion

232 U.S. Markets With Over 100 PDEWs Have No Low Cost Carrier Service

17 (7%) (Alaska/Hawaii)

19 (8%)Misc. Reasons

135 (59%)Remain

61 (26%)Slot Controlled

All of the Remaining 135 Markets Have IssuesAll of the Remaining 135 Markets Have Issues

Gauging the Competitive Response

135Total

13Other7

Wright Amendment "Blocked" Airports

44Hub to Hub47Hub Dominant

24Served By Secondary LCC Market

The LCCs’ Impact on the Industry’s Segments

Delta and US Airways Have the Most to Lose From Planned LCC GrowthDelta and US Airways Have the Most to Lose From Planned LCC Growth

54

87

66

67

79

84

0 20 40 60 80 100

US Airways

United

Northwest

Delta

Continental

American

Remaining Domestic Revenue

Not Directly Impacted

$ 1.4B

$ 1.0B

$ 3.0B

$ 1.7B

$ 1.0B

$ 2.0B

$ 11.0B

Percent of Revenue Exposed to Direct LCC Competition

YE 2Q 2000 YE 2Q 2003

LCCs Have High Levels of Direct Competition With One AnotherLCCs Have High Levels of Direct Competition With One Another

67

74

79

90

45

93

91

0 20 40 60 80 100

Southwest

ATA

Spirit

America West

AirTran

Frontier

jetBlue

Percent of Revenue Earned in Direct Competition With at Least One Other LCC

Percent of Revenue Derived in Markets Served by Other LCCs 2003

Percent of Revenue Derived in Markets Served by Other LCCs 2000

For Every $ in Revenue by Competing LCC Carriers,

Carrier Earns:

$ 0.23

$ 0.17

$ 0.28

$ 0.41

$ 0.34

$ 2.25

$ 0.62

$ 0.12

$ 0.16

$ 0.37

$ 0.29

$ 2.01

2000 2003

$ 0.98 $ 0.25

The Network Carriers’ Regional Affiliates Have Significant Exposure to the Growing LCC’s The Network Carriers’ Regional Affiliates Have Significant Exposure to the Growing LCC’s

50.9%

76.8%

44.0%

66.8%

68.3%

62.7%

0% 20% 40% 60% 80% 100%

US Airways

United

Northwest

Delta

Continental

American

YE 2Q 2000 YE 2Q 2003

Percent of Revenue Earned in Direct Competition With at Least One Other LCC Percent Monopoly

Markets

10.5%10.9%

11.1%8.0%

9.6%17.0%

18.0%19.9%

6.9%13.3%

13.4%26.9%

The Myth of Market StimulationTraffic Growth Is One Thing…

The Myth of Stimulation —Total Market Traffic Stimulation Is Less Than 12%The Myth of Stimulation —Total Market Traffic Stimulation Is Less Than 12%

1994 - 2002

SouthwestAirTranjetBlueSpiritATAFrontier

1888220354131

+11.2M+7.0M+3.9M+3.6M+2.3M+1.8M

+29.8M

+11.1M+4.8M+1.8M+3.5M+1.3M+1.5M

+24.0Mor

+11.7%

(.1M)(2.2M)(2.1M)(.1M)

(1.0M)(.3M)

(5.8M)

New City PairsIntroduced

Actual Passenger* Stimulation

Ind. Carriers Total Market

Redirected Incumbent Traffic

*Measured 12 months prior to service inauguration by LCC, versus 12 months after

With or Without LCC Presence, Revenue Has Declined Significantly in Markets of All SizesWith or Without LCC Presence, Revenue Has Declined Significantly in Markets of All Sizes

A Look at Revenue3Q 2003 v. 3Q 2000

# MarketsTrafficAvg. FareRevenue

612-9.6%

-17.6%-25.5%

1,256-.7%

-12.9%-13.5%

10,830-2.2%

-12.3%-14.2%

537+.9%

-10.0%-9.2%

8,800-2.1%

-10.4%-12.3%

15,042-2.4%

-10.4%-12.5%

Large Hub Airportsto/from

Large Hub Medium Hub Small Hub

Medium Hub Airportsto/from

Medium Hub Small Hub

Small Hub Airportsto/from

Small Hub

Longer Haul and Shorter Haul Markets Have Produced Very Different Traffic Results But Similar Revenue Results

