Wednesday, December 18, 2019

Austin to San Jose: Why This Nerd(bird) Just Might Work Out

Disclosure: As you will find my on ethics and disclosures page, my employment contract with Southwest Airlines does not allow me to directly analyze Southwest Airlines. I can point out public factual information, but analyzing their expected financial impact and performance by American's announcement is not currently permitted. It is clear Southwest will be impacted, any new competition would have some impact, but you will not find an analysis of this impact due to the aforementioned agreement. Now, on to the post. 

The classic nerd bird route between Austin and San Jose has recently become a hot market again. The route has historically operated as one carrier market. Now, three carriers are fighting to take this nerd to the prom. Normally, the pessimist in me would normally believe this much competition could ultimately backfire, but this route feels different. This feels like a market that might, just maybe, able to support all three carriers at the current capacity levels.

It is hard to believe, but Austin to San Jose is one of the few non-hub, point-to-point markets that has been operating near continuously since 1992. Since 1992, there has been only one time the route did not have service. This gap in service lasted all of eight days in 2009 when American discontinued the market and Alaska Air had not started their service yet. In 2010, Southwest jumped into the mix and Alaska jumped out in 2011 then back in 2017. Now, American has decided it wants back in.

Frontier had also operated the route for a very short time with less than daily service. Since I cannot begin to figure out what Frontier is doing yesterday, let alone today, we are largely going to ignore them in this piece. 

American has long had a love-hate relationship with San Jose. In the early 1990s, San Jose had an impressive American offering. The network focused mostly on the west coast, American hubs, and Toyko service.

By the time Austin was added to American's San Jose portfolio in late 1992, American was already pulling its network investment back. In the summer of 1993, American cut their departures from 60+ daily flights to 17 destinations down to 27 daily flights to seven destinations. The exact reason American had such a dramatic decline in service is not entirely clear, however, spiking fuel costs from the Gulf War plus the lagging US economy following the 1991 recession could have easily caused the focus city to be cut.

It did not take long for San Jose to see another large American presence in the market. Following American's purchase of Reno Air in the late 1990s, the San Jose market became another large focus on the American network. But even after the purchase, San Jose saw a slow, steady, death by a thousand cut approach. By 2006, San Jose was served just to American hubs (LAX, ORD, and DFW) and three non-hub airports (AUS, SAN, and SNA). Finally, American pulled all of the non-hub flying out of SJC in 2009.

While 2009 was not a banner year for any carrier, it was particularly tough for American as a whole. As other carriers entered liquidation or entered bankruptcy around this period, American staved off bankruptcy even with their $1B operating loss.

Since 2004, American was in continuous state cutting under-performing flights off their network. Between 2004 and 2009, American reduced their overall size by 15% of their ASMs. 8pts of the 15% reduction was reduced between 2008 and 2009 during the Great Recession. Nearly all of these reductions were focused on their domestic network.

It should come as no surprise that, if a domestic route turned negative in performance, American was quick to react. During 2009, what little remained of the American SJC non-hub flying turned negative. While SNA appears to be inline with system performance, SAN and AUS under-performed system unit revenue results by over 10%.

This was not always the case. Before the recession, American's Austin to San Jose appeared to be performing quite well, producing a healthy double-digit RASM premiums American's system averages until the recession hit. However, things took a dramatic turn in 2007 as the housing crisis spread across California.

After American dropped their Austin to San Jose service, Alaska picked up the route within eight days. Alaska started the AUS-SJC service in September 2009 and operated it without competition until November 2010 when Southwest launched its own service.

In the first year of operation, Alaska appears to have performed just slightly below its system revenue expectations. This is not uncommon has it often takes a few years for a route to fully mature. However, when we dig deeper into their revenue performance, there were clear areas of weakness.

The route started off extremely soft in 3Q2009, however, as the route aged, it began to pick up some steam. A vast majority of the quality market performance came during 2Q2011 and 3Q2011 performance. Once Southwest entered the market in the latter part of 4Q2011, Alaska's revenue performance tanked (down 15-20% year-over-year) until Alaska exited the market in 2011.

As previously discussed and can be found on my ethics page, I am unable to evaluate Southwest Airlines' network performance. 

