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Analysis: The Real Target of WestJet’s New ULCC is Air Canada Rouge

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Analysis: The Real Target of WestJet’s New ULCC is Air Canada Rouge

Analysis: The Real Target of WestJet’s New ULCC is Air Canada Rouge
April 24
13:19 2017

MIAMI – Late last week, Canadian low-cost carrier (LCC) WestJet announced plans to launch an ultra-low cost carrier (ULCC), with service set to begin in late 2017. The proposed ULCC operation will initially be staffed with 10 high-density Boeing 737-800s, subject to an agreement between WestJet and its pilots, but no initial plans for routes or markets were shared.

Canada’s ULCC Competition is nonexistent


This move ostensibly is aimed at rival Canadian ULCCs such as yet-to-launch Canada Jetlines and already-flying NewLeaf Travel Company (operated by Flair Airline Ltd.), but realistically speaking, neither NewLeaf nor Canada Jetlines poses an actual, credible threat to WestJet.

NewLeaf technically launched service in July 2016 but remains a shoestring operation and virtual airline (the actual flights are operated by charter operator Flair Airlines and its fleet of aging Boeing 737-400s) that apparently doesn’t comply with Canadian regulations.

Nearly half of NewLeafs’ 14 destinations (including service to the U.S.) have been “suspended” since an operational meltdown in January 2017. In fact, both U.S. destinations were reportedly dropped before launching due to competition from WestJet. NewLeaf is hardly a threat to Canada’s second largest airline.

Jetlines is hardly any better. Yes, they placed a splashy order for new 737 MAX aircraft back in 2014 and announced lofty plans for routes to 37 destinations from hubs at Vancouver, Winnipeg, and Hamilton. The reality is much bleaker. There still isn’t a clear timeline for a launch of service, even after the Canadian government suspended the country’s foreign airline ownership rules to allow Jetlines to seek extra foreign investment.

Jetlines shares are somehow publicly traded (as a penny stock) and reading through the company’s press releases provides an indication of just how little of a threat Jetlines poses to WestJet at present (http://www.jetlines.ca/announcements/). When an airline is issuing press releases about working with consultants, it’s rarely a good sign.

Canada is simply a tough market for the ULCC business model – the taxes and airport operating costs are simply way too high. This is why you see US LCCs such as JetBlue and Southwest, and ULCCs like Spirit and Frontier largely avoid the Canadian market.

Sunwing and Air Transat are successful leisure oriented carriers that operate a ULCC-esque low-frequency model at an LCC price point, but neither is growing particularly fast (the two airlines have a combined 5 aircraft on order – all at Sunwing). Moreover, WestJet has coexisted successfully in the market with both of these airlines for several years now.

The real target is Rouge


The one thing that has changed in the last couple of years in the Canadian market, is the rise of Rouge, Air Canada’s lower cost subsidiary for regional markets. Rouge, launched after a series of pitched battles with Air Canada’s unions, benefits from lower labor costs, higher density seating, and older aircraft that are fully depreciated.

At the same time, WestJet’s cost structure has naturally increased as its workforce and fleet aged (thanks to health care costs) and it tried to do right by its employees after years of profitability. Costs also rose as WestJet took steps to increase its share of business traffic with moves like adding Premium Economy.

This combination has allowed Air Canada to, for the first time, profitably match WestJet’s lower fares in a wide variety of leisure-oriented markets, which has allowed Rouge to grow to a fleet of 46 aircraft (from 4 at the start) serving 49 destinations.

WestJet lost the cost advantage over Air Canada that has powered the business since 1996 – it clearly believes that has to be reclaimed. And the fact that WestJet is actually targeting Rouge with this move provides clues to where this ULCC will eventually fly.

WestJet’s five most important markets are Calgary, Toronto, Vancouver, Edmonton, and Winnipeg in that order. Winnipeg, Edmonton, and Calgary have basically no presence from Rouge, while Vancouver and Toronto are two of the three biggest hubs for Rouge. Those are likely the two markets where “WestJet Lite” will be based, and Toronto is probably the higher priority of the two (as it has the largest Rouge network of all).

Can WestJet succeed where other airlines within an airline have failed?


While conventional wisdom holds that airline within airline operations are always doomed from the start, the success of the myriad Jetstar offshoots, Vueling, and to an extent Rouge itself proves that it is at least theoretically possible to find success with this kind of model. The key is ensuring that you can drop costs far enough below those of the parent carrier to actually allow a ULCC model to flourish.

In WestJet’s case, some of the cost reduction can come from the shift to higher density seating on the 737-800, as they can theoretically boost capacity from 168 seats (18 Y+ / 150Y) to 189 seats (all-economy), dropping unit costs by 11.1% and allowing WestJet to slash economy fares profitably by up to 10%. The problem is that higher density at the expense of premium economy seating isn’t a panacea, as the premium economy seats generate higher revenue.

For example, to use conservative back of the envelope math, let’s say that JetBlue fills 90% of its economy class seats on a flight at an average fare of $200, and 90% of its premium economy seats at an average fare of $250 (implying a 25% premium for premium economy – it is frequently much greater). This yields revenue of roughly $31,000 for that flight.

Now consider a 90% load factor for the all-economy class configuration – because economy class capacity has increased by 20%, fares could drop by as much as 15%, but even if they drop by just 10%, that flight would only generate $30,600 in revenue.

Of course there are some markets, particularly large volume ones where the economy class fares are already depressed due to heavy competition or ones with a small premium economy revenue premium, where this tradeoff makes sense, but the broader point is that WestJet needs to find more cost savings either from labor or from operations – it cannot simply rely on higher density to make this new ULCC venture a success.

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About Author

Vinay Bhaskara

Vinay Bhaskara

Senior Business Analyst, Big Airline Enthusiast, Avid Airport Connoisseur, Frequent Flyer, Globetrotter. I Miss Northwest Airlines Every Day. vinay@airwaysmag.com @TheABVinay

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3 Comments

  1. globalflyer
    globalflyer April 25, 12:45

    Nice article, however, I do not see Rouge as being the real target. Rouge is basically into the long-haul or international short-haul to mainly leisure destinations. I have not seen the business plan for the new WS ULCC. I agree that WS needs to have a business plan to target Rouge, however I do not see this happening with the current fleet of 767’s that have been plagued with technical issues. Rouge is a two class product whereas the WS ULCC will be a one class high density operation. It will be interesting to see if WS stays domestic to finish off the current ULCC’s and wannabe ULCC’s however I see this proposed operation and an apples to oranges comparison with Rouge. It will be interesting to view the business plan. Thanks as always for your insight! Keep up the great work!

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