Spirit Airlines (NYSE:SAVE) is in the early stages of a massive wave of growth. Over a 15-month period that began in October, Spirit is expanding its aircraft fleet from 58 to 80 planes. That will allow it to boost capacity by about 30% in 2015 on top of this year's 18% growth.
On Friday, Spirit Airlines announced that Houston would be its next expansion target. It's not particularly surprising that Spirit sees Houston as an extremely attractive market. The top carrier in the Houston air travel market is United Continental (NYSE:UAL), a competitor that Spirit has flagged as the highest-cost producer in the country.
Spirit wins on price
Spirit Airlines frequently emphasizes that it has a simple strategy: "Price Above All."
Surveys show that price is by far the No. 1 factor for most people when choosing flights. In response, Spirit focuses on maintaining a big pricing gap under its main competitors. A few years ago, Spirit executives said the company would only enter a new market if they thought they could lower prices by at least 25% while still hitting internal margin targets. The company also focuses on large markets where it can get at least 150-200 daily passengers flying each way.
Spirit likes competing with United
To offer fares far below the competition -- 40% lower on average, according to Spirit -- and still produce an industry-leading profit margin, Spirit must have much lower costs. The company minimizes its costs in many ways. For example, it packs more passengers into its planes than rivals, at the expense of legroom. Spirit uses its planes more heavily than most airlines. It also charges for drinks on board.
However, Spirit's advantage also depends on the cost structures of its competitors. The company recognizes that some rivals are in a much better position to compete on price than others.
Spirit's most recent analysis found that United has adjusted mainline unit costs that are 88% higher than Spirit's adjusted unit costs. By comparison, Delta Air Lines had the next highest cost structure, but its adjusted unit costs were only 56% higher than Spirit's.
Spirit's method for adjusting cost figures for stage length -- the distance covered by the average flight -- might inflate United's cost disadvantage. Nevertheless, the key is that Spirit believes United has by far the highest costs of its competitors.
A theme to growth
If United has the highest costs of any U.S. airline, then Spirit can easily underprice it to stimulate traffic while earning a healthy margin. Indeed, Spirit has declared that its total revenue per passenger is less than half of United's breakeven cost, making it impossible for United to compete on price.
Bearing this in mind, it's no surprise that Spirit is making a big growth push in Houston: United's largest market by passenger count. Next spring, Spirit will add service to 10 new destinations from Houston: three in the U.S., three in Mexico, and four in Central America. On several of those routes, Spirit will represent United's first nonstop competition.
These new destinations follow several other recent moves by Spirit into United Airlines' markets. Since the beginning of August, Spirit has started another five nonstop routes from Houston, as well as three routes from Chicago, which is United's second-largest hub.
Spirit Airlines has also announced two new routes from Chicago that will begin next spring (San Diego and Philadelphia). Between January and April, it is starting eight new routes from Cleveland, a city where United recently closed its hub but remains the largest carrier. Spirit isn't picking up any of the routes United canceled; instead, it will go head-to-head with United on seven of the eight routes.
Obviously, Spirit Airlines isn't growing only in United Airlines' markets. For example, last month it began flying between Atlanta and Detroit, which are Delta's top two hubs. However, among the new routes Spirit has announced/launched in the last few months, United hubs have been targeted disproportionately.
Given that Spirit has identified United as having the highest costs in the industry, it makes sense to target United's routes. Plenty of cost-conscious leisure travelers would gladly fly Spirit to avoid the high fares United must charge to remain profitable.
One thing to watch going forward is how United reacts in the markets Spirit is entering. On routes with plenty of business traffic, United's best move might be to ignore Spirit. Business travelers will pay more for United's amenities and its frequent flights (Spirit flies most routes once a day).
On leisure routes from United hubs, there is a bigger threat of cannibalization by Spirit. These could be ripe for service cutbacks as Spirit expands. Lastly, for some of the routes in Cleveland, United may decide it's not worth fighting the ultra-low cost competition.
Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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