The Role and Impact of Low Cost Carriers

The Role and Impact of Low Cost Carriers William S. Swelbar Managing Director MIT Global Airline Industry Program March 26, 2002

Introduction and Topics to be Covered! Low Fare/Niche segment is less of a topic without the deterioration of profitability that began in 1998, and the market opportunities presented after 9/11.! Each of the network carriers placed a capacity reduction bet on 9/12: How much was too much how little was too little? Either way, the low cost segment had/has a solid platform to grow from.! The cuts in the West would appear to only make a bad situation for the network carriers grow worse.! Low Fare/Niche carrier growth has continued to penetrate the largest U.S. markets, and no region of the U.S. is immune.! The RJ is the low cost growth vehicle for the network carriers Let s just call a spade a spade.

15-Year Cycles; 15-Year Bubbles The Low Fare/Niche-Oriented Carriers and Regional (Small) Jets Have Already Begun Redesigning the New Competitive Landscape 30% 25% Share of Total ASM Growth 20% 15% 10% 5% 0% -5% Technology-Driven Capacity Growth Competition-Driven Capacity Growth -10% -15% 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 % Change in Average Seats % Change in Average Stage Length % Change in Scheduled Departures

Where Has the Revenue Gone? U.S. Scheduled Airlines Domestic Operations 30% Recession 80% 25% 20% Average Load Factor 54% Average Load Factor 63.9% 70% 60% 15% 50% 10% 40% 5% 30% 0% 20% -5% 10% -10% 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 Y-O-Y Change in ASMs Y-O-Y Change in RPMs Load Factor 0%

Deterioration of the Network Carriers Profitability Began as Early as 1998 8,000 Network Carrier Operating Profits 12 Months Moving Total 500 Sequential Change in Network Carrier Operating Profits 12 Months Moving Total $Millions 7,000 6,000 5,000 4,000 3,000 0-500 -1,000-1,500 YE3q98 YE4q98 YE1q99 YE2q99 YE3q99 YE4q99 YE1q00 YE2q00 YE3q00 YE4q00 YE1q01 YE2q01 $Millions 2,000-2,000 1,000-2,500 0-1,000 YE3q98 YE4q98 YE1q99 YE2q99 YE3q99 YE4q99 YE1q00 YE2q00 YE3q00 YE4q00 YE1q01 YE2q01-3,000-3,500 Source: DOT Form 41

The Underlying Economics Have Not Favored the Network Carrier Segment for Sometime Overcapacity? 15.0% Critical Indices Underlying the Industry s Operating Performance Network Carriers Percent Change 1 st st Half 2001 vs. 1 st st Half 2000 15.0% Low Fare/Niche Carriers Percent Change 1 st st Half 2001 vs. 1 st st Half 2000 12.8% 10.0% 8.2% 10.0% 5.0% 0.0% -5.0% -10.0% -15.0% 1.6% -3.9% Network Carrier Operating Profit Change: -$5.0B -11.8% ASMs Rev/ASM Cost/ASM OP. Margin (Pts. Change) 5.0% 0.0% -5.0% -10.0% -15.0% 0.5% Low Fare/Niche Carrier Operating Profit Change: $33.7M -1.3% -0.8% ASMs Rev/ASM Cost/ASM OP. Margin (Pts. Change) Note: Network carriers include American/TWA, America West, Continental, Delta, Northwest, United, and US Airways. Note: Low Fare/ Niche carriers include Alaska, JetBlue, Frontier, AirTran, Spirit, American Trans Air, Southwest, and Midwest Express.

