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ST. THOMAS ST. JOHN ST. CROIX USVI A I R S E R V I C E M A R K E T I N G A N D D E V E LO PM E N T S T R AT E G Y UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT T E C H N I C A L R E P O R T AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT Table of Contents Page I. Introduction ............................................................................................... T-1 A. Why Increase Air Arrivals? .................................................................. T-1 II. Assignment Approach/Methodology........................................................... T-4 III. Airline Industry Trends and their Importance to the Virgin Islands.............. T-5 A. Introduction ......................................................................................... T-5 B. The Current Crisis in the Airline Industry ............................................. T-5 C. Increased Economic Pressures on Airports ......................................... T-9 D. Emergence of Low Fare Airlines .........................................................T-10 E. Airline Consolidation ..........................................................................T-12 F. Industry Maturity.................................................................................T-13 G. Air Traffic Growth in the Caribbean.....................................................T-15 H. International Airline Liberalization.......................................................T-17 I. Summary and Conclusions .................................................................T-21 IV. Historical Traffic Growth at the St. Croix and St. Thomas Airports ............T-22 A. Introduction ........................................................................................T-22 B. How Air Traffic Volumes are Measured...............................................T-22 C. Enplaned-Deplaned Traffic .................................................................T-23 D. Load Factors ......................................................................................T-26 E. Origin-Destination Traffic....................................................................T-27 F. International Traffic ............................................................................T-31 G. Connecting Traffic ..............................................................................T-32 H. Fares to and from the Virgin Islands ...................................................T-33 I. Impact of the September 11 Attacks ...................................................T-38 J. Summary............................................................................................T-39 V. Organization and Community Perspectives ..............................................T-41 A. Introduction ........................................................................................T-41 B. Major Findings - General ....................................................................T-41 C. Organizational/Community Perspectives Related to Air Service Marketing and Development – St. Thomas .........................................T-43 D. Organizational/Community Perspectives Related to Air Service Marketing and Development – St. Croix..............................................T-44 VI. Airline Perspective and Analysis...............................................................T-45 A. Introduction ........................................................................................T-45 B. Operational Issues .............................................................................T-45 C. Promotional Issues.............................................................................T-46 D. Airport Management Issues ................................................................T-47 E. Incentives Issues................................................................................T-49 F. Summary............................................................................................T-49 EDWARDS AND KELCEY T- i USVI VII. Air Service Opportunities Analysis ........................................................... T-51 A. Introduction........................................................................................ T-51 B. Route Evaluation Methodology........................................................... T-51 C. Findings of Domestic Route Evaluations ............................................ T-53 D. Developing St. Croix or St. Thomas as a Hub for the Caribbean......... T-54 E. Long Haul International Services........................................................ T-55 F. Services to Canada............................................................................ T-57 G. St. Croix Technical Stops Program..................................................... T-58 VIII. Recommended Air Service Marketing and Development Strategies.......... T-60 A. Introduction........................................................................................ T-60 B. The Need for Strategies for Each Island............................................. T-60 C. Recommended Strategies .................................................................. T-61 Appendices Appendix A Terms of Reference Appendix B List of Persons Interviewed Appendix C Partial Bibliography Appendix D Flight Performance at St. Croix and St. Thomas Appendix E Commuter Airline Traffic at St. Croix and St. Thomas Appendix F Airline Loads and Operations, St. Croix and St. Thomas Appendix G Origin-Destination Passengers 1995-2002, St. Croix Appendix H Origin-Destination Passengers 1995-2002, St. Thomas Appendix I Detailed Origin-Destination Traffic Profile 2002, St. Croix Appendix J Detailed Origin-Destination Traffic Profile 2002, St. Thomas Appendix K Inbound Air Arrivals to St. Croix Appendix L Inbound Air Arrivals to St. Thomas Appendix M International Traffic to and From the U.S. Virgin Islands Appendix N The Small Community Air Service Pilot Program T-ii EDWARDS AND KELCEY AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT List of Exhibits Page Exhibit I-1. The Tourism and Travel Industry Share of the Gross Domestic Product.......................................................................................... T-2 Exhibit I-2. United States Virgin Islands Share of Caribbean Tourists by Country of Residence, 1997-2001.................................................. T-2 Exhibit II-1. Assignment Approach/Methodology............................................... T-4 Exhibit III-1. Net Earnings/Loss of Domestic Air Carriers ................................... T-5 Exhibit III-2. Revenue Passenger Enplanements, 1950-2002............................. T-8 Exhibit III-3. Operating Expense per Available Seat Mile, Southwest and United Airlines ..............................................................................T-10 Exhibit III-4. Average Fares per Mile (1978 dollars) ..........................................T-13 Exhibit III-5. International Traffic Growth, 1990-2000........................................T-15 Exhibit III-6. Airline Capacity Growth in the Caribbean, 2001-2003 ...................T-17 Exhibit III-7. Map of Liberalized World ..............................................................T-18 Exhibit IV-1. Traffic at the Henry E. Rohlsen Airport, St. Croix ..........................T-23 Exhibit IV-2. Traffic at the Cyril E. King Airport, Airport, St. Thomas .................T-24 Exhibit IV-3. FAA Forecasts for Traffic at St. Thomas and St. Croix..................T-25 Exhibit IV-4. Load Factors by Airline at St. Croix and St. Thomas .....................T-27 Exhibit IV-5. Origin-Destination Traffic at St. Croix, 1995-2002 .........................T-30 Exhibit IV-6. Origin-Destination Traffic at St. Thomas, 1995-2002.....................T-30 Exhibit IV-7. Growth of Scheduled International and Domestic Origin- Destination Traffic, St. Thomas and St. Croix ...............................T-31 Exhibit IV-8. Commuter Airline Traffic between St. Thomas and British Virgin Islands ...............................................................................T-33 Exhibit IV-9. Virgin Islands Fare Comparison....................................................T-34 Exhibit IV-10. Average Domestic Fares at St. Croix, St. Thomas and Other Airports...............................................................................T-37 Exhibit IV-11. Impact of September 11 Attacks on Air Traffic ..............................T-38 Exhibit VII-1. EK Route Evaluation Methodology................................................T-51 Exhibit VII-2. Results of Route Analysis.............................................................T-53 Exhibit VIII-1. Recommended Air Service Development Strategies and Implementation Program...............................................................T-67 EDWARDS AND KELCEY T- iii AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT I. Introduction This Report presents a strategy and plan for increasing air arrivals to the United States Virgin Islands (USVI). It provides the communities of St. Thomas/St. John and St. Croix with a series of actionable steps to promote their economic development through obtaining better air services. The strategies reflect the realities of 2003; an airline industry in a financial crisis and a pronounced decline in air traffic throughout the world. However, they set ambitious goals that will test the creativity and persistence of those tasked to implement them. An air service development strategy is a key component for the development of the Islands. It will lay the foundation for an expansion of the tourism industry, and better position the Virgin Islands in competing for other economic sectors. It will also improve the USVI’s quality of life through integrating them more closely with the world economy. In the Fall of 2002, the University of the Virgin Islands, acting on behalf of the Legislature, initiated this process by requesting proposals for the development of air service strategies to increase air arrivals. In February 2003, Edwards and Kelcey Inc. was engaged by the University of the Virgin Islands (UVI) with a mission to: Develop a Comprehensive Air Service Marketing Strategy/Plan to Increase Air Arrivals in the U.S. Virgin Islands. The original terms of reference are contained in Appendix A. A. Why Increase Air Arrivals? The economy of the Virgin Islands depends on a healthy tourism and travel sector. As shown in Exhibit I-1, the tourism and travel industry account for over 40% of the USVI’s gross domestic product. This is a far higher portion than for the Caribbean as a whole. If this sector stagnates, the entire Virgin Islands will suffer, whatever the success of other industries. The past decade has seen an erosion of the USVI’ competitiveness as a destination. As noted in the “5 Year Plan for Fiscal Recovery” … in the 1990’s, the U.S Virgin Islands has clearly lost significant market share relative to other Caribbean destinations … Over the 1990-97 period, the U.S. Virgin Islands’ air tourism market share has declined from 8.7 percent to 5.5 percent1. 1 United States Virgin Islands Office of Information Technology, 5 Year Plan For Fiscal Recovery (2002) EDWARDS AND KELCEY T-1 USVI EXHIBIT I-1. THE TOURISM AND TRAVEL INDUSTRY SHARE OF THE GROSS DOMESTIC PRODUCT 0 5 10 15 20 25 30 35 40 45 Virgin Islands Caribbean World % of GDP SOURCE: THE VIRGIN ISLANDS, THE IMPACT OF TRAVEL AND TOURISM ON JOBS AND THE ECONOMY, WORLD TOURISM AND TRAVEL COUNCIL EXHIBIT I-2. UNITED STATES VIRGIN ISLANDS SHARE OF CARIBBEAN TOURISTS BY COUNTRY OF RESIDENCE, 1997-2001 0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00% United States Caribbean Japan Canada South American Europe U.S. Virgin Islands Share 1997 2001 T-2 EDWARDS AND KELCEY AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT SOURCE: CARIBBEAN TOURISM ORGANIZATION, CARIBBEAN TOURISM STATISTICAL REPORT (2002) As shown in , the USVI’s share of all but the U.S. market has continued to deteriorate since 1997. Although the U.S. mainland is by far the largest source of visitors, other Caribbean destinations such as the Dominican Republic, St. Lucia, Cancun and St. Kitts are increasingly competing for U.S. travelers. Airlines have launched a plethora of new routes to serve them. Exhibit I-2 Emerging destinations in the Caribbean, such as St. Kitt’s, the Dominican Republic and Cuba, have the advantages of a newer infrastructure that closely matches current tastes, and a perceived exoticism. They will experience faster growth (partly the result of a small base) than mature destinations such as Nassau, Montego Bay and San Juan. The USVI include both the mature destinations of St. Thomas and St. John, and the relatively undeveloped destination of St. Croix. St. Croix thus offers the best opportunity to obtain supra-normal growth rates. St. Thomas is the world’s leading port of call for leisure cruises, and the USVI is second only to the Bahamas in terms of the number of cruise ship passengers. However, while the cruise ships certainly increase awareness of the USVI, they provide comparatively modest benefits to the economy. In 2001, the average cruise ship passenger spent only $269 per visit, while visitors arriving by air spent an average of $1,025 per visit.2 Any attempt to promote air arrivals, and to reposition the USVI as an air destination, therefore could have a disproportionately large positive impact on the economy. Because of the sheer size of the tourism industry, it is necessarily the first focus of any effort to use air services as an instrument of economic development. Other industries, however, such as high technology, telecommunications and finance, are equally dependent on high quality air services. Whether the Virgin Islands goal is to enhance tourism, or develop industrial alternatives to it, high quality and attractively priced air services are a prerequisite for success. The purpose of this document is to present and evaluate the major factors and issues critical to the formulation of an effective, successful long-term air service marketing strategy/plan. Section II outlines the approach followed in developing the plan. Section III provides an overview of the current state of the global aviation industry, and the importance of current trends to the USVI. Section IV reviews the traffic history and air service trends at St. Thomas (STT) and St. Croix (STX). Section V examines the organizational roles/responsibilities and community issues associated with the implementation of the plan. Section VI presents the airline perspectives on issues impacting future air service development in the USVI. Section VI summarizes the analysis of potential service and route opportunities; and Section VII presents a prioritized action/implementation plan. The EK Team is indebted to countless individuals who generously donated their time, efforts and insights while meeting with us. Their friendliness and hospitality made the visits to the USVI particularly enjoyable. They have helped the Team obtain a far better insight into the Virgin Islands than could otherwise have obtained. Their efforts have guided the Team to appreciate the USVI’s diversity, and focus its recommendations and strategies to address the specific needs of both St. Thomas/St. John and St. Croix. Appendix B lists the key contributors. Appendix C provides a list of the major sources of data used in this project. 