Longer Haul and Shorter Haul Markets Have Produced Very Different Traffic Results But Similar Revenue Results

Another Look at Revenue3Q 2003 v. 3Q 2000

1,000 Itinerary Miles or Less

Large Hub Airportsto/from

Large Hub Medium Hub Small Hub

Medium Hub Airportsto/from

Medium Hub Small Hub

Small Hub Airportsto/from

Small Hub

TrafficFaresRevenue

-15.2%-10.6%-24.2%

-7.8%-9.0%

-16.1%

-7.4%-11.8%-18.3%

-8.7%-6.3%

-14.5%

-8.4%-10.9%-18.4%

-6.5%-12.2%-18.0%

More Than 1,000 Itinerary Miles

Traffic -3.1% +7.9% +5.9% +13.4% +8.4% +8.4%Fares -24.2% -17.9% -14.5% -16.2% -11.9% -9.2%Revenue -26.5% -11.4% -9.5% -4.9% -4.6% -1.6%

The Next Phase of Growth by the LCCs Will Challenge the Current Network Architecture

The Next Phase of LCC Growth Will Be An Attack on the Network Carriers Through Their Regional Affiliates

The Next Phase of LCC Growth Will Be An Attack on the Network Carriers Through Their Regional Affiliates

LCCs

Mainline

Regional

HubsSpokes

PT-PT

The Problem for the

Regional and Mainline

The Problem for the

Regional and Mainline

Have the Network Carriers Become Too Reliant on the Regional Jet?Have the Network Carriers Become Too Reliant on the Regional Jet?

0%

10%

20%

30%

40%

50%

60%

70%

80%

Per

cent

of N

etw

ork

Pre

senc

e

Mainline to Mainline Connectivity

Source: Official Airline Guide; Eclat Air Service Model

’95 ’00 ’03American

’95 ’00 ’03Continental

’95 ’00 ’03Delta

’95 ’00 ’03Northwest

’95 ’00 ’03United

’95 ’00 ’03US Airways

Current Regional Carrier Capacity Is Not Cheap Capacity On A Per Seat Mile BasisCurrent Regional Carrier Capacity Is Not Cheap Capacity On A Per Seat Mile Basis

Cen

ts p

er A

vaila

ble

Sea

t Mile

0

5

10

15

20

25

1Q95

2Q95

3Q95

4Q95

1Q96

2Q96

3Q96

4Q96

1Q97

2Q97

3Q97

4Q97

1Q98

2Q98

3Q98

4Q98

1Q99

2Q99

3Q99

4Q99

1Q00

2Q00

3Q00

4Q00

1Q01

2Q01

3Q01

4Q01

1Q02

2Q02

3Q02

4Q02

Regional Network LCC Total Network (Including Regi

Despite the Substantial Reductions in Regional Carrier Unit Costs, They Remain 31% Higher than Mainline Unit Costs

1Q03

2Q03

3Q03

onal)

Are All of the Mid-continent Hubs, Reliant on Regional Jet Capacity, Necessary?Are All of the Mid-continent Hubs, Reliant on Regional Jet Capacity, Necessary?

