has a lot in common with its fellow ultra-low-cost carriers (ULCC), such as its focus on unbundling airfares and its remarkable financial returns. But in many other ways, Allegiant has gone even further than its peers in turning the accepted wisdom of the airline business model on its head.
Allegiant andhave led the U.S. industry in breaking out a wide range of fees from base ticket prices—a major tenet of the ultra-low-cost philosophy that is increasingly rubbing off on legacy carriers. What sets Allegiant apart, however, is its use of older and cheaper aircraft types that allow it to adjust frequency and aircraft utilization according to demand.
Rock-bottom unit costs are obviously a defining characteristic of this industry segment. However, “we get there in a very different way than [Spirit] does,” Allegiant President Andrew Levy tells Aviation Week. He explains that Spirit’s model of high fleet utilization is in sharp contrast to Allegiant’s approach: “We don’t need frequency, and as a result, we can operate in a very selective way.”
It is certainly hard to argue with results. Both Allegiant and Spirit have been financial overachievers in recent years. Allegiant was the highest-ranked carrier in Aviation Week’s annual Top-Performing Airlines study last year, and although it is second this year, it is still the highest-ranked U.S. airline. Spirit, meanwhile, is third overall this year, and second among U.S. carriers. The two airlines can boast profit margins and returns on capital that are among the best in the industry.
Allegiant’s philosophy is closely linked to the nature of its fleet. It predominantly operates MD-80s that have an average age of 24 years, and the comparatively low cost of ownership allows it to keep the aircraft on the ground whenever it chooses. Because of this, it can ramp its operation up or down according to peak seasons or days of the week.
Its fleet economics also mean Allegiant can go into small markets that can support only a few flights a week. This aligns with its core business model of linking smaller cities with leisure magnets such as its main base in Las Vegas, other Western cities including Los Angeles and Phoenix, Honolulu, and five destinations in Florida (see map).
The low-frequency and heavily seasonal approach shows that the carrier is even more reliant on leisure travel than its other ULCC peers, says Levy. Because Spirit generally offers more flights than Allegiant, it has a greater ability to draw non-leisure traffic—although both airlines are far less focused on premium traffic than the major network carriers.
Allegiant’s fleet and schedule flexibility is demonstrated by its “massive shift” from peak to trough, Levy says. The carrier’s aircraft averaged 7 hr. of utilization per day in March 2013, which is one of its peak times, but only 4 hr. a day in September, which is typically its slowest month. Utilization goes up and down throughout the year.
While U.S. mainline carriers are showing more seasonality in their scheduling these days, their “variations in capacity are really on the margins, whereas we cut ours by 50 percent sometimes,” Levy says. “It would be far more difficult for all the other carriers built on high levels of utilization to cut their capacity the way we do.”
Allegiant can get away with this approach because of the type of customers it is targeting: leisure and discretionary travelers. “We’re not trying to be everything to everybody, which is what the rest of the industry has always tried to do,” Levy says.
In many other areas, however, the low-cost carriers do learn from each other and replicate ideas, he notes. A good example is fare unbundling and ancillary revenues.
While Allegiant was a pioneer with ancillary fees in the U.S., it borrowed the concept from European LCCs such as. Spirit followed Allegiant with many fees, but the roles were reversed in some cases when Spirit introduced them first and Allegiant followed. For example, Allegiant led with checked-bag charges, and Spirit was first with carry-on bag fees.
Many U.S. legacy carriers have also begun charging for services such as checked bags, but none have gone as far as Allegiant and Spirit, Levy says. He concedes that Spirit “has done a phenomenal job” with its ancillary revenue per passenger.
This revenue stream is extremely important to the ULCCs. Allegiant, for example, accrues as much as a third of its revenue from ancillary products and services.
Levy believes it will be harder for Allegiant to find new ancillary fee opportunities. Ironically, he says the next step may be toward bundling services for passengers who want this option.
In addition to baggage and onboard fees, Allegiant has also gone beyond other carriers in selling third-party services. Many carriers sell vacation, hotel and rental car packages, but Allegiant approaches this business differently. While most airlines promote those products as a secondary message, Allegiant makes third-party services and optional fees a major part of the purchasing process, promoting them heavily throughout each online transaction.
Also setting Allegiant apart is its success in “cutting out the middle man” from hotel room and rental car purchases, Levy says. The airline has direct contracts with more than 400 hotels around the U.S., and in 2002 it built a hotel module into its reservations system where it can “nest” inventory.
Intermediary companies—particularly the massive online travel agencies—are exploiting an extremely lucrative niche, “so that’s why it’s exciting to get deeper and deeper into distribution, because we think there is tremendous value there,” Levy says.
This approach emphasizes that Allegiant is essentially a travel company that happens to run an airline—its corporate name is actually Allegiant Travel Co. “We do not view our business as [just] the transportation of people from point A to point B,” Levy says. “We view that as an important part of a broader relationship with our customers.”
Allegiant’s network also reflects this philosophy, with its focus on connecting a broad range of small communities from all parts of the country to vacation destinations, either seasonally or year-round. “We want to be seen in these communities as the way to get to your vacation spot. . . . As long as enough [customers] want to go there for long enough, and pay enough money to do it, then we can make that work,” Levy says.
The concept of low frequencies to smaller cities means that there is no competition on 90% of Allegiant’s routes. The airline typically focuses its marketing efforts on the small cities rather than its large destination markets, although the share of traffic originating in the larger cities has increased over time through word of mouth.
While other low-cost carriers attempt to draw traffic from the big metroplexes via secondary airports further away, this is not a major focus for Allegiant. The carrier has tried this approach in some places, but overall it has had “pretty limited success” in penetrating the large markets from the secondary airports, Levy says, noting that in general, “our business is not geared toward big metro areas.”
