When Southwest Airlines (LUV) moved into Delta’s (DAL) home base in the busiest airport on the planet everyone expected a seat war in Atlanta. But that’s not going to happen. Why? Because from their starting positions DAL has to put 4 times as many seats as LUV in the air to cover a single market share point. Delta has a 4 to 1 disadvantage. Four times more exposure to LUV’s low prices in a seat war will dig deeply into DAL’s cash.
On September 27, 2010 Southwest Airlines announced its acquisition of AirTran. A September 29, 2011 Bloomberg Businessweek article noted that this move put Southwest:
… squarely in the sights of Delta (DAL), which turned Atlanta into the world's busiest airport with the "hub-and-spoke" system of funneling passengers to their destinations.
In that same article Chief Executive Officer Gary C. Kelly is quoted as saying:
We need more flights on a combined basis [in Atlanta] than AirTran has today and I do mean significantly more flights—more than a couple.
He was more specific in a recent interview with Mary Jane Credeur at Bloomberg.com where Mr. Kelly said:
Making Atlanta mirror Southwest’s system will boost sales there by $750 million to $1 billion
Daniel McKenzie of Rodman & Renshaw also was quoted in this article. He summed up the effects of these statements in his September 28, 2010 report to clients:
Such a move could spark a fierce response from Delta, akin to a ‘defend the fortress hub strategy.’
On the flip side, I showed in the Physics of Market Share: The Little Guy Has More to Gain that the assets required to support a target market share increase exponentially with that share. Hence the “little guy has more to gain.” Here I develop another important conclusion: Delta faces a 4 to 1 disadvantage if management elects to fight seat wars in Atlanta with Southwest.
SEAT WARS DATA
Dan McKenzie shared with me his data on airline seat capacity to preview the outcome of a seat war between Southwest and Delta in Atlanta. As he said in a January 14, 2011 Airline Industry Report:
Capacity drives pricing…
There are three facts you need to know about McKenzie’s airline capacity data:
They are based on the departing seat capacity of the top five domestic commercial airlines in each metro market.
Differences in aircraft size are standardized by seat counts.
KELLY MEANS BUSINESS
The top five domestic airlines serving Atlanta put 12,299,535 departing seats in the air during the year ended December 31, 2010. DAL flew 78.55% of these seats. AirTran flew 16.66%. American Airlines (AMR), United (UAL) and US Airways (LCC) combined flew 4.79% of the total departing seats.
Now that LUV owns AAI, suppose in the final quarter of 2011 management reported increasing its Atlanta share of seat departures by one share-point to 17.66%. This “modest” share increase requires an additional 149,376 departing seats a year. Applying a common financial metric from finance, to accomplish this gain LUV would need to increase its departing seat position in Atlanta by 100 market share basis points.
WHAT IF DELTA ATTACKS?
Suppose Delta management decided to teach Mr. Kelly a lesson in the fine art of seat wars. Assume in its first 2012 report to OAG/INOVATA Delta increased its departing share of seats to 79.55% matching LUV’s 100 basis point increase. The result is an additional 601,319 departing seats per year. For the same one share point increase DAL must put 4 times as many seats in the air as LUV. And all of these new seats, plus all the existing ones, must be sold at Southwest’s low price points.
In any metro area where LUV’s share of seats is significantly less than the leader’s, the big guy faces much higher out-of-pocket costs per share point. Whether the leader wins or not depends on how much cash management is willing to throw down the drain to “defend its fortress hub strategy.” The main take away: The bigger you are the higher the cost of a seat war.
If you want to explore the theory behind this counterintuitive result see my 14 minute audio slide show The Rule of Maximum Earnings.
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