2 Source: Caribbean Tourism Organization EDWARDS AND KELCEY T-3 USVI II. Assignment Approach/Methodology The recommended strategies/plan are based on: • An analysis of the airline industry, its long term trends and current financial problems; specifically as they relate to their services to the Virgin Islands; • A review of the air service and traffic patterns to and from St. Croix and St. Thomas. This considers total traffic flows, origins and destinations, capacities, load factors and fares; • An extensive series of discussions with legislators, community leaders, business persons, and hotel and resort operators on both St. Thomas/St. John and St. Croix. These meetings considered both specific community concerns about air services, and broader issues relating to the economic development, inter-island relationships, organization structure and mission, and socioeconomic background of the Virgin Islands; • In depth discussions with the airlines to ascertain how they regard the Virgin Islands as a destination. This considers passenger loads, operating costs, airport facility concerns, operational issues and the degree to which the carriers are supported by locally based marketing efforts; • An analysis of airline networks, traffic flows and schedules, to identify those new services having the best prospects for success; • Integrating these findings into a series of time-based and prioritized action steps. Exhibit II-1 EXHIBIT II-1. ASSIGNMENT APPROACH/METHODOLOGY depicts this process schematically. Airline Industry Analysis St. Croix/St. Thomas Traffic Analysis Conclusions Consultations With Community Leaders Interviews With Airlines Recommendations Current Risks What New Services? When? How to Promote Them How to Manage the Process A plan to increase air arrivals to the Virgin Islands will succeed only if it creates a genuine partnership between the community and the airlines. The airline industry in 2003 is under severe financial hardship. While the problems will affect the timing of every step of the strategy, they should not distract the Virgin Islands from the overall goal of increasing air arrivals. Rather, they only impart an added sense of urgency to the recommended measures, and provide the Virgin Islands with opportunities to excel in a difficult environment. The next section examines the fundamentals of the airline industry, and how they affect the Virgin Islands. T-4 EDWARDS AND KELCEY AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT III. Airline Industry Trends and their Importance to the Virgin Islands A. Introduction A successful program for increasing air arrivals to the Virgin Islands will have two major components. One component addresses the intrinsic attractiveness of the Islands as an airline market. It considers what factors draw airborne visitors to the USVI, and how effectively these assets are communicated to prospective markets. The other part considers the supply of scheduled airline capacity. It identifies the key destinations and carriers, and considers how the airlines could profitably deploy new capacity to the USVI. The two components, working together in harmony, will ensure that the USVI’s supply and demand for air travel grow together. This section assesses the issues facing the airline industry, both in the broadest sense, and in their implications for St. Thomas and St. Croix. The objective is to look beyond the current crisis in the airline industry, to identify the key factors of importance to the Virgin Islands. This will serve as the point of departure for a detailed analysis of the Virgin Islands’ air market, to be discussed in Section IV. B. The Current Crisis in the Airline Industry In the Spring of 2003, the airline industry faces a crisis without precedent. While the industry has always been very cyclical, with severe losses corresponding to economic downturns, the magnitude of current problems have jeopardized the survival of even the best managed companies. In 2002, the U.S. industry lost more than $1 million every hour. outlines the net revenue / loss of domestic airlines from 1970 – 2001. Exhibit III-1 EXHIBIT III-1. NET EARNINGS/LOSS OF DOMESTIC AIR CARRIERS -10,000 -8,000 -6,000 -4,000 -2,000 0 2,000 4,000 6,000 8,000 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 Year Net Earnings / Loss (mils $) SOURCE: AIR TRANSPORT ASSOCIATION EDWARDS AND KELCEY T-5 USVI Total annual losses exceeded the cumulative profits of the last 45 years. United Airlines is in the midst of a Chapter 11 bankruptcy, and could fail altogether. USAirways only recently emerged from bankruptcy, but continues to operate at a loss. American Airlines, the largest carrier in the USVI, remains at grave risk. Other airlines serving the USVI, such as Continental and Delta, continue to generate huge operating losses. The investment community has rated the debt of every airline except Southwest as junk status. Average debt loads exceed 90% of capital value. Multiple factors account for this crisis: • The 9-11 terrorist attacks on New York and Washington have increased traveler anxiety, and have reduced the desire to travel by air; • Upgraded security procedures, including tougher inspections and longer lineups, have further contributed to the reluctance to travel; • The Iraq War has also exacerbated traveler anxiety. In the weeks immediately preceding the war, some airlines received more cancellations than reservations on international flights; • Continuing problems in the Middle East have led to very volatile fuel prices. While some carriers have wholly or partially hedged their fuel costs, many airlines remain vulnerable to higher prices; • The national economy has still not fully recovered from the recession, initially induced by excessive inventory levels and asset valuations of late 2000 in the technology sector. Strong consumer spending has kept the recession very mild for many sectors; however the economic weaknesses have proven unusually persistent; • The increased use of Internet websites for booking flights has made airline fare structures largely transparent. Passengers can readily shop for the lowest fares. Airlines are forced to compete increasingly on the basis of fares. The new distribution channels have undermined the effectiveness of traditional yield management techniques3; • The weak economy has particularly affected the demand for business travel. Business travelers usually pay higher fares, and generate a disproportionate share of airline profits. United and American have traditionally served mostly business travelers, and have therefore been particularly harmed by the decline in corporate travel; • Many airline costs are largely fixed in the 5-6 month term through the design of the schedule. Other costs are stipulated in collective agreement contracts, and can only be reduced by a lengthy process of negotiation. These factors make it difficult for airlines to reduce costs in the face of declining demand. Between 1990 and 2001, the best year for the world airline industry was 1997, with a 2.9% net margin on revenues4. Between 2000 and 2002, U.S. industry revenues fell by fully 24%5. Such a precipitous drop in a highly leveraged industry makes huge financial losses inevitable, regardless of the pace of cost reduction; • The inherent nature of airline competition. On most routes, market shares are highly concentrated, and airlines behave as oligopolies6. Even with declining traffic, airlines are 3 “Yield management” refers to a range of techniques airlines use to manage their seat inventories. Airlines develop a wide range of fares for any city-pair, which vary according to purchase price, length of stay, advance purchase requirements and other factors. They then assign a certain number of seats on each flight to every fare class, based on historical patterns and advance bookings. These assignments are reviewed and revised daily. The objective is to obtain the largest revenue possible from each flight. 4 Source: International Civil Aviation Organization Air Transport Reporting Form EF-1, International Civil Aviation Organization, Montreal PQ 5 Source: Air Transport Association, “U.S. Airlines: The Road to Resuscitation”, Washington, January 2003 T-6 EDWARDS AND KELCEY 6 In oligopolistic markets, producers base their output decisions partly on the actions of their competitors. Airline oligopolies sometimes attempt to out-schedule their rivals or “bracket” their flights. The resulting capacities may have only a distant AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT reluctant to withdraw capacity and cede market share, and future profits, to competitors. This slows the process of cost cutting, and assures all carriers on a route of insufficient traffic. This factor has made the airline industry chronically less productive, and has exacerbated the recent downturn. Carriers facing short-term cash problems cannot afford the long and risky process of market development. New routes usually require initial investments in opening new stations, and often involve a lengthy period before they become profitable. This also means that communities should moderate their efforts to obtain new services. Weak traffic levels mean that an airport recruiting new carriers may place its current operators at risk. The crisis also places existing services under pressure. Virtually every U.S. airport has lost scheduled services and traffic. Between 2000 and 2002, St. Thomas lost 3.32%% of its passengers and St. Croix 12.51%7. Economic pressures have forced airlines to discontinue many services that were once profitable. Carriers must be particularly careful in controlling operating costs, through measures such as disposing of elderly and inefficient aircraft, seeking wage rollbacks from unions, deploying smaller equipment, making greater use of subcontracted handling at low volume stations, and eliminating staff and operating redundancies. The airlines have been forced to be particularly aggressive in countering any measures that might increase their costs, such as increased airport fees. Significance to the Virgin Islands The industry crisis has important implications for the Virgin Islands and for the goal of increasing air arrivals. On the surface, a failing airline industry poses a severe obstacle to any air services development strategies for St. Thomas or St. Croix. However, the current problems have only increased airlines’ needs for profitable routes. The airlines have been forced to shift their attention from their unprofitable current routes to opportunities they may have overlooked previously. The Virgin Islands have not been high profile destinations in the past, but could prove of growing interest. The reduction in scheduled operations has left many airlines with surplus capacity. They can now consider inaugurating flights that were once precluded for lack of available aircraft. Routes devoted to leisure traffic, such as to the Caribbean, could benefit. Many destinations in the region cannot support daily services, but weekend-only flights could provide valuable links for vacationers. Before 2001, most airlines were reluctant to serve any route unable to support at least daily, or multiple-daily departures throughout the year. Now, such low frequency routes, using aircraft deployed during weekdays to business-oriented routes, have become an attractive source of revenue. The Virgin Islands could therefore seek more weekend-only or seasonal routes, such as United Airlines’ weekend flights to Chicago and Washington. Airlines traditionally have been supported by business travelers paying premium fares, and have therefore been most aggressive in serving large business travel markets. As primarily a leisure destination, the Virgin Islands has received correspondingly less attention. However, the weak economy has been particularly detrimental to the business market. Many corporations have curbed business travel, while obtaining large discounts from the airlines. The Internet, by simplifying fare searches, has made the airline industry much more price- relationship to underlying demands. This behavior, while less prevalent after airline deregulation, continues even in a severe industry contraction. It impedes an adjustment of capacities and costs to lowered traffic. 7 Source: Virgin Islands Port Authority EDWARDS AND KELCEY T-7 USVI competitive, and has significantly eroded the difference between business and leisure fares. Carriers dependent on high fare business travel, particularly United and American, have suffered particularly in the industry contraction. The fares and traffic volumes for leisure travel have been less affected than business markets. This has made St. Thomas and St. Croix relatively more attractive as destinations for the airlines. However, the current situation offers several threats to existing of services. Most carriers serving mainland-Virgin Islands routes offer limited frequencies. Notwithstanding the shift to seasonal or weekend-only services, the airlines will still consider if low frequencies can justify their costs of maintaining stations in the USVI. Some carriers have served the Virgin Islands in conjunction with Puerto Rico, or St. Croix as part of a circuit that includes St. Thomas. These short flight legs are very expensive, since many operating costs, such as engine and airframe maintenance, depend on the number of takeoffs rather than the hours flown. Fuel costs are particularly onerous for short flights by large jets. These factors could affect such services as USAirways’ Philadelphia-St. Thomas-St. Croix-Philadelphia route8; to the detriment of either St. Thomas or St. Croix. It was likely a factor in American Eagle’s decision to discontinue serving the St. Thomas-St. Croix sector. The short-term problems affecting the airline industry may distract both airlines and communities from longer-term opportunities. As illustrated in , the recent industry decline is a truly exceptional period; a modest decline after several decades of rapid growth. Exhibit III-2. Revenue Passenger Enplanements, 1950-2 EXHIBIT III-2. REVENUE PASSENGER ENPLANEMENTS, 1950-2002 0 100,000 200,000 300,000 400,000 500,000 600,000 700,000 1950 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 SOURCE: AIR TRANSPORT ASSOCIATION T-8 EDWARDS AND KELCEY 8 On May 28 2003, shortly after the research for this Study was finished, USAirways announced cessation of the Philadelphia-St. Thomas-St. Croix-Philadelphia circuit. The 142-seat A-320 flight was replaced by a Philadelphia-St. Thomas-Philadelphia round trip operated by a 182-seat 757. An A-320 will operate a Saturday-only Charlotte-St. Croix- Charlotte service. AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT Between 1950 and 2000, U.S. domestic traffic grew at a compounded annual rate of 8.3%9. The 6.4% drop from 2000 to 2002 merely returns traffic to the 1998 level. The earnings crisis, by weakening airline balance sheets, will harm their access to capital to support growth for years to come. However, the current restructuring, a stronger economy, and the recovery of traffic after the conclusion of the war in Iraq, should provide a firm basis for a more expansion-oriented airline industry. The Virgin Islands could benefit as a leisure- oriented destination, combining the exotic ambience of the Caribbean with the security of the United States. C. Increased Economic Pressures on Airports Declining revenues and the increasing importance of price competition have placed airlines under intense pressure to reduce costs. The airlines in turn have been seeking relief from their suppliers. For example, through eliminating many travel agent commissions, the airlines succeeded in shrinking these expenses from 10.