By Michael Manning / Published on Airchive July 31, 2014
This article first appeared the in the June 2014 issue of Airways magazine.
SQUEEZED BETWEEN THE POWERFUL U.S. domestic network airlines and the aggressive ultra low-cost carriers, an airline that offers an award-winning travel experience to both leisure and business flyers might not have a chance to grow, much less survive. Virgin America begs to differ with a unique marketing advantage.
Over the past year alone, thirteen million airplane seats have been removed from the skies by airlines as they reduce capacity. With little ability for growth projected for 2014, only the “ultra low cost carriers” of Allegiant Airlines, Frontier and Spirit Airlines are poised to expand. Indeed, the average domestic load factor reached 87.1% during the second quarter of 2013. Beyond this dire analysis, an argument can also be made that true marketing differentiation among airlines in the domestic U.S. market is almost non-existent, if not a source of apathy among passengers whose sole focus is the five letter word: P-R-I-C-E.
In the “low cost carrier” (LCC) category, Southwest Airlines has a unique marketing advantage, with its contagious corporate culture that encourages all employees to carry out their duties (on the ground and in flight) with humor and panache. After all, this was the first airline where this author experienced a passenger safety briefing sung in the Rap music genre by a flight attendant over the on board public address system. Outside of Southwest, a passenger would be hard pressed to associate anything significant about “flying in the aluminum tube” that would distinguish one airline over another.
When Airline Branding Mattered
In the “legacy carrier” category of U.S. airlines, one would have to go back to defunct Eastern Airline’s highly touted television and print campaign called the “Corporate Rate”. Created by marketing executive Jim O’Donnell, passengers in 1990 could purchase a First Class seat for the price of an unrestricted Coach Fare. In an aggressive bid to lure business flyers back to Eastern, passengers received an extra wide leather seat (aboard select aircraft), extra legroom, full meal service, and an extra-designated flight attendant. While unthinkable in today’s commodity-driven economy, Eastern took the bold step of doubling the size of their First Class cabins. The closest competitors to this program, TWA and American Airlines, merely offered extended legroom in Coach Class, only to abandon the program a short time later to maximize yields.
In the late-1990s, British entrepreneur and Virgin Atlantic Airways founder and chief, Sir Richard Branson, felt that there had to be a better way. He also observed the struggle that his archrival British Airways endured, after they were stymied from increasing their 24.6% investment in US Air.
Under U.S. law, a foreign investor is restricted to less than 50 % of the capital, and only 25 % of the voting rights on the board of directors. Convinced that regulatory authorities in the U.S. would eventually relax these restrictions and allow an increase in foreign investment, British Airways executives soon became fed up and divested themselves of their US Air stock. Branson was convinced that the U.S. commercial aviation industry had succumbed to a lamentable state of affairs. Passengers complained of surly service in the airports and in-flight. What Branson saw that was missing was the lack of any distinguishable service characteristics when deciding upon which carrier to fly. To this end, he reasoned that U.S. domestic passengers deserved better service and more amenities for their money.
No More Business As Usual
In early 2004, Branson decided to “shake things up” when his Virgin Group announced the intention to start a new United States-based airline named “Virgin USA” (later changed to Virgin America). He envisioned a low-fare airline that differentiated itself from competitors by providing domestic travelers with a higher level of comfort. Branson also envisioned offering coach seats at prices well below the fares of larger rivals.
To cite an example, Virgin America’s introductory fares between its base at San Francisco to New York were set at $278 round trip, at least $50 lower than the lowest advance fares available from United and American – the route’s two dominant carriers.
Similarly, Virgin America’s first-class service aimed to become a more comfortable experience, taking advantage of a high tech in-flight entertainment system at each seat called “RED” (a nod to the red-painted aircraft tails). Virgin’s then-CEO Fred Reid described “RED” as “arguably two or more generations ahead of anything in the U.S. market today”, offering 18 channels of TV from the Dish Network, pay-per-view movies and a wide variety of electronic games and music. Further, passengers would be able to text message each other, send drinks to one another, and order meals through the system at an extra cost in coach class.
A Change of Mood
Beyond technology, Virgin endeavored to introduce “mood lighting” inside its fleet of 53 Airbus A320’s to improve the passenger’s perception of the cabin environment and the passage of time through multiple time zones. These settings include “dawn”, “dusk” and “blue sky”. Further, the Virgin sense of “loosening the tie” (in self-deprecating fashion, Branson refers to himself as a “tie-loathing lothario”) and having fun has extended to the naming of various aircraft in the fleet.
