A History Lesson For Young Ted: Continental Lite 101
By ELIZABETH SOUDER
Of DOW JONES NEWSWIRES
NEW YORK -- Ten years ago, Continental Airlines Inc. (CAL) started its own low-cost airline, called Continental Lite.
These days, executives with the Houston airline say that was a mistake they won't repeat. Continental Lite offered only the most basic airline service: safe air transport. To trim costs, the airline cut meal service and even cut the number of cleanings the planes received each day.
Customers didn't like it, and walked. Furthermore, customers confused the Lite product with the main airline, and stopped flying Continental altogether. So within a few years, Continental shut down the Lite operation.
The failure prompted Continental Chief Executive Gordon Bethune to make his signature statement: "You can make a pizza so cheap nobody wants to eat it."
Thursday, a decade after Continental's flop, UAL Corp. (UALAQ) launched a new low-cost airline, called Ted. And last year, Delta Air Lines Inc. (DAL) launched its own low-cost carrier, called Song, though Delta has since halted Song's growth as the Atlanta-based carrier reviews all of its operations.
Both are going about the exercise much differently than Continental, offering passengers some extra amenities while cutting costs by boosting productivity on the most popular routes.
But many experts urge the airlines to consider history: no low-cost airline operated by a major carrier has succeeded. Critics say the benefits of Song and Ted could be done without going to the trouble of starting a whole new airline and without risking confusion among customers. Plus, those efforts do nothing to solve what experts say is the most pressing problem: high labor costs.
"No legacy airline, in our opinion, will be successful with a low-fare airline within an airline. The simple reason is that, in order to operate a profitable low-fare airline, that airline must actually have low costs," Raymond James analyst Jim Parker said in a research note.
Avoiding Continental's Pitfalls
Ted and Song are intent on avoiding Continental's mistake of cutting back too much on service. Both are keeping some frills, such as on-board entertainment. Song is even installing satellite television, which the main Delta airline doesn't even offer. Other frills, such as meals, are no longer free.
Acknowledging Continental's cheap-pizza problem, Song spokeswoman Stacy Geagan said, "We could never afford to give customers food they would want to eat." Instead, Song sells organic salads, designer chocolate and signature cocktails on board, converting what was once a cost in to a possible revenue stream.
Both Song and Ted say they have cut unit costs, or the cost per seat per flight, by double-digit percentage amounts by boosting productivity. The low-cost airlines operate more daily flights on their routes than the parent airlines, and use technology to keep costs down.
The secret is making use of economies of scale. The airlines fly big planes on popular routes, back and forth constantly throughout the day. Ted Vice President Sean Donohue said the routes Ted flies among big cities such as New York and sunny destinations such as Las Vegas and Florida are so popular, he can justify operating flights at all hours of the day, from 7 a.m. to 10 p.m.
UAL's last attempt at a low-cost airline, like Continental Lite, flew short hops to smaller cities. Those flights, which Chicago-based UAL now operates in part with regional carriers, are more expensive to fly and these days command much higher fares than the Ted routes.
High Labor Costs Persist
But critics say all those cost cuts could be done without all the trouble of starting new airlines. And still, the two start-ups have the same labor costs as their parent airlines.
Delta's labor costs are among the highest in the U.S. airline industry, and Delta is pleading with its unions to agree to lower salaries. UAL has trimmed labor costs while the airline restructures under bankruptcy protection, but still costs are higher than those of JetBlue (JBLU).
In the fourth quarter, JetBlue's total unit operating cost was 6.09 cents, while UAL's unit operating cost was 9.85 cents and Delta's unit operating cost was 10.87 cents.
Employees for major carriers are mostly unionized, and bargain collectively for better salaries and benefits. Most low-cost carriers, with the exception of Southwest (LUV), don't have unions. Further, the major carriers have numerous employees who have been on the payroll for decades, earning raises along the way. JetBlue started operations in 2000, so all employees are relatively new hires.
Still, officials at both Ted and Song claim the airlines are on the road to profitability. Once Ted reaches its full-size of 45 airplanes by the end of 2004, Ted's Donohue said, the unit can turn a profit. Donohue said that can happen as early as 2005, though he isn't making an official prediction.
And a source familiar with Song said the airline's load factors are currently better than break even. Delta doesn't break out financial results for Song.
Many airline experts doubt either operation will show sustainable profits. Continental Lite never did.
"Unless they can get labor costs down and some of the other costs down, I don't know what they accomplish," said Sam Coats, who worked for several low-cost carriers before becoming vice president of Continental Lite.
Coats, now an independent consultant to the airline industry, also said Ted and Song risk confusing passengers about the United and Delta brands.
Delta's Song is attempting to create a distinct image marketing itself as a product distinct from Delta, using different colors and targeting its product at women.
As for UAL's Ted, the idea isn't to market a totally different brand, but to hit the "sweet spot" between UAL's familiar United brand, and some new things on Ted, said Vice President Donohue. The changes are slight: the logo is different, and the on-board music and video selections include "more comedy" than the main airline, he said.
Brand confusion about Continental Lite caused customers to think Continental had scaled back service on the main airline, and damaged the Continental brand, said Coats, who is looking for an opportunity to run an airline again.
"We got to the point that the whole airline was perceived as cheap," he said. "We would have done better to call it Ted or Song or Rufus or something."
-By Elizabeth Souder, Dow Jones Newswires; 201-938-4148;
[email protected]
Updated February 13, 2004 11:16 a.m.