% of revenues in 1993 to 3.5% in 200110. The airlines have also targeted airport fees. In 2002, landing fees comprised 2.1% of airline costs, compared to 38.4% for labor and 11.6% for fuel11. Although a small proportion of total costs, they are controversial. They are the most important cost item under at least partial control of the points they serve, and therefore can become the focus of airline-community disagreements. Except for airline fleet costs, they are the fastest growing expense item, and have increased 114% since 1980. They have a large impact on profits in a low-margin industry. In 1999, a “good” year, the airline industry generated a net profit of only 4.5% of revenues. Any large hike in landing fees can therefore have a decisive impact on airline financial performance. In May 2003, USAirways CEO David Siegel stated that airport costs “are part of the next wave of aviation industry restructuring.” Targeting the Pittsburgh hub, he also stated that its high level of debt and high interest payments makes it “an uncompetitive place to do business.” Southwest Airlines has publicly stated that it will not serve Denver, because of the costs of the new airport. It places all the stations it serves under continual pressures to maintain low operating costs. As an absolute minimum, the problems with the industry severely reduce the airports’ limited pricing flexibility. The airports face higher costs because of a greater security awareness. Furthermore, the recent decline in traffic has reduced their revenues. Most airports operate on a non-profit basis, and price their services only to recover costs. Their costs; bond servicing, administration and maintenance, are largely independent of traffic. They spread their costs over the current amount of traffic, making up any shortfall from their signatory carriers. To remain solvent and avoid a default on their bonds, they are under immediate pressure to match any traffic decrease with increased rates. They risk a vicious circle, in which traffic declines force them to raise rates, causing further airline cutbacks and a further round of rate increases. This can have a very negative impact on the perceptions and actions of cost-conscious airlines. To minimize the risks of such a spiral, airports must exercise rigid cost control from the outset. 9 Source: Air Transport Association, 2003 10 Source: Ibid 11 Source: Ibid EDWARDS AND KELCEY T-9 USVI Some airports have used user fees as a marketing tool. Many, including the Virgin Islands Port Authority, grant a temporary holiday on landing fees to recent entrants. The Puerto Rico Ports Authority has reduced its landing fees by 25%. Hub carrier American’s reduction is based on its load factors, with a maximum discount of 25%. In 2002, these landing fee discounts cost the Authority $5.8 million12. Not all airports have the resources to offer similar discounts. There are no simple answers of how airports should react to an unprofitable airline industry. Both the airlines and the airports are under an intense financial squeeze. Airports must trade off their own financial viability against the risk of alienating their tenant airlines. D. Emergence of Low Fare Airlines One of the most important trends affecting the airline industry has been the emergence of low fare airlines. These airlines first appeared in intra-California routes in the 1960’s, but expanded throughout the nation after the deregulation of domestic services in 1978. The largest and most successful operator, Southwest Airlines, was founded in 1971, and originally served high-density routes within Texas. The low fare airlines use a range of business approaches. Southwest flies on mostly short haul, high-density services, but is increasingly active on transcontinental sectors. AirTran and Frontier fly hub-and-spoke routes, while Jet Blue offers long distance point-to-point services. The airlines uniformly share a tight control of costs, simplified fleets, flexible work rules that promote efficiency, an emphasis on under-served markets or airports and simplified fare structures. Exhibit III-3 illustrates the cost advantages of a carrier like Southwest when compared to a network carrier (United Airlines). EXHIBIT III-3: OPERATING EXPENSE PER AVAILABLE SEAT MILE, SOUTHWEST AND UNITED AIRLINES 0 2 4 6 8 10 12 14 Southwest United Cents per ASM T-10 EDWARDS AND KELCEY 12 Source: Puerto Rico Herald, May 12, 2003 AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT SOURCE: QUARTERLY FINANCIAL REPORTS SOUTHWEST AIRLINES AND UNITED AIRLINES APRIL 2003 Most importantly, the low fare airlines did not inherit the wage scales, employee attitudes and corporate culture of a protected industry, in which the government, through the Civil Aeronautics Board, insulated the industry from excessive competition. The low fare carriers have therefore been more opportunistic and adaptable than the legacy airlines, especially in the recent downturn. Low fare airlines have had a major impact on traffic at airports they serve. The combination of their own services, lower fares, and the competitive response of incumbents has often led to large traffic increases13. Low fare carriers such as AirTran, JetBlue and Southwest have been more profitable than the traditional airlines, particularly in the current industry downturn. However, low fare airlines are not on average more successful than the airline industry as a whole. Since airline deregulation in 1978, many firms have attempted to establish low fare air services. Most had insufficient capital, and were unable to survive aggressive competitive responses by the established airlines. Recent low fare airline failures include Vanguard, Access Air, National and ProAir. The three profitable low fare airlines are the exceptions to the poor financial performance of most new and low fare carriers. By the end of 2002, the low fare airlines served 20% of the domestic market, but influenced fares on a much larger share. The traditional airlines have attempted to emulate their advantages, with mixed success14. Some have attempted to launch separate low fare divisions, such as Delta’s “Song” and USAirways’ discontinued “MetroJet.” Significance to the Virgin Islands The low fare carriers have had limited direct importance to the Virgin Islands15. They have focused on high-density mainline services. They usually require high volume stations in order to spread their fixed ground costs over a sufficiently large number of flights. Some seek a minimum of ten daily departures. Almost no communities generating traffic volumes comparable to St. Thomas or St. Croix have low fare airline services. Those that do were required to commit to large financial incentives. Most low fare airlines operate simplified fleets, and will not necessarily own the aircraft appropriate to flying Virgin Islands-U.S. mainland routes. Finally, the low fare airlines have many opportunities within the continental United States, and see no need to diversify into new areas. They are thus very unlikely to operate seasonal or services or routes with less than a daily frequency. Nevertheless, several factors suggest low fare carriers could eventually be of both direct and indirect importance in the quest to increase air arrivals at the St. Thomas and St. Croix airports: • In 2002, JetBlue inaugurated services to San Juan. This does not necessarily indicate a company initiative to expand into the Caribbean. The New York-San Juan route, with 13 See “The Low-Cost Airline Service Revolution”, Federal Aviation Administration, United States Department of Transportation (Washington, 1996) 14 In late 2002, American Airlines announced a fleet rationalization program that would great simplify its maintenance and flight crew training/scheduling. It also “depeaked” its Chicago and Dallas/Fort Worth hubs by adjusting its schedules, thereby greatly reducing aircraft downtime. While not deliberately trying to emulate low fare airlines, it has adopted some of their stratregies. 15 American TransAir, an exception, has operated charter services to the Virgin Islands. It could be considered a candidate for scheduled flights. EDWARDS AND KELCEY T-11 USVI over 8 times the traffic of the St. Thomas-New York market, is an ideal market for JetBlue. It would still be appropriate to view JetBlue as a long term (3-4 years) candidate for service to the Virgin Islands. • JetBlue does not enter into formal agreements with other airlines to exchange traffic. Passengers connecting to JetBlue from other airlines must purchase separate tickets. For passengers traveling to and from the Virgin Islands on short notice, and required to purchase full fare economy tickets, an itinerary via JetBlue and a commuter carrier on the San Juan-St. Thomas/St. Croix leg is financially attractive. The DOT’s origin- destination statistics, available to all airlines, will report this JetBlue traffic as a San Juan origin or destination; the link with the Virgin Islands will fail to be captured. The statistics will therefore understate long haul traffic to and from St. Thomas and St. Croix. As JetBlue expands at San Juan, this anomaly will be a growing problem. • Spirit Airlines recently inaugurated services from Orlando to San Juan, and could be a candidate for serving the USVI; • AirTran’s Boeing 717 fleet has a limited range that precludes its serving Island-mainland routes. However, it has recently taken delivery of A-319’s for trans continental services. These aircraft have the range to fly from the Virgin Islands to the eastern half of the United States, subject to runway limits at St. Thomas. AirTran thus becomes a candidate to serve the Virgin Islands. • As the low fare carriers exhaust expansion opportunities on the U.S. mainland, they will increasingly seek opportunities in the Caribbean, Mexico and Canada. This will become increasingly important by about 2007. • Despite their efforts at emulation, the traditional airlines have been unable to replicate fully the low costs and commercial vitality of the low fare airlines. They continue to surrender traffic to the low fare airlines, and increasingly avoid markets where they face strong competition from this segment. The number of routes where they do not face low fare competition continues to fall. Having no low fare airline services at the Virgin Islands would therefore be a strong inducement for more capacity by the traditional airlines. • To the extent that they can lower their operating costs, the traditional airlines will be more profitable and better able to compete. They will be stronger candidates to increase services to the Virgin Islands and elsewhere. Delta has been particularly successful in reducing its costs, and expects to have implemented a further 15% reduction by 2005. E. Airline Consolidation The years following deregulation saw a massive consolidation of the industry. Airlines such as Piedmont, Ozark, Southern, North Central and National were acquired by larger airlines. Braniff, Eastern and Pan American failed, and the remaining airlines quickly filled any service gaps. Recent merger activity has been limited. In 1999, American Airlines acquired Reno Air, and purchased Trans World Airlines in 2001. United Airlines’ attempt to acquire USAirways was rejected by the Justice Department in August 2001. The Department of Justice and the Department of Transportation seek to maintain competition, and have been very aggressive in scrutinizing proposals and imposing side conditions. Airline executives have claimed that constraints on the proposed Continental/Northwest/Delta alliance would negate any benefits. The lengthy regulatory process and the small likelihood of obtaining approval have likely deterred many proposed combinations. T-12 EDWARDS AND KELCEY AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT A further wave of airline mergers could only succeed if regulators become more receptive. The desperately poor financial condition of many airlines and the prospect of outright failures of leading carriers may encourage greater leniency. If so, additional mergers are likely to take place, reducing the number of network carriers from the current seven to three or four. While the specific transactions are a matter of speculation, the mergers would likely involve each of the “big three”, United, American and Delta, acquiring smaller airlines such as Northwest, USAirways, Continental and America West. Significance to the Virgin Islands Any renewed merger activity would almost certainly involve airlines serving St. Thomas and St. Croix. It could lead at the outset to fewer services. However, the largest operators in the Virgin Islands, American, USAirways and Delta, are very unlikely partners. In the longer term, as the newly merged entities rationalize their networks, a series of larger and stronger hubs will likely result. For example, a Northwest-Continental merger could strengthen both Detroit and Houston, potentially allowing new services to St. Thomas and St. Croix. While a more concentrated industry is likely to boost fares, the tradeoff, airlines sufficiently profitable to obtain access to capital markets, would help assure consistent access to the USVI in the long run. A new wave of mergers, while posing immediate risks of service losses, would be to the long-term benefit of the Virgin Islands. F. Industry Maturity The rapid growth of commercial aviation is the result of national economic expansion and falling airfares. Exhibit III-4 illustrates that between 1970 and 2001, the average per-mile fare in 1978 dollars fell from $.0973 to $.045716. During the same period, total traffic, as measured by revenue passenger-miles, expanded nearly five-fold17. The national economy, as measured by real gross domestic product, grew by 165%18. EXHIBIT III-4: AVERAGE FARES PER MILE (1978 DOLLARS) 16 Source: Air Transport Association and United States Department of Transportation Form 41 Report 17 Source: Ibid 18 Source: Bureau of Economic Analysis EDWARDS AND KELCEY T-13 USVI 0 2 4 6 8 10 12 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 Year Cents (1978) SOURCE: AIR TRANSPORT ASSOCIATION The airline industry owes most of its growth to continually falling fares. Improved technologies have resulted in greater fuel efficiency, lower maintenance costs and two- person cockpit crews. Deregulation, through creating a competitive