During this financial reporting season, analysts have been worried about how regionals will fare with all the cutbacks and how vulnerable they are to having contracts cancelled or, in the long-term, not renewed. They were also interested in the rapid expansion on the international market and whether airlines went overboard, creating destructive pressure on yields at a time when they were banking on strong international traffic to shore up domestic declines.
For their part, airline executives had few answers, except to reiterate the crushing impact of fuel and how challenging their jobs are. They also recounted all the initiatives developed to cope, not the least of which is to pour on fees and chase liquidity, all in an effort to convince analysts they have what it takes to weather the current hurricane. Analysts have been impressed, especially with Delta, given its impending merger with Northwest. Still they classify airlines as a risky buy.
Airline execs agreed that a lot more capacity needs to be cut from schedules and concurred about the over-expansion internationally and warned of cutbacks there. In fact, New York University Law School Distinguished Research Scholar and Senior Lecturer Michael Levine indicated that the cuts already announced are a small fraction of the cuts that will be required to produce a "profitable new equilibrium if oil prices stay high."
Most mainline CEOs indicated that the regionals could expect a different world when contracts come due. Mainlines are clearly reducing utilization in an effort to reduce regional capacity since they are stuck in contracts that are already at minima. All have said they are working with regional partners to further reduce capacity. While airlines all say that the relationships between majors are regionals are true partnerships and thus give and take is necessary to continue successful relationships, there is no question that pressure on regionals is being brought to bear.

Regional Programs Lose Money
The only thing that is certain is that, with oil at current levels – $100+ per barrel – service is unsustainable, regardless of whether it is a mainline or regional carrier. Things would change significantly, however, if oil were to drop below $100. While it has been trending downward, few expect that to happen any time soon, especially with last week’s pronouncement that oil will reach $150 per gallon which prompted another per-barrel hike.
From raw data – regional carrier costs and expenses in major carrier 10-Qs – we know that many regional connection programs – American Eagle, United Express, Northwest Airlink and US Airways Express – are losing big money and have been consistently unprofitable even before the run up in fuel. Related Story AMR announced last November it was trying to sell American Eagle but tabled its plans last month citing market conditions. Only Delta Connection and Continental Express posted enough revenues to overcome expenses and did so by a wide margin, prompting one to ask why those that are losing money are not trying to figure out what they are doing wrong and what Continental and Delta are doing right. Related Story
At a time when carriers are looking at every area to reduce losses, it begs the question as to how these statistics will impact mainline decisions next year, but, far more importantly, in the coming years, as contracts expire.
For now we know that losing money can’t be good. It will catch the attention like a wound pulsing red and raw with inflammation. Certainly airlines are looking at regional costs which have been added to the Air Transport Association’s list of major cost items in its quarterly cost analysis. The latest report showed what it termed “transport-related expenses,” otherwise known as capacity purchase costs, rose 14 percent in the first quarter. During Q307 it rose 13.7 percent and, in the fourth quarter, 13.3 percent. While those are year-over-year increases, it has to be troubling for mainline carriers, especially in view of the fact that capacity purchase costs were the third largest major-carrier expense behind fuel and labor.
Mainline execs have all also indicated that save for dramatic actions from Delta against Freedom and Pinnacle, mainline airlines are relying on reduced utilization for contracts that do not expire for the next two to four years. While, Delta may protest that the actions were a matter of performance, especially given the year-old threat that regionals had to shape up or ship out made before the major carrier emerged from bankruptcy, most believe otherwise. Indeed, the actions against Pinnacle and Freedom are seen as little more than an excuse in the face of the Delta/Northwest merger. The two mainline executives hinted broadly about the impact of that merger on regionals pointing to all the costs that can still be rung out of the combined Connection/Airlink systems.

It is clear that regionals are reaping the benefits of the post 9/11 restructuring. They were no fools in cutting current contracts during that desperate time. Still, current events should give regional execs great pause.
Of course, raw data on regional program revenues and expenses does not tell the entire story. What is missing is the upstream revenue majors earn from connecting passengers, which is the entire reason for regional/major relationships in the first place. What is clear is the fact that approximately 70 percent of regional traffic connects at a hub even as about 95 percent are carried on regional/major partnerships. It is also clear that the days of mainline carriers subsidizing the cost of providing regional service, are long gone, especially given recent fare increases. Even so, Tripplertravel.com estimates that most regional passengers do not pay the full price of service and, luckily for regionals, few remember the days at the dawn of code sharing when a flight on a regional carrier to the hub could be had for $10.

