BrandedfarestakeholdamongthethreelargeUSglobalnetworkairlines.

Marketdynamics
shift
14Mar2016

CAPA

Backin2012DeltaAirLinesbeganquietlytestingfaresatsimilarpricingpointstothoseofSpiritAirlines,aUSULCCthatwasgainingtractioninthemarketplace,es
amonginvestors.By2014thatproducthaddevelopedandmanifestedasthenowwellknownBasicEconomy,partofDeltassuiteofbrandedfaresunveiledbythea
late2014.

BasicEconomywasdubbedbysomeobserversasthe'Spiritkiller',butSpiritsfallfrominvestorgracein2015stemmedmorefromoverallsoftpricingintheUSdom
market.However,thebrandedfareconceptbecameincreasinglypopularintheindustrybusinessasameansbywhichlargerUSnetworkairlinescouldcompeteeffe
withtheirultralowfarerivals.

TheintroductionofmoresegmentedfaresshouldactuallyallowAmerican,DeltaandUnitedtoaddmoresophisticationtotheirrevenuemanagementandavoiddiluti
revenuethesefareproductsaimtocreatepricingsegmentswhichcatertoawideswatheofpassengers.

TheULCCthreatdriveshomeharderintheUSpricingsegmentationgainstraction
Toitscredit,beginningin2012DeltahadtheforesighttostartslowlymatchingcertainfaresofferedbySpirit.AtthattimeSpiritwasrapidlyexpanding,toutingitsthe
strategythatitwasstimulatingjustenoughtrafficinmarketswhereitcompetedwiththemajorstobeabletocoveritsflightstherefore,themajorairlinessuchasAmerican,DeltaandUnitedessentiallyig
Spiritspricingactivities.

DuringthelastcoupleofyearsholeshaveappearedinthattheoryasUSmajors,Americaninparticular,haveconcludedthattheydoneedtopayattentiontoSpirit.AlthoughSpiritrepresentsjust1.6%of
domesticseatsfortheweekof7Mar2016to13Mar2016,itsimpactonthemarketplaceismuchbroader.

UnitedStatesofAmericadomesticcapacitybyairline,(%ofseats):7Mar2016to13Mar2016

Source:CAPACentreforAviationandOAG

In2015AmericansetouttoexplaintheeffectsoftheULCCbusinessmodelintheUSmarket.Atthattimetheairlinestatedthatapproximately87%ofitscustomersduringthelastyearhadbeentravelling
firsttime,andthatparticularpassengerpoolrepresented50%oftheairlinesrevenue.Thecompanyalsostatedthatapproximately85%ofUSdomesticpricingwasinfluencedbylowcostairlinepricepoin

Seerelatedreport:USmajorairlinesrecognisetheULCCthreat.Marketplacedynamicswillchange.Butbewarecostcreep[http://centreforaviation.com/analysis/usmajorairlinesrecognisetheulcc
marketplacedynamicswillchangebutbewarecostcreep250994]

AmericanhasnowstateditsintenttocreateabrandedfareproductthatincludesanoptionsimilartoDeltasBasicEconomy.PriortothemergerbetweenAmericanandUSAirways,Americancreateda'Ch
brandedfareoffering,butitwassomewhatdifferentfromthefourtieredDeltafarepackagethatdebutedin2014.

In2H2016Americanaimstolaunchapriceofferingthatincludesabasiceconomyoption,whichisessentiallythecostoftheairticketanythingextrabeyondthatisanaddonitemforwhichthecustomer
charged.Duringearly2016Americanhighlighteditsexcitementaboutthenewproduct,notingthatitcouldbeassignificantachangefortheindustryastheancillaryproductmovement,whichstartedfullf
theUSmarketin2008.However,thecompanystatedthatitwouldnotbenefitfromameaningfulrevenueimpactfromitsbrandedfaresuntil2017.

Inearly2016Unitedacknowledgedthatpricingsegmentationwasanincreasinglyimportanttoolinrevenuemanagement.Themorewesegmentourfares,thebetteropportunitywehavetominimiserev
dilution,saidthecompanychiefrevenueofficer,JimCompton.

Theairlinerolledoutthefirstphaseofitsbrandedfaresinearly2016anditentailedofferingcustomersacollectionofproducts,insteadofmorelacarteofferings.During2H2016,Unitedplanstointrodu
directlyappealingtothepricesensitivecustomer.MrComptonagainemphasisedthatpricesegmentationwouldavoidsomelevelsofrevenuedilutionbuiltintoourpricingstructurestoday.

Deltaworkstomakebrandedfareseasiertopurchase
Inearly2016Deltawasqueriedaboutthesizeoftherevenuetailwindfromcurtailingthebusinesstravellerwhootherwisemightbebuyinglowerfaretypes.Thecompany'sviewwasthattherewasmore
indirectbenefitfromBasicEconomyFares,butitestimatedthatthebenefitfromtheundilutedrevenuecouldbeintheseveralhundredmilliondollarsperyearrange.TheBasicEconomyproductisavailabl
1,020plusDeltamarkets.

DeltasBrandedfaresMainCabin,BasicEconomy,ComfortPlusandDeltaOne/FirstClassareontracktogenerateUSD2.4billionannuallyby2018,comparedwithUSD1.2billioninbrandedfarereven
for2015.Previously,DeltahadestimatedthatbrandedfareswouldgenerateUSD1.5billionby2018.

DeltaAirLinesBrandedFarerevenue,2014,2014andprojectionsfor2018
2014 USD0.9billion
2015 USD1.2billion
2016 USD2.4billion
Source:DeltaAirLines

PerhapstheenlargedestimatesarepartofDeltaseffortstomakepurchasingbrandedfareseasierforcustomers.BeginninginMay2016thefareoptionswillbeavailableinthepurchasepath.Companye
havealsostatedthattheintentistomaketheproductseasiertopurchase,throughDeltasownchannelsaswellasviaGlobalDistributionSystemsandonlinetravelagencies.

