The last year has been an eventful one in the regional airline industry to say the least. After last years collapse in pay among regional airlines including Pinnacle/Endeavor/PSA this year has been a little different. The trend towards pay cuts does seem irrational considering the shift in supply discussed in the first article of this series. These pilot groups happen to be compensated much less than their mainline counterparts and have been motivated to take pay cuts by the specter of significant fee for departure reductions or even dissolution. Ironically, all of this has occurred in the shadow of what some regional airlines call a pilot shortage.
So how are pay cuts in an environment of pilot scarcity possible?
First, let us look at the regional airline business model. 15-20 years ago regional airlines began to accept “fee for departure” contracts in the way that we know them today. This mechanism was put in place for multiple reasons but the result ultimately outsourced mainline flying to smaller cheaper operators.
As part of these contracts the mainline airlines would do almost everything but operate and maintain the airplanes. Whether the airplanes were full or empty the regional airlines would be paid a predetermined “fee” for each departure. The mainline partners would earn income from the tickets. Sounds like a great deal for the regional airlines, no responsibility for marketing, ticketing, infrastructure, and all the standard trappings of an airline. Airline executives and board of directors liked this model as it provided a consistent revenue stream with which if costs were controlled and accurately predicted then a profit margin could be virtually guaranteed. Revenue was known as well as short and long term costs.
In the last oil spike this model allowed regional airlines to maintain profitability while their mainline partners suffered significant losses.
Even though the majors took the brunt of the marketing risk in this case it wasn’t so one sided.
To understand what they gained we need to look a little closer.
Many regional airlines became dedicated regional feed for a mainline partner. For example ASA became dedicated Delta, Express Jet became dedicated Continental, some airlines diversified the best they could and ended up in some cases with 3 to 5 partners. Due to the regional “fee for departure” structure and as previously stated these regional airlines depended on their partners for almost everything.
Fast forward a couple of years and we find a regional market saturated with players. Competition is fierce as regional airlines compete for this coveted and predictable revenue source. Two factors at this point play a large part in the story
- Some airlines use an “incremental pricing” model to bid for future flying. They assume as they get larger or take new flying their unit costs will go down with economies of scale. What does this mean? It means they choose to bid for new flying below their current cost structure with the hope that their cost structure will fall below what they bid for over time. The mainline carriers happy to have ultra cheap regional feed happily bite. Ultimately, some carriers such as Mesa, and Pinnacle/Endeavor go bankrupt as their bids were too low to sustain there operation.
- Other airlines seeing ultra low bids are motivated to do all they can to match these bids in an attempt to regain flying or obtain new flying. Why are they so motivated? They are motivated because in most cases they have only 1-3 customers, customers that if lost could result in catastrophic reductions in their operations. Even airlines who have diversified among multiple carriers are not immune to this problem. It would be similar to putting all of your retirement investments in not 3-4 mutual funds but just 3 or 4 stocks for 10-20 years at a time.
These two factors have and are occurring simultaneously while board of directors and executives look to retain profits. With revenue shrinking through intense and sometimes irrational competition the only place to adjust the formula to insure profits is in costs. Costs often translate into employee compensation and work rules.
Regional management teams now stuck in this “no win” situation are forced to do all they can to adjust their costs. In many cases the employee groups are just bystanders to the business model developed by their airline management teams. Unfortunately, without exploring other business models the only way the regional airlines will grow will be as a result of cost cuts among their airlines. The Regional airline industry is not a model in creativity, it is more a model in simple arithmetic.
In some cases employees can either leave for better opportunity or risk pay cuts or a reduction in work.
The major airlines in some ways exacerbate the problem as they do all they can to prop up recently bankrupt carriers with unnatural and likely unsustainable low costs. This can be seen with Delta’s efforts with Pinnacle/Endeavor, United’s efforts with Mesa, and AA/USAirway’s effort with PSA.
Eventually something will have to give in the business model. Some carriers like Air Wisconsin will likely slowly fade. Others like Mesa may continue in the boom and bust cycle until the mainline partners tire of the additional and unpredictable costs they incur. Still others who will not bid for flying below future cost will accept a gradual reduction in future flying.