market, has forced carriers to pass these savings on to the traveling public in the form of lower fares. Fares cannot continue to fall indefinitely. Higher fares will be necessary to restore industry profitability. With every cost-saving innovation, it becomes more difficult for the manufacturers to squeeze out further productivity improvements. For example, while the industry has largely made a full transition from 3 to 2-person pilot crews, there is no process in motion to cut crews to 1 person. There are “hard” theoretical limits to fuel efficiency. These factors mean that costs, and fares, will eventually stabilize. Since it is not low fares per se, but falling fares that generate growth, this means that the long-term expansion of the airline industry must eventually slow. During this decade, growth rates of 2-3% will likely prevail in an industry that still expects a 5-7% annual growth. While a rebound from current industry difficulties may cause a large one-time increase, long-term expansion will continue at more modest rates than the past. Significance to the Virgin Islands Communities should adopt more conservative expectations of traffic and air services growth at their airports. The airline industry will become less expansion-oriented, and less willing to invest in new aircraft to launch additional services. Proposals for new services will receive heightened scrutiny by airline planners. The slower growth will make it considerably more difficult to launch new airlines, since fewer underserved market segments are likely to appear, and incumbents will be more aggressive in defending their current revenue sources. T-14 EDWARDS AND KELCEY A major finding of this Study is that the Virgin Islands do not have an immediate and pressing shortage of raw airline capacity. Rather, current schedules are already commensurate with traffic demands, and the major air service opportunities center on tourism promotion. The recommended strategies address these issues in order to expand AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT demand. Carriers would then respond with increased capacity. With a mature industry offering fewer opportunities elsewhere, measures to increase the underlying traffic base at St. Thomas and St. Croix will make the Virgin Islands of particular interest to the airlines. G. Air Traffic Growth in the Caribbean In the last decade, traffic between the United States and the Caribbean grew slowly. shows growth rates for scheduled and charter passengers. Caribbean traffic expanded only 18.4% through the decade, for a compounded annual increase of 1.7%. Exhibit III-5 EXHIBIT III-5. INTERNATIONAL TRAFFIC GROWTH, 1990-2000 Several factors accounted for this weak performance: • A liberalization of air service agreements in other markets, allowing market forces to operate in what were once very restrictive regimes; • Major geopolitical events, such as the collapse of communism, economic liberalization in China, the growth of liberal economies in the Far East and the North American Free Trade Agreement have affected other areas; • Political reform and economic stability in certain destination countries, particularly Central America; • Economic integration and global rationalization of production processes. This has stimulated traffic to large producing and consuming areas such as Mexico, Europe, South America and the Far East; • A limited interest by U.S. carriers in the Caribbean; and • A growing U.S. taste for more “exotic” and distant vacation destinations, aided by a strong dollar. 113.76% 112.93% 82.64% 76.25% 59.88% 42.52% 18.43% 0.00% 20.00% 40.00% 60.00% 80.00% 100.00% 120.00% Central America South America Europe, Middle East and Africa Far East Mexico Oceania Caribbean Growth 2000 vs 1990 SOURCE: UNITED STATES DEPARTMENT OF COMMERCE “INTERNATIONAL AIR TRAVEL STATISTICS FOR U.S. AIRPORTS” EDWARDS AND KELCEY T-15 USVI Since 2001, the Caribbean has seen renewed interest. Exhibit III-6 shows changes in U.S.-Caribbean airline capacity for January 2001 and January 2003. The graph distinguishes between the perennially popular high volume destinations of Bermuda, Nassau, Freeport, Montego Bay and San Juan, and the “non-traditional” points that have been less visited. The established destinations shared the industry-wide contraction prompted by the 9-11 attacks, losing 12.1% of their flights and 2.0% of their seats. However, flight frequencies to the other destinations grew by 4.3% and seat capacities grew by 13.7%. Flights to the Caribbean overall fell by 6.0%, but seat capacities expanded by 4.4%. USAirways has been particularly active in the region. New services include Philadelphia-St. Kitts, Pittsburgh-Montego Bay and the Saturday-only Charlotte-St. Croix route. It has a strong position in the eastern United States, where much of the Caribbean traffic originates. The Charlotte hub has proven particularly effective for routing traffic between the mainland and the Caribbean. Its January 2003 schedule offered a 18.0% increase in flights and a 40.8% increase in seat capacity to the Caribbean over that of January 2001. Its share of U.S.-Caribbean capacity increased from 6.9% to 9.3%. During the 2001-2003 period, USAirways was in a financial crisis, and was forced to make large capacity reductions on its domestic network. T-16 EDWARDS AND KELCEY AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT EXHIBIT III-6. AIRLINE CAPACITY GROWTH IN THE CARIBBEAN, 2001-2003 -15.00% -10.00% -5.00% 0.00% 5.00% 10.00% 15.00% Traditional New All % Change, 2003 vs. 2001 Flights Seats SOURCE: OFFICIAL AIRLINE GUIDE, JANUARY 2001 AND 2003 Significance to the Virgin Islands The growth of services to the Caribbean could create opportunities for the Virgin Islands. As more carriers become familiar with the region, they will view any new services as less risky. Northwest, the largest network airline not serving the Virgin Islands, has become a stronger presence in the Caribbean, and opening routes to the Virgin Islands would now constitute a less radical step for its planners. Should the recent capacity growth in the region be a harbinger to a widespread shift in passenger preferences, the Virgin Islands could see a rapid growth in popularity as a destination. To do so, it would have to differentiate itself as offering a distinct set of attributes and advantages over other destinations. An expanding market of Caribbean visitors does not necessarily pose a benefit to the Virgin Islands. They will face a growing array of competitors, and if the USVI cannot position itself in an appealing manner it could be overlooked. Thus the issues of promoting St. Thomas/St. John and St. Croix are of key importance to any effort to expand air arrivals. H. International Airline Liberalization The U.S. deregulation of domestic travel in 1978 has fostered far-reaching, and still incomplete, changes to the airline industry. The airlines restructured their networks into hub- and-spoke systems. Through a careful selection of hubs throughout the nation, each airline could offer virtually anywhere-to-anywhere travel with high frequencies and no more than two EDWARDS AND KELCEY T-17 USVI enroute stops. Most importantly, these systems eliminated the need to interchange traffic and share revenues and market power with rivals. Airports in the Virgin Islands are now spokes to Miami, San Juan, Atlanta, Charlotte and other hubs. This process also involved a wave of airline consolidations, and the development of small aircraft networks to feed traffic to hubs. Freedom of entry also allowed low fare airlines to initiate services; most efforts have failed, but the few successes have greatly intensified price competition. Better services, low costs and lower prices have led to a rapid increase in traffic. The success of domestic deregulation has prompted policy makers in many countries to seek similar benefits for international services. However, the process has been much slower. International air services are governed by a set of agreements between governments. Two countries wishing to establish an air service connection negotiate an agreement that stipulates the terms under which such links will operate; how many airlines from each country could operate the service, points they could serve, capacities each could offer and how they will establish prices. The “bilateral air service agreements” vary widely. Most older agreements are very strict, and specify in painstaking detail what is permissible; everything else being forbidden. The United States has consistently sought to liberalize such agreements; an “open skies” bilateral creates almost a free market between the participating companies. The United States has signed such agreements with over 50 countries, including Chile, the nations of Central America, Aruba, Jamaica (this has not been ratified by Jamaica) and most nations of western Europe (Exhibit III-7). These agreements would allow both foreign and U.S. carriers to initiate international flights to and from the Virgin Islands. Bilateral agreements with most nations in the eastern Caribbean remain somewhat restrictive. EXHIBIT III-7. MAP OF LIBERALIZED WORLD Liberal Bilaterals Restrictive Bilaterals T-18 EDWARDS AND KELCEY The next step in liberalization is to establish a multi-country common market for aviation, whose members ultimately would conclude collective agreements with non-member nations. The European Union is well advanced in this process, and similar initiatives are underway in Southeast Asia, South America, Africa and the Middle East. The CARICOM Multilateral Air AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT Services Agreement, negotiated among the 14 member states, entered into force in 1998. It allows airlines owned and controlled by nations of CARICOM free entry to intra-CARICOM routes. The CARICOM nations have long allowed airlines from other member states to operate international services on their behalf. For example, BWIA has been designated by the Government of Barbados to operate Barbados-London flights. The multilateral agreement is being broadened to include members of the Association of Caribbean States (ACS). This latter group includes 26 Caribbean island and coastal nations, but excludes the United States. The new agreement would allow the virtually unrestricted expansion of flights within the Caribbean basin by member states. The liberalization process works most effectively if airlines have been privatized. In 1994, Air Jamaica was privatized, followed by British West Indian Airlines in 1995 and LIAT in 1996. Air Jamaica has subsequently developed Montego Bay as a hub for much of the eastern and central Caribbean. It has also boosted services to the United States and Belize. Airline privatization often sparks a process of consolidation. In early 2002, LIAT and BWIA negotiated a strategic alliance under which they would exchange traffic. The closer working relationship has resulted in plans for a full merger of the two entities. The newly merged airline will likely integrate the intra-Caribbean services previously operated by LIAT with BWIA’s long haul flights. It will create new options for people traveling from Europe and the United States to the Caribbean. Significance to the Virgin Islands St. Thomas and St. Croix have both benefited from U.S. deregulation. Any U.S. airline fit, willing and able can inaugurate domestic services. Deregulation has allowed carriers such as USAirways and Delta to serve the Virgin Islands; both through granting them legal authority, and for encouraging them to make the network refinements needed for such flights to be profitable. However, deregulation has reinforced American’s San Juan hub, which competes with direct services to the mainland. While routings via San Juan may be somewhat time- consuming and involve less popular turboprop aircraft, this alternative offers reasonably direct one-stop services to a very wide selection of mainland cities. Although the United States has not liberalized many of its bilateral agreements with Caribbean nations, U.S. carriers usually have few impediments to beginning services. This has placed St. Croix and St. Thomas in intense competition with St. Kitts, Barbados, Antigua and other islands for airline resources. Signatory states to the ACS liberalization will have an advantage in obtaining direct intra-Caribbean air services. However, the current regime of bilaterals could support efforts to develop either the St. Croix or St. Thomas airports as intra- Caribbean hubs. The most important regulatory constraint for the Virgin Islands is the bilateral with the United Kingdom. Negotiations have long been stalemated over the issue of increased access to London’s Heathrow Airport. The current regime therefore precludes any major expansion of service to London’s Heathrow or Gatwick airports, although carriers have free access to other airports in the U.K. In the long term, the U.K. could be an important market for the Virgin Islands. The islands have received a few limited charter services, although a scheduled service, likely in conjunction with another Caribbean island, might be feasible. Such a service, at least from the two premier London airports, would be ruled out by the current imbroglio. Other Caribbean islands face no such constraint, and have recently obtained expanded services to the United Kingdom. The LIAT-BWIA merger could assist St. Thomas/St. John and St. Croix in developing European and Canadian markets more EDWARDS AND KELCEY T-19 USVI effectively. It will have no effect on services to the United States. As a non-U.S. legal entity, the airline will be strictly barred from serving intra-U.S. traffic. T-20 EDWARDS AND KELCEY AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT I. Summary and Conclusions This Section has examined the key trends facing the commercial airline industry and their importance to the objective of increasing air arrivals at St. Croix and St. Thomas: • The current crisis in the airline industry • Increased economic pressures on airports • The growth of low fare airlines • Airline consolidation • Industry maturity • Air traffic growth in the Caribbean • International airline liberalization The discussion has shown how each trend is a two-edged sword, offering both opportunities and risks to the Virgin Islands. None of the trends suggests that the current industry environment makes marketing efforts futile. Nor do they imply that the USVI are likely to obtain a large capacity increase in the immediate or distant future. Efforts to market the USVI directly to prospective carriers, with sophisticated presentations and route evaluations, while potentially useful, are neither sufficient nor even the most important part of the process of increasing air arrivals. Rather, the industry considerations uniformly indicate that an effective strategy should be locally based, and should address two core elements: 1) The manner in which the Virgin Islands are promoted to prospective visitors 2) The airline economics of serving the USVI; specifically user charges at the Cyril E. King and Henry E. Rohlsen Airports. Later Sections will address these issues and describe effective strategies