Thursday, October 26, 2006

CPAs are not an untouchable model

The financial media often portrays the regional airlines in the US as untouchable darlings due to their capacity purchase agreements with major carriers. The lore is that these agreements insulate the regional airline from common industrial turmoil because expenditures are covered by the major partner. These small jet providers however are bound to the major partner, through good and bad. It is the contracting airline that holds all the cards in this relationship; if a provider can't fulfill their end of the bargain there is always someone else in the market that can. Small jet provider management is responsible for ensuring it holds up their end of the bargain, and hopefully they can do it for less than the major is paying per departure. The consequences of this inaction were witnessed in early 2001 when Delta Air Line's SJP, Comair, went on strike. Delta's passenger feed provided by Comair was crippled and Delta learned a valuable lesson: don't leave all your eggs in one basket. Soon Atlantic Southeast Airlines were in the picture and complementing Delta's passenger feed. Other majors in the industry began exploring diversification options. Of course, there is also Atlantic Coast Airline's refusal to subject itself to United Airline's CPA demands, and ACA's attempt to go-it-alone as Independence Air.

Now, Express Jet, which is the former wholly-owned subsidiary of Continental Airlines and operates as Continental Express is feeling the pain. Express Jet were unable to meet the demands of Continental's new CPA and were ordered to return 69 aircraft to Continental, who then planned to contract another partner to provide passenger feed (the SJP business model does not always own the aircraft, they are leased from the major partner). Express Jet could opt to keep the 69 aircraft and lease them from Continental at higher rates, however there was no need for them in the Continental network. So, the question now is: What does Express Jet do with 69 aircraft? Well, some other major may want a new feed partner, however Express Jet has a hard time competing with the major SJPs out there, SkyWest, Republic, and Mesa. Then there is the option of shifting the airframes to Europe where Express Jet has a subsidiary attempting to bring CPAs across the Atlantic. This is not going so well as the majority of major airlines in the EU wholly own or have large equity investments in their regional airlines. So, Express Jet has now started a corporate division. This division will be stocked with 10 aircraft that are being refitted to better suit passenger needs. That leaves up to 59 airframes without a home at the moment.

The SJP business model is not a sure-fire win for stakeholders. Look at the turmoil that Comair, Mesaba, and Pinnacle are going through. While this business model appears to be protected from industry challenges, it may only be truly successful if diversification is possible. Those SJPs that operate for numerous carriers in the market are the most adept at surviving a downturn in the economy.

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