MIAMI — Ben Baldanza is an industry pioneer. Until last January, he was the CEO of Spirit Airlines, the U.S. largest ultra-low cost carrier (ULCC), and the most profitable carrier by operating margins. Ben has given Airways, an exclusive first interview after his sudden departure.
Airways (AW): Ben, we appreciate you taking the time to speak with us just a few weeks after leaving Spirit. Are you happy being up in Washington DC?
Ben Baldanza: Oh, I’m very happy with this whole decision. It’s been a couple of years transition, and it’s the best for my family and my son especially.
We are in an era of low fuel prices, incredible profits, and the operating margins are astonishing by any measure. But with some of the looming macro-economic factors out there, it feels perhaps that we may be at the end of a bull market in terms of airline revenue and profitability. Are there specific clouds that you see on the horizon, existential factors—economic or any inherent in the industry itself – particularly in over-capacity?
Well, yeah. I think the biggest thing is that the industry has a tendency to grow too quickly. And my general feeling is that there is still an over capacity of high cost production, but an under capacity of low cost production.
And what do you see as the effects of possible pitfalls like a slowing economy, rising fuel prices if that occurs, and over-capacity as we look out over the next few years?
I just think it means probably lower margins than the industry is currently earning, and a higher likelihood of either industry losses or under performance once oil prices being to move up again. I think the industry might find itself in a somewhat precarious position when oil starts to rise. I’m not saying that the capacity today is any problem right now, given the current fuel price, but at some point fuel prices are going to increase, and I think a lot of carriers are going to find ‘Hey, maybe we have a little bit too much out there’.
It seems now network carrier airlines are chasing market share. Legacy carriers like American and Delta are answering ULCC’s like Spirit’s encroaching on their turf. Even though it’s a radically different environment from past booms and bust, are airlines making the same mistakes of past in terms of chasing market share and revenue at the expense of profit or are they better positioned as businesses?
I actually think, Chris, that they’re getting smarter, not creating another problem. For many, many years all airlines have sold their marginal seats at very low fares because in most cases the marginal costs are low. One of big challenges of the industry is marginal costs are very low while average costs are very high. So, yield management originally in the 1980’s was developed as a way for big airlines to compete with carriers like Southwest at the time and others, and also to fill their planes more. If a seat is going to be empty why not get some revenue for it? And, if I can create a low price that will fill that seat, but not dilute the revenue from customers willing to pay more, that’s what I would want to be able to do. That’s what the whole idea of revenue management originally was put in place for, to kind of solve that problem and it’s worked very well.
Now, what I think is happening is when you see Delta doing a basic Economy product and you see American and United saying they want to copy something like that, I don’t think that’s anything different that’s been done over the last thirty years, but it’s smarter. I’ll tell you why it’s smarter, because it’s not going to increase the amount of that capacity to the seats that would otherwise fly empty, but it’s going to lower the costs of providing that service, because it doesn’t provide the customer with as many of the benefits as those given to higher paying customers. This creates a sell-up opportunity for some as well. So, I think the industry is starting to really institutionalize this idea in the consumers’ mind. The idea is that just like everything else you buy if you pay more you should expect more, and if you pay less you should expect less. If you pay more for a car you should expect to get a better car. You pay more for a meal, you should expect to get a better meal than if you pay less, and it’s the same in the airline industry. Delta started this by introducing their Basic Economy fare, and United has said they wanted to do this as well and this is smart. It started long, long ago, but paired with smarter merchandising, it allows the consumer to better manage the expectation that you get what you pay for.
That makes perfect sense. How do you believe it affects their overall brand perception in the eyes of their customers?
I think it affects the brand perception in a better way because it starts to make it clear for the higher cost airlines that ‘I need to pay more for that airline. Well, I guess because I get these extra benefits, I get the nicer seat, or I get these better meals, or I get these frequent flier points, I get the upgrade to an extra seat, or whatever it is, not just because I get all of that because I’m entitled to it’. I understand a little bit more why the charges are what they are but also, it puts the power in the consumers’ hands to say ‘Well that stuff is less important to me so I’ll just pay a lower price’. I think it’s a better thing and I think overall it will better manage consumer expectations. There are certainly those who want a nicer experience, but they’re going to realize they have to pay a bit more for that.
In these booming times there is the flip side of labor costs escalating, capacity increasing particularly on the domestic front, and of course a lot of resources committed to new aircraft and upgrades? Do you believe in light of this that there’s any decisions and factors where the industry is setting itself up for pain?