Rock icon Grace Slick was on hand in 2006 to dedicate Virgin America’s new corporate headquarters, and an aircraft dubbed “Jefferson Airplane” after the legendary 1960’s band. Other aircraft names promoting this sense of fun include “Virgin & Tonic” and “Mach Daddy”. This attention to informality and on board amenities differed significantly from competitors, who were scaling back on such services to lower costs and improve yields. Clearly, Virgin America is no “peanuts and soft drink” only airline.
At the time of The Virgin Group’s announcement of its intentions to the press, the newly organized airline expected to become aloft by the following year. However, in a scenario reminiscent of Southwest Airline’s initial start up efforts in 1967, Houston-based Continental Airlines and the Airline Pilots Association (ALPA) met the initiative with strenuous opposition. Both groups alleged that the upstart would not be under U.S. ownership, but rather, operated as a subsidiary of Branson’s Virgin Group in England. This argument appeared to hold some sway with regulators at The Department of Transportation (DOT), who denied Virgin America’s initial application for an operating certificate on December 27, 2006. Indeed, The Virgin Group had provided an initial loan to Virgin America. However, formally, the airline is an independent licensee of the Virgin brand rather than a subsidiary of Virgin Group.
Undaunted by the DOT’s ruling, Branson ordered 33 new Airbus A320’s and selected veteran airline executive Fred Reid as CEO of the fledgling carrier.
Virgin America’s First CEO
A native of San Francisco and a graduate of the University of California at Berkeley, Fred Reid was raised in Africa and has lived in Asia and the Middle East. Beginning in the mid-1970s, Reid held marketing and management positions with Pan American World Airways and American Airlines. He went on to become President and Chief Operating Officer of Lufthansa. After privatizing the latter and restoring it to profitability, Reid became president of Delta Air Lines, where he led the creation of the airline’s low-fare branded airline ‘Song’, the Delta Connection regional subsidiary, and oversaw the acquisition of Atlantic Southeast Airlines and Comair (Airways, February 2014). Under his tenure, the SkyTeam global airline alliance was also created.Regarded as asavvy negotiator, Reid’s first 18 months at the helm of Virgin America in 2004 was spent lining up $162 million in financing from Black Canyon Capital and Cyrus Capital Partners. By November 22, 2005 the airline was capitalized and earned the support of city and state representatives from California and New York.
Eventually, the airline met the government’s fitness test, requiring that it was able to operate for at least one business quarter without any revenue.
In an effort to assuage concerns of regulators at the DOT, Virgin America amended its proposal for an operating certificate by restructuring voting shares of the new airline to be held by a DOT-approved trust. Under this structure, only two Virgin Group directors would serve on the eight-member board. In addition, the airline offered to remove Sir Richard Branson from the board and, amazingly, even drop the “Virgin” branding entirely. Fortunately, the latter proved to be unnecessary.
On March 20, 2007 Virgin America was given tentative approval by the DOT to commence operations, contingent upon changes to its business structure. These changes included replacing Fred Reid as CEO (to assure that a non-U.S. citizen wouldn’t have de facto control) thereby, significantly curbing the Virgin Group’s influence on the airline. The airlines first flights commenced on August 8, 2007 from New York and Los Angeles to San Francisco. Virgin America fought unsuccessfully to retain Reid as CEO; ultimately, he was permitted to stay on nine months after the airline’s certification. This agreement called for him to serve for six months as CEO, and three additional months as a consultant. Fred Reid was succeeded by David Cush on December 10, 2007.
Virgin Receives an American CEO
Born and raised in Shreveport, Louisiana, Cush served at American Airlines for 20 years as Senior Vice President of Global Sales, Vice President of American’s St. Louis hub, and Vice President of International Planning and Global Alliances. In addition to his tenure with American, David Cush also served as Chief Operating Officer of Aerolineas Argentinas, the national carrier of Argentina.
He holds a Bachelor of Fine Arts Degree in Broadcast/Film, a Bachelor of Science Degree in Psychology, and a Master’s Degree in Business Administration from Southern Methodist University
May I have the envelope, please?
Virgin America selected San Francisco as its base of operations, with its headquarters at nearby Burlingame, California. Operating from San Francisco International Airport’s Terminal 2, the airline states that it has created 2,600 new jobs and 36,000 related jobs in the Bay Area. Service routes include flights to Los Angeles, New York, Newark, Washington D.C. (IAD and DCA), Las Vegas, San Diego, Seattle, Boston, Fort Lauderdale, Orlando, Dallas-Fort Worth, Los Cabos, Cancun, Chicago, Puerto Vallarta, Palm Springs (seasonal), Philadelphia, Portland, San Jose, and Austin.
