How many times have you heard the word “lucrative” associated with international and/or business class flying? Yeah, me too. That was obviously the thinking behind upstarts like EOS (whose lie flat beds in their all-premium class 48-seat 757 aircraft are shown at right), SilverJet, and others. I can imagine how the discussions that led to those start-ups went: “Hey, airlines make all their money flying business passengers on overseas routes, so how about we start an airline where that is all we do! We’ll get all the lucrative customers and be a lucrative company!” Of course, there is a lot of truth to that, but can such up-starts get a positive return on investment before the inevitable competition squashes those “lucrative” margins?

So, why, exactly, is it that international business class flying is so much more lucrative than “normal” flying? I see two predominant factors at play: restrictive bilateral agreements and “soft” competition on international routes. Typical bilateral agreements between nations put a cap on the number of flights between two sovereigns and the respective governments are typically responsible for awarding routes to airlines. These were effectively government sponsored monopolies on routes. Additionally, I believe competition has been relatively soft on these routes because the major carriers are better at not triggering price wars, which is a lot easier to avoid when you don’t have LCC’s flying the same routes.

The business landscape on this lucrative flying is changing very quickly and the factors that allowed for abnormal profitability are waning. The EU-US Open Skies agreement obviously opens up the trans-Atlantic flying to new market entrants and therefore increased competition. Market entry by the all premium class international carriers such as EOS, SilverJet, L’Avion, and MaxJet (which has already gone out of business) simply prompted the carriers whose business these new entrants intended to steal to react with similar offerings. British Airways (flying an A318 to where?!?!) and American Airlines have responded with increased amenities and offerings for the premium international traveler on trans-Atlantic routes, and Singapore International Airlines has just announced that they intend to the same on the trans-Pacific front. Add to that the desire of Low Cost Carriers to enter the fray, the prime example being Ryan Air’s stated intention of offering bargain fares to cross the pond.

Expect abnormal profitability from international routes and business/premium class customers to be competed away (think “reversion to the mean”, for you statistics-minded people out there). In the end, “lucrative” is great if you are in business, but “sustainable” is probably better. Mark my words, competition for international and business travelers will get vicious, first on the EU-US routes followed next by US-Asia routes. Airlines that are relying on this business to subsidize other pieces of their enterprise need to get in front of this and expect a reversion to normal levels of profit from this component of your business (it’s scary to think what “normal levels of profit” means in the airline industry). It won’t happen over night, but expect it to happen.

I was struck by the seeming contradiction in the October 16th conference call with Delta Airlines. Namely, Richard Anderson, CEO of Delta, spoke of consolidation within airline industry and then later implied that Delta is likely to divest its regional subsidiary, Comair. So, consolidation “makes sense” to Mr. Anderson, but so too does spinning off its regional? On the surface, this seems contradictory, but a closer look at how competition within the airline industry works reveals that, at least superficially, this makes a lot of sense.

The distinction that must be made here is between the different relationships that mainline carriers have with regional airlines compared to other mainline carriers. Other mainline carriers are direct competitors whereas regionals are really act as suppliers to mainline carriers. Thus, when a mainline carrier acquires a regional, it is essentially an act of vertical integration. Although the airlines avoid trying to say it out loud, the primary benefits from mainline consolidation are anticompetitive in nature. I.e., cancel overlapping flights and hopefully raise prices. The benefits from integrating a regional into a mainline are, supposedly, lower costs and more control. However, most of the benefits from such a relationship would appear to befall the regional more so than the acquiring mainline. The biggest downside from a mainline owning a regional subsidiary is that they can not employ the thumbscrews when it comes time for the next contract negotiation. Delta, for example, has contracts with several regional carriers, including Comair. These regionals have to compete against each other for Delta’s business and regionals live or die by their relationships with the majors. Mainline carriers clearly have the advantage at the bargaining table as they can easily make a credible threat of flying the routes themselves. Regionals lost the credibility of making a similar threat when Independence Air went bankrupt after striking out on its own. Competition for these contracts is fierce. So, it should not be surprising that Delta feels it would be better off with Comair as a separate entity. As such, Delta will be able to put outside pressure on Comair that it likely can’t do as the owner.

