batsky2000
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The Decline of Southwest and the Rise of JetBlue
With Southwest's competitive advantages in decline, JetBlue has an opportunity to take air travel upscale and capture a new mass market of consumers.
By Stephen Ellis
March 21, 2006
A stalwart in decline
Geoffrey Moore (author of numerous bestsellers such as The Gorilla Game) made an interesting comment recently about Southwest <A href="http://quote.fool.com/uberdata.asp?symbols=LUV"><A onclick="openWindow('http://quote.fool.com/uberdata.asp?symbols=LUV', 'quotebox', 776, 460); return false;" href="http://quote.fool.com/uberdata.asp?symbols=LUV">(NYSE: LUV). He observed that Southwest's CEO Gary Kelly commented that the company's core advantages were its performance in areas like on-time flights, baggage handling, and low frequency of complaints and cancelled flights. This was interesting because it ignored what had been Southwest's chief competitive advantage for decades -- price. Moore's salient observation was that the company's core advantage had now become so eroded by competition that it was becoming context.
In addition, secondary competitive advantages such as flying out of smaller, less-conveniently located airports to save money on landing fees are also declining. This is due to the growth of many regional carriers and other low-cost carriers driving up traffic and landing fees at the secondary airports. In other words, Southwest now needs to find a new strategy since its old one no longer works as successfully as it did in the past.
If Southwest's model is slowly weakening, what's the problem?
Answer: JetBlue <A href="http://quote.fool.com/uberdata.asp?symbols=JBLU"><A onclick="openWindow('http://quote.fool.com/uberdata.asp?symbols=JBLU', 'quotebox', 776, 460); return false;" href="http://quote.fool.com/uberdata.asp?symbols=JBLU">(Nasdaq: JBLU).
The above is a bit of an overstatement, but no single airline has such a great opportunity to change the face of airline travel today. Southwest's key competitive advantages have been historically cost driven with low overhead, driven by a highly motivated workforce. Combined with a direct business model versus the industry standard hub-and-spoke model, this enabled the company to offer far lower fares than the competition. Southwest's low prices insulated it from competition, since no other airline could undermine its cost advantage.
In addition to that, Southwest's low-cost direct business model served up something of a disruptive innovation to the legacy carriers' traditional model. The low-cost carrier had a completely different cost structure from the legacy carriers and only offered the bare minimum in amenities to satisfy travelers who just wanted transportation without any extras, and at a super-low price. It captured the mainstream market and quite a few thrifty corporate travel departments. However, unlike most disruptive companies, Southwest failed to move upmarket to capture travelers who were willing to shell out a few extra bucks. This left legacy carriers a considerable market space by default, and a higher margin arena in which to lick their wounds.
But by stripping down air travel to a fairly bare-bones existence, an opportunity was created for an upstart airline to enter the market with something more like "upscale discount." JetBlue's business model had previously allowed it to obtain industry-leading margins by eroding industry profitability, simply by moving upmarket and entering the market space left relatively untouched by Southwest. By mocking the Southwest model quite nicely with lower-cost hubs, no union affiliation, and more cost-effective planes, JetBlue added a little sizzle to the steak.
With their once-safe sanctuary now under attack, legacy carriers have scrambled to respond. Their response, in part, was to launch two new low-cost carriers as subsidiaries of the parent company (Delta's Song and United's Ted -- Song is being "folded" into the rest of Delta), which have seen only checkered success. In addition, the legacy carriers are again retreating upmarket to higher-margin international flights, as Continental <A href="http://quote.fool.com/uberdata.asp?symbols=CAL"><A onclick="openWindow('http://quote.fool.com/uberdata.asp?symbols=CAL', 'quotebox', 776, 460); return false;" href="http://quote.fool.com/uberdata.asp?symbols=CAL">(NYSE: CAL) has shown by its heavy expansion overseas. Since JetBlue is continuing to expand the upscale part of the airline while maintaining fairly low prices, it's reasonable to expect that the airline can continue to capture market share from below (Southwest) and above (legacy carriers) for the foreseeable future.