Assessing the Network Carrier Response: Which Hubs and Network Carriers Cut the Deepest Immediately Following 9/11? -18% -13% -10% -9% -8% -5% -20% 0% United LAX -22% SFO -22% IAD -19% DEN -17% ORD -12% Northwest MEM -21% MSP -12% DTW -11% American/ TWA MIA -12% ORD -12% DFW -8% STL -7% US Airways PHL -11% CLT -9% PIT -7% Continental EWR -17% IAH -4% CLE -1% Delta JFK -29% DFW -8% ATL -5% SLC +1% CVG +4% Note: Changes in carrier service reflect total; changes in hub service reflect nonstop only. Source: Eclat Air Service Model, November 2001 vs. September 10, 2001

A Competitive Reality The Low Fare Carriers Had Built a Strong Base of Traffic Prior to 9/11 90,000,000 Low Fare Carriers Out-Carry Every Major Network Carrier at the Cities They Serve in Common 80,000,000 70,000,000 Annual Passengers 60,000,000 50,000,000 40,000,000 30,000,000 20,000,000 10,000,000 0 AA & TWA HP CO DL NW UA US Hub Carrier Low Fare Carriers

The Reality Low Fare Carrier Penetration Has Pierced Many of the Network Industry Strongholds Core 48 State Cities Served by Low Fare Carriers* 1997 (89 Cities) PDEWs 2001 (82 Cities) PDEWs 4-Year Growth Percent All Network Carriers Average 7,073 7,660 8.2% Low Fare Carriers Average 1,787 2,610 46.1% * Cities with at least 20 PDEWs for Low Fare Carriers

Low Fare Penetration in Top 10 CMSA Markets Note the Migration from West to East Total San Francisco 33% San Francisco 4% San Jose 43% Los Angeles 25% Oakland 69% Long Beach 5% Total Los Angeles 35% Burbank 70% Ontario 61% Large Hub Medium Hub Small Hub Orange County 25% Total Houston 31% Total Dallas/Ft. Worth 23% Total Chicago 17% Chicago (ORD) 0.3% Dallas/Ft. Worth (DFW) 2% Dallas/Ft. Worth (DAL) 94% Houston (IAH) 3% Houston (HOU) 78% Atlanta 12% Manchester 20% Total Washington 18% Total Boston 9% Boston 3% Westchester County Providence Newark Islip 20% Philadelphia 2% 55% New York (JFK) 24% 3% New York (LGA) 4% Chicago (MDW) Washington (IAD) 3% 78% Washington (DCA) 3% Washington (BWI) 41% Total New York 8%

The Low Fare/Niche Carrier Segment: They Keep Growing Because They Can -12% +5% -21% +16% +35% +20% +17%

A Constant Reminder: IT Keeps Growing Because IT Can

Low Fare Carrier Market Penetration Has Been Greatest in the Largest U.S. Markets Since 9/11 Total Service In Markets Low Fare Carrier Service Points Change Large Hubs -12.9% +0.7% +2.1% Medium Hubs -10.0% +0.1% +3.3% Small Hubs -9.7% +3.9% +2.3% Non Hubs -12.5% -9.1% +0.7% We estimate that the Low Fare/Niche carrier segment of the industry has captured 2.4 points of domestic market share in the past 6 months

The Low Fare/Niche Carrier Segment of the Industry Has Increased Its Share of Service in Every U.S. Region Since 9/11 March 2002 September 2001 16.1% 14.3% March 2002 11.7% March 2002 9.6% Sept. 2001 7.4% +2.2 pts. September 10.9% 2001 0% 6% 12% 18% 24% 30% 36% 42% 0% 6% 12% 18% 24% 30% 36% 42% March 2002 September 2001 37.8% 32.4% 0% 6% 12% 18% 24% 30% 36% 42% +5.4 pts. March 2002 0% 6% 12% 18% 24% 30% 36% 42% March 2002 September 2001 30.3% 15.5% 13.3% +2.2 pts. September 2001 28.0% 0% 6% 12% 18% 24% 30% 36% 42% 0% 6% 12% 18% 24% 30% 36% 42%

Capacity Growth by the Low Fare/ Niche Carrier Segment is Forcing the Hand of the Network Carriers The Difference Between Capacity Reductions and Network Effect is Evident -21% -14% -10% -6% -3% +5% 0% United LAX -32% SFO -27% IAD -25% DEN -20% ORD -9% US Airways PHL -4% CLT -6% PIT -11% American/ TWA MIA -10% ORD -11% DFW -7% STL -11% Northwest MEM -23% MSP -3% DTW -2% Continental EWR -12% IAH -4% CLE +10% Delta JFK -27% DFW+20% ATL +3% SLC +2% CVG +11% Note: Changes in carrier service reflect total; changes in hub service reflect nonstop only. Source: Eclat Air Service Model, March 2002 vs. September 10, 2001

