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Spirit Airlines finds itself at a crossroads. The largest low-cost carrier in the US made $420 million in net income in 2017, an increase of 59% over the previous year. It had an operating margin of 15.2 percent, much better than the industry average. It’s also no longer the worst large airline in America according to TPG‘s ranking of airlines: Spirit moved up to 7th place this year, from dead last at number 10.
But there are significant pressures facing the airline on many fronts: Escalating competition, rising costs, and a stagnant stock price, down from $51 to $43 over the past year. In the midst of all this, Spirit is undergoing its third senior leadership change in three years, as Chief Executive Officer Robert Fornaro prepares to pass the baton to current president and CFO Ted Christie next year.
Fornaro will leave after just three years as CEO. He replaced Ben Baldanza, the architect of Spirit’s ultra-low-cost carrier (ULCC) model, in January 2016. Before Spirit, he was the boss at low-cost pioneer AirTran Airways, which he led until its acquisition by Southwest. Christie is no stranger to this part of the industry himself: He began his airline career at Frontier in 2002, although that was before it morphed into a ULCC.
We sat down with both executives for a far-ranging interview earlier this month. What they told us is, essentially, that Spirit will continue being Spirit, charging low base prices but adding fees for pretty much everything beyond basic flying — and may look at acquisitions to expand. And it will open more international destinations.
TPG: Spirit announced its leadership transition a full year before it officially happens. What’s the reason for that, and why the decision to leave after just three years at the helm?
Fornaro: It’s important because it shows continuity. I joined the board in 2014 and it was not my intention to become CEO, it’s just the way things happened. And I always thought about it in terms of three years. I turn 66 in January of 2019 and that’s 40 years in aviation. That’s plenty. You want a CEO who’s got a time frame to actually accomplish things that take years. We talked about this whole thing with Ted in 2016. One of the three things that I needed to accomplish was to find the successor. And you know we felt that this successor was here so we decided to do it early. It takes all the mystery out so this year we are partners. Ted’s leading just about everything in the company right now. When I leave it will be seamless.
Can you elaborate on the changes under your watch and their results?
Fornaro: We’re at about 115 planes. How do you get to 200 or 250? The marketplace is much more competitive today than it was five or six years ago. We need to be better at everything. The competition is getting stronger, they’re playing rougher and everything we’re going to accomplish we need to take from somebody else. We didn’t stand for customer service. We didn’t stand for operational excellence. As a group, we weren’t sure how we would get there, whether we wanted to get there, and then the path to get there. We would be a little further along if we didn’t have some operational issues, tied to some pilot work actions [work slowdowns, sickouts, and threats of a strike] which were really a setback.
You’re at a historic 90 percent in on-time arrivals, ranking in second place of all US carriers. But as far as Department of Transportation complaints are concerned, you’re still at the bottom of the list with 5.59 per 100,000 passengers in 2017, This is nearly double that of another competing ULCC, Frontier.
Fornaro: First of all, if you went back statistically and historically to 2015, we were even further behind. If you look at what happened in May, June and July tied to the cancellations because of the work-related action we went off the chart. When you’re canceling flights you’re going to get it. Now we’re making very good progress there. Wait till you see the first couple of months’ (of 2018) numbers and you are going to see dramatic improvements. The next piece though, is that there are differences in the product, and we may get some complaints just because people feel that they’re paying more for things even though our prices are better. We’re not going to change the model to resolve that. We’re going to fix the things where we don’t deliver on our promise. We are targeting leisure customers and very price-sensitive businesspeople, not corporate customers. At the end of the day what we know is we bring great value and quite frankly the only times many of the bigger carriers create value is when they compete with us, so we’re bringing value. We have to stick to our general business model that provides great benefits to the customer. We really shouldn’t be apologizing for that.
Christie: When a guest enters into our airplane they have certain expectations of what they’re going to see and what they’re going to feel and how it’s going to perform. It’s our job to deliver on that. And that may not be the same product you would expect when you walk on board Emirates, Delta or United, but we must be routine and consistent in the way we deliver it. In conjunction with the Disney Institute and our in-flight leadership, we designed a training program for our customer-facing onboard people, the flight attendants, which is now going to push through the entire organization. And it’s tailored to Spirit. It’s about who Spirit is and what we deliver to our guests and the value that we can give to them. It really gives those people the tools they need to deliver an onboard guest experience that is positive and makes that that guest feel valued.
