Low-Fare Carriers Bear Brunt Of New Security Surcharge

Low-Fare Carriers Bear Brunt Of New Security Surcharge

A new surcharge on passengers to cover the costs of just-passed aviation security legislation will hit low-fare carriers harder than major airlines, according to industry sources. “Percentage wise, it hurts low fare carriers a little more,” said one observer. “If you look at fixed charges, [they tend] to hurt carriers with low fares.”

An increase in airline ticket prices is sure to weaken demand for an industry already reeling from a sharp drop-off in both leisure and business travel. And if demand shrinks, carriers may very well shift capacity.

Referring to the new fee, the industry source said the “added tax will reduce demand across the board in any event.” People say they are willing to pay more for security, but that may not be the case. A $5 fee hardly seems a make- or-break proposition, but companies may have a specified travel budget that cannot be exceeded.

While low-fare carriers will take a hit from the new surcharge, Congress structured the fee to minimize the damage. Low-fare carriers such as Southwest Airlines [LUV] pushed for a fee system based on enplanements rather than one-way trips, and Congress agreed. In essence, passengers of major hub-and-spoke airlines will pay more in fees than passengers of low-fare airlines that do not have a lot of connecting traffic. Under the legislation, it appears that most of Southwest’s customers will pay an additional $2.50 each way compared to a fee of about $5 per person based on a one-way trip formula, according to a source close to the company.

A fee on one-way passengers would have had a significant impact on Southwest. Alaska Airlines [ALK] argued that a fee should be imposed on the basis of enplanements. Because Congress agreed with this thinking, Southwest does not see a substantial change in its business operations.

While the legislation was being debated, Southwest emphasized that fees have the potential to alter the aviation marketplace. The carrier was quite aware that a so-called segment tax imposed on the airline industry a few years ago did indeed influence route structures. Southwest is operating more long-haul flights since that tax was imposed. A similar impact could have occurred if the new airline security fee had been based on one-way passengers.

According to the source, if a fee had been imposed on one-way trips, a smaller universe of passengers would have been taxed, yet the government would want to raise the same amount of money.

Michael Linenberg, an analyst at Merrill Lynch, said the new surcharge could force some low-fare carriers to consider “longer haul and revenue richer markets.”

On Nov. 27, Linenberg also said that things are looking up for low-fare carriers. He pointed out that after Sept. 11, the major carriers have all but abandoned their low-cost, low-fare subsidiaries – United Shuttle and MetroJet have been eliminated and Delta Express has been halved. While the majors have reduced capacity and have cut back or eliminated their low-fare brands, both leisure and business passengers have become more price sensitive.

In fact, Linenberg notes that business travelers look more like leisure passengers today as they tend to book discounted tickets. For these reasons, he thinks network carriers’ ability to command a revenue premium is diminished at least in the foreseeable future due to cutbacks in corporate travel and lower levels of disposable income.

This environment, he says, provides opportunities for low-cost, low-fare airlines to not only remain profitable but also capture market share. In fact, even if Southwest does not grow at all but merely maintains current capacity levels, it will likely gain share as other carriers cut capacity.

The most notable change in the Phoenix-Los Angeles market since Sept. 11 is the withdrawal of service by American Airlines [AMR] and United Airlines [UAL]. However, United’s Shuttle service has been replaced by SkyWest regional jet service. Not only does SkyWest provide a more cost-effective way of serving the market, but also the smaller-gauge regional jet allows United to offer more frequency and better match seat supply with demand, Linenberg noted.

More importantly, he said that United’s use of a regional jet in the market could be an indication that United has no interest in competing with America West [AWA] and Southwest in carrying low-yield, leisure traffic (local and/or connecting). Instead, he said that United’s aim is to capture high-yield, local traffic (premium frequent flyers and corporate travelers) and passengers (first class and higher-yielding coach) connecting to its vast network served from Los Angeles, Asia, Australia, Europe, Latin America, etc. These passenger segments tend to be higher margin for United. >TK United Airlines [UAL]: Delta Air Lines [DAL]: US Airways [U]:

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