Network Carrier Exposure to Low Fare Carrier Competition Generally, and Southwest Specifically Increased Exposure Since 9/11 Delta American US Airways Low Fare Index (Delta = 100 ) Delta American US Airways Decreased Exposure Since 9/11 Continental United Continental United Exposure Unchanged Since 9/11 Northwest Northwest Percent exposure to Southwest Exposure to low fare competition 0 20 40 60 80 100

The Network Carriers Low Cost Competitive Weapon

How the Network Carriers Utilize Their Respective Regional Jet Fleets 1 st Quarter 2002 vs. 2 nd Quarter 1996 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% New AA CO DL NW UA US Average 43.0% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Replace Jet AA CO DL NW UA US Average 23.6% 16% Replace Turbo 80% Supplement Jet 14% 70% 12% 10% Average 9.0% 60% 50% 8% 40% 6% 4% 30% 20% Average 21.3% 2% 10% 0% AA CO DL NW UA US 0% AA CO DL NW UA US

Regional Jet Contribution to Mainline Network Nearly Everyone Uses Them Differently 250,000 200,000 RJs Turboprops 150,000 100,000 50,000 0 Delta US Airways Northwest United American Continental Revenue: $3.3 $1.8 $0.7 $1.6 $2.0 $1.6 ($ Billions) Network Presence: 64% 73% 91% 35% 45% 63% Regional Contribution: 64% 65% 64% 79% 90% 77%

American s Non-Hub Flying With RJs Non-Mainline Markets With Strategic Value to the Overall Network Bangor Oakland Detroit Cleveland Columbus Pittsburgh Portland Boston Providence Hartford Westchester Co. New York-LGA New York-JFK Newark Philadelphia Baltimore Washington-DCA Washington-IAD Richmond Norfolk Los Angeles Nashville Raleigh/Durham Phoenix Albuquerque Fayetteville Post-9/11 Capacity Reductions by Region -15% or More -10% to -14% -5% to -9% 0% to -4% Ft. Lauderdale

Deployment of RJ Capacity Since 9/11 Is This US Airways Network or Delta s? Halifax Montreal Bangor Toronto Albany Portland Boston Kansas City Grand Rapids Chicago South Bend Indianapolis Wilkes Barre Detroit Toledo Pittsburgh Cincinnati New York-LGA Newark Allentown Philadelphia Harrisburg Baltimore Evansville Huntington Charleston Newport News Charlottesville Post-9/11 Capacity Reductions by Region -15% or More -10% to -14% -5% to -9% 0% to -4% San Antonio Oklahoma City Dallas/Ft. Worth Texarkana Monroe Mobile Baton Rouge Houston-Hobby Houston-IAH Corpus Christi Nashville Tri-Cities Memphis Huntsville Atlanta Asheville Augusta Dothan Albany Brunswick Jacksonville Pensacola Tallahassee Orlando Raleigh/Durham Florence

Conclusions/Questions! Over the most recent past, the Low Cost/Niche carriers have measurably increased their share of the domestic market. In just the past six months, they have potentially increased their share 2.5 points.! The network carriers fear of significant encroachment is underscored by the capacity expansions announced by the largest carriers.! The influence of the low cost carriers in the West was significant, and further inroads have been made since 9/11.! Likewise, the low fare segment has increased its presence significantly along the East Coast over the past six months a trend that will continue.! Also, the growth of the mid-continent hubs by the low fare segment should be a concern, as pricing discipline will only increase. This growth will undermine pricing in the transcon market, which will be an important footnote in a bankruptcy filing or a loan guarantee application.

Eclat Consulting, Inc. 1555 Wilson Boulevard, Suite 602 Arlington, VA 22209 USA www.eclatconsulting.com Telephone 703.294.5880 Facsimile 703.294.5899