How Successful Has Alaska Been In Lowering Its Costs?

Over the last few years, Alaska Air Group (NYSE:ALK) has consistently persevered to lower its operating costs in order to both retain its cost advantage relative to network carriers and reduce its vulnerability to low-cost carriers such as Southwest (NYSE:LUV). This cost reduction at Alaska became important a few years back, as large network carriers namely Delta (NYSE:DAL), United (NYSE:UAL) and American (NASDAQ:AAL) began restructuring under bankruptcy to lower their operating costs. Meanwhile, low-cost carrier Southwest already enjoyed a significant cost advantage over Alaska. Additionally, in terms of network overlap, these four airlines – Delta, United, Southwest and American – were the principal competitors of Alaska. Then, Alaska started slashing its costs in order to compete more aggressively with these airlines. In this article, we analyze how successful Alaska has been in reducing its operating costs. We figure lower operating costs are very crucial for Alaska’s future growth, as they will determine how vulnerable the carrier will be to Southwest’s expansion and how aggressively Alaska can compete with large network airlines.

We currently have a stock price estimate of $48.20 for Alaska Air Group, around 8% ahead of its current market price.

See our complete analysis of Alaska Air Group here

Alaska’s Costs Are Now Closer To Low-Cost Carriers Than Network Carriers

In 2009, Alaska incurred 9.20 cents in non-fuel costs to fly an airplane seat for a mile, referred to as non-fuel unit costs. ^[1] This is a standard metric used in the airline industry to measure an airline’s cost efficiency; fuel costs are excluded from this metric as they cannot be controlled by the airline. In comparison, Southwest’s non-fuel unit costs were 7.13 cents in 2009. ^[2] Clearly Southwest enjoyed significant cost advantage over Alaska, making Alaska vulnerable to Southwest’s expansion in its core markets. On the bright side however Alaska’s costs were lower than those of network carriers including Delta, United and American. But, as these network carriers began reducing their operating costs through restructuring, Alaska’s cost advantage diminished. In 2008, Delta was the first large network carrier to complete its restructuring and emerge from bankruptcy through a merger with Northwest. Then in 2010, United completed its bankruptcy restructuring (and acquisition of Continental), and finally in 2013, American completed its restructuring and combined with US Airways. As these large network carriers, all of which currently occupy more than 15% share of the domestic U.S. air travel market, lowered their costs through restructuring, Alaska’s historic cost advantage over these large network carriers diminished. To regain that cost advantage, Alaska began slashing its costs, and accordingly over the last few years, the carrier has subcontracted many services to third-party vendors to lower its operating costs. The carrier has also increased the share of alaskaair.com in total bookings to save on its distribution costs and has lowered airplane maintenance costs by replacing older less efficient airplanes in its fleet with new airplanes, which include Boeing 737-900ER. As a result of these measures, Alaska’s non-fuel unit costs have fallen considerably. For the 12-month period ended June 30, Alaska’s non-fuel unit costs were 7.58 cents, down nearly 18% from 2009. ^[3]

In comparison, Southwest’s non-fuel unit costs were 6.87 cents for the 12-month period ended June 30. ^[3] It is therefore evident that Alaska has been able to reduce the cost advantage that Southwest enjoyed. Additionally, for the 12-month period ended June 30, non-fuel unit costs of American, Delta and United – the largest network carriers and principal competitors of Alaska – were in excess of 8.60 cents. ^[3] Alaska’s operating costs are now significantly below those of large network carriers, and therefore, we figure Alaska can drive down its fares profitably as it takes on Delta, which is rapidly expanding in Alaska’s core market of Seattle.

It also becomes clear that overtime Alaska’s operating costs have moved closer to low-cost carriers than large network carriers. So, in our view, Alaska has done a good job of lowering its costs.

Looking ahead, we figure this lower cost structure will play a key role in helping Alaska defend its dominating position in many west coast markets and expanding its share of passenger traffic on mid-continental and trans-transcontinental routes. Through lower fares enabled by this lower cost structure, Alaska will likely be able to enter and establish itself in new markets. Thus, the cost reduction undertaken by Alaska in the last few years will play a key role in its future expansion and growth.

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1. Alaska’s 2011 10-K, February 2012, www.alaskaworld.com [↩]
2. Southwest’s 2010 10-K, February 2011, www.swamedia.com [↩]
3. Alaska’s Investor Presentation, September 25 2014, www.alaskaworld.com [↩] [↩] [↩]