Fornaro: We’ve never provided any customer service training as part of (flight attendant training). We put every flight attendant through that last year. It will make a big difference at the end of the day, interaction is fundamentally important and actually there’s issues on airplanes you have to resolve and skills that you can do can learn that can help you manage those things.
In 2017, operating costs ballooned by 22%, running far ahead of 16% capacity growth. Revenue rose just 14%. How do you intend to close the gap?
Christie: We are an ultra-low-cost carrier and we clearly have our focus on our cost structure. We believe it to be one of the most important facets that we use to compete. But we make investments in this business all the time. And the word “investment” can sometimes get blurred with the word “cost.” We expect a return for the investments that we intend to make and how we quantify that return can depend on the investment. This company makes investments in a lot of different things. We invest in aircraft, hangar facilities, training facilities, new uniforms, and in training for our people. We look at those things as ways to build a defensible franchise that can deliver on this promise. Yes, our costs were up last year. A lot of it was fuel, by the way. It’s our job as as managers to adjust where we can and clearly we have to look for revenue production when and where we can.
I believe ancillaries are about 50% of your revenue?
Christie: Yes, about 50% of our revenue today. And we think it’s a powerful aspect of the model because it does two things: One is it’s a revenue producer which is great for the shareholder and for the team as they’re looking for ways to improve bottom line performance. It’s great for the customer too because they get to pick and choose the things that work for them. And so our total price is considerably cheaper than our competitors and we use that ancillary model to drive revenue where we can. We remain focused on improving the operation and delivering on the value that we think we have. And if we do all these things and we execute them in the ways that I’ve seen our team step up over the last two-plus years, this is a very, very robust and defensible model over the long term.
Fornaro: I want to follow up on the costs a little bit. Our non-fuel costs will be down in 2018 even with the new pilot contract.
Christie: For 2018, we will be flat to down 1%, even with the pilot agreement.
Fornaro: Over the next couple of years our cost gap versus the bigger carriers is going to widen. The good news is we now have labor certainty around here for a number of years. We think there’s no downward pressure while the other airlines will begin to see other rounds of costs increasing as their labor costs begin the rise.
Let’s talk about your initiatives to drive revenue.
Christie: As far as the ancillary goes, you can divide them into a series of opportunities or buckets. The first is optimizing the product that we offer today, making sure that we’re reaching the right customers with the product we offer. Those types of things we can always look at and price them in ways that more align the demand with the supply.
For the second bucket, we can introduce new products that will provide value, giving the guest the opportunity to for example package or bundle their existing services into a series of more customized experiences. And so you’ve got kind of optimizing the sale of your existing stuff, and by the way that includes not just pricing but also merchandising and technology and the way we interact with our customers on our mobile platform and our web site. All that is currently under revamp and that gives our marketing team the ability to be smart about that.
And then you have the share of the customer wallet as a third bucket, which is they are buying goods and services related to their travel experience that are not necessarily Spirit-focused. But they spend a lot of money on hotels and cars and shows and excursions. Right now, we punch under our weight class vis-a-vis our competitors in getting what we think is the appropriate throughput there, given our distribution platform where we move 25 million passengers every year. It’s a valuable distribution platform. We can sell more products so I do think there’s levers to pull in all those and beginning with the second half of last year we began to see our ancillary revenue per passenger inflect back up again.
Are you considering offering inflight Wi-Fi connectivity?
Christie: It needs to meet a few criteria for us and that has to be a really quality experience on-board. It can’t have the kind of hiccups and some of the issues that early generation Wi-Fi have had. And the second is it has to be delivered in a way that works for the Spirit model. We’re not experts at delivering Wi-Fi, selling Wi-Fi and making Wi-Fi work. We want a partner that does all of that and again thinking about us as a distribution platform we can offer our customers to them for sale. But it shouldn’t be our risk so we’re looking at it that way.
As other airlines continue to compete aggressively with products like Basic Economy, what is your advantage?
Fornaro: Well, first of all you have to remember we bring the value because there’s a massive difference between where the price would be if we weren’t there. Our airline is designed around that discretionary leisure trip. We try to let people buy what they want and that’s it but certainly there’s no bait and switch. They match Spirit (on prices) on some flights and so we’re kind of playing a different game. The service of these legacy carriers is not that good despite what they say and I think we can win on culture. And in terms of delivering, we’ve got to have a high completion rate frankly. We need to do all of these things and we can make a lot of money. The reason is we have the lowest cost structure of any airline in the United States. This airline is designed to compete in those markets against the legacy carriers. Their costs are double ours.
