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 The Brancatelli File

joe DEREGULATION IN MICROCOSM:
THE BATTLE FOR HAWAII'S
INTERISLAND FLYERS


BY JOE BRANCATELLI

July 1, 1984 -- It won’t replace the volcanoes or Waikiki or Diamond Head as a tourist attraction, but Hawaii has something new that’s sure to catch the eye of the discerning frequent flyer. The land of pineapples and macadamia nuts is now home to a hothouse example of the effects of deregulation on regional air travel in the United States.

Since 1981, when MidPacific Air was born, the state’s short-haul industry has been a textbook-perfect case of airline competition. Hawaii has seen suicidal price wars (standby seats for $11); outlandish promotions (discount coupons with McDonald’s breakfasts); protracted philosophical squabbles (The Civil Aeronautics Board had to rule on the “real” meaning of first-class service), and the operational firefights over everything from airport terminal locations to consolidation of flight schedules.

The established carriers, Hawaiian Air and Aloha Airlines, have been bloodied by huge financial losses and declining market shares. Both carriers have been forced to make wholesale management changes, renegotiate union contracts and drastically alter strategies. MidPac, the upstart, now commands 20 percent of the interisland traffic, has the lowest cost structure of the carriers, and has been turning large and regular profits.

“What’s happened in the interisland marketplace during the last few years has been the American aviation experience in miniature,” suggests A. Maurice Myers, Aloha’s new marketing vice president. “Anything and everything that has happened to the airline industry since deregulation has happened to Hawaii’s interisland market.”

Before deregulation, the Hawaiian interisland market hardly looked ripe for such bombastic turmoil. The half-dozen interisland routes were never very glamorous, consisting mostly of short hauls. The longest route of all, between Honolulu and Hilo, was only 216 miles.

And in the palmy days before deregulation, neither Hawaiian nor Aloha seemed to be particularly vulnerable to competition. Both carriers were locally owned and operated, an important consideration in protectionist-minded Hawaii. Both were comparative financial behemoths in Hawaiian business circles. Founded in 1929, Hawaiian was the state’s eleventh-largest homegrown business; Aloha, formed in 1946, ranked thirteenth. And except for a few tiny commuter services, Hawaiian and Aloha virtually monopolized interisland air traffic.

Tourists had always accounted for about 70 percent of Hawaii’s interisland traffic. That was fine while tourism boomed, but became a problem when the growth of leisure travel slowed in the late 1970s. Moreover, as airlines such as United expanded direct mainland service to Hawaiian airports other than Honolulu, many visitors were able to bypass the interisland carriers completely. This double whammy sent interisland traffic into a tailspin. After serving a record 7.3 million passengers in 1979, interisland traffic declined to 6 million passengers last year.

Given those powerful deterrents, the advent of deregulation didn’t appear to be particularly worrisome for Hawaiian and Aloha. While new carriers were announcing their plans on the mainland, none seemed interested in challenging the interisland status quo.

Hawaii’s two-carrier monopoly began to crumble in late 1978 and early 1979 when Hawaiian Air dismissed its senior vice president. Nolan Kramer; executive vice president, John Higgins; and controller, Edward Neilsen. The three men promptly began plans for an upstart, MidPac.

With the aid of two well-known airline industry figures—Arthur Lewis, the former president of both Hawaiian and Eastern, and consultant Daniel Morton—Higgins, Kramer and Neilsen designed MidPac as a low-overhead, low-fare alternative to Hawaiian and Aloha. They cut corners everywhere. MidPac would have no downtown ticket offices, no fancy office space, and no employee unions. Cash-register receipts would serve as boarding passes.

“I built my own typing table,” remembers Keith Haugen, MidPac’s advertising and public relations director. “We were that austere. We didn’t even have desks when we started. Everybody worked on luau tables.”

