Venture Capital
Start-Up Airlines in a Struggle to Survive
July 6, 2010, 2:46 am — Updated: 10:32 am

In the airline industry, the fittest do not always survive. But that has not stopped start-up carriers like Virgin America from trying.

Virgin, now nearly three years old, introduced service from San Francisco and Los Angeles to Toronto last week — its first international destination — and announced plans to fly to Mexico next winter. But its mixed efforts to expand into other markets in the United States illustrate many of the barriers that new airlines face, particularly as big competitors consolidate and expand their global reach, The New York Times’s Susan Stellin writes.

Industry experts offer a long list of challenges faced by start-up carriers, as well as discount airlines like Southwest and JetBlue. That list includes access to takeoff slots and gates at desirable airports, restrictions on foreign investment in American airlines, and rules preventing foreign carriers from flying within the United States — all hurdles that Virgin America has had to overcome.

And because the big legacy carriers benefit from global networks, government policies that favor them and the marketing advantages that come with size — particularly when negotiating contracts for lucrative corporate travel — industry analysts question whether smaller carriers will be able to stay in business.

“King Solomon couldn’t start a U.S. domestic airline these days,” said Hubert Horan, an aviation consultant. “No matter how well they’re run, it’s tough for any airline that’s small to survive.”
Mr. Horan, who has testified before Congress against the proposed merger of United and Continental airlines, said he sees the prospects for Virgin America, and to some degree even JetBlue and Southwest, as bleak.

“Here are these well-run efficient airlines — people like them, they have low costs — but they can’t get the badly run inefficient airlines to go away,” he said. “In a competitive market, the people with the better-run companies ought to drive the high-cost companies out of business, and that just doesn’t work in the airline industry.”

Last week, in a telephone conversation after the Virgin America plane touched down in Toronto, three of the airline’s principals — Richard Branson, the British founder of the Virgin Group who owns a stake in Virgin America; Don Carty, the chairman of the airline; and David Cush, its chief executive — had their own differences on the issue of competition.

Discussing the challenges ahead, all three men agreed that access to gates and slots at major airports like Chicago O’Hare and Newark Liberty, which Virgin America has so far been unsuccessful at negotiating, is central to the airline’s growth. Analysts have more pointedly said that this growth is necessary for Virgin America’s survival, after the company reported an operating loss of $22 million on revenue of $147 million in the first quarter.

Mr. Cush attributed the loss primarily to higher-than-expected fuel costs and a typically soft winter season. He reiterated his earlier statements that Virgin America would be profitable for the full year. (“I certainly will not retract that in front of Richard and Don right now,” he said jokingly. “We’re too good to fail.”)

Yet on the topic of consolidation, and the effect of mergers and alliances on the ability of smaller carriers to compete, some differences of opinion emerged.

“Will consolidation lead to less competition? My view is that it does not,” said Mr. Carty, who was previously the chairman of AMR Corporation, the parent company of American Airlines.
Mr. Branson, on the other hand, argued that not all consolidation is good, citing the alliance between British Airways and American Airlines, both competitors to Virgin Atlantic, as “one consolidation too many.”
“The alternative sometimes is letting some of these legacy carriers go bust,” he said. “And I think that would be good for competition.”

Therein lies the crux of the debate over whether the airline industry has a healthy amount of competition, or if government policies put small start-up airlines at a significant disadvantage.
As Mr. Horan summed it up, “Everyone is sitting there saying, ‘I want to survive, but I want everyone else to go away.’ ”

Severin Borenstein, a professor of public policy at the Haas School of Business at the University of California, Berkeley (and a member of the Transportation Department’s Future of Aviation Advisory Committee), said that even though low-cost carriers were far more efficient, big legacy airlines benefit from their size advantage in ways that go beyond airport access.

“They are protected by a structure that limits the ability of new entrants to get into markets and to expand,” Mr. Borenstein said, citing frequent flier programs — and the fact that miles earned for business travel are an untaxed employee benefit — as an example of a policy favoring big carriers.

“Frequent flier plans are massively popular,” he said. “And people don’t recognize that they’re reducing competition.”

Another often-cited barrier to competition are rules restricting foreign companies from operating airlines in the United States. Although the legality of Virgin America’s ownership structure, which had been challenged by competitors, was confirmed by the Transportation Department in January, few in the industry expect the restrictions to be lifted anytime soon.
Currently, foreign ownership in American airlines is limited to 25 percent of voting rights, and foreign carriers cannot carry passengers within the United States from, for example, New York to Los Angeles.

John Byerly, the deputy assistant secretary for transportation affairs at the State Department, said the second stage of the Open Skies agreement between the United States and the European Union that was signed in late June — an update on the 2007 agreement that allowed any European or American airline to fly between Europe and the United States — did not change the ownership rules. That would require legislative approval.

“The Europeans pressed us very hard to change our law on ownership and control,” Mr. Byerly said. “We said it’s not possible at this time. Our Congress is not able to endorse that. What we did agree to do on that issue is we’ll continue to discuss it.”

But it is an open question whether changing that policy would significantly affect the competitive landscape in the United States.

“Even if we did allow it, I don’t know if there really would be a long line of potential investors in U.S. carriers,” said Henry Harteveldt, an airline analyst with Forrester Research. “But if a foreign airline wants to invest in the bloodbath that is the U.S. airline industry, why should we stop them?”