MIAMI — Ben Baldanza is the CEO of Spirit Airlines, the nation’s largest ultra-low cost carrier (ULCC) and its most profitable one by operating margins. In Part 1 of our interview, we discussed a range of topics including why Spirit’s business model is good for high oil prices and the competitive environment that Spirit faces. Today, we shift to address the competition in markets like Dallas Fort Worth and Chicago, what new legacy fare classes such as Delta’s basic economy, and how Spirit views the competitive threat posed by fellow ULCC Frontier Airlines.
AirwaysNews (AWN): That definitely makes sense. But if you look at the fare data in specific markets – places like Chicago, Houston, and Dallas Fort Worth – it does definitely show that in specific markets like that – where you’ve got a legacy carrier with a fortress hub or really large hub, and you guys have a big operation – that the legacy carriers are dropping more into that low fare pool, maybe not on a macro level but on a specific one.
Ben Baldanza (BB): That’s true, and you’ll have to do this on a lagged basis obviously. But if you look at the average fare on their airplane, and the average fare on our airplane, the average fare is still going to be a lot higher than ours. Because we’re selling all of our seats at that rate; they’re controlling inventory and selling what they need to of that. But why on earth would they charge sixty dollars to someone who will pay them five hundred. Why they want to do is just fill otherwise empty seats with sixty dollar people so that they can make money on that. Now if there’s a future quarter where you look at earnings and you look and see that United, or Delta, or American’s average fare is the same as Spirit.
That tells you what to do with their stock, because they’re an eight and a half cent ex-fuel cost [CASM] carrier and we’re a five and a half cent ex-fuel cost [CASM] carrier. So if all they can attract is our traffic, that’s a bigger problem for their business model than an ability to attract some of that traffic now given low fuel prices, it’s very different. In the long run, cost structure matters. In the short term, sure someone can say – “I’m going to match this price right now because I can do it.” But in the long term, I’d rather be the five and a half cent carrier trending down than be the eight and a half cent carrier trending up.
AWN: And do you think that the emergence of fare classes like Delta’s Basic Economy, or American just announced a new no-frills fare class. Do you think that that changes the competitive landscape for Spirit? Because, while it doesn’t pull out the majority of their costs like the aircraft or fuel, it does pull out some of those variable costs.
BB: I actually think that helps Spirit, and I’ll tell you why. I think it helps Spirit for a couple of reasons. One is that it clearly shows in Delta’s case that they’re trying to segment this traffic. They’re not saying, “we’re now in the business of selling Basic Economy, now look at this great fare, we’re going to give it to everyone.” What they’re doing is that they’re saying, “I recognize that I’m going to have to be competitive with some of these fares, and to be competitive because my costs are so much higher, I can’t give you the full Delta product. So I’m not going to give you as many frequent flyer miles, I’m not going to let you upgrade to my business class, I’m going to put you in a middle seat, and I’m going to do things that essentially de-content the product.”
And that has two advantages to me as Delta. One – if you buy that fare from me, you don’t cost me quite as much, because I’m not accruing frequent flyer liability at the same rate and things like that. And if you buy that fare from me, maybe for some percentage of you, I can talk you into paying me twenty or thirty dollars more to buy the next higher fare where you get all the Delta goodies. So it works as a sell-up fare for them, and in the case where it doesn’t work as a sell-up, they at least save a little money. So it’s a smart strategy – Basic Economy for Delta – but what it doesn’t do is make them want to sell more Basic Economy fares.
The reason I think it’s good for Spirit is because it absolutely furthers the customer education that in the airline business, just like in everything else that you buy, if you pay less you should expect less and if you pay more you should expect more. Everybody understands that a thirty thousand dollar car is probably a better car than a twenty thousand dollar car. But for some reason, the general thought in the airline business is that all airlines are the same so I can just pick the cheapest price. What Delta’s doing, is saying if you pay less you’re going to get less, and if you pay me more I’ll give you more. And in that sense, Basic Economy fits exactly with Spirit’s whole customer education strategy.
