A Spirited Defense: The ultra-high margins haven’t disappeared. But America’s largest ultra-LCC isn’t worry free
Is it silly to worry about an airline that earned a 22% operating margin last quarter? Maybe “worry” is too strong a word. But concerns about Spirit Airlines are serious, not silly.
Since a financially damaging summer pilot strike in 2010, it’s been pretty much all good news for America’s largest ultra-lowcost carrier. Spirit topped the U.S. airline industry with a 14% operating margin in 2011. It followed with margins of 13% in 2012, 17% in 2013, 19% in 2014 and 24% in 2015, in each case ranking first or second among all U.S. carriers, behind only Allegiant in 2012 and 2015. Through the first half of this year, Spirit’s operating margin was 22%, reaching that figure in both the first and second quarters.
So what’s wrong? On the surface, not much. Spirit continues to have considerably lower unit costs than nearly all of its peers—38% below those at Southwest, it claims, adjusting for stage length. It’s still hugely successful in the realm of ancillary revenues, which equal nearly half of its total revenues. It continues to reap the scale benefits of rapid capacity growth. Cheap fuel helps justify even faster growth given its highly variable cost base—and in a cheap-fuel environment, the lowest-cost carriers often have an even bigger unit cost advantage than before (because non-fuel costs, where ULCCs have the biggest advantage, become a bigger piece of the overall cost pie). Spirit depends on leisure demand, which seems to be holding up better than corporate demand at the moment. And there’s clearly a large market of travelers willing to trade the perks offered by higher-cost LCCs—more legroom, inflight connectivity and entertainment, a more robust frequent flier plan and so on—for a cheaper ticket, typically cheaper even including all the extra fees.
But the U.S. airline industry is also changing in ways that make Spirit’s life harder. The U.S. Big Three, once highly vulnerable to ultra-LCC attacks, even in their fortress hubs, are no longer distracted by merger integrations, no longer cutting as much domestic capacity, no longer have balance sheet concerns and no longer feel handcuffed by high oil prices. So they feel emboldened to match ultra-LCC fares more aggressively, both in overlapping nonstop markets and on itineraries involving a connection.
Going one step further, Delta pioneered cheaper “Basic Economy” fares offering fewer frills than standard economy…
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