American Airlines seems to share the same view as Delta, as Gerard Arpey indicated in their last conference call that they are also considering selling their regional subsidiary, American Eagle. Unlike Delta, however, American seems more realistic about the difficulties of consolidation of mainline carriers and projected a more pessimistic tone for such transactions.

There is one other timely reason for mainline carriers to spin off their regionals: airport congestion. Given the increased traffic delays and increasingly louder outcry from public officials, there has been a call on airlines to replace regional jets with larger aircraft making fewer flights. Shifting the ownership of those regional jets gives the mainlines a little bit more “plausible deniability” for their role in the problem.

Thus, the industry is left in an awkward position where it makes little sense for mainline carriers to own their own regional carrier when it is easier for them to pit the regionals against each other for their business. This, in turn, leads me to believe that consolidation within the regionals is the next logical step. Only when there are fewer regionals at the bargaining table with the majors will the regionals have the ability to negotiate from a position of power. Of course, if that happens, then it will make sense for the mainlines to consider acquiring regionals again….

Steven Levitt, of Freakonmics fame, blogged yesterday about his invitation to be interviewed by Sky Radio Network, airing on American Airlines. Although accustomed to turning down dozens of interview requests a week, he decided that he would agree to this interview request. That is, until he realized that this was not an interview request, but a sales pitch to get a sound bite delivered to a captive audience under the auspices of journalism. Dr. Levitt was afforded the opportunity to pay just $3,995 to get his interview aired on AA via Sky Radio Network’s programming.

All of my flying over the past several years has pretty much been limited to short haul flights on so-called regional airlines, so Sky Radio Network was new to me. Jumping over to their website you are instantly greeted with a long list of prominent personalities and the ability to listen to their interviews. Had I just stumbled upon the site, my first impression may have been that I found a treasure trove of information, but, finding it as I did, my first thought was “Wow! Look at all these people who shelled out four grand to make an infomercial!”. However, given some of the names on the homepage, I think it’s a safe bet that not all the interviews were paid for by the interviewee. And therein lies the problem: if you can’t tell the difference between an interview and an infomercial, the the credibility of all of them becomes suspect. My guess is that the masking of the fact that the “interviews” are paid for by the interviewee is part of Sky Radio Network’s business plan. To be fair, at the bottom of each web page the statement “Guests on our shows may have paid a fee to appear.” can be found. How many of you frequently read the footers of webpages?

I just listened to about 15 minutes of “Radio Entrepreneur” as broadcast by Sky Radio Networks on American Airlines, and I have it say it was a little painful. It started out decent enough, with what was probably a “real” interview, but then turned into a series of infomercial-esque “interviews”. One was particularly amusing at the “interviewer” said something like “this is exciting” in a dead monotone voice. I’m sure it’s pretty obvious to most people that these interviews are really advertisements, but no where in the programming was that explicitly made clear.

It is easy to see how Sky Radio Network is attractive to the airlines. As airlines become more savvy at finding and exploiting “ancillary” revenue streams, getting paid to broadcast radio programming on flights is a great proposition. My initial line of thought was that American Airlines, or any other airline broadcasting this programming, could be adversely affecting by associating their name with the broadcast. However, I think that is really pretty unlikely given what I just listened to, just like I doubt a passenger would look down on an airline for making the Home Shopping Network available through a seat-back TV.

Perhaps Sky Radio Network and/or American Airlines should reconsider their existing model. Obviously there is a market where passengers will pay to listen to or watch CNBC or ESPN, but ad-supported broadcasting on airlines likely has more potential than is currently being exploited. I’ve stared at a moving map display in the seatback of a Frontier flight for hours because I was too cheap to pay for the programming, but I would have happily sat through commercials in order to have something free to listen to or watch. Likewise, I’m sure a lot of passengers would be interested in hearing a thoughtful interview of Steven Levitt, and he was there for the taking until he was asked for $3,995.