In a strange dichotomy, Virgin America has become a multi-award winning airline, but since its start in 2007, the airline has lost approximately $700 million. In 2013, Consumer Reports named Virgin America the “Best U.S. Airline”. The Airline Passenger Experience Association (APEX) awarded Virgin America “Best Overall Passenger Experience” and “Best Ground Experience” in 2013, and Skytraxawarded Virgin America with its 2013 “Airline of the Year” award. Conde Nast Traveler’s Reader’s Choice Awards chose Virgin America as “Best Domestic Airline”, and “Best Business/First Class” in the Condé Nast Traveler’s Business Travel Poll for five consecutive years (2008-2012). Travel + Leisure awarded Virgin “Best Domestic Airline” for six consecutive years (2008-2013), and Zagat’s Global Airlines Survey rated the airline #1 in Class in 2008, 2009 and 2010.
On May 21, 2009, Virgin America became the first U.S. airline to offer Wi-Fi access via the Gogo Inflight Internet on every flight. To inaugurate service, television personality Oprah Winfrey chatted with flight attendant Mandalay Roberts, aboard Flight 780 between Seattle and Los Angeles using Skype. Voice over IP, however, is not ordinarily allowed during flight.
In March 2010, Virgin America announced flights to Toronto from Los Angeles and San Francisco to begin on June 29th as the airline’s first international destination. However, high operating costs led the airline to cease Toronto service in favor of the higher demand at Dallas/Fort-Worth International Airport (DFW). Service to DFW began on December 1, 2010 with non-stop service to LAX and SFO. With typical Virgin flourish, Sir Richard Branson flew aboard the inaugural flight, which included a water canon salute for the arriving A320 aircraft, theme music from the iconic television series “Dallas”, an outdoor press barbeque, and live cattle in a partitioned corral on the airport tarmac. In his opening remarks, a jovial Branson dressed in Western clothing stated: “You’ve got a choice. You can either go on that other carrier, and get their kind of service—which is sort of a bit like those animals over there”, he said, gesturing to the cattle nearby. “Or you can come on the Virgin carrier, and you’re going to have a blast”.
American Airlines responded immediately to Virgin America’s incursion on its home turf by dropping prices twenty to thirty % on duplicate routes flown.
In April 2011, Virgin America’s hub at San Francisco International Airport relocated to the newly remodeled Terminal 2, sharing gates with American Airlines. A much reported reservation system outage in late October, during its migration to Sabre’s global distribution system (GDS) was resolved, and today Sabre handles Virgin America’s reservations, management of the carrier’s “Elevate” frequent-flier accounts, flight operations data, and crew scheduling.
On December 12, 2012, Virgin America introduced tits first airport lounge, entitled the “Virgin America Loft” in Los Angeles at the LAX Terminal 3, where drinks, snacks, and Wi-Fi are complimentary. Elevate Gold and Elevate Silver members receive a select number of complimentary day passes each year, while passengers flying Virgin America, or another Virgin America airline partner, can purchase day passes to the Virgin America Loft.
The Virgin America Cabin Experience
Virgin America offers dual-class service on all flights it operates. Both cabins feature the aforementioned “Mood Lighting”, and all seats are equipped with Panasonic Avionics’ RED personal in-flight entertainment system dubbed. Quite apart from texting and sending drinks to other passengers, features include a position mapping system, in-flight shopping with open tab capabilities, and enabling passengers to surf the Internet on the seat-back device without the need for a laptop. As the first U.S. airline to offer WiFi service, Virgin America also introduced “network on the fly”, the nation’s first in-flight social network application, using geo-location technology at 35,000 feet. Based on surveys of passengers conducted in San Francisco, Dallas and New York markets, the tech-savvy airline partnered with Here On Biz to enable passengers to download the free app (before their flight) through the Apple store. After signing in via their LinkedIn accounts, connections can be made with complimentary business passengers on their specific flight, other Virgin America flights in the air, or fellow travelers at their destination. Users can also manage their privacy settings, so that travelers can shut off or limit their visible connections to others onboard.
First Class cabin seats offer 55 inches (1,400 mm) of pitch and are 21 inches (530 mm) wide with power-ports, adjustable headrests, a massage function, and recline controls. Passengers receive complimentary meals, refreshments, alcoholic beverages, dedicated airport check-in, security screening, and aircraft pre-boarding. In First Class, RED offers free live satellite television, free on-demand movies, free on-demand television programming and a selection of games.
