Published in June 2016 issue
Ben Baldanza is an industry pioneer. Before joining the Board of Directors at WOW Air (WW) last March 10, 2016, he was the CEO of Spirit Airlines (NK), the largest ultra-low cost carrier (ULCC) in the US, and the most profitable airline by operating margins.
In this exclusive interview, the first following his sudden departure from Spirit early this year, Baldanza discusses how low-cost airlines fit into the airline marketplace, how he grew Spirit into a powerhouse, and what the future airline market looks like. (This conversation was edited for space)
By Chris Sloan
Ben, we’re in an era of low fuel prices, incredible profits, and the operating margins are astonishing by any measure. But with some of the looming macroeconomic 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—economic or something inherent in the industry itself—particularly in overcapacity?
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 posible 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 tan the industry is currently earning, and a higher likelihood of either industry losses or underperformance 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 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 ULCCs like Spirit encroaching on their turf. Even though it’s a radically different environment from past booms and bust, are airlines making the same mistakes of the past in terms of chasing market share and revenue at the expense of profit, or are they better positioned as businesses?
I actually think 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.
So, yield management—originally, in the 1980s— was developed as a way for big airlines to compete with carriers like Southwest, 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 créate 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 30 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’ minds.
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. Delta started this by introducing their Basic Economy fare, and United has said they want 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.
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, American, Delta, United, and Southwest, are fully flushed out— they have large networks that either have or don’t have the ability to have a worldwide 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—it seems like all of those networks would economically make sense as part of something bigger over time. It wouldn’t surprise me, 10 years from now, if there were some further consolidation, but it would surprise me if there were in the next 12 months.
Do you believe consolidation is a possibility between Frontier and Spirit? No comment.
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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 US any longer. Do opportunities out there exist for alternative strategies à la Ryanair and EasyJet to créate 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 guy to being a big airport one.
When I joined Spirit, it was flying to LAX and O’Hare and to Reagan National Airport in DC and Detroit Metro. It was doing some alternatives, such as Fort Lauderdale as an alternative to Miami, but it’s also developed its own market to some extent. 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 and, over time, those airports are going to have to get their costs in line if they want to attract more traffic.
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 US 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 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 50 empty seats from New York to Cincinnati and 50 empty seats from Cincinnati to LA. And the big nonstop markets become more expensive when they’re not being cannibalized by the airlines running nonstop 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 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 bring 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.
Spirit has an 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 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 the idea that bigger carriers are going to be more aggressive against ULCCs, nor does it create any real longterm threat towards the ULCC sector.
I can tell you that, 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.
But yet, you’ve had revenue pressures, in markets such as Dallas-Fort 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 helped prove, and Allegiant has done as well, is that there’s more traffic out there tan the industry was carrying. The idea that everyone who wanted to fly could fly was absolutely not true. Spirit proved that by offering even lower fares and generating more traffic. So, I think that, if anything, airlines are learning organizations, just as they should be.
I think that 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 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.
Is there any way in which the US 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 traditionally had on some things. Spirit, even under my tenure over the last couple of years, was moving towards a better-managed customer expectation. 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 customers pay 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 tenets you have to do.
Having worked at bigger airlines as well as at Spirit, I could tell you that 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 about 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 proved that the market was there by creating a strong, viable, growing company from, essentially, 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 do differently if you had to do it all over again?
No, it’s hard to look back on the success and nitpick individual things. I could pick a lot of different things from the basket of my 11 years’ experience but, for the most part, I wouldn’t change it.