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ALLEGIANT AIRLINES: FINDING A NEW CUSTOMER SEGMENT W17093 ALLEGIANT AIRLINES: FINDING A NEW CUSTOMER SEGMENT1 Arpita Agnihotri and Saurabh Bhattacharya wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. This publication may not be transmitted, photocopied, digitized, or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e)
[email protected]; www.iveycases.com. Copyright © 2017, Richard Ivey School of Business Foundation Version: 2017-02-21 Allegiant Airlines (Allegiant) was founded in 19972 with a vision to provide ultra-low-cost travel services for leisure travellers. Adopting unique business practices, such as using old aircraft, paying labour with hourly wages rather than salaries, and unbundling airline fees, it grew from just one aircraft in 1998 to 84 aircraft by the end of 2016,3 targeting primarily 19 tourist destinations and 92 under-served cities4 (see Exhibits 1 and 2). Furthermore, the base fares of Allegiant were not only the lowest in the industry but also half the price of the round-trip fares provided by any other low-cost domestic airline in the United States.5 In addition, Allegiant offered the convenience of nonstop flights to vacation destinations across the United States. Further, it created value for leisure travellers by providing complete travel solutions at affordable prices: it partnered directly with hotels and car rentals to provide complete low-cost vacation packages to consumers. Consequently, for 53 consecutive quarters, until March 31, 2016, Allegiant reported no losses.6 Allegiant also received various awards. In 2010, it was recognized as the best low-cost airline by Aviation Week.7 Furthermore, Forbes named Allegiant one of America’s best small companies for four consecutive years, from 2009 to 2012.8 However, by 2014 customer complaints were also highest for Allegiant among all budget airlines.9 In 2015, it was one of the lowest scorers on the customer satisfaction index among all major U.S. airlines (see Exhibit 3).10 After September 2015, other problems arose with Allegiant, such as delayed and cancelled flights, several emergency landings, labour issues, and pilot strikes. Even though Allegiant started taking corrective actions by July 2016—for example, raising pay for pilots and buying new aircraft—the company’s fast pace of profitable growth and low customer satisfaction continued to puzzle the entire U.S. airline industry. What was so unique about Allegiant’s strategies that it could offer the lowest possible airfares and also become a profitable airline, while competitors were struggling to earn good margins? How did Allegiant remain so profitable despite such poor customer satisfaction scores? Further, would it be able to sustain its profitability in the long run? COMPANY BACKGROUND Allegiant was founded in 1997 by Mitch Allee, Jim Patterson, and Captain David Beadle.11 However, Maurice J. Gallagher, Jr., who was previously associated with ValuJet Airlines (ValuJet) and West Air Co., Ltd. and was also one of the largest creditors and the chief executive officer (CEO) of Allegiant, gained For the exclusive use of M. Harthi, 2022. This document is authorized for use only by Mashor Harthi in BA 590 Marketing Management (2022W CHEN)-1 taught by Johnny Chen, Oregon State University from Dec 2021 to Jun 2022. Page 2 9B17M030 control of the airline in December 2000 immediately after Allegiant filed for bankruptcy.12 Immediately after taking control, he looked for low-cost strategies to build Allegiant’s revenue.13 Gallagher decided to “. . . go where they ain’t,”14 and therefore targeted markets like leisure travellers, who were not served by larger commercial carriers. Allegiant therefore launched its services in smaller towns or cities such as Colorado Springs, Colorado; Casper, Wyoming; and Appleton, Wisconsin, as these cities did not have the population base to support regular airline service. In March 2002, the airline acquired its first MD-80 aircraft; these aircraft were old, used, and less fuel-efficient.15 Allegiant took on new destinations cautiously, typically starting with a few flights per week, and it did not sign any long-term agreements with airports. When Allegiant had enough travellers in a set timeframe, it invested more in that destination; otherwise, it left the market easily.16 By 2004, with this approach of cautious growth, Allegiant was flying from 13 small cities to Las Vegas, its major hub. In 2006, it became a public limited company and was registered as Allegiant Travel Company. This company name signalled Allegiant’s intention to provide not only low-cost air travel but also overall economic vacation deals through partnerships with hotels, car rentals, and entertainment service providers. While other small airlines were selling their MD-80s to buy Boeing and Airbus aircraft, Allegiant maintained its strategy of using old, less fuel-efficient (but cheaper) MD-80s. In 2011, to further support its growth to additional cities, it purchased 13 MD-80s from Scandinavian Airlines.17 By 2015, Allegiant had a fleet