Will Unbundled Amenities be the Future for Budget Hotels? Sponsored This content is created collaboratively with one of our sponsors.
Having just broken even, if it’s a bit bold to go for the IPO. But then again you have to be bold to run an airline.
Launching an airline right before an economic crisis is crazy. Going public in the midst of widespread industry upheaval is downright insane.
Which means Virgin America is right on schedule.
Virgin America, after all, was founded by the always colorful billionaire Sir Richard Branson, who still owns a part of the Burlingame discount carrier. Forged during the recession, the company recently marked its first full year of profits, and analysts expect that it will soon file paperwork for an initial public offering.
But like its competitors Southwest and JetBlue, Virgin America faces Wall Street’s version of a Faustian bargain: By accepting investor cash, it becomes beholden to investors. In the quest for expansion and profits, Virgin America might have to sacrifice its carefully cultivated image for high-end, low-cost service.
Company executives tell me they don’t see it that way. Virgin America can succeed if it sticks to the game plan and responsibly manages its growth, they say.
This is, however, the airline business — an industry where carriers are either brawling over prices and routes or biding their time before a spike in oil prices deep-sixes already thin profit margins.
Given Virgin America’s tumultuous past, it’s a small miracle that the company has managed to break even. The airline launched in August 2007, just as oil prices began to rise. By the time the global economy collapsed, Virgin America had already bought eight jets and hired hundreds of employees.
“Airlines attract bigger-than-life personalities — risk-takers,” CEO David Cush told me. “It’s a lot more interesting than a fertilizer plant or a steel mill. By the time we started the airline, there wasn’t really wasn’t an option to pull back even if you had a crystal ball.”
Sticking to Formula
Virgin America, though, feels it crafted a winning formula: adopt a strict cost-control system while investing just enough in design to wow customers. It was the first airline to introduce “mood lighting,” altering light and color schemes depending on the stage of trip: boarding, in-flight and landing. Virgin also replaced those cumbersome meal carts with in-seat devices that allow customers to order food and drink.
The company’s strategy of surprising discount customers with upscale experiences recalls mass retailer Target’s “Expect More, Pay Less” mantra — a comparison that Cush dislikes.
“I hate to shop. I look like I climbed out of the 1990s,” Cush joked. “I do all of my shopping on Amazon and Levi’s online. It’s a beautiful time to be a non-shopper.”
In any case, Virgin America’s business model has taken off. The company flies to 22 cities in the United States and Mexico and boasts a frequent-flyer program with 2.9 million members. Over the past two years, the company ranked No. 1 in overall performance, according to the Airline Quality Ratings, a benchmark industry scorecard.
“You have to be a certain size to even make it into the ratings, and the first year Virgin qualified, they zoomed right to the top,” said Brent Bowen, dean of the College of Aviation at Embry-Riddle Aeronautical University in Prescott, Ariz., who helped compile the ratings. “The company is very efficient and performs in each category exceedingly well.”
But managing customer expectations is different from managing Wall Street expectations.
“Being private means you don’t have to answer to anyone but the board. Now you have financial analysts questioning your every move,” said Seth Kaplan, managing partner of Airline Weekly, which closely tracks the industry.
Of the world’s 49 airlines that made money last year, Virgin America ranked 27th in operating profit margin, far trailing Southwest and JetBlue. Once Virgin America goes public, investors will demand that the company vastly improve those numbers.
Virgin’s high-end, low-cost model is problematic, Kaplan said. The airlines that make the most money are either legacy carriers like Delta and American Airlines, which command pricing power; or bargain basement, no-frills operations like Spirit Airlines, which requires customers to pay for overhead storage and other amenities.
“People always say they hate Spirit, but they keep coming back because of the low fares,” Kaplan said. “Virgin is correct that people will pay more for a better experience — but will they pay enough?”
Still, the success of Virgin America has caught the notice of competitors, especially the legacy carriers, Kaplan said.
“Virgin has already made a big impact on these airlines,” he said. “They have taken some business.”
It hasn’t been easy. In New York, Chicago and Washington, Virgin America has fought other airlines to lease gates. Last week, Virgin bested Southwest and Delta to win two coveted slots at Love Field in Dallas. American Airlines had to divest those gates in order to buy U.S. Airways.
“If you want to go into these business markets, this is the battle you have to fight,” Cush said.
Going public will help Virgin America finance these slugfests and generate more sales and profits over the long term. The company does not plan to expand overseas but sees plenty of domestic opportunities, especially as more gates come into play because of airline consolidation. Virgin has already ordered 40 more jets.
But will Virgin lose the special something that has defined its existence? Cush could sure use that crystal ball.
Thomas Lee is a business editor and columnist for The San Francisco Chronicle. In December, Palgrave Macmillan will publish “Rebuilding Empires,” his book on the future of big-box retail.