The customer aggravation that we create at times comes from the fact that some people buy us because our fares are so low, but are then disappointed that we’re not Delta and we’re not JetBlue. And we don’t want that to happen, we want them to know exactly what they get when they buy Spirit. So the idea that Delta’s out there pushing this if you pay more you should expect more, if you pay less you should expect less message is absolutely helping our educational efforts. And as a fare in the marketplace, it’s not particularly threatening to us because big carriers have always sold their most marginal seats at really cheap fares.
And what Delta’s doing is it’s doing a really good job limiting its exposure to have to match carriers like Spirit with significantly lower costs and focusing really well on selling those higher average ticket prices. I think Delta is the model for what all legacies should be doing in a sense. They’re focusing on their core customer really really well, and saying “I recognize there’s this really value-based customer out there that might be on a Spirit plane or an Allegiant plane or something and once in a while, maybe I’m going to have to match that ticket price. But that’s not the business I’m in and I don’t really want to sell a lot of that.”
AWN: So earlier to mentioned your high growth plans, and just to spin off of that, you’ve talked in the past about having a list of routes, I think it was something like 500 or 600 markets that work for your business model and that you are sort of adding them one by one to your actual network. If the drop in fuel prices holds, does that make additional markets viable? And can I get a sense of how many markets there are (i.e. what opportunities for profitable expansion this opens up)?
BB: We continue to refresh our analysis on that, and right now there are over 700 markets. Basically, there’s not a single market in the US right now where more than 200 people travel each day, that we could not add profitably to the Spirit network right now. We limit ourselves to larger markets, simply because with our smallest plane having one hundred forty five seats, we need to generate at least one hundred forty people. So you can pick two very small places and put in low fares, and maybe you’ll attract twenty, thirty, or forty people, but it’s much better to go to place where there’s already a lot of people flying and paying high fares, cause that suggests there’s a whole bunch of people willing to fly if the fare’s lower. So when we first added that kind of chart to our investor pack, we talked about being over three hundred growth markets, then we went to five hundred, now it’s over seven hundred.
If you look at Europe, the number of people that travel on a carrier that is like Spirit is almost twenty percent of the market. And in the US, if you take Spirit plus Allegiant and even if you want to throw Frontier in there since they hope to be like Spirit someday, collectively we’re all under five percent of the market. So the reality is that the assumable market for the ULCC business model, I’m not even saying Spirit specifically, but that business model, is probably three to four times the size of the capacity being offered by that model today. And that’s why we’re so bullish on our own growth, and why Frontier says they’re so bullish on their growth, and why Allegiant’s bullish on growth.
AWN: One last question, which you actually hinted at in your previous answer. Frontier has definitely been shifting their business model towards your territory for a while now. How much of a competitive threat do they represent, how do the business models stack up – at a high level, how are you guys thinking about the competition that Frontier provides to you guys in the market?
BB: Right now, certainly they’re a future threat more than a current threat. Right now we just don’t fly that much against Frontier, more because they choose not to fly against us. I’ll give you two examples – they were flying a reasonably heavy schedule in Cleveland, we entered the city of Cleveland with service to nine cities and they basically pulled out. They still fly there but they’re only a couple of flights a day. Southwest pulled down in Atlanta, that created some gate availability in Atlanta and we and Frontier both took a few new gates. Our schedule has continued to build, they have basically torn down their Atlanta flying to only a couple of flights. So basically, their capacity deployment has suggested they can’t be profitable flying against Spirit yet.
That doesn’t mean that that will always be true. So right now we just don’t run into Frontier that much, and when we think about the competitive landscape, they don’t really hit the radar yet. But they may someday, and certainly we’re concerned about them. You know when I talked about that total size of the ULCC market – if I were king of the world, I’d want Spirit to own all of that. I don’t want to share that with Frontier or anybody else. So in that sense, they clearly are a threat – basically to absorb some of the growth that we think would naturally accrue to Spirit over time. And that’s how I think of them. Not as any sort of near term competitive factor in our planning right now.