Christie: As the market goes through cycles, it becomes extremely punitive for high-cost carriers to deliver low-cost transportation. We are built for the discretionary underserved leisure-based fare class and that will remain in a boom or bust cycle and high and low oil prices. If you just look back in history it’s generally been a pretty sticky group. And so the first thing that happens when you go through a bad cycle is that corporate traffic starts to turn off. That means that our opportunity remains and gets bigger. We have to be honest with you: How higher-cost, higher-fare carriers manage their inventory on a day to day basis is beyond us.
Spirit’s capacity in available seat-miles (ASM) is growing at a precipitous rate, exceeding most, if not all, competitors in the industry. Wall Street does not like that. What is driving Spirit’s ASM growth, and is it disciplined?
Christie: We’re going to grow around 23 percent this year, but some of that is just mathematical, lapping 2017 because of the hurricanes for example and the pilot-related disruption. Normalize for that, and we’re going to have a good growth year that was going to be around 20 percent. So the deployment of that comes in the form of stage length — how long we’re flying the airplanes. Bigger airplanes are now on longer markets. We’re taking more airplanes, even though the delivery count may be lower in 2018, and we took six airplanes in the fourth quarter last year. It’s large leisure destinations continuing to build up: Orlando, Vegas, New Orleans, and Fort Lauderdale. Then there is big city origin-type flying that we continue to work on getting more and more of, whether it’s Dallas, Chicago or Houston or any of those places.
Then there’s the international component of this airline, that has quite frankly been under-developed here over the last three or four years. As a percent of the total it’s now approaching around 10% of the airline whereas if you look back in 2012 it was more like 18-20%. I think there’s opportunity there (…) so we’re starting to move more to international as well.
Your stock price is down over 50% from its 2014 high. What’s your message to investors?
Fornaro: First of all, the stock multiples across the entire industry are down. In 2014, no one was competing (directly with us) so it’s actually irrelevant. There was no capacity growth for years and I think if you want to compare capacity in 2014 it wasn’t much different than what it was around 2000. That’s changed, so I think the whole industry backdrop has changed a little bit. We had two areas of overhang last year. We have an overhang from the pilot deal and we took a pretty big earnings hit in May and June of 2015. The forecast is that we are going to be earning more money in the coming years but 2014 is not our target. We had 50 airplanes. No one paid attention to us. That’s not the baseline.
Is there room for further consolidation in the US ULCC space?
Fornaro: I’ve been asked that question since the day I became CEO. This is part of the business and you can grow internally and buy airplanes to accomplish that. But (consolidation), it’s something that we think about.
Christie: I agree, and I think some things are true about us today are: We are the biggest and best-known brand in the ULCC space in this country. We’ve been the most successful and I think that our objective is to continue to enhance upon those things that put us in a position to lead the space whatever that might mean organically or inorganically.
Let’s talk fleet. The A320neos with Pratt & Whitney engines have been a pain for most of their operators, with Spirit being no exception. What’s been your experience with the induction of the neo into the fleet?
TED: Well, the entry into service has been a little bit frustrating for everybody. That includes Airbus and Pratt and ourselves and all the operators. But Pratt has worked very hard to resolve the issues. We believe they have their fixes in place and are deploying those now to set up this aircraft to be exactly what it was intending to be. The neo will be the future of this airline long-term. When operating, it delivers the fuel efficiency that was promised and better. It will deliver the range which is very important to Spirit. And so the prognosis for the neo is very good.
Christie: I think so. As Bob alluded to earlier we face a period now where we start evaluating our long-term fleet needs. We’re going to look at all the available options.
Fornaro: We want choice and we want competition on the manufacturer side. We’re an all-Airbus customer but we think you have to look at everything. And, you know, there’s my own experience from AirTran, where we had two separate fleet types. At AirTran, we had the lowest cost United States with two fleet types (the Boeing 737 and 717). So you can do it, you just need to manage the process. At Spirit, we also need to have enough scale in the airplane to make it worth our while.
Chris Sloan is an aviation journalist and lifelong AvGeek based in South Florida, where he is managing editor of Airways Magazine. At his day job, he is also owner of one of the nation’s top television production companies, design, and marketing agencies, 2C Media. His mantra is pretty much the same as the classic Delta Airlines slogan: “I Love to Fly, and It Shows.” His specialties are inaugural flights and financial analysis.
The interview has been edited for grammar and brevity. All images by the author.
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