in greater depth. The next Section will consider air services at St. Thomas and St. Croix in detail. It will provide a detailed description of air services, traffic and fares at both airports, and their relationship to the goal of increasing air arrivals to the Virgin Islands. EDWARDS AND KELCEY T-21 USVI IV. Historical Traffic Growth at the St. Croix and St. Thomas Airports A. Introduction An important step in a program to increase air arrivals at St. Thomas and St. Croix is to quantify existing and recent historical levels of traffic. This analysis, through identifying long term trends and persistent patterns in the USVI travel market, will serve as the point of departure for preparing air arrivals strategies. This Section addresses the following: • Recent air traffic trends at the Cyril E. King and Henry E. Rohlsen Airports; • Load factors of scheduled air services to and from the USVI; • The origins and destinations of all travelers to the U.S. Virgin Islands; • International traffic; • Connecting traffic at the two airports; • Air fares to and from the Virgin Islands, both in relationship to points in the continental United States and between the U.S. and competing destinations in the Caribbean; and • The impact of the 2001 terrorist attacks on traffic at the two airports. B. How Air Traffic Volumes are Measured The airline industry uses two methods to measure air traffic. The first is to count the number of persons physically boarding an aircraft. This “enplaned-deplaned” measure accurately reflects the level of activity, but usually fails to capture the destination of the traffic. At hubs, where many passengers make connections, it overstates the number of persons traveling to or from the community itself. The Virgin Islands Port Authority assembles and distributes enplaned-deplaned traffic statistics from operating statements regularly submitted by the airlines. The Department of Transportation also assembles five reports on enplaned- deplaned traffic at every airport in the nation19. The second definition is the “origin-destination” passenger. This measure considers the true itinerary of each passenger; where he or she originally started the journey, and the final destination. This could include several intermediate connections. Origin-destination statistics are usually developed from airline sales reports or reservations systems. The Department of Transportation requires all large U.S. carriers to submit a 10% sample of tickets sold in each quarter to compile its origin-destination reports. The database shows, by domestic and international city-pair, the number of passengers, airline, routing, fare class and routing. The two sources of data seldom agree perfectly. The airline accounting systems usually have several sources of lags that reflect differences in the date of sale, the beginning of the T-22 EDWARDS AND KELCEY 19 The DOT’s reports are based on reports produced by the airlines. The “segment” reports show, by month, airline, city-pair and aircraft type, total passengers, air freight and mail carried by flight segment. The “market” report shows, by airline and month, total passengers, air freight and mail carried between every city-pair for which through flights are available. There are separate segment and market reports for international and domestic routes. A commuter airline traffic report shows, by airline, city-pair and quarter, total passengers, air freight and mail actually carried. This report summarizes traffic of airlines operating under Part 298 of the Federal Aviation Act. AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT journey, the end of the journey, and the date on which the fare paid is officially counted as revenue. Although the DOT strives to maintain a uniform reporting system, the are minor differences in how each airline prepares its sample. C. Enplaned-Deplaned Traffic Appendix D provides a detailed report of flight performance (enplaned-deplaned) traffic at the St. Thomas and St. Croix airports by airline and destination, and summary tables. It shows the traffic of “large” airlines, which report to the DOT’s T-100 reports. Appendix E shows commuter airlines’ traffic; those carriers submitting data to the C-298 report. The large decreases in commuter traffic and corresponding increases in mainline volumes result from Executive Airlines’ changes from a “commuter” to a “mainline” carrier after its acquisition by American Airlines, with new requirements for reporting data. St. Croix Exhibit IV-1 EXHIBIT IV-1. TRAFFIC AT THE HENRY E. ROHLSEN AIRPORT, ST. CROIX shows traffic for the Henry E. Rohlsen Airport in St. Croix. The decline of the “Other” airline traffic in the early 1990’s reflects the failure of Eastern and Pan American. Commuter airlines traffic declined during the same period because of the discontinuation of operations by Aviation Associates and Executive Air Charter. 0 100,000 200,000 300,000 400,000 500,000 600,000 700,000 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Passengers/Year American Commuter Continental Delta US Airways Other Total SOURCE: UNITED STATES DEPARTMENT OF TRANSPORTATION REPORTS 28DM AND C298 The graph shows several important facts about air services at St. Croix: • Traffic at St. Croix fell steadily from 1990 to 2002, with decreases in 10 of the 12 years. By 2002, its traffic volumes were less than half those of 1990. This could result from the progressive worsening of air services and a general decline in the tourism industry. A second, and misleading cause would be runway improvements at St. Thomas, which EDWARDS AND KELCEY T-23 USVI reduced the need for aircraft to stop in St. Croix while returning to the mainland. Passengers on these flights could have been counted as enplanements or deplanements at St. Croix. The decline has, however, continued well beyond this potential anomaly; • Continental and Delta carried few passengers to and from St. Croix, and discontinued services in 1994 and 1999, respectively. Their withdrawal, while reducing passenger choice, did not contribute significantly to the decline of traffic; • American Airlines and American Eagle have a strong dominance of the market; and • USAirways has steadily grown at St. Croix, but it is far from being large enough to counterbalance the marketing power of American. St. Thomas Exhibit IV-2 EXHIBIT IV-2. TRAFFIC AT THE CYRIL E. KING AIRPORT, AIRPORT, ST. THOMAS depicts the recent history of traffic at St. Thomas. 0 200,000 400,000 600,000 800,000 1,000,000 1,200,000 1,400,000 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Passengers/Year American Commuter Continental Delta Other US Airways Total SOURCE: UNITED STATES DEPARTMENT OF TRANSPORTATION REPORTS 28DM AND C298 It provides several important insights: • Traffic at St. Thomas showed a pronounced trough in 1996 reflecting Hurricane Marilyn in 1995, followed by only a partial recovery to 2000; • The post-2000 decline resulting from the weak economy and the 9-11 terrorist attacks was relatively mild; • Traffic from “other” airlines declined in 1990-1992 after the failure of Eastern and Pan American; T-24 EDWARDS AND KELCEY AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT • American/American Eagle has a market dominance at St. Thomas; but to a lesser extent than at St. Croix; • USAirways, Delta and Continental, although collectively far smaller than American, are sufficiently large to provide meaningful competition. The Federal Aviation Administration produces forecasts of traffic for all major airports. depicts the traffic history at each airport from 1976, and its anticipated growth through to 2020. The FAA believes that traffic at St. Thomas will continue to grow, re- attaining its 1993 maximum by 2015. However, the FAA is more pessimistic about St. Croix. It expects traffic to stabilize at current values, but sees no evidence on which to base a turnaround. This forecast reflects the airport’s long-term traffic decline. When challenged by the Consultant Team, the FAA emphasized that it would revise this forecast if given sufficient reason to do so. Exhibit IV-3 EXHIBIT IV-3. FAA FORECASTS FOR TRAFFIC AT ST. THOMAS AND ST. CROIX 0 200,000 400,000 600,000 800,000 1,000,000 1,200,000 1,400,000 1,600,000 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 2018 Passengers/Year St. Thomas St. Croix SOURCE: FEDERAL AVIATION ADMINISTRATION EDWARDS AND KELCEY T-25 USVI D. Load Factors The “load factor” is the portion of occupied seats on a flight or service. The load factor and the average revenue per seat are key determinants of the profitability of a route. Since traffic varies by season, day of week and time of day, load factors in excess of 80% usually indicate that many flights are operating full, and that the carrier is turning away traffic. Airlines therefore face important tradeoffs in obtaining the load factor that maximizes total profitability. Business-oriented routes, where passengers require high frequencies, and pay relatively high fares for convenience, have lower load factors, and higher revenues per seat, than leisure routes, where passengers prefer low fares over the convenience of high frequencies. Appendix F provides detailed information on load factors for St. Croix and St. Thomas by carrier and route. Figure III-4 summarizes the data by carrier and airport. The highest load factors were generated by USAirways at St. Croix for the St. Thomas-St. Croix-Philadelphia flight20. However, average load factors at both airports were less than 70%. This is low for a predominantly leisure destination. Furthermore, discussions with airline managers revealed that the flights are popular with travelers redeeming frequent flyer points. On one carrier, this component exceeded 25%. The rightmost bar in Exhibit IV-4 shows the breakeven load factor for the U.S. airline industry as a whole. This value, 80.9%, represents the load factor necessary for a zero-profit performance under industry-average costs and fares. This hurdle is at historically high levels, and reflects the severe decline in fares since 2000 and the high fuel costs resulting from problems in the Middle East. Neither St. Thomas nor St. Croix attain the break-even level. While industry-wide aggregates must be interpreted cautiously, several findings are evident: • It is likely that the airlines are recovering direct operating costs, but losing money serving the Virgin Islands once various operating and corporate overheads are accounted for. This does not make their St. Thomas-St. Croix services unique; the airlines are generating huge losses system-wide. • The large aircraft serving the USVI (mostly 757’s, 737’s and A-320’s) have low costs per seat mile. However, revenues per seat-mile are also relatively low because most Virgin Island-mainland passengers are flying long distances on very low tourist fares. Breakeven load factors for the Virgin Islands may be lower, or higher, than the 80.9%; • As part of its realignment of services, USAirways will replace its St. Thomas/St. Croix- Philadelphia route with a St. Thomas-Philadelphia flight. Its substitution of 182-seat 757’s for 142-seat A-320’s will provide an additional 240 seats in each direction weekly, all dedicated exclusively to St. Thomas; • Current load factors suggest that the USVI do not suffer from a “capacity problem” per se; there is no evidence of a chronic shortage of seat capacity. Thus the goal of increasing air arrivals to the Virgin Islands can be attained even with the existing level of services. T-26 EDWARDS AND KELCEY 20 DOT statistics indicate that only 25% of the traffic of the flight originated in St. Croix. The high costs of the St. Thomas-St. Croix flight leg more than offset the high load factors to make the flight unprofitable. AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT EXHIBIT IV-4. LOAD FACTORS BY AIRLINE AT ST. CROIX AND ST. THOMAS 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 80.00% 90.00% St. Croix - American St. Croix - US Airways St. Croix - All St. Thomas - American St. Thomas - United St. Thomas - Delta St. Thomas - Continental St. Thomas - US Airways St. Thomas - All Industry Breakeven Load Factor SOURCE: UNITED STATES DEPARTMENT OF TRANSPORTATION REPORT 28DS AIR TRANSPORT ASSOCIATION, “U.S. AIRLINES – THE ROAD TO RESUSCITATION,” JANUARY 2003 E. Origin-Destination Traffic All major U.S. airlines21 submit a 10% sample of ticket coupons sold to the United States Department of Transportation every quarter. The DOT consolidates the samples from each airline, performs a series of edits, and compiles several databases which present traffic flows by city-pair. The databases, which include fare and routing information, provide the most comprehensive source of regional traffic patterns in the nation. The Virgin Islands Bureau of Economic Research monitors visitor trends through an exit survey. The Origin-Destination databases provide a second source of detailed travel information. The database distinguishes between travelers originating in the USVI and 21 The determination of those airlines required to submit a coupon sample is based upon annual revenues and the passenger capacities of aircraft operated. Of the airlines serving the Virgin Islands, American, American Eagle, Continental, Delta, United and USAirways participate in the study. Cape Air, Air Sunshine, Air St. Thomas, Coastal Air Transport and floatplane operator Seaborne do not participate. They report to the less detailed C298 report. As a foreign carrier, LIAT is not required to submit a 10% coupon sample. EDWARDS AND KELCEY T-27 USVI traveling to or from other points, and off-island visitors. However, it does not capture any information on purpose of trip. T-28 EDWARDS AND KELCEY AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT Appendices G through L provide detailed information for St. Croix and St. Thomas by destination: G Origin-Destination Passengers 1995-2002, St. Croix H Origin-Destination Passengers 1995-2002, St. Thomas I Detailed Origin-Destination Traffic Profile, 2002 for St. Croix J Detailed Origin-Destination Traffic Profile, 2002 for St. Thomas K Inbound Air Arrivals to St. Croix L Inbound Air Arrivals to St. Thomas St. Croix Exhibit IV-5 summarizes the origin-destination statistics for St. Croix. Since the database contains literally hundreds of destinations, traffic flows have been aggregated by region. The graph records a steady decline in traffic to the other Virgin Islands and to Puerto Rico. However, destinations on the U.S. mainland have experienced steady growth. Traffic to the Midwest, Central States (Texas, Oklahoma, New Mexico, Colorado, Wyoming) and the Far West (Arizona, California, the Pacific Northwest, Alaska, Hawaii), while growing, is still modest and would be insufficient to support daily services to new gateways. While the decline of traffic at the Henry E. Rohlsen airport is clearly a key concern of this Study, the airport’s long haul markets have been performing well. St. Thomas Exhibit IV-6 provides similar data for St. Thomas. It follows similar patterns St. Croix; declining traffic to Puerto Rico and the other Virgin Islands, combined with healthy long haul markets. Traffic to the northeastern