In The Amazing JetBlue, I highlighted the upstart's remarkable success to date. There are reasons aplenty. JetBlue (NASDAQ:JBLU) was the best-capitalized startup in industry history. The airline serves lucrative, high-volume markets, and most of its competitors are ill-managed and heavily in debt. By offering customers an exceptional experience, JetBlue has fostered brand loyalty in what had become a commodity industry.

But let's not overlook the single most important driver of the airline's success: JetBlue charges considerably less than just about any other airline. In the industry, analysts track what's called passenger revenue per revenue passenger mile (RPM). In English, that's what an airline charges the average paying customer to fly one mile. For JetBlue, in 2002, that number was 9 cents.

By contrast, Southwest Airlines (NYSE:LUV), the industry gold standard for discount fares, charged 11.8 cents/RPM, 31% more than JetBlue, though, admittedly, this difference is largely due to the fact that JetBlue's average flight is 60% longer. Delta Air Lines (NYSE:DAL), considered one of the better major carriers, charged 12.1 cents/RPM, 34% more than JetBlue -- though this, in part, reflects Delta's first-class seating and other perks. It's little wonder customers are flocking to JetBlue. In June, passenger counts soared 61% year over year and planes flew at an exceptional 87% of capacity.

With its focus on high volumes and rock-bottom pricing, one might assume that JetBlue runs a low-margin business -- think Costco (NASDAQ:COST) or Wal-Mart (NYSE:WMT). In fact, that wouldn't be so bad, given that last year major carriers rode large negative margins to a collective loss of more than $10 billion. But JetBlue's operating margins are remarkably high -- 16.5% in 2002. By contrast, Southwest's was 7.6% and Delta's a minus 9.8%. The differences in Q1 '03 were even more dramatic: JetBlue, 15.9%; Southwest, 3.4%; and Delta, -17.0%.

So, how does JetBlue charge the lowest prices and still earn the highest margins? Simple: Its costs are the lowest, by a long shot.

At the risk of losing you with more industry jargon, airline costs are typically measured by dividing operating expenses by available seat miles (ASM). In other words, how much an airline spends, on average, to fly each seat (whether filled or not) one mile. For JetBlue, in 2002, that was 6.43 cents. The same thing cost Southwest 7.41 cents/ASM (15% more than JetBlue) and Delta 10.31 cents/ASM (a staggering 60% more than JetBlue).

What's behind this huge cost advantage? Let's examine the income statements of these three airlines, converting all expenses into cents/ASM:

JetBlue     Southwest      Delta
TOTAL REVENUES 7.71 8.02 9.39OPERATING EXPENSES Salaries, wages, and benefits 1.97 2.89 4.35 Fuel and oil 0.93 1.11 1.19 Maintenance materials and repairs 0.11 0.57 0.50 Aircraft rentals & depreciation 0.82 0.79 1.31 Landing fees and other rentals 0.53 0.50 0.59 Other operating expenses 2.08 1.56 2.37 ----- ----- ----- Total operating expenses 6.43 7.41 10.31 ----- ----- -----OPERATING INCOME 1.27 0.61 -0.92
* year ended Dec. 31, 2002

From this, we see that JetBlue's much lower costs more than make up for moderately lower revenues, resulting in more than twice Southwest's operating income/ASM. (Let's not even talk about the disasters at Delta and other major carriers.)

We also see that JetBlue's lower costs are driven by two key elements: lower salaries, wages, and benefits (highly productive people); and lower maintenance and aircraft rentals and depreciation (highly productive aircraft).

Essentially, there are three ways a company can improve return on equity: (1) raise profit margins (increasingly difficult in an environment where companies are struggling merely to maintain their margins); (2) increase leverage, which adds risk (and corporate America is already at record-high debt levels); or (3) increase asset utilization (sales/assets). It is in the last -- maximizing the productivity of assets (including human assets) -- that JetBlue schools other companies and industries.

Productive people
JetBlue achieves tremendous labor productivity in a number of ways:

  1. Employees feel valued and respected and have a sense of ownership, which translates into a motivated, productive workforce. How JetBlue has achieved this in an industry infamous for catastrophic labor-management relations is a topic I will address in a future column.

  2. Workers aren't unionized so there are no restrictive work rules.

  3. JetBlue flies one type of aircraft, which keeps training costs down, improves productivity, and increases scheduling flexibility.