While most of MidPac’s operational economies were classic cost-cutting measures embraced by other no-frills airlines, Higgins, Kramer and Neilsen took the low-overhead approach to seemingly ludicrous lengths. Hawaiian was flying DC-9s and Aloha was phasing in a fleet of Boeing 737s, but MidPac planned its interisland service around 60-seat YS-11 turboprops.

The Japanese-built YS-11s commuter planes seemed to have everything against them: they were much smaller than the DC-9s and 737s, of course, but they were also slower, as much as sixteen minutes slower on the longest route. The YS-11s were also noisier, flew at more turbulent lower altitudes, were less comfortable and weren’t air conditioned. And they were old, too. The YS-11s MidPac planned to use had already been in service for an average of fifteen years.

By the time MidPac began service between Honolulu, Kauai and Maui in March 1981, the company already had been written off by most aviation experts. “There’s not a place for a third carrier,” scoffed Ed Swofford, who was then the president of Aloha. “Nobody expected MidPac to survive the year,” recalls the Hawaii region vice president for a major mainland carrier. “Besides, everybody thought Kramer was a jerk.”

But Kramer and the other MidPac executives had an answer for the doubters. “We made our mistakes when we were at Hawaiian,” Kramer said. “We’re not going to make them again.”

MidPac was successful from the very first day. Its biggest lure, of course, was low fares. While some one-way interisland fares had crept above $50 on Hawaiian and Aloha, MidPac’s introductory fare was $25. Ensuing fare wars, most of them started by MidPac, slashed prices to $18.95, $15, and, at one point, $10.95 standby.

“A lot of local people had been priced out of the market by Aloha and Hawaiian,” claims MidPac’s Haugen. “The higher fares may have been acceptable to the tourists on vacation, but they were very difficult to swing for the people who lived in Hawaii. When we started service, maybe 90 percent of our passengers were locals.”

But MidPac got its share of the tourist market, too, thanks to a tactical blunder by Hawaiian and Aloha. When MidPac began flying, the established carriers kept it out of Honolulu’s existing interisland terminal. MidPac was forced to rent ticket, baggage and gate space in the "overseas" terminal, the building where all mainland and foreign tourists arrived.

“I’d like to tell you that I was brilliant and wanted to be in the main terminal all the time,” says Kramer. “But I wanted to be in the interisland terminal with Hawaiian and Aloha. I thought being in the interisland terminal would heighten our credibility. But they shoved us into the overseas terminal, claiming there was no room for us in the interisland terminal. Naturally, when travelers arrived, MidPac was often the only interisland airline they saw. We got a lot of tourist business that way.”

MidPac even successfully neutralized its largest potential disadvantage: the slow, rackety, YS-11s. It offered free beverages and snacks, emphasized two-across seating, touted the view of the islands from the YS-11s lower cruising altitudes, and played up the smiling, friendly service of MidPac’s eager, young flight crews. “We kill you with kindness,” says Haugen.

Three years after MidPac’s start-up, the airline is flying high. It now offers a daily schedule of more than 150 interisland flights. Thanks to the relentless promotions—even competitors admit MidPac offers the best flight, hotel and car rental packages—it has a visibility far beyond its 20 percent market share. And MidPac is making money: net income for 1982 was $532,000; in 1983, it soared to $2.6 million.

Meanwhile, Hawaii’s once-invincible old-line carriers are recovering from the MidPac blitz. Hawaiian Air, long the dominant factor in the interisland market, was badly wounded by MidPac. Saddled with an enormous debt and huge operational costs, it racked up three consecutive bad years (pretax losses of $2.6 million in 1981, $17.3 million in 1982, and $6.1 million last year) before posting a first-quarter profit this year.

“You’ve got to understand that the old Hawaiian Air was terribly vulnerable to an operation like MidPac,” said a mainland airline executive who spent more than a decade working in Hawaii. “Hawaiian had some of the highest labor costs in the industry. They just gave and gave. It was like a license to steal.”

