Air carriers studying interisland market

By Susan Hooper
Advertiser Staff Writer

As Hawaiian and Aloha airlines prepare to merge into the state's only sizable interisland carrier, some major airlines already have begun exploring the possibility of entering the market as competition.

The past three startups to operate in the interisland market have failed, most recently Mahalo Air, which filed for Chapter 11 bankruptcy protection in 1997 after less than four years in service. Advertiser library photo

And while analysts say starting a local airline to rival the merged entity would be a challenge for both a name airline and a startup, at least two major carriers, United and Continental, have not ruled out the possibility.

Still, for a potential competitor there are any number of reasons not to proceed. Since the Sept. 11 terrorist attacks, airlines worldwide have seen a sharp decline in passengers and lost millions of dollars. Expanding to a market with a powerful, established monopoly player could be a gamble few can afford to make now. And any eager startup likely will have trouble finding financing because airlines look like poor investment risks these days.

Other observers, however, say the Hawai'i market cries out for competition, in part because the newly merged Hawaiian-Aloha carrier will have a lock on three of the top 20 busiest domestic airline markets — the routes between Honolulu and Kahului, Maui; Lihu'e, Kaua'i; and Kona on the Big Island. Furthermore, the Hawaiian-Aloha merger is not scheduled to close until mid-2002, by which time some airlines could have revived enough to seriously entertain expansion plans.

"Until the travel industry starts recovering, particularly the Japanese market, I don't think it's a good time to try it," said Fredrick Collison, professor of transportation and marketing with the University of Hawai'i's School of Travel Industry Management. "If I were looking to do it, I think I'd want to see at least some real positive signs in terms of visitor arrivals, and we don't have those at the moment."

Taking a look

Some airlines may be preparing ahead of time for that recovery.

Greg Kahlstorf, president of Pacific Wings Airlines Ltd., a small Kahului-based carrier, said he has heard from six airlines interested in working with Pacific Wings in the interisland market. The first of these potential partners is scheduled to come to Maui this week, Kahlstorf said.

"We have several very heavy hitters from major airlines coming to talk to us about a variety of cooperative service partnerships," he said.

Kahlstorf said he has signed non-disclosure agreements with four national and two "major regional" carriers that prevent him from identifying the airlines. The financial troubles in the airline industry since the terrorist attacks have made the prospective partners especially shy, he said.

"A lot of people are pleading poverty with one hand and merging with the other," he said. "They're real sensitive to that."

The marriage of Hawaiian and Aloha, announced this month, leaves Hawai'i with just one major interisland carrier for the first time in 55 years. Greg Brenneman, the executive who will be heading the new airline, has said the market can support only one interisland carrier. But he has also said that, if his new airline does not provide the right kind of service at the right prices, it will open the door to competitors eager to do a better job.

Others in the industry appear to agree with him, despite the belief among many that this is hardly the best time for another airline to set up shop in the Islands.

For one thing, interisland airline traffic has shrunk in recent months. Hawai'i's tourism market is still suffering from the effects of the terrorist attacks, with visitor arrivals in November off 27 percent from a year earlier. And the thousands of layoffs locally that followed the attacks have forced Hawai'i residents to curtail their interisland travel.

In addition, the effects of the attacks have left many major airlines with neither the cash nor the energy to spend on expansion, analysts say.

Collison said he believes a carrier already established in Hawai'i would have an easier time entering the interisland market than a startup would.

"But I don't know whether United or American or Delta or Continental, given the uncertainties in the industry these days and the large losses many are sustaining, have the resources right now to put into something like that," he said.

As for startups, Collison says, getting the cash necessary to begin interisland operations is likely to be a major challenge.

"I think access to capital right now is going to be extremely difficult, just in general, but particularly in the airline industry," he said. "It's going to be difficult to convince lenders to lend to a startup airline in the U.S., period, whether it's Hawai'i or anywhere else, because the lenders are going to look at this as a very risky proposition right now."

Previous startups

Investor interest is also likely to cool in light of the failures of the past three startups to operate in the interisland market, Collison said. Mahalo Air was the most recent to fail, filing for Chapter 11 bankruptcy protection in 1997 after less than four years in service. Discovery Air preceded it, operating for just three months in 1990 before shutting down amid charges by Hawaiian and Aloha that it had more foreign ownership than was allowed under U.S. aviation law. Mid Pacific Airlines operated for seven years before running into financial problems and closing in 1988.

