Is JetBlue's Flight Plan Flawed?

Miscalculations, cutthroat competition. CEO David Neeleman faces tough challenges to keep the airline on the ascent

David G. Neeleman is nothing if not confident. And it shows even on this bitterly cold day at Boston's Logan International Airport, even though he has been up since 3:30 a.m., even though he has $100,000 riding on the day's events -- and even though the head of the airport authority mispronounces his name not once, but twice. (It's Neel-uh-man.) None of that diminishes his enthusiasm. What matters to this 44-year-old entrepreneur, who competitors concede has one of the most creative minds in the business, is that JetBlue Airways Corp. (JBLU ) is starting service in its 22nd city with its biggest launch ever: 11 flights to 5 destinations within a month.

As the airline's visionary founder, Neeleman is happiest preaching the gospel of JetBlue. After all, this wildly profitable, fast-growing New York-based startup may have forever changed what's expected of a low-fare airline. In a slickly choreographed show, complete with a Boston fife-and-drum corps, Massachusetts Governor Mitt Romney, and a private production company to provide TV and radio feeds to nearly 30 stations around the country, Neeleman shows off what every passenger can expect from JetBlue: a friendly cabin crew, roomy overhead bins, live satellite TV at every leather seat, and soon, 100 channels of satellite radio and pay-per-view movies. It's all part of what Neeleman calls "bringing humanity back to air travel." Which is how he built a bona fide brand at a time when most consumers have about as much regard for their air carriers as they do for their phone companies.

Neeleman still has a lot more he wants to prove, though. He intends to spend some $7 billion to more than quintuple JetBlue's fleet by 2011, to 290 planes, which would make it bigger than US Airways Group Inc. (UAIR ) is now. Starting next year, he'll wield a new 100-seat jet to attack smaller markets that previously seemed safe from the discount onslaught. In short, Neeleman has dramatically upped the stakes in the airline wars. The reaction has been fierce, driving down JetBlue's operating margin and its stock price. There may be worse to come. After slashing costs and building up cash, wounded carriers such as American Airlines Inc. (AMR ) and Continental Airlines Inc. (CAL ) are now in better shape than they've been in years to defend themselves from JetBlue and other fast-growing low-cost interlopers. In late January, Delta Air Lines Inc. (DAL ) announced it would add eight new destinations from New York's John F. Kennedy International Airport, JetBlue's home base. And Delta and United Airlines Inc. have started their own discount airlines, Song and Ted, respectively.

At the same time, many of the discounters are increasingly likely to find themselves competing against one another as they try to expand their presence nationally. Even Southwest Airlines Inc., (LUV ) Neeleman's onetime employer and notoriously no-frills rival, is considering offering satellite-TV service and buying smaller planes, just like JetBlue. "JetBlue has effectively painted a fairly large target on its back," warns one competitor. Or as Jamie Baker of J.P. Morgan Chase & Co. (JPM ) puts it: "The industry is gunning for JetBlue."

How Neeleman handles these fresh pressures will determine which of two scenarios plays out: On the one hand, the counterattack from rivals could blunt JetBlue's ambitions or Neeleman and his team could fumble their growth plan. That would leave JetBlue a niche player under constant assault. "They have chosen a fast-growth approach," says Michael S. Allen, chief operating officer of Back Aviation Solutions. "It's going to require some good execution."

The happier outcome would have JetBlue and other low-cost carriers, which now account for 22% of the U.S. market, push the legacy carriers aside and go on to dominate air travel. James D. Parker, of Raymond James & Associates Inc., believes that's the more likely conclusion. The discounters could nearly double their market share in the next five years, he says, leaving the big names to focus on international and long-haul travel. "The major airlines' initial reaction is to increase capacity, reduce fares, and defend themselves. But it can't last, because they don't have the low costs to match those low fares."

