United Covets Competitors’ Profit Margins in Smaller U.S. Cities

United Airlines is significantly underperforming its competitors at its hubs in Chicago, Denver and Houston, so it will add flights from them to smaller U.S. cities as it seeks to match profits produced by American Airlines and Delta Air Lines, executives said Tuesday.

“Our international gateways have higher profit margins — about seven points higher — than our competitors,” United President Scott Kirby said during an investor event coinciding with United’s fourth quarter earnings call. “And Chicago, Denver and Houston, despite being big markets, despite being well-positioned geographically, have profit margins that are about 10 points lower than our competitors mid-continent hubs.”

Kirby should know. As president of US Airways and later American Airlines, he took advantage as previous United’s management placed less of a priority on domestic flights, favoring long-haul international routes from coastal hubs in New York and San Francisco. First, at US Airways, Kirby built a massive Phoenix hub with connectivity across the American West, and then later, at American, he bulked up operations in Dallas/Fort Worth, Chicago and Charlotte. Airline insiders consider the Charlotte hub, along with Delta’s in Atlanta, two of the most profitable hubs in the world.

To Kirby, the math is simple. The two largest U.S. ultra-low-cost carriers — Frontier Airlines and Spirit Airlines — tend to focus on point-to-point service, often between larger cities, leaving opportunity for network carriers such as United to sell connections between markets like Rochester, Minnesota and New York at relatively high prices.

For United, Kirby said, Rochester to Chicago to New York is potentially more profitable than Chicago to New York, where United must price to compete with Delta, American, and, perhaps more importantly, Spirit.

The more flights United adds to from Houston, Chicago and Denver hubs, the more possible city-pair combinations it can offer smaller-city customers. Earlier this month, United announced several new routes that fit the strategy, including Chicago to Bismarck, North Dakota; Denver to Appleton, Wisconsin, and Houston to Dayton, Ohio.

“More scale and more connectivity is what we have to drive at these hubs,” Kirby said. “A hub-and-spoke airline is really a manufacturing company. It is about manufacturing connections. The more connections you can drive to hubs, the higher profits you drive at that hub.”

Kirby told analysts United might not erase all 10 points in margin gap, but it should get close. “We are not going to accept 10 margin points lower in profitability,” he said.

Investors react

United reported fourth quarter net income of $580 million, with a pre-tax margin of 6.4 percent. For the full-year, net income was $2.1 billion with pre-tax margin of 7.9 percent.

United told investors it will increase capacity 4 to 6 percent in 2018, with similar numbers expected in 2019 and 2020. Not all of it will come from domestic routes from Chicago, Denver and Houston. There will be growth elsewhere, and United executives said they’ll be more aggressive in flying during off-peak periods. In the past, it might have parked a plane when demand decreases, but now it will fly it and try to earn whatever revenue it can, executives said.

Just after the call, United’s stock fell nearly $5 in after-hours trading. Investment analysts often prefer more prudent capacity management in line with GDP increases, which they believe helps keep tickets prices high.

Some analysts also told Kirby they fear United, American and Delta will now battle for market share in smaller cities, depressing yields. But Kirby said he does not expect airlines to skirmish over share in small cities. Instead, he said, markets where Delta and American each had 50 percent share will resettle, with all three big airlines grabbing one third.

Credit cards

United is third in share in many smaller cities near Houston, Denver and Chicago, which not only hurts the airline’s ticket revenues, but also affects credit card penetration, Kirby said. That’s important to an airline trying to persuade more customers to apply for co-branded cards as a means toward increasing revenues.

“The kind of people who get airline credit cards are the kind of people that travel and need to fly,” Kirby said. “And just like a Houston-based customer is naturally biased to have a United Airlines credit card, a Kansas City or Wilmington, North Carolina customer has a natural bias to have the credit card of the airline that is biggest in that city.”

Kirby said United has a “real opportunity” to attract more customers to apply its credit cards. He said he is working with Chase, United’s partner, on other strategies to increase sign-ups.

Product and Segmentation

During the event, executives briefly discussed product, including Premium Plus, United’s new premium economy for long-haul flights.

Chief Commericial Officer Andrew Nocella said it will take United about three years to roll out the seats “across its international system,” though he did not say which aircraft will get them. That puts United significantly behind American, as last week an American spokesman said the airline had installed it on 39 of the 82 long-haul aircraft slated to get it. Delta’s product, meanwhile, started flying late last year on A350s arriving new from Airbus.

Also, Nocella said United will expand and tweak its no-frills Basic Economy fare. It expects to sell it in some international markets this year, and soon will permit Basic Economy customers to select a seat for a fee. Today, Basic Economy customers cannot buy a better seat, no matter how much they’re willing to pay.