  4. On average, its pilots are paid for 83 hours per month, of which 82% are "block hours" -- the time from when a plane pushes back from one gate and arrives at another. This is a critical measure of pilot productivity since an airline only earns money during block time. JetBlue maximizes this metric primarily by reducing training time (again, flying one type of plane) and by shunning the industry-standard hub-and-spoke system and its associated delays between flights.

  5. Finally, while JetBlue doesn't advertise this, its salaries are lower. The average JetBlue captain earns $135,000 annually (including overtime pay) vs. $149,000 for Southwest and $245,000 for Delta. Flight attendants start at $20 per hour and reservations agents at $8.25 per hour, though they work from home, saving overhead and contributing to employee satisfaction.

Wage discrepancies are not so great as they initially appear, however. Flight attendants and pilots earn time-and-a-half overtime above 70 flight hours per month, and there is ample opportunity to work extra hours (the average flight attendant works 89 hours per month). In addition, the company contributes 15% of its pre-tax income to a crew member profit-sharing plan, which last year translated into a 15.5% bonus for all employees. Finally, there's a generous stock purchase plan for employees, with nearly 70% participation, and some get stock options.

Other factors offset the lower pay at JetBlue. For one, there's a high degree of job security. There are also opportunities for advancement. For example, pilots can be promoted from first officer to captain in as little as three years -- virtually unheard of in this rapidly downsizing industry. And with JetBlue growing so fast, new employees quickly gain seniority and its associated perks: choosing which days and routes to fly, avoiding dreaded "red-eye" flights, etc. As a result -- and, of course, with all of the layoffs in the industry -- JetBlue is deluged with job applications. The company has 6,000 pilot applications on file, approximately 12 times the number of pilots hired to date.

A JetBlue flight attendant who used to work for United tells me that while her base pay is lower, she makes it up by working overtime and participating in the stock purchase plan. She likes working for JetBlue because the company treats her well, she is already quite senior (meaning that she has her pick of routes), and her fellow flight attendants work as hard as she does. At United, she said relations with management were terrible, she was among the most junior flight attendants (which was why she was laid off), and was often frustrated by burnt-out, unmotivated colleagues who -- knowing that their union would protect them -- were rude to passengers or simply sat at the back of the plane during the bulk of the flight. I don't want to read too much into one anecdote, but I suspect that her story is typical.

Productive planes
Given their high cost, it's critical to squeeze every ounce of productivity from each airplane. To keep aircraft operating costs low, JetBlue buys only new planes, which tend to need less maintenance and, even better, come with a five-year warranty. There's a rumor going around that Airbus is giving JetBlue planes for free, which is obviously untrue -- though I don't doubt that JetBlue gets excellent prices.

Equally important, JetBlue keeps its planes in the air -- the only time when they're earning revenues -- an average of 13 hours per day. This is the highest in the industry, 18% higher than Southwest (11 hours, though again this is largely due to JetBlue's longer flights) and 44% more than Delta (9 hours).

JetBlue achieves this productivity because:

  1. Its planes are at the gate for, on average, 35 minutes, vs. an hour or more for most airlines. This is partly because flight attendants are expected to help clean the plane, which motivates them to be persistent in encouraging passengers to pick up trash before the plane lands. Also, as noted above, JetBlue shuns the delay-causing hub-and-spoke system.

  2. New aircraft tend to spend less time out of commission due to unexpected breakdowns and scheduled maintenance.

  3. With many coast-to-coast routes, JetBlue flies many planes on all-night "red-eye" flights. By my count, 17 of JetBlue's 44 aircraft (39%) are in the air at some point between midnight and 6 a.m. every day.

Low distribution costs
JetBlue further benefits by selling 71% of its tickets via its website, vs. just 50% for Southwest and far fewer for most major carriers. It encourages this by offering a $5 discount per ticket. In addition, it pays no commissions to travel agents and issues no paper tickets whatsoever, which saves $5 to $7 in processing and distribution costs.

The ways in which JetBlue has built a low-cost structure should be a lesson to almost any type of business. This structure allows the company to slash prices, gobble up market share, and grow rapidly, yet remain highly profitable. This is precisely the formula that the likes of Wal-Mart and Dell (NASDAQ:DELL) used to dominate their industries.

Whether JetBlue will be able to do the same is another question, and one I'll take up in a future column.

Whitney Tilson is a longtime guest columnist for The Motley Fool. He did not own shares of the companies mentioned in this article at press time, though positions may change at any time. Under no circumstances does this information represent a recommendation to buy, sell, or hold any security. Mr. Tilson appreciates your feedback on the Fool on the Hill discussion board or at The Motley Fool is investors writing for investors.