states (north of Virginia but including Washington) grew robustly, generating the largest level of activity by far. New York City alone generates over 200,000 passengers per year, or 280 in each direction daily. Destinations in the Midwest, Central and Western regions also displayed strong growth; the two latter generating nearly 100 passengers per day in each direction. Both St. Thomas and St. Croix depend primarily on inbound travel. In 2002, 62.01% of the traffic at St. Croix consisted of arriving and departing visitors. This proportion was even higher at St. Thomas, with 88.75% of the traffic originating elsewhere. EDWARDS AND KELCEY T-29 USVI EXHIBIT IV-5. ORIGIN-DESTINATION TRAFFIC AT ST. CROIX, 1995-2002 0 50,000 100,000 150,000 200,000 250,000 300,000 350,000 400,000 450,000 500,000 1995 1996 1997 1998 1999 2000 2001 2002 Passengers/Year Puerto Rico/VI Northeast Florida Southeast Midwest Central West SOURCE: UNITED STATES DEPARTMENT OF TRANSPORTATION DATABASE 1B, YEAR ENDING JUNE 30 2002 EXHIBIT IV-6. ORIGIN-DESTINATION TRAFFIC AT ST. THOMAS, 1995-2002 0 20,000 40,000 60,000 80,000 100,000 120,000 140,000 160,000 180,000 200,000 1995 1996 1997 1998 1999 2000 2001 2002 Passengers/Year Puerto Rico/VI Northeast Florida Southeast Midwest Central West T-30 EDWARDS AND KELCEY SOURCE: UNITED STATES DEPARTMENT OF TRANSPORTATION DATABASE 1B, YEAR ENDING JUNE 30 2002 AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT F. International Traffic Information on international travel is limited. Foreign carriers such as LIAT do not contribute to the DOT’s ticket coupon survey. In order to protect the contributing carriers, the DOT forbids international origin-destination data to be publicly disclosed. It does, however, publish the international flows recorded in its C298 commuter and onboard databases. Other anomalies, such as connecting passengers traveling on separate domestic and international tickets, can cause a mis-reporting of traffic. Appendix M summarizes the modest information available. In 1991, British West Indian Airways accommodated nearly 15,000 passengers at St. Croix. Some passengers from the Virgin Islands travel via American Eagle to San Juan, and connect to other points in the Caribbean. The appendix also shows charter traffic between St. Thomas and London. The Caribbean Tourism Organization and the Virgin Islands Bureau of Economic Research assemble, monitor and publicize visitor arrival statistics. In 2001,the Virgin Islands received 2,918 visitors from other Caribbean nations, excluding Puerto Rico and the British Virgin Islands22. This corresponds to 4 arriving and 4 departing passengers daily. The origin-destination report provides information on scheduled international traffic. While information as to the specific destinations, routings and fares cannot be released publicly, traffic totals using domestic services to access international flights can be cited. In the year ending June 30, 2002, St. Thomas boarded nearly 66,000 scheduled domestic passengers connecting downline to international services. This was 5.52% of the traffic boarded on mainline carriers. During the same period, St. Croix accommodated 35,000 international passengers, comprising 8.07% of its mainline traffic. Although direct international services are limited, international traffic has displayed strong growth at both airports. Exhibit IV-7 summarizes annual growth rates since 1995 for domestic, international and total traffic. 22 Source: Caribbean Tourism Organization Statistical Report, Caribbean Tourism Organization (Barbados, 2003) table 29 EDWARDS AND KELCEY T-31 USVI EXHIBIT IV-7. GROWTH OF SCHEDULED INTERNATIONAL AND DOMESTIC ORIGIN-DESTINATION TRAFFIC, ST. THOMAS AND ST. CROIX 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00% Total U.S. International Total Annual Change, 1995-2002 St. Thomas St. Croix SOURCE: UNITED STATES DEPARTMENT OF TRANSPORTATION DATABASE 1B, YEARS ENDING DECEMBER 31 1995 AND JUNE 30, 2002 At St. Croix and St. Thomas, international traffic grew at double the rate of domestic markets. With domestic markets relatively mature, and international markets in their infancy, this performance suggests that a greater emphasis on international markets would be part of a program for increasing air arrivals. While direct international services would be necessary to attract a large number of visitors, foreign connections with current domestic services could be part of a process for incrementally expanding traffic. G. Connecting Traffic Through serving connecting passengers, an airport can obtain a much higher level of service than could be supported by its immediate traffic. Hub airports such as Dallas/Fort Worth, Cincinnati and Charlotte have become large-scale domestic and international gateways through their reliance on connecting traffic. Balanced against these advantages are the airports’ loss of power to the hub carrier and the increased risk of depending on one airline. At most hubs, the weakened competition forces local passengers to pay a fare premium. Low cost carriers such as Southwest Airlines are often reluctant to serve a hub airport. Any risks faced by the hub airline confronts the airport with large uncertainties. Baltimore, Nashville, Dayton and Raleigh-Durham abruptly lost many services after their hub carriers retrenched. Chicago, Denver, San Francisco and Washington are gravely concerned about the survival of hub airline United Airlines. The hub concept is important to the Virgin Islands in two respects. First, St. Thomas currently serves as a hub, for passengers traveling to St. John and the British Virgin Islands. Second, several USVI parties are interested in developing either St. Thomas or St. Croix as an air hub for the eastern Caribbean. T-32 EDWARDS AND KELCEY AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT Exhibit IV-8 EXHIBIT IV-8. COMMUTER AIRLINE TRAFFIC BETWEEN ST. THOMAS AND BRITISH VIRGIN ISLANDS shows total commuter air traffic between St. Thomas and the British Virgin Islands. Even if all the passengers shown on the table were connecting between mainland and BVI flights, the traffic flows are small. However, the table excludes passengers who fly between the U.S. mainland and St. Thomas, and make onward connections by ferry. Airport improvements in the British Virgin Islands will likely reduce the importance of St. Thomas as a regional gateway. Under a US$55 million expansion project, Tortola’s Beef Island Airport (to be renamed the Terrence B. Lettsome International Airport) will obtain a new terminal, expanded apron, new control tower and a better access road. The 3,600’ runway will be lengthened to 4,600’ to accommodate American Eagle’s 64-seat ATR-72. This will encourage more passengers to fly directly to the BVI from San Juan The DOT’s origin-destination database also indicated that current volumes of connecting traffic are modest. Fewer than 7,000 passengers annually connect between the U.S. mainland or Puerto Rico and other points in the Caribbean at St. Thomas. At St. Croix, the corresponding traffic flows are less than 800 passengers. While these findings neither support nor refute plans for developing a hub in the Virgin Islands, they do show that such an operation would rely on altogether “new” traffic rather than existing volumes. This concept is discussed in more detail in Section VI. Year Passengers 1990 7,042 1991 8,514 1992 9,669 1993 10,899 1994 5,855 1995 2,941 1996 1,397 1997 2,505 1998 1,812 1999 1,352 2000 3,586 2001 4,716 2002 1,939 SOURCE: UNITED STATES DEPARTMENT OF TRANSPORTATION REPORT C298 H. Fares to and from the Virgin Islands Fares to the US Virgin Islands remain a concern not only for inbound tourists, but also for USVI residents traveling to the United States. This section examines fares to and from airports in the Virgin Islands. It examines differentials between short notice and advance purchase fares, in order to determine if the differentials for the Virgin Islands are unusual. It also considers the totality of fares to and from St. Croix and St. Thomas, to determine if the Virgin Islands suffers from a broad-based problem of excessive prices. EDWARDS AND KELCEY T-33 USVI Advance Purchase and Short Notice Fares A common complaint during the interviews with Virgin Island businesses was high fares to the U.S. mainland. While advance-purchase fares were judged acceptable, many persons cited the need to travel from the USVI on short notice. They considered the fares charged to be altogether excessive. The EK Team tested the validity of these claims by comparing St. Thomas/St. Croix fares to those from other airports. The Team considered both next-day and 14-day advance purchase fares available through Orbitz. For comparison purposes, the team selected coastal cities in the Southeast with limited competition from low fare airlines. Results are displayed in . Exhibit IV-9 EXHIBIT IV-9. VIRGIN ISLANDS FARE COMPARISON Return Fare Routes 1 day out 14 days Distances greater than 1000 miles but less than 1599 Charleston-New Orleans $1,311 $472 Richmond to Dallas $1,618 $468 St. Croix to Miami $568 $469 St. Thomas to Atlanta $834 $585 St. Thomas to Miami $559 $446 Distances greater than 1,600miles but less than 1,999 miles Charleston-Phoenix $975 $578 Richmond to Phoenix $784 $518 St. Croix to Atlanta $748 $603 St. Croix to New York (JFK) $603 $453 St. Thomas to New York (JFK) $593 $317 Distances greater than 2,000 miles but less than 2,999 miles Charleston-Los Angeles $928 $695 Charleston-Seattle $1,197 $691 Richmond to Los Angeles $901 $555 Richmond to Seattle $1,023 $648 St. Croix to Chicago $533 $503 St. Thomas to Chicago $654 $481 Distances Greater than 3,000 miles St. Croix to Los Angeles $921 $678 St. Croix to Phoenix $770 $679 St. Thomas to Los Angeles $995 $658 St. Thomas to Phoenix $899 $661 T-34 EDWARDS AND KELCEY AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT SOURCE: ORBITZ EDWARDS AND KELCEY T-35 USVI Exhibit IV-9 indicates that both advance purchase and next-day fares from St. Thomas and St. Croix are comparable to fares charged for journeys of similar length from airports on the mainland. While travelers may object to paying high fares to travel on short notice, they are not being treated any differently than their counterparts on the mainland. Charging last minute, “must go” passengers a very high premium is a cherished principle of airline pricing, both from the Virgin Islands and from airports throughout the world. The major exceptions to this behavior are low fare airlines such as Southwest, who offer a simplified tariff structure in which differences between walk-up and restricted economy fares are modest. Some persons interviewed suggested that one desired outcome of this study would be the availability of a walk-up fare comparable to the advance notice rates. However, residents of the USVI are not being “singled out” by this pricing behavior. The EK Team believes that the airlines would be very reluctant to agree to such a fare, or to set a precedent that might complicate their pricing behavior on the mainland. Those passengers paying premium fares are vital to the profitability of air services to St. Thomas and St. Croix. The revenues they provide give the airlines the hope of operating profitability at current load factors. The airlines can then sell any remaining seats at the discounted advance-purchase fares needed to support the tourism industry. The fares comparison illustrates the anomalies of airline pricing. The St. Thomas-Atlanta fare of $834 compares to a St. Croix-Atlanta fare of $748. The fare from St. Thomas is based on Delta’s nonstop service. From St. Croix, passengers would need to transit Miami or San Juan. They could also fly by commuter aircraft to St. Thomas. The fare from St. Croix is set to make the service competitive with Delta’s flight from St. Thomas. Average Fares at St. Croix/St. Thomas and Other Airports A second analysis considered the overall level of fares at USVI airports relative to other comparable airports. Average fares at St. Thomas and St. Croix were compared to those at other airports in the U.S., and at competing airports in the Caribbean. Except for San Juan, all mainland airports ranged between 200,000 and 2,000,000 origin-destination passengers annually. Average fares at an airport depend on the mix of destinations, distance traveled, the distribution between leisure and business travel, airline competition, proximity to other airports, seasonality of traffic, and other factors. Finally, the fare data applies to the 2001- 2002 period, in which the industry faced considerable stress because of the large decline in revenues. These circumstances make any simple comparison of average fares difficult, and render charged statements about the reasonableness of fares at one particular community unreliable and potentially misleading. Exhibit IV-10 displays the analysis of fares. The red line denotes a “mean” fare in relation to distance, although deviations are large. A fare index was constructed to avoid disclosing international fare data. T-36 EDWARDS AND KELCEY AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT EXHIBIT IV-10. AVERAGE DOMESTIC FARES AT ST. CROIX, ST. THOMAS AND OTHER AIRPORTS Exhibit IV-10 Belize Cancun ST. CROIX Grand Cayman Montego Bay Antigua St. Maarten ST. THOMAS San Juan Barbados Bermuda 0 10 20 30 40 50 60 70 80 90 0 500 1,000 1,500 2,000 2,500 Distance (Miles) Fare Index Continental U.S. Caribbean Average SOURCE: UNITED STATES DEPARTMENT OF TRANSPORTATION DATABASE 1B, YEAR ENDING JUNE 30, 2002 shows that fares at St. Thomas and St. Croix (excluding frequent flyer redemptions and intra-Caribbean passengers) lie slightly above the mean fare line. However, the differences are too small to be statistically significant, especially when considered in light of the overall dispersion of the population from the mean. Furthermore, the Virgin Islands lie below several competing destinations in the Caribbean. While higher than points such as Cancun or Montego Bay, the Virgin Islands lie within the cluster of Caribbean destinations. Average fares are higher than those from San Juan because of the intense competition for the large Puerto Rico-mainland traffic. This analysis suggests that the average level of fares at St. Croix and St. Thomas are, once travel distances are considered, commensurate with those charged at airports on the mainland. There is no evidence that travelers to and from the Virgin Islands are paying excessive prices. Furthermore, the current regime of air fares does not render the USVI at a major competitive disadvantage in competing with other Caribbean destinations for inbound tourists. EDWARDS AND KELCEY T-37 USVI I. Impact of the September 11 Attacks The terrorist attacks on New York and Washington precipitated a severe decline in air traffic and airline revenues throughout the world. The attacks occurred at the time that many travelers were making winter vacation plans, making the Caribbean particularly vulnerable. According to the World Travel and Tourism Council, personal travel and tourism to the Virgin Islands fell by .1%. However, business travel suffered a 26.1% decline23. This is consistent with experience elsewhere, in which business travel suffered the steepest decline. Exhibit IV-11 EXHIBIT IV-11. IMPACT OF SEPTEMBER 11 ATTACKS ON AIR TRAFFIC portrays data on the impact of the attacks for the Virgin Islands and other world areas. All calculations are based on a comparison of the October 2001-September 2002 period to October 2000-September 2001. The bars for the two USVI airports show changes in total passengers; other bars show changes in passengers between the United States and selected world regions. 