How Airports Plan for Changing Aircraft Capacity: The Effects of Upgauging (2019)

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12 This chapter provides a brief overview of the key historical changes in the aviation industry, with a focus on the evolution of the airline business in the United States since the Deregulation Act of 1978. The goal is to present high-level information regarding the airlines’ customary planning objectives and strategic considerations involved in the management of aircraft fleets and the development of new routes at a network level. Using a complex variety of factors, airlines plan their development on a system-wide basis and usually on a shorter horizon than airports plan for their own development. This timing inconsistency is generally a source of uncertainty in the assessment of future airport activity and can potentially result in risks to airport investments. For this reason, it is important to determine the causes of airline upgauging (or downgauging) to better understand the impacts on airports and identify the best solutions and practices to develop flexible plans and strategies at the airport level. While this chapter looks primarily at the airlines’ perspectives, chapters 3 through 5 will present the airports’ and state agencies’ opinions on the subject matter collected through the survey and follow-up interviews. Airline Mergers and Market Consolidation In 1978, the Deregulation Act allowed airlines to choose their own fares and routes. These changes radically modified the industry landscape as well as the passenger experience. It increased the competition between airlines, creating more choices for air travelers and lower fares. The 2016 McGill University paper referenced in Chapter 1 gives an overview of the aviation market conditions over the course of the 30-year period following the Deregulation Act: [M]arket conditions and competition laws promote high frequency with small aircraft and, therefore, on many long-established routes . . . , airlines have down-gauged their aircraft by roughly 30% so that 3 flights in 2012 carried roughly the same number of passengers as two flights did in 1992. Competition is such that it is not uncommon to see competitor’s jets follow each other across the skies (Fitzgerald 2016). However, after 20 years of traffic growth and an exponential increase in the number of airlines with access to the market, the aviation sector was severely affected by the events of September 11, 2001 (9/11). For the past decade, the industry has been experiencing a major cycle of airline mergers and market consolidations, with many other airlines entering bank- ruptcy and eventually having to cease operations. The effects of this market consolidation have rapidly translated into two major trends that have had direct impacts on airport facility and operations planning: (1) the development of airline hubs and (2) the growth of low-cost carriers. C H A P T E R 2 Literature Review

Literature Review 13 The four most notable deals of airline mergers from the past 8 years are as follows (see also Figure 2): • Delta Air Lines’ acquisition of Northwest Airlines closed in December 2009. This merger resulted in forming the world’s largest airline at that time. • United Airlines’ acquisition of Continental Airlines closed in October 2010 and United replaced Delta Air Lines as the world’s largest airline. • Southwest Airlines’ acquisition of AirTran closed in May 2011. • American Airlines’ acquisition of US Airways closed in December 2013 and American replaced United Airlines as the world’s largest airline. The successful completion of this market consolidation has resulted in a domestic airline landscape of only 10 large air carriers, down from the 18 carriers in operation a decade ago. Airline strategist Tom Bacon summarizes the current structure of the U.S. airline industry in a recent article (Bacon 2017): • Four carriers with over 80% of domestic capacity: – Three large, hub-oriented, global legacy carriers (American, United, Delta) – One large, point-to-point oriented “low cost” carrier (Southwest) • Six much smaller carriers, each with less than 5% of the market – Three smaller, primarily hub-oriented carriers (Alaska/Virgin, JetBlue, Hawaiian) – Three much smaller point-to-point travel merchandisers, heavily reliant on ancillary fees, so-called “ultra low cost carriers” or “ULCCs” (Spirit, Frontier, Allegiant) This period of consolidation was also accompanied by a period of “capacity discipline” for the airlines. Various studies analyzed that particular period of the aviation industry when airlines had carefully managed their seat capacity increase between 2011 and 2015, even though the economy began improving. Bachwich (2017) explains that strategy, saying the airlines Figure 2. Recent U.S. airline mergers (Source: www.usfunds.com).