Significantrevenuepotentialfrombrandedfaresbringspricingcomplexity
AlthoughthepotentialforbrandedfaresisinthebillionsofannualrevenueforthethreelargeUSglobalnetworkairlines,itdoescreatemorecomplexityinthemethodstheyusetopricefares.

Attheendof2015DeltachiefrevenueofficerGlenHauenstein(thenewPresidentofDelta,effectiveMay2016)explainedthatbeforethecreationofbrandedfaresandthetechnologytosellthoseprodu
purchasepaththerewasahierarchyofpricefencing,includingmandatorystaysandadvancepurchases.

Now,saidMrHauenstein,thereisathirddimensionofpricing,whichiswhatproductdoyouwanttobuywithineachfence?Thecompanyspricingteamnowhastoensurethattheymaintaintheproper
andthattheydosoformultiplecabins.Deltaspricingexpertsalsoneedtopreventinversions,whereaBasicEconomypricecanpotentiallyenduphigherthanaMainCabinfarebecauseofinventorycontr

DeltabelievesBasicEconomyisapplicableoutsideULCCmarkets
AlthoughbrandedfaresarestillafairlynewconceptatDelta,theairlinedoeshavesomedatatodrawfrominordertodeterminethecustomerresponsetothetieredstructure.AtYE2015theairlineestima
itwinsanupsellfromBasicEconomybetween50%and60%ofthetime.

MrHauensteinstatedthatBasicEconomywasnotdrivinghugevolumesitselfitwasmoreofadefensiveplaytocompetewithULCCs.Deltahasstartedrollingoutbrandedfaresininternationalmarketsa
believesthatBasicEconomyfaresshouldbeavailableinalloftheairlinesmarketsbyYE2016.CommentingonsomelessonslearntfromtheBasicEconomyrolloutMrHauensteinstatedthatalthoughDel
thebarebonesfarelevelasaformofdefence,theairlinepredictsbroaderapplicationsforBasicEconomyinmarketswherecompetitionwithULCCsdoesnotexist.

ProductandoperationalperformancetakeonnewimportanceinULCCpricematching
Inlate2014,asDeltawaspreparingfortherolloutofitsownnewbrandedfares,companymanagementtooktheopportunitytohighlightthatSpiritwasnotthemostontimeairline,nordiditofferthepit
Deltaofferedineconomy.SpiritseconomyseatpitchisthetightestamongUSairlines,at28in.(ItalsooffersfourBigFrontSeatswitha36inpitch).

ThepointwasthatDeltasproductwassuperiortoSpiritsoffering.IfyourchoiceistobuySpiritortobuyDelta,orbuyanultralow[fare],wewillalwayshavethebestproduct,saidMrHauenstein.

WiththeBasicEconomyproductdevelopedbyDeltaandthesimilarofferingsindevelopmentbycompetitorsAmericanandUnited,ULCCsdofaceachallengeiftheydonotdriveoperationalexcellenceand
theircustomerservice.Thesebrandedfareproductsarenotsimplypricematchingtheyaresophisticatedrevenuemanagementandpricingtools,appealingtoawiderangeofcustomers.

CustomerswillultimatelymigratetowardsamorereliableairlineiftheyareabletofindfaressimilartothosechargedbyULCCs.DatafromtheUSDoTshowthatforthe12MendingNov2015,Deltason
performancewas86.3%.DataisnotavailableforSpiritforthattimeframe(SpiritonlybeganreportingitsdatatoDoTinJan2015),butitsaverageontimeperformanceforthefirstthreequartersof2015
67.2%.ByOct2015Spirithadimproveditsontimeperformanceto78%,and75%inNov2015.AmericanandUnitedsontimeperformancefiguresforthe12MendingNov2015were79.9%and77.7%
respectively.

Delta,AmericanandUnitedontimeperformanceforthe12MendingNov2015
Delta 86.3%
American 79.9%
United 77.7%
Source:USDoT

Spirit'snewCEO,RobertFornaro,wasappointedinearly2016andhasstatedthataslargerairlinesbegintomatchtheairlineinprice,thecompanysoperationalperformancewillimprove.

MrFornaroexplainedthatthebasiceconomyfaresofferedbythoseairlinesactuallycreatelesspricecompetition,duetothefactthatlargerairlinesarenotdilutinghalftheirairplane,rathertheyarelimi
thosefarestoacertainpercentageofthemarket.Indeed,thethreelargeUSmajorairlinesarecraftingmoresophisticatedtechniquestocompetewithULCCs,whichentaillessrevenuespill.

Seerelatedreport:Spirit'snewCEOhintsatnuancedchangesratherthananoverhaul.Operationsareakeyfocus[http://centreforaviation.com/analysis/spiritsnewceohintsatnuancedchangesrath
overhauloperationsareakeyfocus266615]

ChangesareafootinthedynamicsbetweenUSULCCsandthelargenetworkairlines
ULCCsareanecessaryforceintheUSmarketplace.Theirproliferation,insomerespects,hasarguablyforcedthelargeUSmajorairlinestozeroinontheirpricingandrevenuemanagementtomaximise
andminimisecostlydilution,whichtakesonincreasingimportanceinthecurrentenvironmentofsoftUSdomesticpricing.

TruebrandedfaresofferedbytheUSmajorsthatcatertoawidepassengersegmentarestillintheirearlyphases,butthedynamicscreatedbythatsegmentationshouldunfoldduringthenext24months,
triggeringsomechangestothecurrentcompetitivelandscape.

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