"The history of the interisland market for startups is terrible," Collison said. "They've all failed, and there were others proposed that never even made it into service."

Those startups, however, were all competing as the third airline against Hawaiian and Aloha. A second carrier might have better luck against a merged entity, some analysts said.

"If the new airline doesn't provide high-quality service at a reasonable cost, you can be assured that somebody will want to in their place, if they're allowed," said Mike Niehuser, equity analyst with RedChip Review, a research firm in Portland, Ore.

"You do have new airlines starting all the time," he said. "It's just whether they can continue to function is another question. If you can buy new airplanes, keep costs down and provide consistent service, you will have people who will certainly check you out."

Major carriers have expressed interest in Hawai'i's interisland markets before. Ten years ago, United Airlines explored the possibility, but eventually decided against it. At the time, Hawai'i Sen. Dan Inouye expressed concerns that United's entry might lead to the demise of either Hawaiian or Aloha, both of which were then locally owned.

Aloha, a private company, still is locally owned. Hawaiian is a public company, and its majority owner is New York investor group Smith Management LLC, which owns Hawaiian through its Airline Investors Partnership.

Tom Renville, managing director of United Airlines-Hawai'i, said Friday that it is "too early to tell" whether United would be interested in entering the interisland market, in part because the Hawaiian-Aloha merger has yet to be completed.

In addition, he said, United's major focus now is returning to profitability.

"I think that's the main focus of the airline right now — to take care of employees and customers by getting the company financially healthy," he said. "If this (entering the interisland market) is an opportunity to do that, then I'm sure we'll look at it."

Nonstop flights

The interisland market has changed greatly since United explored the possibility in 1991, Renville pointed out. In the past several years, the number of nonstop flights by United and other carriers from the Mainland to the Neighbor Islands has increased significantly, reducing the number of Mainland passengers who connect in Honolulu for Neighbor Island trips on local airlines.

"So, has that taken from the market enough so that there's really only room for one, or is there room for two or more (carriers) still to do interisland flying?" asked Renville. "And my guess is that's the question anybody who has an interest in this is asking and trying to research."

Ron Wright, managing director of Continental-Hawai'i, also said it is too soon to tell whether Continental might explore the possibility of developing its own interisland routes.

One question yet to be answered, Wright said, is which carriers will have code-sharing agreements with the merged airline. These agreements allow the partners to sell seats on each other's flights, assuring smooth connections for Neighbor Island travel by Mainland visitors flying into Honolulu.

Aloha has a code-sharing agreement with United, while Hawaiian has agreements with Northwest, Continental and American. Brenneman has said that those relationships would continue until the merger and the merged carrier would then negotiate new agreements.

"You have to make sure those relationships are still going to be valid after the merger ... " Wright said. "I think they're going to have to treat everyone fairly. If that continues, I would guess that Continental probably wouldn't have an interest (in developing interisland service), but it's a little early. There's probably another month or so to look at the structure to make sure you're able to facilitate people to the Neighbor Islands ... But (interisland service) is something that you really can't dismiss offhand."

Tough competitors

If the Hawaiian-Aloha merger becomes a reality, those contemplating entering the interisland market in a big way should do so with their eyes open, say analysts who have studied monopoly airline markets.

"A monopoly has a huge interest in wanting to forestall any new entry," said Kevin Mitchell, chairman of the Business Travel Coalition, a lobbying group that represents the business travel interests of large corporations.

In some other monopoly markets, the established carrier has responded to the new entrant by dropping its prices so low that the newcomer can't possibly compete and eventually is forced to fold, Mitchell and other analysts say. In the industry, that practice is known as predation, Mitchell said.

"It's worth almost any price to run them out of the market, because then you can raise prices above the previous level to recoup that investment and send a message to other potential competitors down the road ... " Mitchell said. "That's why it's so hard to find investors who will start up airlines, because of the fear of predatory response."

Reach Susan Hooper at shooper@honoluluadvertiser.com or 525-8064.