Spirit Airlines: Ultra-Low-Cost, Ultra-Impressive-Profits
Spirit Airlines has accomplished the seemingly impossible in the US airline industry: it has never lost money. It does so by keeping its business model, customer promise, and operating model simple and tightly aligned. It offers the lowest fares by being the lowest cost operator and has captured a segment of the market that is unprofitable for most of its competitors to serve.
The business model
Spirit describes itself as an “ultra-low-cost-carrier”, and specifically targets price conscious customers with low fares and a “no frills” flying experience. It is committed to being the lowest-cost airline in order to be recognized as the low fare leader in the markets they serve.
Moreover, rather than offer its customers a bundled price that airlines traditionally use to cover the cost of non-essential services beyond the base fare (e.g. checked luggage, advance seat assignments, refreshments, staff assistance at check-in), Spirit unbundles these options and gives its customers the option to pay for them individually.
Spirit serves a segment of the market that most airlines cannot without losing money. Spirit had the market insight that many base fares are beyond the reach of a large customer segment who cannot afford frequent air travel, and Spirit recognized that if it could sufficiently lower its cost base it could serve this segment without significant competition.
Operating model
Spirit’s operating model is tightly focused on maximizing asset utilization and non-ticket revenues per passenger to reduce base fares and stimulate passenger demand that most airlines cannot serve profitably.
Maximize asset utilization: airlines are inherently high-fixed-cost businesses, and Spirit seeks to lower per unit costs with high asset turnover and by managing the variable costs associated with using those assets.
- Single fleet type: they avoid the additional costs of training crews to operate multiple types of aircraft and ensure that flight crews are interchangeable across their network. Maintenance, operational support, and spare part inventories are highly simplified versus competitors with more complex fleets.
- High seat density: Spirit invested in adjustments to its aircraft fleet to allow for 20% higher seat capacity on average vs competitors with comparable aircraft.
- Route maximization: Spirit’s average daily aircraft utilization is 12.7hrs vs 11.8hrs for JetBlue and 10.9hrs for Southwest.
Incentivize lower-cost customer behavior: Spirit uses fees to incentivize customer behaviors that lowers its operating costs. Two examples:
- High baggage fees: Spirit charges comparatively high costs for carry-on and checked baggage versus other airlines. It seeks to dissuade passengers from flying with checked baggage which allows it to board and empty planes faster and thus fly more routes in a single day, employ fewer baggage handlers and support personnel, and increase fuel efficiency (fuel costs are ~40% of operating costs for a typical airline and the additional weight of luggage has a material effect on the amount of fuel consumed in-flight).
- Boarding pass printing: Spirit charges passengers $10 for boarding passes printed by a gate agent and temporarily introduced $2 charges for passengers who printed boarding passes at kiosks at the airport. Its goal is to drive passengers to print their boarding passes at home to reduce the expenses they incur] by employing a large number of gate agent staff.
Maximize ancillary revenues: Spirit stimulates passenger demand through low base fares while offering a suite of additional products and services designed to maximize non-ticket revenue per passenger including a subscription service to access flash sales of $9 fares, third-party travel insurance, advance seat selection, third-party travel packages, in-flight products, and on-board advertising. They have been remarkably successful, growing ancillary revenues per passenger from $5 in 2006 to $55 in 2014.
Conclusion:
The result of Spirit’s strategy has been an unrivaled low cost position among domestic carriers. It’s Cost Per Available Seat Mile (CASM), an important measure of unit costs in the airline industry, is 20% lower than Southwest’s, and 100% lower than United Airline’s.