It’s hard to predict that. Labor costs are high. There’s pressure to continue to increase wages, and it puts pressure on the industry’s costs. In a way, I would say a lot of stakeholders in the airline industry tend to overreact to short-term things, meaning fuel prices are low so let’s add a lot of capacity, or make money for a couple of years so time to increase wages, things like that. The idea is that long term, I think all stakeholders of the airlines, including labor, are best served when the airline is able to be stable, provide good, stable employment, and be consistently profitable, not just cyclically profitable. I think in the end, there’s certainly room to raise labor rates and there’s certainly room to buy more airplanes. I think that those kinds of decisions should be made in a longer-term kind of context all the time. I’m not suggesting that right now there’s something wrong or a big problem is coming down the pipe with things. Given that the industry’s been profitable for a few years now, first because of consolidation when fares stayed high, and then when fuel prices are low keep everyone profitable – even carriers that don’t have longer-term sustainable models. It potentially creates the opportunity to create some issued down the road right now, but I wouldn’t necessarily suggest that those issues are there right now.
So, let’s say another black swan event occurred like in 2001 or 2008, how do you think the industry would respond differently than in the past?
I think the industry would probably respond reasonably effectively. Just the fact that there are fewer players helps make that true. Also, even though I complained a little bit earlier about this, most of the growth in the industry may not work with higher fuel, most of this growth has come in relatively smart ways: meaning adding seats to planes, or flying a little bit higher utilization with the existing fleet, rather than wholesale going out and making long term commitments for capital. What that suggests to me is that if there is a downturn at some point, the industry should be able to react pretty quickly to pull some capacity back, to the extent that the industry has baked in higher labor is going to be more of a challenge. What will happen, given that there are just four players that drive more than 80% of the capacity is that the likelihood that fares will adjust upward to cover that. So, I think that the industry is likely to fare better in the next downturn than it has in the past just because it’s structurally in a better position.
So, do you actually believe that industry could remain profitable if we hit another sever downdraft as around 9/11 or The Great Recession?
Yes, I think the industry could stay profitable. But in the past in good times the high cost guys earned high single digit margins and the low cost guys earned in the mid-teens. Now, the big guys are earning in the mid-teens and low cost earning north of twenty. So in a downturn the likelihood of the industry losing money again is relatively small but I think that margins revert to where they were before. A good year will be an 8% year for the high cost players. It’s not going to be another 17-18% year.
With four major consolidated players now controlling 80% of the US market, do you expect a next wave of industry consolidation?
There is no urgency for more consolidation in the industry. But, I think there is economic rationality over time for a little more consolidation in the industry. The four big carriers, in American, Delta, United, and Southwest, that are fully flushed out—they have large networks that either have or have the ability to have a world wide set of partners. Three of them do, Southwest doesn’t, but they certainly could. So the issue is, the carriers that aren’t those four – what do they do and are they able to take their smaller fleets and their smaller geographic presence and make that work long-term? If you look at Alaska, Virgin, JetBlue, and we can use Frontier, Spirit, Allegiant, those three are a little different because of cost structure but I think at some point I don’t know—it seems like all of those networks would economically make sense as part of something bigger over time. It would surprise me ten years from now if there weren’t some further consolidation, but it would surprise me if there were in the next twelve months.
Do you believe consolidation is a possibility between Frontier and Spirit?
What do you feel what the industry looks like 5-10 years out from now?
Here’s kind of what I see. Today, I think the industry has three sectors in it if you will. It’s got the large worldwide network carrier sector, which is American, United, Delta, and Southwest. And then it has the true low-cost sector, which is Spirit, Frontier, and Allegiant. And then you’ve got some middle-tier carriers. I’ve heard the term hybrid-carriers. I think longer-term is the likelihood that the industry will ease back to a two-tiered structure like it was. So I think over time it’s going to move over to a two-part world again, where there’s going to be the big guys with full-featured networks with fully flushed out products. Then there’s going to be low-cost guys, and I think the middle-tier some are going to move up and some are going to move down, but it’s going to be hard for them to stay where they are.
So, where does a say a hybrid carrier fit into this future?
I don’t know. They either can compete long-term with a smaller network, even as their costs sort of asymptotically reach the big guys’ cost. The challenging thing is they have cost pressures that move their costs closer and closer to the big guys, but they don’t have the revenue strength, because their networks aren’t as full so they have a harder time attracting a higher fare paying customer. I think that’s why they are actually at some point going to move up and become part of one of the bigger guys, or they all get together and create one big guy, four big guys, five big guys, if that’s possible, or something like that. Or, they move down, and say ‘We’ve got to make our costs significantly lower so we can compete more on that basis’.
