The $2.6 billion sale of Virgin America Inc. shows that it just doesn’t pay to be different.
Despite the mood lighting, club music, touchscreen food orders, and additional frills that made it a customer favorite, Virgin America couldn’t escape the reality that ticket price is king. For a niche player, the new world order for airlines means passenger goodies and competitive industry pricing are an almost impossible combination.
Virgin America’s fares aren’t remarkably different from what other airlines charge, even with all its extras. They can’t be, given the fierce pressures on every major route. In fact, Virgin America was a “price disruptor” in the industry, and its sale should prompt less discounting, Standard & Poor’s analyst Jim Corridore said in a note to clients. Still, British billionaire and Virgin founder Richard Branson feels that the airline dusted off a customer service ethos that had been lost over the years.
“Because of Virgin America, the industry finally had to consider the customer,” Branson wrote on Monday in a blog post about the deal with Alaska Air Group Inc. Branson said he feels “sadness” about the airline’s sale, but as a foreign shareholder with a minority stake he was unable to block it.
Virgin America began flying in summer 2007, before U.S. airline mergers concentrated 84 percent of industry revenue among four behemoth carriers, up from 65 percent in 2010. That consolidation wave left most of the remaining market to three second-tier airlines, including Virgin America, and an additional three ultra-low cost carriers.
“These are big, powerful carriers that can do pretty much what they want in the marketplace,” David Cush, Virgin America’s president and chief executive officer, said Monday in an interview.
One strategy for smaller airlines is to bulk up—as Alaska Air is doing by taking over Virgin America—if they hope to survive the next recession. Cush predicts that legacy carriers American Airlines Group Inc., United Airlines Inc., Southwest Airlines Co. and Delta Air Lines Inc. will respond to a future downturn with a merciless war on smaller carriers. “How do you withstand what I would imagine would be a tremendous competitive onslaught if the legacies start to feel the economic environment is turning south?” asked Cush, who plans to leave Virgin America when the merger with Alaska Air closes.
“The merger reflects market forces at work: Neither had the necessary scale economies to compete with the Big Four,” said George Hoffer, a transportation economist at the University of Richmond.
The original Virgin America business plan called for keeping costs below the industry average as a way to deliver a better product and still turn a profit. It regularly wins awards from consumer and airline groups that love its hip sensibilities. In 2012, Virgin America began slowing its ambitious growth strategy and produced several quarters of profits, finally going public in late 2014. But last year, when jet fuel costs plunged, Virgin America reported just $201 million of net income—not really a lot for investors. (The largest player, American Airlines, had $6.3 billion.)
Virgin America’s purchase by Alaska Air comes largely because of the sizable cash offer, which the airline couldn’t refuse on behalf of shareholders. The merger is designed to strengthen Alaska Air’s position on the West Coast, especially in California, where it’s been trying to increase market share amid the huge population, relative to that of the Pacific Northwest. The deal will make Alaska Air the fifth-largest U.S. airline, surpassing JetBlue Airways Corp., which came up short in the bidding for Virgin America.
Alaska is buying another important asset in the deal: the right to use the Virgin brand. “There is a chance we could use the Virgin America brand somewhere else down the road,” Alaska Air CEO Brad Tilden said on a conference call.
©2016 Bloomberg L.P.
This article was written by Justin Bachman from Bloomberg and was legally licensed through the NewsCred publisher network.