14 How Airports Plan for Changing Aircraft Capacity: The Effects of Upgauging “carefully control their capacity growth and instead focus more intently on increasing profit- ability.” According to the same study, “system passenger yields at NLCs (network legacy carriers) increased from 12.90 cents per mile in 2010 to 14.59 cents per mile in 2015—a 13.2% increase” (Bachwich 2017). In addition to airlines’ network planning considerations and market share strategies, ACRP Report 18 (Martin 2009) notes the key role played by the change of passengers’ behavior and expectations in the development of airline hubs and the low-cost-carrier model. • Leisure passengers leak to smaller airports with LCC service: “leisure travelers who typically value fare savings over total travel time—will drive relatively long distances to reach an airport served by Southwest, AirTran, Frontier Airlines, or other LCCs” (Martin 2009). • On the other end, “Business passengers leak to larger airports because of: – More nonstop destinations, – Frequencies, – Choice of arrival and departure times, – Ease of access by highways, and – Fares”(Martin 2009). Looking back, from the 1978 deregulation onward, at the different market cycles that resulted in significant and multiple changes for the airline industry’s landscape, one of the main questions that the airport sector must answer to better plan for the future is, What happens next? According to Bacon (2017), the next consolidation phase could lead into two major groups: the national multi-hub carrier and the ultra-low-cost carriers (ULCCs), resulting from further merger opportunities primarily driven by potential shocks (e.g., fuel price variation), reactionary moves, and geographic logic (see Figure 3). Network Planning and Strategic Alliances A large variety of complex and detailed strategies can be implemented by airlines to increase their market share, sustain their competitive advantages, and ensure profitability of strategic elements in their network. These different system planning and management techniques are generally categorized in two main families: hub-and-spoke and point-to-point. ACRP Report 18 (Martin 2009) gives an overview of these two families in terms of airline objectives and passenger perception. In theory, hub-and-spoke systems emerged as the most Figure 3. U.S. airline industry consolidation (Source: Bacon 2017).

Literature Review 15 efficient means for connecting passengers between two different locations. Passengers often do not care for connecting over hubs, but hubs do allow airlines to aggregate traffic in ways that make serving many smaller communities possible. On the other end, only a certain number of markets will be able to support nonstop service. Point-to-point nonstop flights require substantial demand in the local market to justify such service. Other factors, such as flight frequency, times, and total travel time play a key role in the way airlines build their network, based on an assessment of customers’ preferences and expectations. These factors will have a direct effect on a particular airport’s attractiveness for airlines and air travelers (business and leisure): Business travelers generally prefer to travel early in the morning and in the late afternoon to maxi- mize time at their destination. Leisure passengers may travel at any time of day. If sufficient passenger demand exists, a typical minimum flight complement in a city pair is three flights per day—morning, noon and evening. In many leisure markets, one flight per day may be sufficient to match the market demand (Martin 2009). In addition to building efficient and profitable networks of routes and airports, airlines have expanded the use of bilateral and global agreements with each other to keep being competitive and attract more passengers. Through alliances and joint ventures, airline partners share common economic incentives to promote the success of the alliance over their individual corporate interests. By pooling resources to improve the overall service offering, and by sharing gains and losses, the partners are able to harmonize the global network and become indifferent as to which of them collects the revenue and operates the aircraft on a given itinerary. They are then able to focus on gaining the customer’s business by providing the best available fare and routing between two cities (Fitzgerald 2016). Since the first airline joint venture in 1997 between Northwest Airlines and KLM Royal Dutch Airlines, a multitude of bilateral agreements have been successfully initiated. In addition, three major global airline alliances are currently shaping the aviation landscape: Sky Team, Star Alliance, and One World (see Figure 4). Number of member airlines 35 30 25 20 15 10 5 2000 2002 2004 2006 2008 2010 2012 2014 Figure 4. Historical development of airline alliances (Source: www.oag.com).

16 How Airports Plan for Changing Aircraft Capacity: The Effects of Upgauging ACRP Report 98: Understanding Airline and Passenger Choice in Multi-Airport Regions (Parrella 2013) provides additional details and explanations on airlines’ evaluation of the underlying size and nature of air travel demand. Such evaluation will address the following: • Size of the overall market • Nature of the market (business versus leisure, propensity to travel, disposable income, etc.) • City-pair market sizes (past and current) • Market demand, traffic trends, and causality (growth, stagnation, decline) • Specialized business demand drivers (corporate headquarters, production facilities, etc.) • Inbound leisure demand (resort destinations, seasonal traffic, special events, etc.) • Ethnic and cultural market affinities (diaspora, family visitation travel, etc.) These primary characteristics of air travel markets will be quantified, evaluated, forecast, and applied to potential air service scenarios as part of airline route planning efforts grounded in the airline’s business model considerations. While airports will be able to examine and understand some of these factors, they generally have difficulties capturing comprehensively all the data and underlying economic drivers that will be used by airlines. For this reason, as part of the survey and individual interviews discussed later in this report, the project team tried to briefly extract socioeconomic data at the local level, to provide the reader with additional perspective on the responses given in the survey. Fleet Management and Aircraft Upgauging Various factors enter into considerations when managing a fleet of aircraft, in both domestic and international markets. While the intent of the report is not to research in detail the processes and tools involved in fleet management, this section provides a high-level summary of the key parameters considered in the selection of aircraft types and sizes: Market Characteristics ACRP Research Report 163: Guidebook for Preparing and Using Airport Design Day Flight Schedules (Kennon et al. 2016) explains the following: Generally, short-haul markets are served with small aircraft at high frequency, and long-haul markets are served with large aircraft at low frequency. Competitive markets (those served by more than one airline) tend to be served by smaller aircraft with greater frequency than noncompetitive markets of similar size and segment distance. Business markets tend to be served with smaller aircraft at greater frequency than leisure markets because business travelers select flights largely on the basis of schedule. Operating a greater number of smaller aircraft costs the airlines more on a seat-mile basis, but they are able to recoup those costs because of the premium fares paid by time-sensitive business travelers. Pilot Shortage and Perspectives According to the FY 2017–2037 FAA aerospace forecast, “the regional airlines in the United States are facing pilot shortages and tighter regulations regarding pilot training. Their labor costs are increasing as they raise wages to combat the pilot shortage while their capital costs have increased in the short-term as they continue to replace their 50 seat regional jets with more fuel efficient 70 seat jets” (FAA 2017, 11). Regional airlines have experienced some of these challenges following the new pilot quali- fications standards that the FAA made effective in 2013. The new standard, commonly called the “1,500-hour rule,” has increased the qualification requirements for first officers who fly

