For U.S. airlines, yield, not fares, dictates profit

A quarter-century of mergers and joint ventures has transformed the competitive landscape for U.S. airlines domestically and overseas, giving them a new metric for success: yield instead of price.

That’s good news for time-pressed road warriors who can pay for convenience but bad news for price-sensitive travelers.

“Airfares are not going to go down,” declared Mike Boyd, president of Boyd Group International.

It’s the culmination of a flight path that began with the 1993 joint venture between Northwest Airlines and KLM Royal Dutch Airlines and ended with the American Airlines/US Airways merger announced in 2013. 

Today, four mega-carriers control 85% of U.S. domestic capacity. Three antitrust-immunized joint ventures manage nearly 85% of capacity over the Atlantic, a stark contrast to the 1980s, when Pan Am competed with 26 carriers on transatlantic routes.

Disrupters like Freddie Laker’s $300 fares between New York and London triggered decades of fare wars that were a heyday for cheap travel but disastrous for carriers’ bottom lines. Price-cutting plagued the aviation industry well into the 21st century.

“Chasing a low-cost customer is not a sustainable model,” said Andy Menkes, CEO of Partnership Travel Consulting.

Gone are the days of airlines fighting each other over passengers, routes and market share. Consolidation has given them capacity control and freed them from the need to battle for the masses by slashing fares.

Instead, they’re now competing for more deep-pocketed customers.

“If you’re going to fill the plane anyway,” Menkes said, “fill it with the highest-yield passengers you can, especially those who will repeat.”

Those travelers are business travelers, who are more focused on schedule than on cost. And the currency in that competition is product, not price.

It’s all about “lie-flat beds and beautiful lounges,” Menkes said.

This also enables airlines to take care of another key stakeholder, their investors.

Carriers are focusing on “ever-higher, investment-grade returns on capital,” said aviation consultant Robert Mann.

And they’ve been able to deliver for investors. The first quarter is typically a money loser for carriers — but not this year. Delta Air Lines reported a record profit two weeks ago and its best first quarter ever. Analysts expect most airlines to see all-time highs for the quarter. Certainly, low fuel prices are a major factor in this — although they’re not always a blessing in a highly hedged world; it will cost Delta Air Lines roughly $1 billion to settle its fuel hedges early.

All these latest numbers follow a profitable 2014 for the four major carriers.

If airlines, business travelers and investors are the beneficiaries of this new world, who are the losers? “The price shopper,” said Menkes.

Deal hounds are going to have to accept that in trade for lower fares they will be sacrificing convenience, Menkes said, often having to settle for connecting flights rather than nonstop. They’ll have to be more flexible with their schedules and settle for flights that might not depart on the days they want, because flights to some destinations are no longer offered on a daily basis.

Numbers are mixed on what’s happening with airfare pricing. ARC projects that fares will level out domestically this summer and actually trend down on flights to Europe. The problem with ARC numbers is that they do not include ancillaries, which can add substantially to the cost of an airline ticket. These numbers are significant, as illustrated by Delta’s Q1 results. Branded fares, upsells to first class and preferred seating grew by 27% and added $50 million to the carrier’s top line, according to Ed Bastian, Delta’s president.

Mann said that fares to many European markets are particularly high this year.

A suddenly strong dollar — it moved 20% vs. the euro in less than six months — has made this a “once-in-a-lifetime summer” for airlines, he said. Because Europe is cheap on the ground, airlines are hoping to keep a greater share of travelers’ spending.  They know the siren call cheap hotels in Europe hold for travelers.

Mann has charted “nose-bleed” high roundtrip fares to Europe for summer 2015: $2,300 from Los Angeles to Paris, $2,000 from San Francisco to Rome, $1,700 from Denver to Athens. Menkes, planning a business trip to London, said that he was looking at $2,500 for an economy ticket.

The travel search website Hipmunk looked at airfares its users booked to Europe and found that summer 2015 roundtrip fares from the U.S. to the eurozone are up 7% year over year.

There is hope for procrastinators: Fares to many destinations are actually down from last year, and looking for less expensive city pairs is another way for savvy travelers to shave some costs.

Airlines are clearly reacting to skyrocketing demand; Hipmunk said March 2015 searches on its site for eurozone travel were up 31% over March 2014.

There are also costs beyond price, said Timothy O’Neil-Dunne, managing partner at T2Impact, an industry consulting group. For one thing, airlines are devaluing their frequent flyer programs.

More importantly, O’Neil-Dunne said, cities like Cincinnati, Memphis and St. Louis are still on airline route maps but are seeing far fewer departures. And residents of fortress-hub airports like the Twin Cities and Houston are probably “longing for more competition,” said industry analyst Henry Harteveldt.

This fall, it could be tougher for travelers to find less expensive fares, and scheduling could be less convenient as airlines make seasonal cuts to their service, Harteveldt said.

“Travel agents will definitely need to pay attention to these [developments], depending on who their customers are,” he said.

Harteveldt voiced other concerns about the current competitive landscape.

“Competition breeds innovation, but it is so hard for new entrants to get into the airline business,” he said. And though airlines are focusing on product, Harteveldt said he was “alarmed” by decreasing legroom and thinner seats.

At the same time, it’s not totally clear skies for airlines.

U.S. carriers still source as much as 15% to 30% of their international tickets from overseas points of sale, Harteveldt said, and the same strong dollar that is sending so many Americans to Europe is keeping European travelers home. Even those who do travel are paying U.S. carriers with devalued euros.

Likewise, the joint ventures, too, are a double-edged sword. While they provide airlines with many benefits, they also mean that U.S. carriers share their partners’ financial ups and downs.

U.S. airlines also still face competition in certain markets, and since many of their coveted high-yield flyers belong to more than one frequent flyer program, carriers still have to work to attract them.

Moreover, pricing competition still exists in some markets. Southwest Airlines and JetBlue occasionally stay true to their low-cost roots, though only in certain city pairs. The ultra low-cost carriers, Allegiant Air, Frontier Airlines and Spirit Airlines, also provide some pricing competition. Spirit, in particular, is opening up new markets, such as Bellingham, Wash., and Trenton, N.J.

And not all U.S. cities are fortress hubs; there are some in which no single carrier dominates. Examples include San Francisco, Los Angeles and Boston.

Foreign carriers are also providing some pricing competition. Low-cost European carrier Norwegian is still fighting for the right to flag itself out of Ireland, ostensibly to gain access to farther-flung markets, but, U.S. carriers charge also to benefit from less costly labor laws. But along with Wow, the low-cost Icelandic carrier, Norwegian is already bringing lower fares to some Northeast markets. (Wow has fares as low as $99 from Reykjavik to Boston).

Not surprisingly, U.S. carriers are doing whatever they can to thwart foreign competition. Among these moves is an alliance in which one-time adversaries —airline management and unions — have teamed up against Middle Eastern carriers. The group, the Partnership for Open & Fair Skies, is protesting what it calls “massive government subsidies” to state-owned Emirates, Etihad Airways and Qatar Airways. The U.S. is now looking into the U.S. carriers’ allegations that these subsidies exist and violate open-skies agreements.

“They are always against government benefits in the marketplace — unless it benefits them,” Kevin Mitchell, founder of the Business Travel Coalition, said in describing U.S. airlines’ motivations. Mitchell fumed over the way U.S. airline executives communicate with each other during earnings calls.

“They’re telegraphing their intentions with regard to capacity,” he said.

But others scoffed at the thought of airline collusion.

“They don’t need to collude anymore,” said O’Neil-Dunne. “They’re making so much money it doesn’t matter anymore.”