I don’t see any urgency happening towards that right now. But in some ways, you see JetBlue already doing that in both directions — on the one hand they have a Mint product to compete for the customers that would likely otherwise be in an AA or DL first class cabin, but they’re also adding a bunch of seats to their airplanes to try and become a little bit more cost efficient, so they’re pushing at both ends, right? You see things happening, but I think over time, that middle space is going to become a more and more uncomfortable space to be in. So, the players in that space are going to start thinking either ‘what do I need to do to get the revenue stream to cover my cost structure or lower my cost structure?’”
The JetBlues of the world were disruptors 15 years ago, but now some of the original legacy carriers, with the advantages of the network scale and frankly bankruptcy, have allowed them to disrupt the original disruptors.
Yeah, that’s right.
While we’re on the hybrid carriers getting squeezed by the power of the network carriers, what do you make of Delta’s aggressive moves in Seattle?
I don’t know what Delta’s intentions are in Seattle are. They have trans-Pacific flying there that certainly needs feed. I think it does sort of lend some credence to what I said earlier, that the middle-tier space is going to over time be an increasingly uncomfortable place because you face risks like this.
Let’s switch gears a bit. PSA, then Southwest were the original LCC’s, maybe ULCC’s. There were of course others like PeopleExpress but until you repositioned as an ULCC, there wasn’t really a truly successful scale low cost carrier in its purest sense in the U.S. any longer. Do opportunities out there exist for alternative strategies à la RyanAir and EasyJet to create a new business model such as flying to smaller airports.
I wouldn’t say that Spirit ever changed its strategy from being an alternative airport to a big airport guy. When I joined Spirit, Spirit was flying to LAX and O’Hare and to Reagan National Airport in DC and Detroit Metro. It was doing some alternatives, such as how Fort Lauderdale was an alternative to Miami, but as you know living down in South Florida, it’s also developed its own market to some extent. There’s some overlap of course, Miami has some distinct traffic and Fort Lauderdale has some distinct traffic. So, I think what’s happened is the consolidation of the industry has created some opportunities to move into some airports that were traditionally thought of as more expensive airports and over time those airports are going to have to get their costs in line if they want to attract more traffic. Pittsburgh used to have over 600 flights a day. Pittsburgh wants more traffic now, but it’s going to have to be a lower cost airport. You see that in Pittsburgh, Cincinnati, Memphis, a lot of places, so I don’t see that as a change in strategy or a sort of meaningful issue there on the horizon. The airport size isn’t as important as the size of the market it serves.
Is there a more obvious niche to be exploited that’s being overlooked?
There will always be people that think about that. Maybe, there is something new. Nobody really predicted JetBlue. No one really predicted Allegiant and what they would do. I would argue some people didn’t predict Spirit and what they would do when they transformed. I’m not going to be so silly to say that no one else could do that, it just doesn’t seem obvious to me. My point is that I don’t see any gapping lacks of service in places today that suggest there’s this huge void that needs to be filled. There’s a reason Kansas City isn’t a hub, there’s a reason Pittsburgh isn’t a hub, there’s a reason Cincinnati isn’t a hub. It’s not that places that used to be hubs to create all this opportunity.
You’ve just wrapped up a nearly 11-year incredibly successful run, where you led the transformation of Spirit from a relatively obscure carrier into a ULCC that has disrupted the US industry at large. Can you reflect on how that strategy morphed from first being focused on Caribbean and Latin American markets, and then pushed into the U.S. domestic market?
I think it’s been a matter of opportunity. When we started the international operations that Spirit now flies, the near term international operations were characterized by very high fares and only served by high-cost airlines. And so, it was a natural place for the airline to expand to really create new traffic, to essentially price back into the market, or price into the market a whole demographic that hadn’t been served by other airlines. There was less opportunity in the domestic industry when you had eight carriers and lots of hubs in lots of places. There were a lot of low fares though the industry was under duress.
Then the industry consolidated and it abandoned some marginalized hubs. What that did—and you would understand this more than most, Chris—is when you close a Pittsburgh, a Cincinnati, and a Cleveland as hubs, entrenched hubs like New York and LA become more expensive because now you don’t have cheap connection alternatives with the fifty empty seats from New York to Cincinnati and fifty empty seats from Cincinnati to LA. And the big non-stop markets become more expensive when they’re not being cannibalized by the airlines running non-stop with all these marginal hubs that were filling themselves on just connecting traffic. So, that created an environment in 2011 and beyond for Spirit to have the same opportunity flying domestically as it has had early on internationally. So, the idea wasn’t different at all, it was just the leverage of a lower-cost platform, leverage of a simpler product that allows customers to travel for lower prices and prices that traffic into the market and build the traffic base that way. There just wasn’t that much opportunity domestically, before 2010, so most of the initial growth of Spirit was internationally because that’s where the opportunity was. The fruit tree has just gotten a lot bigger. That’s all that’s happened, it’s not a change of strategy really.