Literature Review 17 for U.S. passenger and cargo airlines. According to the FAA (2017), “the rule requires first officers—also known as co-pilots—to hold an Airline Transport Pilot (ATP) certificate, requiring 1,500 hours total time as a pilot. Previously, first officers were required to have only a commercial pilot certificate, which requires 250 hours of flight time.” The 2017–2037 FAA forecast shows that the number of active GA pilots (excluding ATPs) is expected to decrease about 7,500 (down 0.1% yearly); the ATP category is forecast to increase by 15,500 (up 0.5% annually). The numbers are provided in Figure 5, which shows the projec- tions by type of certificate for the period 2006–2037. On the other end, the FY 2017–2037 FAA forecast predicts that the number of aircraft in the U.S. commercial fleet would increase from 7,039 in 2016 to 8,270 in 2037, an average growth rate of 0.8% a year. Later in this chapter, the “Aircraft Market Outlook and Fleet Forecast” section will present additional fleet growth details by aircraft type, especially for mainline traffic and narrow-body aircraft versus regional. The general discrepancy observed between commercial traffic growth predictions and the relatively low increase of active pilots is seen by some industry stakeholders as a potential “pilot shortage.” Pilot availability in the country and policies regarding training requirements can also play a role in some instances when airlines develop their fleet management strategy. On this topic, ACRP Report 98 (Parrella 2013) notes, “Although capacity decisions are driven primarily by commercial opportunity, existing staffing levels can heavily influence network and planning decisions—particularly at established full- service carriers.” Fuel Efficiency Fitzgerald (2016) indicates that “fuel prices that rose dramatically between 1998 and 2005” have been also a major factor in the airlines’ decision to look at larger aircraft for their short-haul domestic markets with lower cost per passenger than the 50-seat regional jets. In May 2012, Delta announced a major upgauging initiative. It would acquire 88 100-seat Boeing B717s and Figure 5. Active pilots by type of certificate (Source: FAA 2017).