This has allowed them to dominate a market segment where they face little viable competition. 80% of Spirit’s passengers buy tickets priced in the lowest fare band where they have a clear cost advantage:
Moreover, the success of their ancillary revenue strategy has allowed them to drive base fares well below the competition’s break-even cost. Spirit’s average total fares (inclusive of ancillary revenues and base fares) are $100 versus $125 for Southwest and $150 for JetBlue, despite higher pretax profit margins (21% for Spirit versus 16% and 12% for Southwest and JetBlue, respectively):
It has accomplished this while delivering industry-leading operating margins of 13 – 20% every year since their IPO in May 2011. To be clear, Spirit is not a pleasant flying experience. But its business model and operating model give it an impressive competitive advantage that has allowed it to reach a customer base for whom flying was once out of reach, all while delivering profits rarely seen in the airline industry.
Sources:
http://files.shareholder.com/downloads/ABEA-5PAQQ9/1137752048x0x860114/F80EC5FA-AC2D-4F79-9E21-E39AEBD89EEB/Baird_2015_Spirit_Airlines_FINAL.pdf
http://files.shareholder.com/downloads/ABEA-5PAQQ9/1137752048x0x846205/971A17A5-D3D8-4E78-90A3-0EE9193A4B35/Spirit_August_2015_FINAL.pdf
https://www.spirit.com/Content/Documents/en-US/Spirit%20Airlines%20History.pdf
http://ir.spirit.com/events.cfm
http://marketrealist.com/2015/11/investors-introduction-spirit-airlines-pioneer/
Looks like a very efficient company, and that they have found a market willing to buy “unpleasant” flights. Do you think that big airlines can find a way to serve this market with one of their second/low cost airlines? If so, do you think that the barrier to entry this market is low or high for these bigger airlines?
Really interesting. A lot of fliers hate Spirit, and according to Consumer Reports it was rated the absolute least popular airline in 2013, and yet clearly a lot of people are still flying Spirit. Given their business model, they clearly aren’t in the market to court business travelers. Would be interesting to understand how they think about growth given that. I definitely see a few places where Spirit can add a lot of value (direct flights between smaller, non-hub cities, for example), and wonder if these are viable strategies for them.
Interesting post, thank you! I understand the point about maximizing asset utilization to reduce the cost base in order to offer low fare tickets, but I wonder where the tradeoff point is between utilization and maintenance/replacement costs. I would imagine that the higher average daily utilization of the planes would mean they need more maintenance and ultimately need to be replaced sooner than other airlines’ planes (and then reconfigured for the higher seat density), which would increase costs.
If I remember correctly, Spirit’s transition to being an ultra-low-cost-carrier coincided with the recession, when the idea of a low cost, no-frills flying experience was very palatable to people. Even though the economy has improved, I believe people are still being cautious about spending, especially on discretionary items such as flights. As we get further away from the recession though, I wonder if there will start to be a backlash against the unpleasant no-frills experience, or at least not enough new people willing to sign up for it, thereby inhibiting Spirit’s growth.
EBITDARRRRR
Hey Fennerty – thanks for the interesting post! Curious to hear what you think about United’s upcoming initiative to offer a “no frills” option to their customers to fight off the likes of Spirit. What do you think Spirit can do to respond to such initiatives by the legacy carriers, especially given that Spirit doesn’t have a loyalty program. Cheers!
I totally agree, Katherine. Your point on maintenance and replacement costs is spot on. I echo your concern about getting enough new customers to grow, but more than that, I worry about how you keep your customers.
Is being the lowest cost provider really enough of a customer promise? Does the $50-$100 customers save on a flight really create enough value to counter the potential value that’s destroyed when they are stuck at an airport for days? Will these customers really come back? Note this quote in a recent Travel & Leisure article which ranks Spirit as the worst airline for customer service: ““Worst airline in the world,” wrote one reader. “They leave you stranded when they cancel your flight, then basically tell you they don’t care. If they could figure out a way to charge for oxygen, they would do it. Used to fly them regularly but now I would pay more to avoid them.” (http://www.travelandleisure.com/slideshows/worlds-worst-airlines-customer-service/25
I understand that they are differentiating themselves on price and by not providing good customer service but I just question whether that is really a sustainable business model over the long-term.