A lot has changed for Alaska in San Jose since they originally launched the market in 2009. Alaska has invested nearly four times the flights and six times the ASMs than were deployed when Alaska originally entered the AUS-SJC market.

This investment has generated a significant amount of local customer loyalty within the SJC market. Year-ending 2Q2019, Alaska is up 400% in SJC originating traffic compared to 2009.

Alaska is not necessarily unique to the San Jose growth. The entire point-of-origin San Jose market has grown significantly since 2009. In fact, San Jose is 69% larger than what it was in 2009. Nearly every carrier has experienced some level of growth. However, Alaska and Southwest are clear gainers in the market.

This leads me to why I believe Austin to San Jose can support all three carriers at the announced capacity levels. First, let's take a look at Alaska's performance in the market since they restarted the market. Since Alaska has restarted the market, its performance appears to be inline to slightly above their system-level RASM performance.

So what had changed within the Austin to San Jose market? Well, the economic foundation in each of the cities is completely different. In the last ten years, the entire GDP for the Bay Area and Austin has nearly doubled in size. This economic growth puts natural upward demand pressure in market from both Austin and the Bay Area.

This is reflected in the Austin to the Bay Area traffic demands as well. The entire market (Austin to all of the Bay) as nearly doubled in nice from 600 PDEWs to 1,200 PDEWs. Interestingly, most of the growth has been to San Francisco, not San Jose. San Francisco is up nearly 400 PDEWs (144%) vs San Jose at 175 PDEWs (84%).

This is exactly why I foresee the ability of all three carriers to be (marginally) profitable and sustainable within the Austin to San Jose market. The entire Bay Area to Austin market has grown unevenly and the new service to San Jose will add increase competitive pressure to not only SJC, but also SFO and OAK. With only minor stimulation and share shift from SFO to SJC, each of the carriers could have plenty of demand between all three to serve the market (marginally) profitability. Let’s not kid ourselves, this much capacity across this many carriers it would be unlikely the route would bankroll any carrier’s P&L, but they should be able to make it work.

United service between Austin and San Francisco, however, might take a hit. With their hub in the Bay, they could shift their revenue management strategies to take flow passengers if they are struggling within the local market.

Finally, I do not believe any carrier, regardless of their profitability, can exit Austin to the Bay Area. Why? Alaska's last non-hub focus city in California is SJC. I appear to be incorrect on Alaska refocusing on San Diego. With Alaska's retrenching back to San Jose, any additional flight reductions within the market will only decrease their SJC relevancy. Alaska currently services 12 of SJC's largest 20 markets, but they are already missing major markets (LAS, PHX, DEN). Reducing a 200 point-of-origin PDEW market only increases their marginalization within the city. If they were to reduce a top 20 market, it could start to question their relevancy in the city, as well as their entire California, non-hub strategy.

For Southwest, (again see disclosure), they are the largest carrier in both Austin and San Jose by far. The probability of the largest carrier In both sides of a market being driven out of the market seems remote. If any carrier were to weather competitive pressure best it would be Southwest.

This leaves American. With American launching this new service, they clearly believe the benefits far outweigh the risks associated with this market. I have little doubt that American can make this market work in the longer term. With economic growth in both San Jose and Austin, any short term market weakness will likely be grown into as the economies on both sides of the market continue to grow.

Ultimately, this market is going to be a wait and see. But do not color me shocked if as we near 2021 if all three careers are still operating in the market. Heck, I also would not be too shocked if we see one other carrier tries "focusing" their Austin service to San Jose as well. If that were to happen, the market dynamics in Austin to San Jose could be completely up in the air.

Thank you all for a great 4Q launch. I continue to be impressed by the growing audience. With the upcoming holiday season, I am taking the next couple of weeks off (unless some carrier does something truly crazy) to spend time with family and friends. To all the crews and support staff operating at the airports this season. Thank you. You guys do far more than many of your passengers will ever realize. 

To the back office professionals, thank you for coming by and reading the blog. I have received quite a bit of positive feedback from my professional network. If you guys have ideas for future posts, please feel free to send them my way: 

Everyone, have a great (and safe) holiday season and I'll see everyone again January 8, 2020. 

No comments:

Post a Comment