In an industry in which 117 airlines have filed bankruptcy since 1979, Joseph Lorenzo thinks he can make Reno Air work.
Despite record industry losses, widespread bankruptcies, huge costs of entry, and rabid competition, it still seems that everyone wants to start an airline. Joseph Lorenzo thinks he's figured out how to make money in a business in which almost no one else can
The summer of 1993 was another endless summer of burning dollar bills. No matter what they tried, the nation's airlines seemed unable to escape their tough times. They had lost an average of $9.6 million a day for the previous three years, a record of futility exceeded in recent times only by the savings-and-loan industry. In financial terms, the industry as a whole was technically bankrupt.
Continental Airlines announced that it would lay off 2,500 workers, ground 30 planes, and end service to nine cities. Northwest Airlines prepared a bankruptcy filing while it fought for concessions from its unions. American Airlines pulled back from many of its California routes. All the while a national commission appointed by President Clinton was puzzling over the question of how to save the domestic airline industry.
Meanwhile, nobody seemed to notice the most startling development of all.
A new entrepreneurial carrier, Reno Air, completed its first year of flight operations on July 1, 1993, reporting $72 million in revenues and, more significantly, something that only one other scheduled carrier, Southwest Airlines, was able to claim -- a profit.
Few experts had given the airline much of a chance when Joseph A. Lorenzo, its founder, put its first plane in the air, in mid-1992 -- not after an entire generation of new carriers had started amid great fanfare and then failed during the 1980s.
But to Lorenzo (no relation to Frank Lorenzo, former chairman and CEO of Continental Airlines), the travails of the industry were in fact its greatest attraction. The more intractable the problems for the nation's biggest carriers were, the greater his new airline's potential was. Lorenzo had probed the industry's soft spots and devised a strategy that would turn those problems to Reno Air's advantage.
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"Out of business" -- that unhappy notation is scribbled next to the names of no fewer than 172 of the airlines that started during the first great wave of entrepreneurship that greeted the 1978 deregulation of the airline industry. Gone are People Express, Midway, and Muse Air. Gone are Air Florida, Air Atlanta, and Air One. Among the ambitious start-ups of the last decade, only America West remains, flying the past two years under the watchful eye of a bankruptcy-court judge.
Many of the start-ups were gone by the time the financial carnage spread to the larger carriers. From 1990 to 1992 alone, the U.S. airline industry lost $10.5 billion, more than wiping out all the profits earned by the industry since the Wright brothers flew the first plane at Kitty Hawk. Eastern, Pan Am, and Braniff disappeared; TWA emerged from bankruptcy court once, Continental twice. The industry's long-term performance has not been much better: in only one year in the past 25 has the industry earned profit margins as high as 4% to 5%, which are average for U.S. industry as a whole.
Despite that record of overwhelming failure for airlines large and small, scores of entrepreneurs continued with plans to start new carriers. All one needed to start an airline in the age of deregulation was a plane, a pilot, and a certificate from the federal government -- and an investor with selective memory loss concerning the industry's recent disaster with start-ups. From January 1991 through the end of 1993, the Department of Transportation authorized 84 new airlines and was reviewing applications for 32 more. A number of the airlines that have received certificates to fly, however, have not been able to raise enough capital.
By June 1992, a month before the first Reno Air jet took to the air, Joseph Lorenzo had accomplished what no other airline entrepreneur of the 1990s had done: he had raised $6 million in an initial public offering for his new airline based in Reno, Nev.
Lorenzo had been waiting for such an opportunity for some time. In 1983 he left Continental Airlines, where he was senior vice-president of marketing, and started an airline consulting business. Even then he was thinking about starting a new carrier. But Lorenzo remained on the sidelines as many others with similar ideas took to the air. By 1990, when most of the first generation of start-ups had already passed from the scene, he was finally ready to make his move.
Lorenzo did enjoy one major advantage. The industry's big three -- American, United, and Delta -- carry 57% of domestic air traffic, but their cost structure makes it increasingly difficult for them to do so profitably. Their costs are high for two reasons. First, they are full-service airlines. The meals, the movies, the frequent-flier programs, the huge investments in computer systems, ground equipment, and maintenance bases -- all represent enormous operating costs.
Second, the major carriers had operated for four decades under a system in which the federal government regulated fares and routes, building a rate of return into the fare structure based on the industry's cost of flying. That gave individual companies little incentive to hold down costs. Wage rates ballooned, union work rules proliferated, and capital investment in planes and ground equipment skyrocketed. Those tremendous costs stayed embedded in the system when Congress freed the airlines from fare and route regulation, 16 years ago. "The airlines did a lot of things that, if you were operating from scratch today, you wouldn't do," Lorenzo says. "So I had it in the back of my mind that the best thing to do would be to start an airline from scratch."
Lorenzo understood the overriding lesson that emerged from the failures of the '80s. Many of the new carriers went down after competing directly against larger carriers whose superior resources won out. Others, such as America West and People Express, ran into trouble when they expanded beyond an initially successful, well-defined niche. The lesson: define a niche in which you can be profitable, and stick to it.
There was, by then, a sterling model for just such a strategy. Despite the industry's troubles, Southwest Airlines has been profitable every year since 1971. Southwest has prospered on low operating costs, low fares, and no frills. It offers no meals, no drinks, no frequent-flier miles, no first-class seats, no elbow room, no advance boarding passes.