Still, there are more questions with few satisfactory answers:
How many 50 seaters are coming out of the system and over what period?
Embraer suggests that the system is too dependent on the small jets to jettison them en masse. Even so, Delta has already announced the elimination of the equivalent of 100 RJs over the next year and others are following.
With the fall cutbacks, OAGback, using data available on July 7, identified 36 points that had air service in the fourth quarter of 2007 but are losing all air service by the end of the year. To be fair, many of these are Essential Air Service points, caught in the Air Midwest and Big Sky shutdowns, and, thus, may regain service as the new EAS awards are made. However, calls for reforming the troubled program will take on a new urgency as the impact of capacity cuts are revealed later this year.
Regionals account for 96.9 percent of all departures at the 36 points. Regionals will lose nearly 54 percent of departures being pulled from the system, according to OAGback. Regional share of the total decline in seats is only 15.5 percent, however, or 2.6 million. OAGback, which is issuing its analysis of capacity cuts and its impact on global aviation August 4, also looked at the number of communities with a single carrier to a single hub and concluded that 150 more are at risk.

Will they be parked or brought in and out of utilization in an effort to cover costs until they are sold?
Horizon, at least, is retiring two CRJ 700s and intends to operate the remaining seven until a sale is completed. Its long-term goal is to shed its Dash 8s and RJs in favor of growing its fleet of Q400 turboprops. Delta is retaining Pinnacle’s CRJ 900s, and, for now, the seven remaining on order destined for Pinnacle. Delta has another eight on order as well. What is clear is that airlines are targeting frequency to reduce costs. With Continental’s program being profitable there is less pressure but it remains vulnerable since almost its entire Express program relies on 50 seaters owing to its scope clauses.

Will the age of the turboprop return?
Bombardier and ATR have been crowing about the revival of turboprops for three years, but there has been no head-long rush to t-props. While sales have been brisk in the international arena, the vast majority of ATRs are heading for developing nations. ATR announced that it is studying its next aircraft offering beyond its -600 series. For now, it looks as if majors will retain larger jets, although Frontier and Alaska have opted for the Q400. Northwest is replacing its aging DC 9 fleet with larger RJs. Meanwhile, Continental’s scope has restricted it to 50-seat RJs but it, too, has tipped its hand at larger aircraft with its commitment to the Q400 through Pinnacle and Colgan as a way around scope.
Bloomberg reported last month that that 80 percent hike in fuel has resulted in a total grounding of 433 jets and reductions in force of 22,000. The Air Transport Association says the industry will likely lose a record $13 billion.
For now, the answer lies not only with fuel, but whether or not further scope relief can be obtained during this crisis. Most have a hard time believing that scope relief will happen in this storm.

The waters are sufficiently muddy that it will be at least three years before Embraer tips its hand on its next commercial aircraft, and, like Boeing and Airbus, awaits engine developments, judging by Farnborough announcements, albeit for big iron. Related Story
Bombardier, in the meantime, is betting the company on a new narrow-body replacement, the CSeries, and is hoping to break into the mainline market against Boeing and Airbus. However, if smaller planes equal higher seat mile costs, it will have an uphill battle, given mainline preference for 150+ seats. In its favor is the fact it will be available at least five years before any competitor comes to market from the big-two rivals.
Also targeting the majors is Embraer with its right-sizing and low-cost aging aircraft replacements arguments that have, at least for now, been bought by US Airways, Air Canada, Northwest and others around the world. Certainly all the action is happening at the mainline level rather than regionals. It seems as if the days when a Farnborough or Paris yielded large regional orders are long gone.
Like most questions the answer lies in the price of fuel as well as whether troubled carriers will be able to finance these new aircraft. So far, most of the Embraer/Bombardier, large aircraft firm sales were announced before the most dramatic fuel hikes and are only now in the process of delivery so it remains unclear as to what will happen in the future.

What will result from the current negotiations between regionals and majors?
There has long been pressure on regional cost-plus rates as regionals, in the past, posted profits to major-carrier losses. It is clear that current models – mainline or regional – do not work which will likely mean radical changes in the mainline/regional relationships. The Delta/Northwest merger is enough to make regionals sweat out the expiration of their contracts. Even so, Delta Connection revenues consistently overwhelm expenses by a good margin begging the age-old adage – if it ain’t broke, don’t fix it.
Even so, regional executives cannot be too confident given the changing landscape and expiring contracts which will come at a time when options might be a little clearer for their mainline partners who now understand that post-9/11 rates must be a thing of the past.

What impact will the announced cuts have on regional profits?
The impact will not be known until the end of the year, after third and fourth quarter cuts kick in. But it is likely the scope of profits will trend down for the foreseeable future and will be further impacted with the next round of contract negotiations.

What is happening to the discretionary income once used for travel?
In the northeast and many other parts of the country it has evaporated with rising fuel costs that go beyond the pump to the oil tank in the basement. Just as the airlines are reorganizing for survival, so too are their customers who also face rising food costs.
Farecompare.com suggests that those who live in a small city have experienced 50-70 percent increases in fares over last year, while for bigger cities or ones served by Southwest fares may be up only 10–15 percent.