of 80 aircraft—of which 51 were MD-80s—and was flying to 88 destinations in the United States (see Exhibits 1 and 2). Allegiant’s unique initiatives resulted in high profitability, profit margins, and earnings per share, all of which grew tremendously in 2011–2015 (see Exhibit 4). UNIQUE ELEMENTS OF ALLEGIANT’S STRATEGY Focusing on Untapped Consumer Segments Allegiant Airways did not focus on high-fare-paying business travellers, the segment that was the emphasis of traditional commercial and some low-cost airlines.18 Allegiant was more interested in offering low-cost travel services to passengers who would have their Disney ticket in their back pocket and a sunscreen tube and bikini in their carry-on bag.19 It thus focused on cost-conscious leisure travellers residing in smaller cities, with populations less than 900,000, who wanted to fly to vacation destinations such as Las Vegas, Los Angeles, Phoenix, Orlando, or Honolulu (see Exhibit 5). Allegiant connected these travellers, who would otherwise not fly, to leisure destinations at costs as low as $20020 for a round-trip journey.21 Competitive Advantage According to Andrew Levy, former president of Allegiant, one advantage at Allegiant was that it was clear about its target passengers: “We’re not trying to be everything to everybody, which is what the rest of the industry has always tried to do.”22 Further elaborating on Allegiant’s strategy, Levy noted, “We’re not taking share [from other airlines]. We’re stimulating new demand.”23 Before Allegiant, these cost-conscious leisure travellers were not flying at all because traditional airlines considered smaller cities’ airports to be unprofitable. Consequently, by June 2014, Allegiant had a monopoly over 90 per cent of the routes it was flying; only 10 per cent of its routes overlapped with other ultra-low-cost carriers and full-service carriers in the U.S. aviation industry.24 Furthermore, its route economics were different from those for ultra-low-cost carriers because the company focused on leisure travel. For example, Allegiant flew mainly during weekends and did not require quick turnaround time.25 Other ultra-low-cost airlines, such as Spirit Airlines (Spirit) and Frontier Airlines (Frontier), had to focus on quick turnaround and flight frequency as they targeted both For the exclusive use of M. Harthi, 2022. This document is authorized for use only by Mashor Harthi in BA 590 Marketing Management (2022W CHEN)-1 taught by Johnny Chen, Oregon State University from Dec 2021 to Jun 2022. Page 3 9B17M030 leisure and business travellers. However, given that Allegiant primarily catered to smaller cities, it had a low market share in the U.S. airline industry (see Exhibit 6). In 2014, when Allegiant explored launching international flights to vacation destinations in Mexico, Canada, and the Caribbean, it clearly indicated that it would grow only to the extent it could manage operations profitably. According to Allegiant, the firm could afford slow and manageable growth as it perceived no competition26 from other airlines given their non-overlapping airline routes. Unique Low-Cost Initiatives Fleet and Frequency Management To lower costs, Allegiant did not purchase new aircraft. It purchased a fleet of MD-80s, which in the airline industry were called the “jalopy of the skies.”27 These were typically old aircraft that were dumped by commercial airlines due to rising fuel prices. Although MD-80s were less fuel-efficient than other aircraft, Allegiant still saw potential for cost saving: old MD-80s were available for $3 million, whereas a new aircraft would have cost $1 billion. Further analysis by Allegiant indicated that MD-80s had plenty of reliable life, as they were on average used for 34,000 cycles,28 whereas the Federal Aviation Administration (FAA) permitted up to 60,000 cycles.29 Additionally, Allegiant did not offer frequent flight services on a daily basis but rather offered more flights on weekends; it could follow this model because of its emphasis on tourism. Instead of offering three flights per day, it served consumers just three days a week.30 Furthermore, flight frequency even depended on the season, since tourism was a seasonal business. For example, in March 2013, the average aircraft utility was seven hours per day, while in September, it was four hours per day.31 Allegiant aircraft also did not require quick turnaround time due to the low frequency of use.32 With these measures in place, even though MD-80s were older and less fuel-efficient aircraft, they remained a good fit with Allegiant’s business model. Consequently, the company’s return on investment and assets was one of the best in the industry (see Exhibit 6). Allegiant also had other cost-saving measures in place, such as using airports in smaller cities. These airports charged lower landing fees, and their security was relatively cheaper. For example, in 2015, surcharges for the St. Pete-Clearwater International Airport in Florida amounted to $1.60 per passenger, whereas it was $5.50 per passenger for the larger Tampa International Airport, Florida.33 In