Continental: In For The Short Haul

A poster in his Houston office vividly depicts Sam Coats's awesome challenge. One panel reads: "The airline industry circa 1993" above

a drawing of a dinosaur. Next is a glowing picture of an overflowing treasure chest, with the caption: "The mission of CALite," the wry internal nickname for Continental Airlines Inc.'s new low-fare, short-distance service. Achieving the riches of the second image won't be easy. But Coats, one f the creators of the new service, is upbeat. "It's an operation that shows that a large airline can begin to remake itself," he says.

Just how much Continental is willing to change became apparent on Oct. 1, when CEO Robert R. Ferguson III introduced low-fare service on more than 50 short-haul routes in the eastern U.S. Modeled after the successful strategy of Southwest Airlines Co., the low-cost industry leader, CALite has undercut competitors' unrestricted fares by 50% to 80% (table). And while Continental's low-fare scheme is still in its infancy, representing just 5% of the Continental system, analysts reckon it could ultimately grow to 25%.

CALite is a key part of the rebirth of Continental, which emerged from its second bankruptcy in a little more than seven years on Apr. 27. The Houston-based airline is counting heavily on the potentially lucrative short-haul market to return to profitability. CALite is also supposed to infuse the rest of the company with more efficient operating methods, such as quicker turnarounds. "It's supposed to infect the whole bloody company," says Coats. And Continental is hoping that CALite will give its image a little lift on Wall Street. Before the end of the year, the carrier hopes to raise $150 million through an initial public offering. "These guys have taken a risk worth taking," says analyst Raymond E. Neidl of Furman Selz Inc.

Big rivals, already squeezed by profitable Southwest and a slew of upstarts, are watching CALite warily. If the service makes money, "then we have a real problem on our hands," says Donald J. Carty, executive vice-president of finance and planning at American Airlines Inc. Not to get caught flat-footed, United, Delta, and USAir are all studying proposals to create their own low-cost, short-haul operations to remain competitive.

CUTTING COSTS. Whatever the competition does, Continental has a healthy head start. After breaking union contracts during the combative reign of former Chairman Frank A. Lorenzo in the 1980s, the carrier now enjoys below-average wage rates and flexible work rules that enhance productivity. American, which agreed on Nov. 22 to binding arbitration to end a bitter strike with its flight attendants over wages and work rules, figures that Continental's unit labor costs--measured in terms of the number of seats available and distance flown--were nearly 40% lower than its own last year. On top of that, Continental has slashed its long-term debt to $1.7 billion from a burdensome $4 billion.

To build on such improvements, Ferguson, 44 and an eight-year Continental veteran, turned to Coats and other executives last April to devise a profitable short-haul service. What emerged was a low-fare program that closely tracks that of Southwest. Like Southwest, CALite focuses on providing frequent, direct flights between cities, instead of forcing passengers to travel to a hub for connecting flights. Partly because of the hub-and-spoke system's inefficiencies, Continental's costs on short-haul flights had been running roughly 60% higher than Southwest's.

CALite intends to boost productivity by turning planes around at the gate in 20 minutes or less--compared with 50 at Continental's hubs. And it's using cut-rate "Peanuts Fares" to lure passengers who might otherwise have traveled by car or stayed at home. Continental is even imitating Southwest's promotions--no surprise, since the airline recruited former Southwest marketing executive Donald G. Valentine. He kicked off CALite with an "Add-a-Penny, Add-a-Pal" program--in which passengers can buy an extra ticket, with some restrictions, for only a cent--a knockoff of Southwest's "Friends Fly Free" campaign.

Despite the copycat strategy, Continental has been careful not to go head-to-head with Southwest on its selected routes. Instead, analysts point out that Continental's biggest short-haul competitor is struggling USAir Inc., one of the highest-cost carriers in the industry.

So far, Continental executives say CALite is running at 60% of capacity--well ahead of projections--though they concede that the service is not yet profitable. Daniel Garton, the airline's chief financial officer, says the service should be in the black in six months. Overall, the line has lost $12 million on revenues of $2.5 billion since emerging from bankruptcy. Many analysts expect the carrier to post a loss for the year and to at least break even in 1994.

Still, it's one thing to mimic Southwest, but quite another to show its consistently stellar results. Some rivals and analysts question whether CALite can lure enough customers on such routes as Greensboro, N.C., to Cleveland to sustain frequent, Southwest-style service. And then there's the competition. USAir and American have matched Continental's low fares on selected flights, though they've restricted the number of seats available at those prices.

But the nagging question is whether Continental can truly duplicate Southwest's strategy. Unlike Southwest, Continental has no intention of abandoning its long-haul and international travel or the amenities that go with it, such as first-class service, hot meals, and advance seat assignments, all the things that Southwest does without. And some fear the effort to be all things to all passengers will only muddle Continental's efforts to burnish its image, especially with business passengers. Years of bankruptcy and periods of shoddy service have driven away many longer-haul business passengers, who typically pay higher fares.

But after 21/2 years of struggling in bankruptcy court, Continental figures it must take some risks to restore itself to health. And with the megacarriers frantically searching for solutions to their cost problems and facing long battles with recalcitrant unions, there may never be a better time to try to fly in a Southwest direction.

      Continental has sharply reduced fares on over 50 routes. Here's how they 
      compare on selected flights:
                               Average route     CALite
                                market fare*     Peanuts Fare 
      CLEVELAND-BUFFALO           $121              $59
      GREENSBORO, N.C.-TAMPA       162               99
      FORT LAUDERDALE              160               49
      ATLANTA-CHARLESTON, S.C.     152               99
      PROVIDENCE-NEWARK, N.J.      108               59
      *One-way 1992 fourth-quarter fare, including nonstop and connecting flights
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