Hawaiian, which still commands about 47 percent of the interisland market, is now a substantially different airline. Most of the old management is gone, many of the union contracts have been renegotiated, and Hawaiian has totally restructured its service. Although it still uses DC-9s for interisland service, it has switched to 50-seat Dash-7 turboprops on about half of its 140 daily flights. And as much as 25 percent of Hawaiian’s 1984 revenue is expected to come from a mainland charter service operation it began late last year.

“We had to completely turn this company around,” admits Lindsey N. Pollock, Hawaiian’s new senior vice president of marketing. “Mid-Pac is a fact of life and so is deregulation. We’ve got new union contracts and work rules, lower salaries, and more competitive pricing and aircraft. The first quarter of 1984 [was] the most profitable in the company’s history, but we had to some bleeding to get there.”

Aloha also suffered three consecutive bad years (losses from airline operations were $2.5 million in 1981, $5.6 million in 1982, and $7 million last year) before breaking back into the black in this year’s first quarter. And like Hawaiian, Aloha has been completely reorganized.

“All the old management is gone,” says Myers. “There’s nobody left. This is like a completely new company. We’re repainted our fleet, refurbished our terminals, renegotiated our union contracts and made ourselves competitive in the free market. This is, in essence, a new Aloha from top to bottom.”

The “new” Aloha, which controls about 33 percent of the interisland market, is positioning itself as “Pacific experts.” Aloha has announced a new division, Aloha Pacific, which was scheduled to begin international service in May by flying between Honolulu, Guam and Taipei. Aloha is also starting a joint-venture airline in China.

Back at MidPac, the focus is on fending off the resurgent Hawaiian and Aloha. The new management at the old-line companies has been so combative that Kramer claims, “MidPac is being harassed because of our success.”

Although the fare war has cooled off—MidPac’s unrestricted one-way fare is $41.95 between any two points; Aloha and Hawaiian’s unrestricted fare is $49.95—the three airlines have been squabbling over other issues. MidPac’s highly advantageous position in the overseas terminal is now a major bone of contention. The new managements of Aloha and Hawaiian have demanded that MidPac be moved into the interisland terminal. The state of Hawaii, which runs the Honolulu airport, has ordered MidPac into the interisland terminal. MidPac is protesting.

“We’re being penalized because we’ve been successful,” huffs Kramer. “Why should we move now just because Aloha and Hawaiian are being hurt? They were the guys who wouldn’t let us in there before. Hey, these guys made their own bed. They should be made to lie in it.”

MidPac’s flight schedule is also under fire. Aloha recently began guaranteeing it will run all of its 105 daily flights as scheduled. Aloha claims MidPac—and, to a lesser extent, Hawaiian—has been consolidating flights and delaying passengers. “We run them all,” fumes Myers. “The other guys consolidate all the time. We checked them out. MidPac only runs about 75 percent of their scheduled Maui flights. One day they only ran half the flights the schedule called for.”

But MidPac has already fended off the first big challenge to its service. MidPacs tickets have always carried the “F” designation for first class. Last year, Hawaiian and Aloha complained to the CAB. They claimed the practice was deceptive because all Hawaiian, Aloha and MidPac flights were one-price/one-cabin/one-service operations. Hawaiian and Aloha, which used the “Y” coach designation on their tickets, demanded MidPac conform to the practice. CAB let MidPac’s “F” designation stand. Aloha then started traditional, premium-priced first-class service on its flights and appealed the CAB ruling. In April, the CAB refused to change its decision.

“I just think a one-class service being labeled first class is deceptive,” says Myers. “MidPac’s service is not first class. Aloha offers our first-class passengers different service and different seats in a separate cabin. That’s first class. MidPac’s service isn’t.”

“You know,” responds MidPac’s Haugen, “the only complaints CAB got about our service were from Aloha and Hawaiian. We’ve flown millions of passengers, but not one of them ever complained about our service to the CAB.”

This column originally appeared in Frequent Flyer magazine.

Copyright © 1983-2009 by Joe Brancatelli. All rights reserved.