Let The Country Benefit From The JetBlue Effect

Richard Branson once famously said (reflecting on his adventure with Virgin Atlantic), “If you want to be a Millionaire, start with a billion dollars and launch a new airline.” For his part, Warren Buffett wrote in a 2007 letter to Berkshire Hathaway investors that “if a far-sighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.”

Thankfully for consumers, capitalists continue to invest (and often to lose money) in airlines. Buffett’s letter was prompted by his loss of billions investing in US Air. He came back for more, however, and in 2020 Berkshire HathawayBRK.B
ended its most recent experiment in the industry by selling multibillion-dollar positions in the “Big Four” — American, Delta, Southwest, and United.

It’s romantic to think of founding a new airline, but the economics of the industry are tough to crack. Without national network access airlines are typically restricted to flying customers from home cities to select resorts. Airlines that wish to become national, benefiting from network effects, have enormous upfront costs to buy or lease airplanes, hire and train staff, and build reliable physical and electronic networks. Meanwhile, empty airplane seats procure no revenue and the marginal cost of an additional traveler approaches zero. So startup airlines tend to compete fiercely on price, which often pushes profit margins down to a level that can’t support capital investments, especially when downturns (COVID, weather, etc.) crater demand for air travel. The list of airline bankruptcies and defunct carriers is long indeed. Today over two-thirds of domestic flights are Big Four routes.

As mentioned above, there is a small non-national segment. Spirit AirlinesSAVE
controls about 4% of domestic air travel and reported a net loss of over $270 million in the fourth quarter of 2022, even though most airlines made money during that period. The influential Airline Weekly is unsure of Spirit’s long-term viability. JetBlue, for its part, takes about 6% of our aviation market and has a stellar reputation in its relatively concentrated corridor of the Northeast and Florida. Unlike Spirit, JetBlue is reputed for customer service. Still, the Queens, New York-based carrier lost $151 million during the fourth quarter of 2022, when its operating margin was a shocking -2.8 percent. Expenses jumped nearly 38 percent from 2019 on a revenue increase of 16 percent. Fuel was the single largest contributor, but costs excluding fuel also rose 14.5 percent. True, other small airlines also have cost concerns. Alaska AirlinesALK
saw overall expenses increase 29 percent (and fuel expenses 54 percent) over the same period, and Frontier Airlines saw expenses jump 70 percent on a fuel increase of 141 percent. But Alaska and Frontier brought in enough revenue to offset these increases. JetBlue did not.

Scale would help JetBlue. Spirit’s spread-out route map would allow JetBlue to establish a national network. So in July 2022 JetBlue (beating out a bid by Frontier) acquired Spirit for $3.8 Billion. The purchase will create the U.S.’s fifth-largest carrier, with a fleet of 458 aircraft and an order book of 300 planes. Over 125 American cities will be served by the merged airline. Personally, I hope that my fast-growing home airport, Greenville-Spartanburg (GSP), will be one of them. An MIT study coined the famous “JetBlue effect” — when JetBlue enters a new market, every round trip fare drops by an average of $64.

Alaska Airlines merged with Virgin America in 2016 to produce a viable airline. Frontier acquired Midwest Airlines in 2010. The merged company has agreed to divest current Spirit assets in New York City, Boston, and Ft. Lauderdale (where the current JetBlue is already strong) to enhance competition in those markets. Yet there is now widespread speculation that the Justice Department will in early March oppose the merger on antitrust grounds. Defending against a DOJ antitrust challenge can take years and impose tens of millions in costs, even if the merged company ultimately prevails.

Spirit is a bare-bones product that offers nothing like JetBlue’s space, inflight entertainment and other amenities that must be provided to the newly acquired equipment. As Spirit crews earn less than their peers at JetBlue, current Spirit employees will receive an immediate bump from the merger. Bringing Spirit up to JetBlue standards increases costs, and anticipated revenue synergies of $600-700 million annually won’t accrue to compensate for these increased costs until 2024 even without antitrust litigation. The substantial costs of defending against a DOJ suit could scupper the deal.

With Southwest now a high-price member of the Big Four, there is little meaningful price competition in most markets. Airfares are the highest in recent memory. There is a great need for a fifth national carrier. Network effects give an intrinsic advantage to national carriers, and no small carrier has sufficient access to capital to expand to national status without a merger. The Big Four might smile if DOJ blocks the JetBlue/Spirit deal, but such a move would be a major disservice to the flying public. Please, President Biden, allow the country to benefit from the JetBlue effect.