0

25

50

75

100

COCLE

DLDFW

DLCVG

NWMEM

USPIT

COIAH

DLSLC

AAORD

AASTL

USPHL

UAORD

USCLT

DLATL

NWDTW

AADFW

NWMSP

UADEN

Per

cent

of M

arke

t Pre

senc

e C

reat

ed

Thro

ugh

Reg

iona

l Par

tner

Excludes IAD, JFK, EWR, LAX, SFO, MIA (International Gateways)

If Connecting Revenue Is to Be the Target of Planned LCC Growth, the Power of the Hub Will Be Tested

If Connecting Revenue Is to Be the Target of Planned LCC Growth, the Power of the Hub Will Be Tested

0

25

50

75

100

DLATL

AADFW

UAORD

NWMSP

UADEN

USCLT

DLCVG

AASTL

COIAH

NWDTW

AAORD

USPIT

DLSLC

USPHL

DLDFW

NWMEM

COCLE

COEWR

Inde

x of

Hub

Con

nect

ing

Rev

enue

DL

= 10

0

Excludes IAD, JFK, EWR, LAX, SFO, MIA (International Gateways)

Network Carrier Vulnerability to Growth by the “Big 3 LCCs”Network Carrier Vulnerability to Growth by the “Big 3 LCCs”

100.0

75.4

54.048.1 46.2

41.4

29.0 27.0

Delta Northwest OtherIndustry

American USAirways

United Alaska Continental

Other Industry Comprised of: America West, Spirit, AirTran, Southwest, Midwest, ATA, Frontier, Sun Country and jetBlue.(Listed in Order of Vulnerability)

Index = 100

Is It Time to Begin Rethinking the High Frequency/Small Aircraft Approach In This Pricing Environment?

LCCs v. The Feeder Partners --Growing Battle with Limited Artillery?LCCs v. The Feeder Partners --Growing Battle with Limited Artillery?

Number of City Pairs Where Network Carrier Regional Jet Competes With an LCC Service On At Least 1 Frequency

Nonstop Competition One-stop Competition

Num

ber o

f City

Pai

r Mar

kets

July 2000

Num

ber o

f City

Pai

r Mar

kets

July 2003

0

50

100

150

200

250

300

350

400

American Continental Delta Northwest United US Airways0

200

400

600

800

10001200

1400

1600

1800

American Continental Delta Northwest United US Airways

Sources of Capacity Change in the US Domestic MarketSources of Capacity Change in the US Domestic Market

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 YE3Q03

% Change in Departures %Change in Average Seats %Change in Average Stage Length

Per

cent

Conclusions – If the Network Carriers Are to Minimize/Block Future LCC EncroachmentConclusions – If the Network Carriers Are to Minimize/Block Future LCC Encroachment

For the Network Carriers that Have Restructured at Least Once: It’s Time to Get On With the Next Phase of Restructuring (i.e. rethinking the network architecture)

– The Current Regional Partner - Mainline Carrier Relationship Is Dysfunctional and Changes Will Prove Necessary

• Financial Relationship– Cross subsidy inside a network is one thing, guaranteeing profit while absorbing 100 percent of

the market risk is quite another• Labor Issues

– Expectations at the current regional level are too high– Significant mainline concessions permitting use of 70 seat aircraft are not enough to overcome

the structural disadvantage faced by existing network carriers

For the Network Carriers That Have Not Gotten Through the First Phase of Restructuring: Best of Luck

– Phase 2 Will Prove Much More Difficult Than Just Rate and Productivity Reductions Whether From Labor or Fixed Capital

Conclusions – If the LCC’s Are to Continue Exploiting the Network Carrier’s DomainConclusions – If the LCC’s Are to Continue Exploiting the Network Carrier’s Domain

Do Not Underestimate the Competitive Response– The next phase of US domestic growth will challenge the network

carrier’s strongest hubs

Do Not Falsely Believe That Cost Reductions at the Network Carriers Have Been Fully Realized– The gap is closing and will close further

We Are Entering a New Phase of the Growth Cycle– Markets Are Smaller– Already Have Seen Both Service and Price Stimulation, therefore

• Stimulation Rates Will Be Lower– jetBlue has signaled growth opportunities that are not domestic markets

• As have other LCC’s with announcements into Mexico

Low Cost Carriers in the U.S.:Shifting Strategies Required for the Next Growth Phase

William S SwelbarEclat Consulting

3rd Annual MIT Airline Industry Conference“Winds of Change: The Airline Industry in 2004 April 15, 2004