It seems that Spirit had its initial first burst of success while much of the industry was suffering through harsh economic conditions and high fuel cost. Was Spirit uniquely positioned to take advantage of these types of headwinds?
I’m not saying it was built just to be profitable in a tough economic climate. I would think Spirit was built to be profitable in any macro-economic environment, whether that was high fare, whether that was recession, whether that was high-industry capacity, or low-industry capacity. It was sort of like, if you go back to 2008, the airline shrunk 20% and was profitable in 2008 because it got rid of capacity and it couldn’t be profitable when oil prices spiked up. I think that’s more indicative of just how profit focused Spirit has been. It’ll grow when it can make more money growing and it’ll shrink if it’s going to make more money by shrinking. I wanted Spirit to be profitable in any environment. I think where Spirit’s strength is, at least when I left the company was that it basically created its own market wherever it flew, and by bringing in lower prices than were offered in the segments it added. It brought in new traffic. I know there are people in the industry that would dispute that but I think the DOT data can prove that quite well. So, I think that the markets get bigger when Spirit starts flying them. I think you can expand this beyond Spirit. You can expand this to Allegiant and Frontier also. I think that’s the sector of the industry that is about growing the traffic base not taking share from the bugger guys, and that ultimately it is the long-term competitive advantages of the sector.
Spirit has outsized impact certainly. You have gone toe-to-toe in routes and markets with the big guys. DFW, Chicago, Minneapolis, Atlanta, etc. I’m wondering—it seems like these airlines started significantly responding to the threat of Spirit. You’ve got a ferocious competitor from the LCC space now running a legacy airline like Doug Parker saying ‘We’re not going to allow ourselves to be beat by price’. Do you feel like you guys poked the sleeping bears there and now are paying the price?
I don’t speak for the whole ULCC sector here, ok? I don’t think anyone’s poked any bears. What the ULCC sector has done is identify that there’s traffic not being carried by the rest of the industry, so let’s create a new business model, be profitable carrying traffic that is largely ignored by the rest of the industry. That’s what has compelled Spirit’s growth and that’s what Frontier is chasing as well. Allegiant has found that in a lot of the very unique markets that they serve and so on. I think that’s all true.
I’m not saying from the other side that the sector looks like ULCCs are poking the big guy, but I don’t think that’s ever been thought of that way from the ULCC side. So, as far as I’m concerned the big guys have always responded, they’ve always been aggressive. They absolutely do what is best for their companies and their shareholders long-term. If that means being really aggressive to low-fare carriers then that’s what they should do, but I think it also should mean serving the higher fare customers as well, and there’s a lot of things that I think they should do. So, I don’t think anyone should criticize any of the big guys for what they do at all. They’re running their businesses. Everyone should just run their business to do the best they can, and far be it from me to say anybody else is doing a bad job of that, right?
I thought that when I was running Spirit we were doing a pretty good job of that and for running Spirit, but we weren’t running another airline at that point. I don’t believe that the idea that bigger carriers are going to be more aggressive against ULCCs nor does it create any real long-term threat towards the ULCC’s sector. I can tell you when I worked at American in the 1980s, the airline had an obsession about Southwest and how are we not going to let Southwest grow, and how effective was AA in that? The ULCC sector will grow because the market is making it profitable for them to do so.
For sure, but also, but yet, you’ve had revenue pressures in markets such as Dallas/Ft. Worth and Chicago, because of the big guys like American responding to this perceived threat. Would you agree with that?
I guess I would agree to some extent. One of the things that I think Spirit help proved, and Allegiant has done as well is to prove there’s more traffic out there than the industry was just carrying. The idea that everyone who wanted to fly could fly absolutely was not true. Spirit proved that by offering even lower fares and generating more traffic. So, I think, if anything airlines are learning organizations just as they should be. I think this idea that ‘Hey, there is more traffic than the traditional airline industry has focused its laser on’, and to that extent bigger airlines can sort of realize, ‘Hey there is this much more traffic, how do we make money on all of this traffic’, that’s ok, they should be thinking that, right? Maybe that’s one thing that the low-cost sector did was point out that there are more people willing to fly if you can give them the right price.