JetBlue's great opportunity
JetBlue has sought to do something that breaks somewhat from both the legacy carrier and low-cost carrier models -- in effect, splitting the difference. To be sure, this has altered the face of the customer experience -- offering free DirectTV, leather seats, and XM Satellite Radio <A href="http://quote.fool.com/uberdata.asp?symbols=XMSR"><A onclick="openWindow('http://quote.fool.com/uberdata.asp?symbols=XMSR', 'quotebox', 776, 460); return false;" href="http://quote.fool.com/uberdata.asp?symbols=XMSR">(Nasdaq: XMSR) satellite radio for their passengers, but maintaining the aforementioned affordable fares all the while. Combined with a feisty culture created by CEO David Neeleman, the non-unioned airline had been thriving until recent fuel costs took their toll on company profits. While Southwest's low-cost business model is devastating the legacy carriers, its service offerings aren't quite equal to JetBlue's. In addition, Southwest's price advantage is eroding as other low-cost carriers and legacy carriers seek to match its fares, and JetBlue has smartly presented an attractive alternative with a bit of oomph to it.
While the ticket prices may be rising $5 to $10 in the short term, as Neeleman indicated in the wake of last quarter's earnings report, their prices should still be quite competitive relative to the industry pricing.
Oil has recently hovered above $60/barrel, rendering the competitive environment and threats from legacy carriers (and United, recently emerged from bankruptcy) a relative non sequitur, since they too are heavily exposed to fuel costs. And I wouldn't be surprised if Southwest also raised its fares, since its hedges don't present a solution to the chronic threat that continuously higher fuel costs present.
Essentially, the U.S. marketplace can be described as such: because of the hub model's structural limitations, the legacy carriers are constrained in their ability to respond to low-cost carriers, and Southwest is no longer the only low-cost carrier in the game. By adding a little pizzazz to its flights, JetBlue is paving an attractive middle road for passengers.
The question therein is this: Is JetBlue worth my investment dollars? Stay tuned, and I'll have a look that way in part two.
With Southwest's competitive advantages in decline, JetBlue has an opportunity to take air travel upscale and capture a new mass market of consumers.
By Stephen Ellis
March 21, 2006
A stalwart in decline
Geoffrey Moore (author of numerous bestsellers such as The Gorilla Game) made an interesting comment recently about Southwest <A href="http://quote.fool.com/uberdata.asp?symbols=LUV"><A onclick="openWindow('http://quote.fool.com/uberdata.asp?symbols=LUV', 'quotebox', 776, 460); return false;" href="http://quote.fool.com/uberdata.asp?symbols=LUV">(NYSE: LUV). He observed that Southwest's CEO Gary Kelly commented that the company's core advantages were its performance in areas like on-time flights, baggage handling, and low frequency of complaints and cancelled flights. This was interesting because it ignored what had been Southwest's chief competitive advantage for decades -- price. Moore's salient observation was that the company's core advantage had now become so eroded by competition that it was becoming context.
In addition, secondary competitive advantages such as flying out of smaller, less-conveniently located airports to save money on landing fees are also declining. This is due to the growth of many regional carriers and other low-cost carriers driving up traffic and landing fees at the secondary airports. In other words, Southwest now needs to find a new strategy since its old one no longer works as successfully as it did in the past.
If Southwest's model is slowly weakening, what's the problem?
Answer: JetBlue <A href="http://quote.fool.com/uberdata.asp?symbols=JBLU"><A onclick="openWindow('http://quote.fool.com/uberdata.asp?symbols=JBLU', 'quotebox', 776, 460); return false;" href="http://quote.fool.com/uberdata.asp?symbols=JBLU">(Nasdaq: JBLU).
The above is a bit of an overstatement, but no single airline has such a great opportunity to change the face of airline travel today. Southwest's key competitive advantages have been historically cost driven with low overhead, driven by a highly motivated workforce. Combined with a direct business model versus the industry standard hub-and-spoke model, this enabled the company to offer far lower fares than the competition. Southwest's low prices insulated it from competition, since no other airline could undermine its cost advantage.