Main Cabin Select refers to Virgin America’s premium economy product. While not a distinct class (the service is located at Main Cabin seats in the exit rows and behind the bulkheads) passengers are afforded a 38 inch (970 mm) seat pitch, 17.7 inches (450 mm) of width and dedicated luggage bins. As with First Class, meals, refreshments, alcoholic beverages and premium priority services are complimentary.
Main Cabin offers 32 inches (810 mm) of pitch and 17.7 inches (450 mm) width with power-ports and adjustable headrests. RED is available with free live satellite television, pay-per-view on demand movies and on-demand television shows, a small selection of free games (with a larger selection of games for purchase).
Passengers may also purchase snacks, meals, and alcoholic beverages from their seats via RED. Flight attendants orders via a tablet computer for prompt food and beverage service.
Financial Performance and Fleet
Despite the industry’s highest customer service awards, becoming profitable has been an uphill battle for Virgin America. The airline’s 2012 net loss was $145.4 million.
In the first quarter of 2013, its bad streak continued losing $46.4 million – a slight improvement from its $76 million loss during the same period in year.
In the second quarter of 2013, however, the airline posted a net income of $8.8 million. This allowed for a third quarter operating income of $44.4 million and net income of $33.5 million. The airline posted an operating margin of 11.5%.
Between the second quarter of 2010 and the second quarter of 2012, the carrier took delivery of 25 Airbus A320 family aircraft. The airline has recently been cutting interest payments and deferring deliveries of new aircraft. Fleet plans now include accepting one new A320 beginning in July 2014, and four more by the end of the year. Five additional A320’s are scheduled for delivery by the end of 2015. Virgin America currently operates a fleet of 53 Airbus A320’s.
As 2013 drew to a close, Virgin America released an upbeat operational performance report for December and, indeed, the full year. The airline’s December traffic (RPMs) rose 7.1% on capacity (in available seat miles) that was 0.8% lower than the same month in 2012. Load factors in December were 81.9%, an increase of six points from the same month the previous year. The number of onboard passengers rose 10.7% from December 2012. Load factor for the full year were 80.2%, up one point from 2012.
In late October 2013, Virgin America created quite a stir in social media outlets when it released its Safety Video, which was set to song and dance. Relishing opportunities for fun themes, a little over a week later, “Operation Chihuahua” was implemented. Working with The San Francisco Animal Care and Control, and the ASPCA, an airlift flew puppies from overpopulated West Coast shelters to East Coast shelters, where demand exceeded availability.
First Full Year of Profitability in 2013
Virgin America’s Fourth Quarter 2013 results yielded $14.2 million in net income. This, compared to a quarterly loss of $25.0 million a year earlier. Total operating revenue of $359.9 million reflected an increase of 2.7% from the fourth quarter of 2012 as well. Revenue per Available Seat Mile (RASM) increased 4.1% to 11.70 cents. An increased load factor of 78.5% (up 1.6%) and yield (up 2.4%) contributed to the improved revenue per available seat mile. Capacity decreased 1.3% during the fourth quarter, while stage length decreased 8.1% to 1,426 miles.
Perhaps the brightest news for the airline was reaching a milestone of its first full year of profitability for 2013. Net income of $10.1 million reflected an increase of $155.5 million from a loss of $145.4 million in 2012.
Addressing Losses and Debt
The airline recently converted $290 million of debt (mostly owed to Richard Branson’s Virgin Group) into conditional equity that the debt-holders will own after an IPO, providing the stock hits predetermined targets.
According to Virgin America’s CEO, David Cush, a share offering would allow Virgin Group and other shareholders to recoup some of their investments. How much of the company might be offered to the public is wholly contingent on the strength of its finances. However, launching an IPO could come as early as mid-2014 to late 2015. The airline is also cutting interest payments and deferring deliveries of new Airbus A320’s. Slowing growth is a key component of making the airline profitable, Cush stated.
Meanwhile, the airline is intensely focused on expanding to Hawaii. It is currently considering targeting the large business hubs of Denver, Phoenix and Atlanta, according Cush, all of which are heavily fortified by United, US Airways, Southwest and Delta respectively. “Ultimately, we’re going to have to go into those places,” said David Cush.
“People are going to want to see some profit” before determining how much Virgin America is worth, he said. In January 2014, Virgin America announced the appointment of Intel Corporation Executive Vice President and Chief Financial Officer Stacey J. Smith to the company’s board of directors. The appointment was heralded by the airline’s Chairman Donald J. Carty “as the airline prepares for the next phase of its growth”.