Do you think that if oil had remained at $80 or $100 a barrel would the legacy airlines have been enabled to challenge the LCC sector like they are doing now?
There are two answers to that question. I think that certainly they could still do it, but it would be more expensive for them, but secondly I think that the other thing is it would be a bit hard. The whole industry has grown 4% or so in the last couple of years. So, the growth in the industry would have been more problematic if oil prices had remained high, and probably wouldn’t have happened or at least wouldn’t have happened as much if it did. So, I think that would have been true, and therefore there would have been less ability for the bigger carriers to price really low and fill empty seats because there would be fewer empty seats and the empty seats would just be more expensive. So, I wouldn’t say it couldn’t happen but it would be less likely to happen in the same way that it did. I think that’s a fair way to say it.
There seems like an irony that Wall Street punished Spirit in a year where you’ve got these stratospheric operating margins accompanied by achieving the growth Spirit promised.
I agree with you on that irony, but I can’t comment on reasons or why. I think Spirit’s numbers just have to speak for themselves on. So far, the public data on that in 2015-16 operational numbers known for Spirit are all very, very strong. Only the stock price doesn’t reflect that.
It’s indisputable what Spirit has done for shareholders, employees, and its customers even if they don’t always appreciate. Spirit is clearly disrupter, but not always perceived as customer friendly. In Europe, ULCC Ryanair evolved to become more customer friendly and more focused on improving its operations. Do you see Spirit and the ULCC model evolving in a similar fashion?
I see a real role for the ULCC in the U.S. just like they’ve evolved in Europe. In Europe about 20% of the travelers travel on Ryanair, Easyjet, and a few other carriers that have cost structures like that. In the U.S. those cost structures carry 4% of the traffic. Now, I don’t know if the U.S. gets 20% of its traffic carried by that base, because in the U.S. we have Southwest and Europe doesn’t. Southwest plays in both spaces: they play in the legacy space and they play in the lower-cost space to some extent. But I think under any extent, there’s absolutely strong growth available for the ULCC sector in the United States.
Is there any way in which the U.S. ULCC product is improved in execution?
There are all kinds of things it’s trying. Frontier says ‘lower fares done right’. They try to have softer edges than Spirit has had traditionally on some things. Spirit, even under my tenure over the last couple of years, was moving towards a better-managed expectation of the customer. Ultimately, customers are going to choose the airline they fly or the food they eat or the refrigerator they buy based on their perception of the value of that purchase. So, airlines are going to have to continually adapt to that. I will say though, that as a largely commodity product, and as an intermediate good – which is an economic term meaning something that you buy because you need to not because you want to — it puts a huge premium on the price point that the customer pays in terms of what they’re willing to accept.
That doesn’t mean they’re going to accept anything for a low price. Gordon Bethune used to say ‘you can make a pizza so cheap nobody wants to eat it’ and he’s right about that. You’ve still got to have the basics. You’ve got to be safe, you’ve got to get people there reliably, you’ve got to deliver their bag to them, and it’s nice if you smile at them. There are some basic tenants you have to do. Having worked at bigger airlines as well as at Spirit, I could tell you there were customer service issues that were big at those airlines, too. It’s not like the big airlines have it right and the low-cost guys have got to figure it out, that’s not true at all. They’re just different challenges.
What is it that you’re most proud of with what you achieved with your team over the last decade?
What I’m most proud of is that we were essentially able to create a new sector of air travel in the United States. That we identified a market and that we were able to execute in ways that proves that the market was there creating a strong, viable, growing company from essentially from a set of assets that were losing money. That creates pride and everyone at Spirit should feel that.
In hindsight is there anything you would’ve done different if you had to do it all over again?
No, it’s hard to look back on the success and nit-pick individual things. I could pick a lot of different things from the basket of my eleven years experience, but for the most part I wouldn’t change it.
What’s next for Ben Baldanza?
I don’t know, I’m just going to be picky about what I do next. That’s the only way I’m going to think about it. I’m just going to picky. For the next 10 years, my life is in the Washington DC area and that will constrain things a bit. I’m ok with that.
Would you ever come back in the industry or would you want to disrupt another industry?
I like disrupting things. It might be fun to try that in another industry. It doesn’t mean I’ll get that opportunity, doesn’t mean I will do that, but it certainly would be fun to try that.
So, that’s the long-term. What are you going to do in the short-term?
In the short-term I certainly am going to enjoy seeing my wife and son again who moved to the Washington D.C. area six months before I did. I’m going to enjoy that. I’ve still got a lot of energy and I’ll still be doing something.