18 How Airports Plan for Changing Aircraft Capacity: The Effects of Upgauging require its commuter partners to dispose of 281 50-seat regional jets, cap the 70-seat regional jet fleet at 102, and increase by 70 the size of the 76-seat two-class regional jet fleet to 325. To meet airlines’ expectations on aircraft fuel efficiency, manufacturers have been striving to innovate engine performance and airplane aerodynamics. The consequent research and development effort put toward the achievement of this goal has progressively shaped the “new generation” aircraft characterized by its longer wings (extended by winglets) and its much wider engines. For instance, Boeing announced a 20% fuel cost savings when it introduced the B787 Dreamliner in 2011. Due to the higher fuel efficiency of this new generation of aircraft, its introduction has played a key role in the opening of the long-haul international market to LCCs, such as Norwegian Air Shuttle. In 2018 Norwegian was operating 20 B787s and had 22 more on order. In addition to the availability of these new generation aircraft, secondary airports have recently been able to attract new international LCCs by offering economic incentives to open long-haul routes. A New York Times article (Negroni 2017) notes the combination of factors, such as new generation aircraft fuel efficiency and financial incentives, that allow secondary airports to have access to these new markets. Negroni (2017) gives the example of Bradley International Airport in Connecticut: “Bradley Airport has budgeted about $3.6 million for a three-year marketing effort, while the State of Connecticut has given Aer Lingus revenue guarantees of up to $4.5 million a year for two years while it establishes its route.” These key economic factors will be discussed in the next chapters of the report, as part of the national airport survey and the individual interviews with some of these secondary airports. Aging Fleet and Aircraft Replacement According to Airbus (2017) and as shown in Figure 6, aging aircraft are a particular issue for the North American market, since, on average, the North American airlines fleet is much older than in the rest of the world: • North American average fleet age (in 2015): – 12 years for single-aisle – 15 years for twin-aisle • World average: – 9 years for single-aisle – 10 years for twin-aisle • 50% of the North American fleet is aged 13 and above. In the United States, among the three “Majors,” Delta has the oldest fleet mix with an average age of 16.8 years, followed by United. Of the three, American Airlines has the youngest fleet with an average age of 10.1 years. For the two largest LCCs, Southwest and JetBlue, their respective fleet has an average age of 10.5 and 9.3 years, respectively (see Figure 7). Each airline is going to implement a unique strategy to maintain and renew its aircraft fleet, based on its business model, operational needs, and financial situation. A 2015 CAPA article analyzes the different techniques used by U.S. airlines and groups them into two main approaches: • Hybrid model (Southwest, United, and Delta): These airlines opt to take new deliveries while accessing the used markets when favorable opportunities arise. They mix new and used aircraft. • Low fleet age model (Alaska, JetBlue, and American): These airlines are opting to stick to their orderbooks and take delivery of new-build aircraft rather than switch to a hybrid model of adding new and used jets (CAPA 2015).

Literature Review 19 Note: CIS = Commonwealth of Independent States. Figure 6. Global fleets in service age (Source: Airbus 2017). Note: AA = American Airlines. Figure 7. U.S. airlines average fleet age comparison (Source: http://www.airfleets.net).

20 How Airports Plan for Changing Aircraft Capacity: The Effects of Upgauging Figure 8 shows a comparison of U.S. domestic airlines’ fleet age by aircraft type and size. It presents an overall picture of the current aircraft use and how airlines are currently imple- menting their fleet management and replacement strategy. The next section of this chapter will present the aircraft market outlook and fleet forecast, based on the current strategies used by U.S. domestic and international airlines. Aircraft Market Outlook and Fleet Forecast On the basis of the many factors that drive changes in passenger behavior, aircraft character- istics, and airlines strategies, the FAA, the two main aircraft manufacturers (Boeing and Airbus), and other industry organizations develop and publish on a regular basis their forecast and global market outlook aimed at predicting the future of the airline and airport industry. These documents are usually a good source of information to better understand the current and future trends of aircraft equipment and technology expected to be used in the airline and airport industry. According to the FY 2017–2037 FAA Forecast, “the number of aircraft in the U.S. commercial fleet is expected to increase from 7,039 in 2016 to 8,270 in 2037, an average annual growth rate of 0.8%. Increased demand for air travel and growth in air cargo are expected to fuel increases in both the passenger and cargo fleets” (FAA 2017, 28). Figure 9 shows the forecast by U.S. carrier fleet, per aircraft category: mainline NB (narrow- body aircraft), mainline WB (wide-body aircraft), cargo jets, and regionals. The FAA forecast provides a detailed overview of the aircraft market outlook and fleet forecast for the U.S. airlines industry. The FAA (2017, 28) makes the following observations: • Between 2016 and 2037 the number of jets in the U.S. mainline carrier fleet is forecast to grow from 4,073 to 5,199, an average of 54 aircraft a year as carriers continue to re-move older, less fuel-efficient narrow body aircraft. • The narrow body fleet (including E-series aircraft at American and JetBlue) is projected to grow 37 aircraft a year as carriers replace the 757 fleet and current technology 737 and A320 family aircraft with the next generation MAX and Neo families. • The wide-body fleet grows by an average of 17 aircraft a year as carriers add 777-8/9, 787’s, A350’s to the fleet while retiring 767-300 and 777-200 aircraft. In total the U.S. passenger carrier wide-body fleet increases by 67 percent over the forecast period. • The regional carrier fleet is forecast to decline from 2,156 aircraft in 2016 to 2,027 in 2037 as the fleet shrinks by 14 percent (309 aircraft) between 2016 and 2025. Carriers remove 50 seat regional jets and retire older small turboprop and piston aircraft, while adding 70–90 seat jets, especially the E-2 family after 2020. • The cargo carrier large jet aircraft fleet is forecast to increase from 810 aircraft in 2016 to 1,044 aircraft in 2037 driven by the growth in freight RTMs. The narrow-body cargo jet fleet is projected to increase by less than 1 aircraft a year as 757’s and 737’s are converted from passenger use to cargo service. The wide body cargo fleet is forecast to increase 11 aircraft a year as new 747-800, 777-200, and new and converted 767-300 aircraft are added to the fleet, replacing older MD-11, A300/310, and 767-200 freighters. The forecast and market outlook information from the FAA and from other industry orga- nizations will be discussed as part of the airports survey and individual case examples chapters. In particular, the goal of this synthesis was to obtain insight from airport managers and operators on how they manage and plan for the future changes of airlines’ fleet and operations predicted by the FAA and other agencies.