6.14% 3.48% 10.36% 14.36% 18.09% 18.15% 18.26% 11.00% 10.85% 12.95% 14.62% 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00% 18.00% 20.00% St. Thomas St. Croix Central America Canada U.S. Domestic South Pacific Mexico Caribbean Far East South America Europe Decline 2001-2002 SOURCE: VIRGIN ISLANDS PORT AUTHORITY, UNITED STATES DEPARTMENT OF TRANSPORTATION REPORT 28IM, AIR TRANSPORT ASSOCIATION T-38 EDWARDS AND KELCEY 23 World Travel and Tourism Council, “Virgin Islands – The Impact of Travel and Tourism on Jobs and the Economy – 2002 plus Special Report on September 11 th Impacts”, 2002 AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT The graph shows that St. Croix and St. Thomas were less affected by the attacks and the ensuing industry downturn than most other world areas. Significantly, other points within the Caribbean experienced a larger decline than the Virgin Islands. Trans Atlantic services and routes to the Far East were particularly affected, and suffered further declines from anxieties about the Iraq War. The recent (Spring 2003) difficulties with the Sudden Acute Respiratory Syndrome (SARS) has caused a further decline in trans Pacific traffic. The traffic declines at St. Croix and St. Thomas were similar to those suffered at other U.S. airports. In 2002, 219 airports accommodated more than 100,000 domestic enplaned- deplaned passengers. They collectively withstood a 9.02% decline in domestic passengers24. Of the 219 airports, 86 experienced larger percentage traffic declines than St. Croix. 127 airports suffered larger relative traffic declines than St. Thomas. J. Summary An initiative to increase arrivals at airports in the Virgin Islands must address the airline industry and its needs, current air services and traffic at the St. Croix and St. Thomas airports, and factors affecting the promotion of the USVI as a business and leisure destination. This chapter has summarized the second element. It has provided the necessary factual background on air services, traffic and fares on which the initiative must build. The major conclusions of this chapter are as follows: Enplaned-Deplaned Traffic Traffic at St. Croix has fallen steadily in the late 1990’s. Current volumes are less than half those of the early 1980’s. The decline since 1995 results primarily from reduced boardings by American Airlines, exacerbated by the cessation of services by Delta Air Lines and Continental. Air traffic fell in 1995 at St. Thomas following Hurricane Marilyn. It has grown steadily through the late 1990’s but has yet to attain pre-hurricane levels. American Airlines’ traffic has increased modestly; most of the growth resulted from greater activity by USAirways and Continental. Load Factors Load factors from St. Thomas and St. Croix remain within the 65-70% range. USAirways generates the highest load factors with 80% on the St. Croix-Philadelphia flight. These load factors are not unduly high for a leisure destination, and are significantly below the breakeven load factor for the airline industry as a whole. The USVI’s mediocre load factors suggest that aggregate seat capacities are adequate, and that there is no shortage of raw lift. 24 Source: United States Department of Transportation Database 28DS EDWARDS AND KELCEY T-39 USVI Domestic Origin-Destination Traffic The number of passengers traveling between St. Croix/St. Thomas and Puerto Rico has declined steadily since 1995. Long haul markets to the U.S. mainland have experienced steady growth from both airports. The St. Thomas-Northeast U.S. market has shown a particularly strong performance, although other regions have also seen rapid growth. Since the likely focus of any initiative to increase air arrivals must focus primarily on long haul services to the U.S. mainland, this performance is very encouraging. International Origin-Destination Traffic Direct international traffic to neighboring islands in the Caribbean is modest. However, long haul international passengers, traveling to and from the Virgin Islands, account for 8.07% of the mainline traffic boarded in St. Croix and 5.52% at St. Thomas. At both airports, this component has grown at twice the rate of domestic traffic. Connecting Traffic Although St. Thomas is the gateway to the Virgin Islands, the quantity of connecting traffic is modest. Most passengers traveling onward from the Cyril E. King Airport to the British Virgin Islands use ferries rather than scheduled aircraft. The aviation statistics therefore suggest that air-to-air connection traffic is very limited. Fares Fares for travel to and from the Virgin Islands on short notice are much higher than advance purchase fares. This differential is a major source of frustration for residents of the USVI and its business community. However, the airlines follow similar pricing policies on the U.S. mainland. There is no evidence to suggest that the USVI are being treated in any unfair or discriminatory manner. The level of average fares to and from St. Croix and St. Thomas is commensurate with the average distance traveled. Average fares are somewhat higher than the norm, but the modest differences are not statistically significant. Average fares to and from the USVI are higher than for some Caribbean destinations but lower than others. Fare differentials between the Virgin Islands and competing resorts are not sufficient to provide any major advantage nor pose any disadvantage in attracting vacationers to St. Thomas and St. Croix. T-40 EDWARDS AND KELCEY AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT V. Organization and Community Perspectives A. Introduction Unlike most large US airports or their governing bodies, the United States Virgin Islands has neither a structured, formalized air service development program housed within a single government department/agency, nor a key individual responsible for leading efforts to enhance air service to the USVI. Thus, an essential task was to undertake a broad based, comprehensive series of interviews of government and community and business leaders to obtain an understanding of past and current efforts, results and the nature of participation in air service marketing and development. The information and data gathered during this process would aid in the formulation of a comprehensive air service development strategy/plan that would: • Increase air arrivals at St. Croix and St. Thomas; • Provide a set of clear and realistic but ambitious air service goals; • Be cost-effective; and • Promote the economic development of the USVI. A concurrent interview program was conducted with key airline officials with an interest in USVI. The findings of interviews with the airline executives are presented in Section VI. At the outset of the project, the Steering Committee provided Edwards & Kelcey with a preliminary list of key individuals/organizations to be contacted. Throughout the extensive interview program, many additional recommendations for contacts were received, scheduled and conducted. A complete list of those participants involved in this phase of the project is contained in Appendix B. The key objectives of the interview program were to: 1. understand the mandates, roles and responsibilities of various government departments/agencies as related to air service development; 2. understand the roles and specific interests of private sector parties and their associations as related to air service development; 3. collect relevant data and information; 4. review current and previous initiatives in air service development; relevant studies and documentation; and 5. identify key issues and potential solutions from the perspective of the interviewees. The preliminary draft findings of the interviews were summarized and distributed for comment to the Steering Committee on April 8, 2003. The original information collected, and subsequent research have been integrated, analyzed and are presented below. B. Major Findings - General 1. The economic importance/impact of quality air services to the overall economy of the USVI is not widely understood or appreciated. 2. A Comprehensive Air Service Marketing Plan/Strategy has not been developed for the USVI EDWARDS AND KELCEY T-41 USVI As was mentioned previously, most major airports/destinations develop, and maintain current, a comprehensive plan for air service marketing and development. The plan is updated on an annual basis to reflect changes in the industry and, if appropriate, specific economic objectives of the airport. Detailed analysis is carried out of potential for retention and expansion of existing routes, or of acquiring new routes/service. Subsequent to the analysis, a recommended strategy is formulated which comprises the “workplan” for the year. Budget allocations for carrying out the marketing plan are formulated based upon priorities identified in the plan. Contingencies are built in for unanticipated “targets of opportunity” which were not originally captured in the marketing plan. Endorsement of the plan and strategies contained within this document will comprise the first comprehensive air service strategy for the USVI. 3. There Exists no Clear Responsibility/Accountability for the Development and Management of an Ongoing Air Service Development/Marketing Program The interview process revealed that officials from several government departments, private sector agencies, as well as prominent individuals, have conducted “marketing” activities with the airlines. Such “marketing” activities range from attending conferences related to air service development, visiting airline executives, making formal presentations to airlines for service, negotiating offers of financial assistance, encouraging formation of new airlines, etc. The enabling legislation for the Virgin Islands Port Authority (VIPA), the Department of Tourism, the Economic Development Authority and the Department of Planning and Natural Resources was examined for clarification of responsibility with respect to the air service development/marketing function. While such responsibilities have not been called out specifically, the language is such that every agency could interpret a role for itself in air service marketing efforts. In many cases, the interaction between government departments and private sector organizations, such as the Hotel Associations, Chambers of Commerce etc. has lent itself to joint and separate efforts aimed at increasing air service to the VI. In additional instances, perceived government inaction has resulted in the private sector pursuing initiatives independently. Overall, it was concluded that air service marketing efforts are weak, lacking continuity, and fragmented among many organizations which lack a specific mandate to carry out this mission, and who are not working together. Generally speaking, air service promotional efforts are poorly integrated with tourism/economic development efforts, and lack long-term consistency. In addition, there was clear evidence of inter-agency, inter-island and public- private rivalry. Many of the efforts lack professionalism or any genuine appreciation of airline economics. Bearing witness to the findings above, a draft Bill (No. 25-0015) “To amend title 29 of the Virgin Islands Code, to establish the Virgin Islands Tourist Authority” was tabled in April 2003 and is still under review. While the bill seeks to bring the “tourism” elements of various departments under one Authority, an analogous point can be made that the responsibility for air service marketing and development requires a similar approach i.e. to be housed in one department. T-42 EDWARDS AND KELCEY The preceding findings were supplemented by specific issues identified in the interviews as they relate to the two islands - St. Thomas and St. Croix. While an umbrella air service development/marketing strategy for the USVI is essential, as much as possible, it must take AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT into consideration the distinct issues and requirements for each island. While industrial/business demands for air service are increasing, the greatest concerns surrounded high value tourism, and its dependence on air access. Tourism and the different nature of the tourist offering for each island are inextricably intertwined with air service issues. Consequently, many of the issues raised during the interview process were related to tourism. The issues/findings related to these two markets are presented below. C. Organization/Community Perspectives Related to Air Service Marketing and Development – St. Thomas Tourism/Destination Issues STT continues to serve as a “gateway” to the Virgin Islands and other destinations within the Caribbean. The prominence and role of STT as a “gateway” has been eroded with the aggressive development of San Juan, and may be further challenged as the airport expansion in Tortola is completed in 2004. Those interviewed expressed the opinion that the image of the destination, as a destination (St. Thomas) is not well defined. It was felt that advertising dollars would be better spent targeting organizations that actually deliver people to the islands i.e. wholesalers, travel agents, and airline travel departments. The recent introduction of ACT 6390, dated February 1, 2001, “To Amend Title 29, Chapter 12, Virgin Islands Code, Relating to Economic Development Commission Benefits and for other Related Purposes,” has resulted in considerable relocation of industry executives due to the tax incentives provided. It was felt that there was growing success in attracting senior executives of corporations to locate and take up residence in the USVI, however, for those without corporate aircraft, access would continue to be an issue. Seasonal service was also identified as an issue. With respect to the hotel aspect of the tourism product, there was widespread opinion in the private sector that the government was not responsive to their needs. On the opposite side, perception of some government officials was that businesses should be more active, and rely less on government initiatives in the promotion of business. On St. Thomas, there currently are sufficient hotels to meet demand, and the current inventory could support additional lift. Many private sector and government individuals interviewed, were supportive in principle of the effort to establish a Tourist Authority. Airport/Air Service Issues A critical element of any air service marketing development program is the management, operation adequacy and affordability of facilities of the destination airport. Both the Cyril E. King, and Henry E. Rohlsen airports are owned, operated and managed by the Virgin