What's Up With the Cheap Airfares and How Long Will They Last?

Phoenix to Houston for $68. Chicago to New York for $99. That's a lot of pressure on the airlines.

Photographer: Michael Nagle/Bloomberg

Travelers, rejoice. Bargain airfares on many routes have become the big story in the domestic airline industry, with the deals likely to continue well into 2016.

It's all due to a glut of new flights from ultra low-cost carriers such as Spirit and Frontier, as well as new flying by the major airlines and a long-planned expansion in Dallas by Southwest. Amid this capacity growth was a decision by the world’s largest airline, American, to defend market share by matching Spirit’s fares on competitive nonstop routes.

“In some of our markets we continue to see very low prices from all competitors,” Spirit Chief Executive Officer Ben Baldanza said Tuesday on a conference call with analysts. During the peak summer travel period, Spirit's average ticket price plummeted 21 percent, to just under $67. “We think that may continue, perhaps for longer than people expect,” he said.

These low fares are abetted by cheap jet fuel and offer some eye-popping round-trip deals not seen in ages, or, in some cases, ever: $68 from Phoenix to Houston; $79 from Los Angeles to Dallas and from Dallas to Orlando; $87 from Denver to Fort Lauderdale; $117 from Chicago to Los Angeles and Dallas; $97 from Dallas to New York; $99 from Chicago to New York; $126 from San Francisco to Chicago.

Most of these fares are the result of growth by Spirit and Frontier, which base their business models on cheap fares and the ancillary fees they charge for seat assignments, water, printing a boarding pass, and other services. Yet American has been a fervid price matcher on selective nonstop routes, in a bid not to cede passengers to the upstarts. 

American executives defend the price matching as critical because 87 percent of the airline’s customers fly the carrier only once a year and account for half of company revenue, President Scott Kirby said Friday in a call with analysts. Many of them were unhappy about the fare-matching and its effects on American's passenger revenue, which has declined even as the company posted a record $1.7 billion quarterly profit. Spirit earned $97 million in the third quarter.

“Given that 50 percent of our revenue is up for grabs in these markets and that these carriers have had so much success when they weren’t matched, we know that we have to match their fares,” Kirby said. More than a quarter of American’s domestic capacity overlaps with Spirit's, he said.

The fare bargains are causing a bit of an existential crisis among some who had turned bullish on the consolidated industry. Does the world’s largest airline need to join a race to the bottom to lure the most price-sensitive customers? United and Delta aren’t matching the cheap fares to the same degree.

And were Spirit executives foolish to think they could expand their flying 30 percent in 2015 without sparking a fierce backlash from rivals, at a time when cheap fuel is helping bolster American even more than others in the industry? American doesn't hedge its fuel needs, meaning it hasn't paid above-market prices this year or last, unlike its three largest rivals. That financial benefit has soared into the millions.

Florida-based Spirit is now “our No. 2 competitor” at Dallas-Fort Worth International Airport, with 25 nonstop routes—more flights than Delta or United, Kirby said. “In those 25 routes in Dallas that Spirit flies, they have 20 percent market share, huge market share,” he said. In Chicago, where American has a hub, Spirit has 60 daily flights to 24 cities. 

As a result of Spirit’s low fares, American plans a new, no-frills fare in 2016, much as Delta devised “Basic Economy” as a way to match Spirit in competitive nonstop markets. American declined to discuss specifics of the new economy fare.

More broadly, the bare-bones fare innovations at Delta and American are the latest permutation in legacy airlines' decades-long effort to combat the rise of low-cost rivals. In the early 2000s, after the vaunted “Southwest effect” had begun lowering fares in major markets, legacy carriers turned to an “airline-within-an-airline” model, with a goal of flying a lower-cost airline alongside their mainline operations. In 2003, Delta started Song and United followed not long after with Ted. Both flew only briefly.

The big change now: Airlines are producing solid profits thanks to cheap energy. The real issue today is whether the industry's behemoths can match the low fares and keep the upstarts at bay, without, as one analyst put it, blowing themselves up in the process.

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