In addition to that, Southwest's low-cost direct business model served up something of a disruptive innovation to the legacy carriers' traditional model. The low-cost carrier had a completely different cost structure from the legacy carriers and only offered the bare minimum in amenities to satisfy travelers who just wanted transportation without any extras, and at a super-low price. It captured the mainstream market and quite a few thrifty corporate travel departments. However, unlike most disruptive companies, Southwest failed to move upmarket to capture travelers who were willing to shell out a few extra bucks. This left legacy carriers a considerable market space by default, and a higher margin arena in which to lick their wounds.
But by stripping down air travel to a fairly bare-bones existence, an opportunity was created for an upstart airline to enter the market with something more like "upscale discount." JetBlue's business model had previously allowed it to obtain industry-leading margins by eroding industry profitability, simply by moving upmarket and entering the market space left relatively untouched by Southwest. By mocking the Southwest model quite nicely with lower-cost hubs, no union affiliation, and more cost-effective planes, JetBlue added a little sizzle to the steak.
With their once-safe sanctuary now under attack, legacy carriers have scrambled to respond. Their response, in part, was to launch two new low-cost carriers as subsidiaries of the parent company (Delta's Song and United's Ted -- Song is being "folded" into the rest of Delta), which have seen only checkered success. In addition, the legacy carriers are again retreating upmarket to higher-margin international flights, as Continental <A href="http://quote.fool.com/uberdata.asp?symbols=CAL"><A onclick="openWindow('http://quote.fool.com/uberdata.asp?symbols=CAL', 'quotebox', 776, 460); return false;" href="http://quote.fool.com/uberdata.asp?symbols=CAL">(NYSE: CAL) has shown by its heavy expansion overseas. Since JetBlue is continuing to expand the upscale part of the airline while maintaining fairly low prices, it's reasonable to expect that the airline can continue to capture market share from below (Southwest) and above (legacy carriers) for the foreseeable future.
JetBlue's great opportunity
JetBlue has sought to do something that breaks somewhat from both the legacy carrier and low-cost carrier models -- in effect, splitting the difference. To be sure, this has altered the face of the customer experience -- offering free DirectTV, leather seats, and XM Satellite Radio <A href="http://quote.fool.com/uberdata.asp?symbols=XMSR"><A onclick="openWindow('http://quote.fool.com/uberdata.asp?symbols=XMSR', 'quotebox', 776, 460); return false;" href="http://quote.fool.com/uberdata.asp?symbols=XMSR">(Nasdaq: XMSR) satellite radio for their passengers, but maintaining the aforementioned affordable fares all the while. Combined with a feisty culture created by CEO David Neeleman, the non-unioned airline had been thriving until recent fuel costs took their toll on company profits. While Southwest's low-cost business model is devastating the legacy carriers, its service offerings aren't quite equal to JetBlue's. In addition, Southwest's price advantage is eroding as other low-cost carriers and legacy carriers seek to match its fares, and JetBlue has smartly presented an attractive alternative with a bit of oomph to it.
While the ticket prices may be rising $5 to $10 in the short term, as Neeleman indicated in the wake of last quarter's earnings report, their prices should still be quite competitive relative to the industry pricing.
Oil has recently hovered above $60/barrel, rendering the competitive environment and threats from legacy carriers (and United, recently emerged from bankruptcy) a relative non sequitur, since they too are heavily exposed to fuel costs. And I wouldn't be surprised if Southwest also raised its fares, since its hedges don't present a solution to the chronic threat that continuously higher fuel costs present.
Essentially, the U.S. marketplace can be described as such: because of the hub model's structural limitations, the legacy carriers are constrained in their ability to respond to low-cost carriers, and Southwest is no longer the only low-cost carrier in the game. By adding a little pizzazz to its flights, JetBlue is paving an attractive middle road for passengers.
The question therein is this: Is JetBlue worth my investment dollars? Stay tuned, and I'll have a look that way in part two.
imp: (highlights for effect)