X-MAN. In the center of the storm, seemingly unperturbed, sits Neeleman. He is a successful entrepreneur with an unshakable belief in his own abilities. "I think there are a lot of people who would love to be in my shoes," he says. That lack of humility, though, concerns even his backers. "The only thing I'm worried about [at JetBlue] is overconfidence," says Darryl Jenkins, visiting professor at Embry-Riddle Aeronautical University. "I'm glad they've had these hits." Neeleman is also a practiced, some say calculating, salesman who once told his wife, Vicki, that he has "X" -- the ability to see how things work, a skill that would let him "make money from doughnut holes." And he is a devout Mormon and father of nine who regularly invites acquaintances to his New Canaan (Conn.) home for big Sunday dinners to discuss faith and the Scriptures. JetBlue executives who have worked for the charismatic Richard Branson of Virgin Atlantic Airways joke that Neeleman is just like their old boss, except without the "blondes and champagne."

Neeleman is also an easily bored, often distracted leader who (correctly) diagnosed himself with attention deficit disorder. "He is not the guy to run a day-to-day business," says Mark C. Hill, vice-president for strategic planning at WestJet Airlines Inc., the Canadian discounter that Neeleman helped build in the 1990s. Although he has a group of seasoned airline executives who handle operations, his most important partner, President and Chief Operating Officer Dave Barger, has yet to negotiate a new long-term contract. Instead, since December he has been working under an agreement that automatically extends from year to year, unless the board otherwise notifies him. Barger, who has been wooed in the past by JetBlue rivals, insists he would sign a long-term deal tomorrow but has simply been too busy to work out the details with the board. Likewise, Neeleman and some board members say they're not worried that Barger is going anywhere anytime soon. If he were to leave during this critical period, though, Neeleman would be in a precarious position. He is a CEO who needs a strong No. 2.

None of these challenges are hypothetical for JetBlue. They already have affected the financial health of an airline that until this year usually exceeded its predictions. Because of competitive pressure and its own heady growth, JetBlue's fourth-quarter operating margin fell 3.5 points, to 13.3%. In one of the gloomiest forecasts on Wall Street, J.P. Morgan's Baker figures that JetBlue's profit this year will fall nearly 7%, to about $86 million, as rivals add flights and slash fares in JetBlue's markets. Revenues are expected to grow nearly 30%, to $1.29 billion. The uncertainties have pushed JetBlue's stratospheric stock price down 52% since October. Neeleman, who holds 7.3 million shares, worth $166.4 million, claims to be relieved by the slide. When every "stubbing of the toe is monumental, that's not nearly as much fun," he says.

But the kind of company Neeleman is used to running is one like Morris Air, where he was president for eight years. It had 22 planes. With Neeleman's big airline ambitions come big airline problems. JetBlue's Airbus jets will eventually require expensive maintenance that won't be covered by warranties, and some rivals argue that JetBlue is grossly underestimating those increases. Neeleman devotes considerable energy to keeping his employees happy, but the longer they stay, the more he'll have to pay them. And if JetBlue's stock price stalls for a long period, Neeleman might have a tougher time persuading his workers not to unionize and to accept stock options and profit-sharing rather than big raises.

At the same time, next year JetBlue will introduce a second type of aircraft, the smaller, 100-seat Embraer 190. While this will add cost and complexity to the airline's operation, it is essential to JetBlue's expansion plans. The airline is buying at least 100 of the planes over the next seven years; Neeleman won't reveal how much they will cost, but as the first customer he's undoubtedly paying less than the $3 billion list price. These regional jets could allow JetBlue to fly such routes as Boston to Buffalo or New York to Charlotte. And it could enable JetBlue to go after bigger, more competitive markets, such as Chicago and Dallas, with less risk. But one rival says it takes "heroic assumptions" about stimulating passenger traffic in smaller cities to justify the planes' cost.