Note: AA = American Airlines. Figure 8. U.S. airlines fleet age comparison by aircraft type (Source: http://www.airfleets.net, DY Consultants analysis).

22 How Airports Plan for Changing Aircraft Capacity: The Effects of Upgauging Impacts of Airline Consolidation and Upgauging on Airports After noting the effects of airline consolidation and aircraft upgauging on airports, recent studies show that airline business model changes have affected aviation communities and stakeholders in different ways. In particular, Bachwich (2017) looked at the trends and key impacts of those changes during the period 2006–2015. The causes and effects that were analyzed include the factors summarized in the previous sections, such as cost convergence between traditional LCCs and NLCs, multiple rounds of consolidation, airlines network and fleet strategies, and a recent period of “capacity discipline.” One key finding from the study was that “seat capacity has grown at large hub airports from 2006–2015, whereas smaller airports have all seen declines in service levels to varying degrees.” In particular, the study shows “how secondary airports in major metro areas have been affected by changing LCC strategies, and how the smallest airports have experienced significant declines in NLC service, yet some gains in ULCC service” (Bachwich 2017). Figure 10 gives an overview of the seat capacity trends observed at different airport size categories: large-hub, medium-hub, small-hub, and non-hub airports. At large-hub airports, after a drop during the period 2006–2012, annual seat departures recovered in 2015 (591 million) to a level greater than in 2006 (550 million). At medium hubs, annual seat departures had followed a similar trend, experiencing a recovery period since 2012. However, their 2015 level has not gotten back to prior 2006 numbers. Bachwich (2017) shows that both small airports and non-hub airports are still in a period of reduction of seat capacity. Annual seat departures at small and non-hub airports decreased 18.6% and 13.4%, respectively, from 2006 to 2015. Unlike larger airport categories, these markets have not seen a reversal in the declining trend since 2006. Note: NB = narrow-body aircraft; WB = wide-body aircraft. Figure 9. U.S. carrier fleet forecast (Source: FAA 2017).

Literature Review 23 Note: NLC = network legacy carrier; LCC = low-cost carrier; ULCC = ultra-low-cost carrier. Figure 10. Capacity trend by airport category (Source: Bachwich 2017). Note: NLC = network legacy carrier. Figure 11. NLC changes in flights and seats, 2006 versus 2015 (Source: Bachwich 2017). The difference of impacts on different airport markets can also be observed with flight frequency. Bachwich (2017) also analyzed the changes in number of flights operated by NLCs at the four airport categories for the same period (2006–2015), as shown in Figure 11. Figure 11 and Bachwich (2017) show that “from 2006 to 2015, non-hubs lost 37.3% of their NLC flights yet only 22.6% of their seat capacity, indicating an increase in gauge, suggesting many 50-to-76 seat aircraft replacements.” Similarly, small hubs lost 34.5% of their NLC flights, while losing 24.9% of seat capacity. Medium hubs lost the most frequency (with a 42.7% reduction in NLC flights from 2006 to 2015), while large hubs experienced the lowest loss for both flights and seat capacity for the same period. Eventually, these disproportionate impacts of reduction of seat capacity and flight frequency between large/medium hubs and small/non-hub airports lead to a reduction in connectivity

24 How Airports Plan for Changing Aircraft Capacity: The Effects of Upgauging for the smaller communities. While the LCCs and ULCCs mostly provide point-to-point connections, gradual reductions of NLC air service at smaller airports directly limit the number of destinations accessible for these communities. As shown in Figure 12, the large majority of connectivity comes from NLC air service at these airports. Since the airline upgauging trend can have many different impacts on airports, depending on their size, geographic location, mission, and customers’ behavior patterns (e.g., leisure versus business travelers), the goal of this study was also to obtain and collect feedback from a large variety of airport stakeholders. These valuable insights were collected through online surveys and individual interviews and are summarized in the next chapters of this report. The intent is to develop a database of concrete case examples and to document practical examples of impacts to support the observations made earlier in the report. Note: NLC = network legacy carrier. Figure 12. Percentage of total connectivity lost without NLCs by airport category, 2015 (Source: Bachwich 2017).