Will carriers continue all their hubs?
Northwest and Delta have both said they are committing to retain their Memphis hub once the merger is completed but the changing dynamics of the industry could still put hubs at risk. If past is prologue, then the US Airways/America West merger holds lessons with the elimination of the Pittsburgh hub, although, with DL/NW two hubs are at risk in addition to Memphis – Cincinnati and Salt Lake. ATA figures show that by the fourth quarter of this year, Cincinnati will have 24 percent fewer flights than a year earlier. Cincinnati, would, of course, impact Comair the most and Salt Lake would deal an unprecedented blow to SkyWest, one of the best regionals in Delta’s stable.

What is not widely understood is the power for the regional airline industry on the Northwest/Delta merger. It is not insignificant, said one industry insider, that regionals failed to speak out about the impact of the merger on hubs or on community air service. Had they done so, the merger may not have happened, especially given Congressional worries about hub closures.

As hubs go, so goes community air service and the political support residing in these communities. Indeed, this industry insider indicated that the mainline carriers understand the political power of regional airlines because they know regionals serve the very people who have to get to their constituencies in small-community America. There is also the business traveler from medium-sized cities, defended so eloquently by regional execs during the last Regional Airline Association meeting that must get to financial and political markets such as New York and Washington. Related Story
What is so very interesting is how many flights start, connect and end on a regional airline with no mainline carriage at all. Regionals are carrying passengers over longer distances.

The Domino Effect
Consequently, the question remains; what will the industry look like during 2009? Whether 2009 gets dramatically worse or stabilizes depends on fuel. Are we going to get into a spiral where high fuel begets decreasing capacity and rising fares begets reduced demand? That seems to be what we are in now. Most have a hard time envisioning a world where ordinary people don’t travel. Even so, it will certainly change the frequency of kids getting to and from college and grandparents and distant grandchildren getting together.
Perhaps more important, is what air service will look like for passengers and what will it do to connectivity? We know that many airports will drop off the map. The Air Transport Association has said it will be 100, although it will not identify which ones. “Fifty-nine airports that had commercial service in 2007 don’t have any today,” ATA Spokesperson David Castelveter told the Wall Street Journal. “Another 38 have it, but won’t at some time in 2008.” The ATA also thinks as many as 200 more points could lose service next year.
The Regional Airline Association said more than 100 are at risk of losing service solely because of the Department of Transportation’s congestion pricing proposal to say nothing of capacity cuts. Ironically, as in past airline crises, the necessity for such maneuvers is expected to evaporate along with demand. Even so, RAA indicated as many as 450 other airports are at significant risk of losing air service because of congestion pricing.
We also know that people will drive as much as three or four hours for cheaper fares or to eliminate the cost of the air service that connects at the hub. Even with high pump prices it is cheaper to drive six to eight hours when the alternative is flying even on Southwest.

What impact will these changing passenger habits have on regional air service?
It is likely that passengers, facing high pump prices and high fares, will just not travel, something seemingly confirmed with the latest DOT statistics showing a deep decline in road travel since fuel spiked. And both reduced road and air traffic will mean reduced revenue for highway and aviation trust funds and less money to invest in infrastructure. This may prompt problems for both programs.

Opportunity Out of Chaos
Where there is strife, there is also opportunity. After all, while Pittsburgh suffered from the loss of US Airways, Southwest saw it as an opportunity to expand. Don’t count on regionals to tap into point-to-point service, though, since the last two such experiments – Independence Air and ExpressJet (XJT) ended in dismal failure. To be fair, XJT’s business plan was ruined by the uptick in oil and could have been successful, it said, given community response and the hassle factor of mainline connecting service.
What may happen is the acceleration of on-demand air taxi services at points once served by regionals, although few believe that the business model, even in good times, would have been successful. One insider said that under the current ground rules and economies of scale, Very Light Jets (VLJs) will just not work for today’s passengers who “are not ready to get on an aircraft with no lavatory and sit next to the pilot.” Ironically, that is exactly the type of airline offered at the dawn of the regional airline industry, including many who grew from a single route to, say, SkyWest Inc.
Even so, historically, there has always been a new aviation segment to replace those who are abandoning a lot of markets, just as the local service carriers and regionals did for the majors in pre- and post-deregulation America. While changes in the past decade, including the single level of safety raised the barrier too high for scheduled replacement services such as the regionals at the dawn of deregulation, the air taxi industry is hoping to reap the benefits this time around.
Migration of business travelers to business jets has been steadily increasing with the growing hassle factor of commercial air transport. Recently, the Travel Industry Association indicated that 41 million trips are not taken because of that hassle factor. Stanford Transportation Group (STG), a leading U.S.-based aviation consultancy, also completed an analysis that indicates that business aviation has grown from 16 percent of all premium business traveler trips to 41 percent.
The final question then becomes, whether or not that growth will be sustained in the current economy. The reason for the growth of business travel was the growing post-9/11 hassle factor, whereas the growth of the regional industry, which occurred at the same time, resulted from the rationalization of the mainline industry. Some say that hassle factor is decreasing and will drop more as capacity is taken out of the system and delays are not such a huge factor.
The bottom line is that the industry is facing a brave new world for which there are few answers and absolutely no guideposts.