STAYING POWER. Managing expansion, as any airline veteran will tell you, has bedeviled many an upstart. It took Southwest 27 years to grow to 280 aircraft. With its top-ranked performance for on-time flights with few lost bags, JetBlue doesn't show signs of operational stress yet, but some worry that could change as the airline gets bigger. "I'm not as concerned about the cost structure as I am about the risks from the growth strategy," says credit analyst Betsy R. Snyder of Standard & Poor's (MHP ).

Neeleman admits that it was his miscalculation that led to JetBlue's ill-fated foray into Atlanta. Delta's fares to Los Angeles were so high that about half of the passengers chose to suffer layovers to get a reasonably priced ticket. And Neeleman figured that low-cost rival AirTran Airways (AAI ), which also has a hub in Atlanta, wouldn't have a plane capable of making the long trip for at least a year.

He figured wrong. AirTran quickly leased planes and crews to fly the route. Then Delta increased the number of flights by 50% and slashed fares. When Neeleman couldn't make enough money on the route, he pulled out after seven months. Some rivals and analysts read an ominous message into the airline's re- treat. "It seems pretty evident that JetBlue's growth prospects have dimmed considerably," says one competitor. "Delta figured out the formula to prevent JetBlue from flying to a hub," he says, a move likely to be repeated in other big markets JetBlue is eyeing, such as Chicago, Dallas, and Denver.

But for all this, nobody is predicting that JetBlue will be the next People Express Airlines Inc, the discounter that flamed out in the early 1980s. Far from it. To start with, JetBlue has a strong balance sheet: $571 million in cash at yearend and one of the lowest debt-to-capital ratios in the industry. And though the airline's margins could keep falling in the next few years, they are likely to be better than most anyone else's. More important, lower margins shouldn't stall the company's growth plans. "If a low double-digit margin is the worst we can expect, even in the face of intense competitive pressure, JetBlue definitely has staying power," says Gary L. Chase of Lehman Brothers Inc. (LEH ).

As for those growth plans, most industry insiders believe there is no shortage of new markets that JetBlue could go after with its regional jets. "There are plenty of opportunities out there for JetBlue and JetBlue look-alikes," says Mo Garfinkle of GCW Consulting. Nor does everybody consider Atlanta a troubling precedent. Parker at Raymond James says it is "absurd" to believe that JetBlue can't grow in other airlines' hubs. As for execution, Neeleman's team has proven itself very capable so far. Then there is Neeleman himself. "Every time David has a problem, he gets right out in front of it," marvels Donald Burr, the founder of People Express. Adds WestJet's Hill: "Don't ever bet against David Neeleman."

IMPULSIVE ACTIONS. In the cutthroat, carefully calibrated airline industry, Neeleman seems an unlikely CEO. To the dismay of his public-relations team, he openly discusses his attention deficit disorder. At times, he is almost childishly impulsive. His executive assistant, Carol Archer, recalls being shocked the first time he stuck a fork into her dinner plate without asking. He has been known to touch an executive's shirt or a woman's leather skirt if they catch his interest. At Barger's insistence, he has stopped receiving alerts about flights that are even a minute late. "I really try to stay out of the operations," says Neeleman, "but sometimes I can't help myself."

Neeleman's shortcomings are offset by his creativity and infectious energy, traits that are also associated with ADD (which is why he refuses to take medication). It was Neeleman's idea to establish operations at underused JFK Airport in New York, thought to be a dud as a domestic hub because of its distance from Manhattan. He scooped up takeoff and landing slots at the limited Long Beach (Calif.) airport to create a popular alternative to crowded Los Angeles International. Likewise, colleagues say Neeleman was the driving force behind the Embraer deal.

Already Neeleman is planning new routes for the fall and has announced that JetBlue will introduce service out of New York's other main airport, LaGuardia. And if anybody doubted Neeleman's desire to lead JetBlue into a brave new world, they should talk to his wife. Neeleman has canceled the family meeting he promised her to discuss whether they might move back to Utah five years after starting JetBlue.

By Wendy Zellner in New York

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