An exception to the small-city philosophy was made in 2011 when Allegiant bid—unsuccessfully—on slots at New York LaGuardia Airport.
The carrier also links a few larger market pairs such as Las Vegas-Phoenix and Honolulu-Los Angeles, although in each case there are specific reasons why it works in the Allegiant model.
Allegiant has made no secret of the fact that it intends to launch international flights in the near future. Vacation destinations in Mexico—particularly Cancun—are the top prospects, Levy says, with flights to Canada and the Caribbean longer-term possibilities.
However, the carrier has pushed back its planned international launch from this year to 2015 and has yet to reveal details of routes and start dates.
“We haven’t made [international service] a high priority even though we’ve been interested in Mexico for many years,” Levy says. “We’ve just seen other things that appear to have a better risk/reward profile, since they don’t have the complexity of international [service].”
The airline would have to enhance its sales and IT systems to sell international tickets. While Levy says this would not be “overly complicated,” it has been easier to add more domestic cities.
Allegiant is “not in a big rush” to introduce international flights, as it believes that the market will still be there no matter what other carriers do in the meantime, says Levy. Because Allegiant’s model is so different, “we’re going to serve those [destinations] in ways nobody else does, from cities that nobody else would,” he says.
The carrier already caters indirectly to international traffic. Some of its U.S. airports are close enough to Canadian cities to attract a significant number of passengers from across the border. For example, a lot of Canadians from Vancouver fly on Allegiant out of Bellingham, Wash. The same thing occurs with some Mexican cities that are close to Texas airports served by Allegiant.
Cancun heads the list—by a large margin—for potential direct international service, says Levy. In addition to targeting Mexican vacation markets, connecting other Mexican cities to U.S. leisure destinations would also be an option. Las Vegas is very popular for travelers from Mexico, Levy says.
Flights to Canada are “something we’re interested in downstream,” says Levy, adding that there are “interior markets we think are attractive” for direct service.
To a large degree, Allegiant has established its network and business model based on the economic advantages of operating MD-80-family aircraft. While it is now branching into other aircraft types, its 53 MD-80s remain the backbone of its fleet.
MD-80s can be purchased for around $3 million, and they “basically pay for themselves in a year in terms of cash flow,” Levy says. “So it’s hard to beat that as a return on capital.” The “incredibly low” cost of ownership allows Allegiant to fly the MD-80s more selectively, which matches the high degree of seasonality in its operation.
The carrier does not intend to add any more MD-80s, although it is also not contemplating the retirement of this model. “I don’t think we’re close to that point yet. I can’t imagine that we wouldn’t still be flying MD-80s in 10 years,” says Levy.
The only factors that could trigger the phase-out of these aircraft in the medium term would be an unexpected uptick in their maintenance cost—such as if there were a major airworthiness directive affecting MD-80s or if fuel prices spiked dramatically.
Otherwise, from a mechanical perspective, the aircraft still have plenty of reliable life, Levy says. He notes that Allegiant’s MD-80s have reached about 34,000 cycles on average, and the type is certified up to 60,000. The only reason the maximum is set at that level is that nobody has asked theto take it higher, he says.
Allegiant has, however, begun adding other aircraft types, either for specific missions or because they are becoming economically attractive as well. Since 2010, it has purchased six, which are better suited to its Hawaii routes, and it began adding -family aircraft last year. It has seven A320s and three A319s, with contracts in place to purchase another two A320s and seven A319s through 2015.
With the new fleet types, the carrier has stuck with its practice of buying used aircraft. While the Airbus aircraft are more expensive than MD-80s, their greater fuel efficiency is becoming more valuable thanks to higher fuel prices. Increasing the percentage of these aircraft in the fleet helps bring down fuel costs and hedge against future price rises.
In addition, the carrier saw that there was “some [price] softness that we expect to continue” in the market for used Airbus narrowbodies. This further increases the attractiveness of the A320 family, which will comprise Allegiant’s future growth.
The airline’s fleet types are used differently according to their strengths. The Airbus fleet will be flown with more frequency to maximize its better fuel burn, while the MD-80s can be used for variable capacity since they do not need high utilization.
Allegiant is relatively opportunistic with its aircraft buying, so its fleet-growth rate “can be a bit lumpy at times,” Levy says. The carrier firmly believes in owning rather than leasing its aircraft.
The airline’s double-digit capacity growth rate is higher than most in the U.S. airline industry, but Levy says this does not mean it is diluting the market. “We’re not taking share [from other airlines]. We’re stimulating new demand—that’s how our business works.”
Both Allegiant and Spirit offer a lower price point that allows people to travel more often, so they are “increasing the size of the pie,” says Levy. In addition, Allegiant targets cities that previously have not had convenient air service.
However, Allegiant will always sacrifice growth in the name of profits. In other words, it will grow only at a rate at which it can maintain its profit margins.
Levy cites independent financial studies that have identified Allegiant as having a higher spread than any other airline between the cost of capital and return on capital. Because of this, economic theory would suggest that Allegiant should be growing 3-4 times faster than it already is, since it would still be creating value.
But Allegiant is not going down that path, says Levy: “We want to make sure we grow at a reasonable pace where we can control the operation. We don’t believe in hyper-growth.”
Also, market expansion is far from irreversible. Allegiant typically enters new destinations with just a few flights a week and does not sign long-term leases or invest heavily at new airports. Since its cost of entering markets is so low, it mitigates risk, and the carrier can also leave them relatively easily.
“We’re very quick to get out of markets that don’t perform,” says Levy. Allegiant is prepared to take calculated risks, but “you can’t be afraid to fail—that’s part of being entrepreneurial.”
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