Virgin America’s Bread and Butter: Trans-con Routes
Virgin America does much of its flying between New York, San Francisco and Los Angeles. It has recently added the San Francisco-Newark service, which puts it in head-to-head competition with United Airlines with hubs in both of those cities. Cush says that Virgin America’s flights to Newark are already profitable, but how long can this profitability last against the entrenched United Airlines (which assumed the Cleveland hub from its merger with Continental)?
“We can sustain it forever. We think it’ll be profitable at current fare levels,” said Cush. “All it did was reduce Newark fares to the same level as JFK fares”.
Virgin America’s coast-to-coast flying has been met with fierce resistance from other airlines. The carrier flies from San Francisco and Los Angeles to Boston, New York, Philadelphia and Washington with two-thirds of its capacity in the California-East Coast markets. Cush said the JFK Airport routes are the most profitable. JetBlue announced in late July that it will add new first-class cabins with premium sleeper seats for transcontinental flights aboard its Airbus A321s. “JetBlue is a great airline with a great product, just as we are,” Cush responded. “But it’s a question of whether you can create a first-class product and first-class service in a small percentage of your markets”, he added. JetBlue’s new product would be offered initially on 16 seats on trans-con flights from New York. “We have first class in all our markets,” Cush said. “It’s not as simple as throwing a lie-flat seat on your plane and calling it a first-class product.” Meanwhile, United Airlines increased its flying from nine flights per day to 15 between San Francisco and Newark.
The remaining “legacy carriers” (American, United and Delta) are pitted against low-cost carriers (Southwest, JetBlue and Virgin America), and “ultra low cost carriers” (Allegiant, Frontier and Spirit Airlines). Of the low-cost carriers, JetBlue and Virgin America have embarked on a strategy to target the business flyer.
Commenting on Virgin America’s incursion into Newark, New Jersey in April 2013, a United Airlines hub, Wolfe Research analyst Hunter Keay criticized the strategy with harsh words, citing the move as “an example of behavior that still keeps many longer term equity investors out of these stocks.”
Virgin began flying from Newark to San Francisco and Los Angeles with $99 one-way fares. Keay, feels her criticism is justified.
“[United] responded by nearly doubling its frequencies in that market, which now has 111 % more capacity than it did over the prior decade, on average. Fares remain depressed, with both airlines charging an identically sickening $381 for travel less than two weeks away”, she said.
In separate interviews, Virgin America CEO David Cush and Chairman Donald Carty (former chairman and CEO of American Airlines) defended their strategy by stating that the airline’s business model is far more sensible and realistic than industry analysts consider it to be. “The efficacy of the model is showing up, and we’re making money,” Carty said. “That sort of belies the thesis that you can’t make money doing things differently.”
New Routes from New York’s LaGuardia & Washington’s Reagan National Airports
In early December 2013, Virgin America purchased 12 of the 34 takeoff and landing slots at New York’s LaGuardia Airport that American Airlines had given up for government approval of its merger with US Airways. Southwest Airlines purchased the remaining 22 slots.
In February 2014, Virgin America also acquired 4 takeoff and landing slots at Reagan National Airport (DCA).
US Airways and American agreed to give up 52 slot pairs at LaGuardia, Boston’s Logan Airport, Chicago’s O’Hare Airport, Reagan National Airport in Washington, Miami International and Dallas Love Field. The slot divestiture is central to settle a lawsuit brought by the Department of Justice seeking to block the airlines from merging.
The Justice Department selects which airlines are eligible to buy the assets, and maintained that the slot and gate sales would give low cost competitors better access to some of the country’s busiest airports.
Since its launch in 2007, Virgin America flies to San Francisco, Los Angeles, New York, Newark, Washington D.C. (IAD and DCA), Las Vegas, San Diego, Seattle, Boston, Fort Lauderdale, Orlando, Dallas-Fort Worth, Los Cabos, Cancun, Chicago, Puerto Vallarta, Palm Springs (seasonal), Philadelphia, Portland, San Jose, Austin and Anchorage (seasonal).
With the much heralded news of finally achieving its first full year of profitability, one this is certain. The airline has withstood years of an uncomfortable dichotomy of distinguishing itself from competitors with inflight amenities and cabin service not seen in the U.S. since the early 1990’s. With sheer tenaciousness, the airline is positioned for an initial public offering to expand services and survive with a unique marketing advantage against all odds.
All photos courtesy of Virgin America.
Contact the editor at Jeremy.Lindgren@Airchive.com.