How to manage commuter feed airlines October 1998

Commuter airline affiliations are becoming increasingly problematical for the major jet carriers. In this article Louis Gialloreto of McGill University takes a look at the strategic options available to large jet airlines when managing their commuter affiliates.

For most airlines, the original rationale for connector or regional airline affiliation is threefold:

1) Incremental traffic feed revenue; and/or

2) Downloading routes (city–pairs) that are more cost effective when served by an affiliated regional airline with much lower costs/seat mile than the mainline jet airline partner; and/or

3) Experimenting on new thin city–pair markets to see whether or not these can be grown into trunk–line jet routes.

A rather simplistic market access or protection strategy was first deployed by USAir. Linking the USAir commuter group services (Allegheny or Piedmont etc) to USAir’s rather expensive jet operations in what were mostly monopoly northeast US city pairs locked up feed and therefore market share and geographic predominance. Many other US trunk airlines quickly adopted the same strategy as USAir in the Iate 1970s and early 1980s.

Other national markets such as Canada, Australia and New Zealand also became ideal proving grounds into which the majors could deploy commuter affiliates, due to large territorial expanse, limited population density and limited national jet airline competition, all mixed in with some form of deregulation. As long as markets were growing and deregulation forced re–allocation of city pairs then all was well.

In fact, things went so well that the value of feeder networks became very significant. At this point many of the regional airline pups — most of which were still independently owned — began thinking of how to best maximise shareholder value.

In the US this inevitably led to commuter groups being willing to affiliate and re–affiliate with the highest bidder jet trunk airline. This musical chairs approach to feeder relationships led to two main effects — the Majors now faced a new element of competition when securing feed, while customers trying to follow the code–share trail became increasingly annoyed at the constant changing of the trunk airlines’ feeders.

Buying-out the problem

There was a simple way to defend an airline against the threat of constant feeder change — to buy majority stakes in the commuter or gaggle of commuter groups a carrier wished to lock–up. In the mid–1980s this became the strategy of choice in North America.

This strategy did, however, produce some unwanted consequences for the trunk airlines. First, the cost of the feed — when one counted variable and now capital expense of ownership — rose significantly.

Second, organised labour was not keen, to say the least. The jet airline unions were upset that that flying/mechanical work was being outsourced to regionals, while the regional airline unions eventually got tired of flying short hops in bad weather for much less pay than their jet comrades. Thus airline managements faced a squeeze from either side — from jet unions pushing for compensation for work they gave up without agreement to the regionals, and from the regional unions pushing for equality of wage with the jet parent workers.

Why, one might ask, have the Majors put up with these cost and labour problems and tolerated increasingly expensive solutions to their grassroots network feed requirements?

The simple answer is that the aviation cycle often disguises the problems of costly commuter feed. In an upturn, jet airlines increasingly compete for market share — and thus want as much feed as possible — while in a downturn lay–offs and the like seem to have a quieting effect on labour unions.

But whether in upturn or downturn, the absolute cost of running the regional commuter affiliates rises gradually, but surely, to the point where the gap between major airlines and majority–owned commuter affiliate carriers shrinks beyond the level of even semi–effective returns. Then the issue becomes one of divestiture or outright closure/rationalisation of services back under one, now cheaper, organisational umbrella.

Usually the parent airline loses money on its original investment because if it closes the regional any shareholder value disappears, while if it tries to re–sell the commuter without the code–share and attendant linkups (FFP, CRS etc) this means that the newly independent commuter is worth a fraction of its previous value.

Inaction, however, is now not an option for airline managements because of two factors. First, aircraft technology has moved regional jets into the 35–70 seat range, previously the reserve of the turboprops. This has further blurred the lines between labour at trunk jet operations and the regional commuter airlines, and in addition these regional jets have forced a re–discussion on hub versus point–to–point network design.

Second, the last downturn forced many of the major airlines in North America to sell off pieces of their wholly–owned regional carriers, whether they wanted to or not.

A third strategy?

So, do airlines have an alternative to traditional commuter feeder networks or buying their own commuters? If an airline has its own majority–owned feeder the starting–point is what to do with this carrier. As it becomes cost–ineffective one possibility is for the feeder to be gradually wound down. This can be achieved by pushing larger routes up to the mainline jet network while creating a new “grassroots” feeder underneath the current regional by transferring smaller, thinner volume routes to a new lowest–cost (non–equity) partner.

However, the grassroots partner need not work exclusively for one jet airline. For example, at Mesa one operator provided feeder operations for many different partners based on geographically delineated territories.

Indeed, as the jet airline will be operating the larger feeder routes itself, the smaller, thinner routes may be dispersed and it would be unlikely that one feeder could serve them all.

Under this strategy, as routes are transferred up into the main jet operation or passed to a grassroots feeder, over time the cost–bloated mid–range commuter airline is reduced in size and can either be spun–off or collapsed with minimal damage to the major airline brand.

Three evolving strategies

The US experience has shown that it takes about two deregulated cycles (about 10–15 years) for feeder network competitiveness to start becoming critical, with three evolving strategies for commuter feed management:

1) A brand–franchise premised, non–equity–based management of constantly evolving groups of operators that are contractually managed to optimise feed revenue to the trunk airline.

2) A constant building and rebuilding of a trunk airline’s own majority–owned commuter network and airline partners.

3) A development of self–standing non–major airline affiliated commuters, premised on point–to–point non–network linked route systems.

This third strategy, however, may be a leap too far for many airlines. Recent difficulties at Mesa, as well as a very slow evolution of a self–standing commuter/regional group, may indicate that the first two strategies will remain the most frequently used options at the major jet airlines.

This may be a missed opportunity, as the third strategy has plenty of potential for a new kind of relationship between trunk airline and commuter feed carrier.