Islands Port Authority (VIPA). Opinions were expressed that the principal interest, focus and expertise of VIPA lay in the management of the Ports, and not the airports. There were no credentialed airport managers at either facility. Furthermore, with respect to air service development, the mandate of the Authority was focused on facility development and operations management, and not marketing of the facility. There was ambivalence about the role of VIPA in air service development and marketing, with the majority of responses identifying the responsibility to be that of the Department of Tourism. EDWARDS AND KELCEY T-43 USVI Users of the facility were critical of the terminal and apron layouts, maintenance and condition of facilities, and the operation and location of INS facilities. The location of concessions and revenues was also considered non – optimal. Widespread opinions were expressed that airport rates, fees and charges were amongst the highest in the Caribbean and that failure to address them could be a key factor in reduction and withdrawal of service. The different practices amongst the islands, however (e.g. departure taxes/fees etc) complicate any comparison. In summary, airport management, operations, facilities, rates, fees and charges, were identified as issues to be considered in the formulation of an air service marketing and development plan. D. Organization/Community Perspectives Related to Air Service Marketing and Development – St. Croix Tourism/Destination Issues Tourism and destination issues were the major concerns of the officials interviewed on St. Croix. Indeed these have been fully documented and recommended action steps formulated in the St. Croix Economic Development Action Agenda25 and the Department of Tourism’s Marketing Strategy for St. Croix. The definition and success of an air service marketing strategy for STX is highly dependent on development and marketing of the destination. A soft tourism industry, weak jewelry sector and refinery cutbacks were cited as significant contributors to the high unemployment. A common view among those interviewed is that there is a need to market St. Croix more vigorously, and to differentiate St. Croix as a tourist destination – separate customized marketing initiatives were recommended. There was also widespread concern that St. Croix is not sufficiently represented in Tourism promotion efforts. Lack of a flagship hotel, conference center and absence of hotels with a large number of rooms were also identified as issues. Past attempts at encouraging traffic and tourism with the introduction of casinos has been of limited impact. Airport/Air Service Issues The airfield and terminal facilities at the Henry E. Rohlsen airport were considered more that adequate. As STX is managed by VIPA, similar comments made previously relating to the ownership, operation and management by VIPA, apply to STX. As was illustrated in Section IV, traffic has declined significantly over the past five years and is not projected to increase in the near future. The completion of the runway extension may offer long-range air service potential, and this will be addressed in Section VII. There is an acute need for airlift, as fewer carriers, destinations, and seats are available to the mainland than from STT. These findings were made before USAirways reduced services at St. Croix. T-44 EDWARDS AND KELCEY 25 Trend Associates, November 2001. AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT VI. Airline Perspective and Analysis A. Introduction A critical part of the development of a strategy to increase air arrivals to the USVI involves the collection of information and perceptions from the key operators of air service to the islands, the scheduled air carriers. All the major airlines operating to the islands were contacted: American, Continental, Delta, United, and USAirways. The conversations with the airlines were broad, and touched upon all areas impacting the successful operation of routes to St. Thomas and St. Croix. The major areas of concern, which affect performance of airline routes to the Caribbean, are outlined below: • Operational Issues • Promotional Issues • Airport Management Issues • Incentives Issues B. Operational Issues The operational discussions with the airlines centered on the condition of service to the two USVI airports. Generally, the airlines were pleased with the yield and passenger performance of the market, noting the islands have a good mix of tourists, home owners / commuters and business people. In terms of yield (revenue per passenger per mile traveled) and passenger numbers, Delta estimated that the USVI ranks in the 50th percentile in both yield and passengers. The airlines operating to both St. Thomas and St. Croix, however, did express genuine concerns about the St. Croix market. Airlines seek a favorable mix of passengers when operating one flight to two destinations. However, many of the airlines polled expressed concern that while the St. Thomas market is generally strong, the St. Croix market is critically weak. This places services to the St. Croix airport at risk. Delta Air Lines emphasized the reason their St. Croix extension was cancelled was the fact that St. Thomas was a strong enough market to justify an independent operation. Airlines that operate or had operated a co-joined service to St. Croix estimated only 1/4th to 1/5th of the passenger load was actually headed to St. Croix; usually a tag requires at least 1/3rd to ½ passenger loads to justify the large operating expenses. Since the St. Thomas airport has aircraft / takeoff limitations, many airlines operate service to the island in conjunction with service to San Juan or St. Croix. This enables the airlines to refuel in either St. Croix or San Juan, and travel to an eastern US hub with an acceptable payload. Tag operations are expensive; USAirways estimates the cost of its St. Thomas – St. Croix flight operation at $4,000 - $5,000 per flight. Landing fees at St. Croix, even after the 25% increase, comprise only 10% of this cost. United Airlines still operates A320 combination services to the USVI in conjunction with San Juan on flights from its hubs at Chicago and Washington (Dulles). Fully loaded A320’s cannot execute departures from STT nonstop to their hubs at Chicago and Washington; therefore they have combined two strong markets (San Juan and St. Thomas) to make the tag operation feasible. Due to the physical constraints of the St. Thomas airport and technical limitations of available aircraft, the some airlines must consider co-joined EDWARDS AND KELCEY T-45 USVI operational patterns when serving the USVI. This places the Virgin Islands’ leg at risk if the other market is strong enough to justify the flight on its own. A second operational issue was the restrictive nature of scheduling aircraft to the region. Airlines noted the fact that travelers to the Caribbean want to leave the U.S. in the morning and arrive at the destination by lunch. On the return the tourist wants to leave late in the day to maximize time on the islands. This “scheduling window” makes it difficult to use idle aircraft at other times of the day. It also contributes to congestion at the Caribbean airports, as flights tend to arrive and depart in one wave of activity in the afternoon. C. Promotional Issues The airlines interviewed for this study generally found the promotional authorities of the USVI helpful and proactive. They expressed appreciation for the work of the Department of Tourism, and offered no significant criticisms. The primary concerns the airlines had about promoting the USVI can be grouped into three categories: • Differentiation of the islands • Perception of criminal activity • Ascendance of rivals • Quality of tourist product (e.g. hotels) • Importance of cruise traveler as repeat visitor All the airlines noted that the USVI are a group of three distinct islands, each with unique attributes. The USVI therefore has opportunities to differentiate its marketing to capture a larger segment of disparate travel groups. Several airlines urged a greater differentiation of destinations that capitalizes on each island’s special characteristics. They believe that a single, integrated and uniform product positioning and message would fail to appeal to certain distinct segments of the leisure market. Greater differentiation would attract travelers with widely different vacation preferences, who would otherwise have no awareness of the USVI’ appeal. This marketing would answer the questions travelers have before planning a vacation, such as: why visit the USVI?; and what activities are available to experience and enjoy? One airline indicated the key to marketing the USVI is finding the destinations each island competes with and targeting those markets’ distributors. Efforts would be taken to familiarize them with the islands and have them critically review current marketing efforts. The airlines also noted that a way to increase air arrivals is to get feedback from the top sellers to each island of the USVI, have them review the positive and negative aspects of each island, and then market to each island’s strength. Most airlines felt differentiating each island was the best way to market the USVI effectively; one airline however felt they should be marketed together, but as distinct islands emphasizing diversity, i.e., an island for every taste. T-46 EDWARDS AND KELCEY Every airline interviewed indicated there was a perception of security problems on St. Croix. Most airlines did not believe that there was a strong factual basis for this perception. However, it remains an impediment to promoting St. Croix. One airline said that the USVI needs to address the crime perception head-on much in the same way South Florida addressed crime after several high-profile incidents with foreign tourists. They also noted perception of crime might stem from an unhindered flow of media between the USVI and the mainland. AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT The airlines also noted the ascendance of newer rival resorts around the Caribbean. These resorts are new and offer good value for the money. One airline said the primary challenge of the USVI is marketing against the emergence of the Dominican Republic. This airline called the Punta Cana “the next Cancun” and emphasized the excellent marketing work the Dominican Republic had done in promoting its destinations independently. The airline also remarked that Hilton now has four new properties on the island, which further validates its prominence as a destination. This airline also mentioned that people used to visit the USVI as a vacation in conjunction with San Juan (Puerto Rico). Visitors would gamble in San Juan and then enjoy the USVI. This activity has declined. The airline emphasized the importance of connecting the USVI with vacationers headed to Puerto Rico, noting most airlines still offer stopover Puerto Rico – USVI packages. On the hotel front, most airlines felt there were enough hotel rooms on the islands, but concern was expressed about the quality and suitability of the existing hotels. One airline noted St. Croix needed a half dozen to one dozen 80 – 150 room properties ranging from budget to five-star with one or two high-end properties. The airline indicated that the currently accepted flagship property, is “middle class and middle of the road” and did not have the critical mass to draw traffic to the island. The airline felt that there were sufficient quality hotel products on St. Thomas, but not enough quality offerings on St. Croix. An airline cautioned against building large meeting or convention hotels on St. Croix. It emphasized that St. Thomas, Aruba, Cancun, and San Juan are the only places in the Caribbean capable of supporting meeting and convention traffic. The problem hinges on airlift; there is insufficient airlift to ensure 200 – 300 people arrive on the same day, which is a requirement for a meeting or convention. This means convention / meeting organizers would have to rely on charter transport, which significantly increases the costs of the event. The airlines offered a range of perspectives on cruise ship travelers. One airline indicated that while the hoteliers regard cruise lines as the nemesis of the USVI, some airlines viewed the cruise traveler differently. They regard cruise ship passengers as those taking a regional familiarization trip and in search of a place to return. This airline urged the USVI to enhance the arrival experience of travelers to St. Thomas and St. Croix. They expressed concern about the cruise arrival process in St. Thomas. Sellers hawking their souvenirs immediately approach passengers arriving at St. Thomas. This airline feels the USVI could increase repeat traffic (by air), if the islands had a controlled, hassle-free environment for arrivals by cruise ship and a showcase harbor front in St. Thomas. An airline mentioned that in the wake of 9/11 many islands were cutting prices as a means of increasing air arrivals. The airline was against such practices and favored the creation of “value-added” incentives rather than discounting. Some examples included islands that offered $200 credits for shopping and destinations that were paying the airfares for the bulk of tourists arriving at the island. D. Airport Management Issues EDWARDS AND KELCEY T-47 USVI Most of the airline comments about airport management centered on two themes, the airport costs and passenger processing. On the cost side, two carriers expressed strong concern over the recent airport cost increase and the process under which the costs were approved. One airline claimed to have received only two weeks notice before the new fees were implemented. This airline commented that the industry standard for airport cost increases is usually six to twelve months. The airline was frustrated in that capacity choices for the time period were locked in- taking into account the old cost structure. Therefore, the airline could not make last minute changes to its schedule to improve their revenue forecast. Had it known of the changes sooner, it already would have reduced its capacity accordingly. The airline’s perception was that the cost increase was a “bad move” by the Port and that it will cost them in air service. This airline sent a representative to a schedule input meeting where they felt the rate increase was already a fait accompli. This airline also mentioned its representative received an unfriendly reception at the meeting. Airlines emphasized that the cost issue was a strong concern, especially at a time when carriers are in bankruptcy, and other Caribbean facilities are lowering fees. It makes the airlines’ decision to expand or maintain service to the USVI difficult. The Port Authority maintains that due notice was provided, and that this airline’s surprise reflects its poor internal communications. One interviewee also noted that the airport cost increases had a detrimental effect on the local economy. After the cost increase, this airline had to disengage the mainline ground handling staff and transfer those responsibilities to a regional airline – this resulted in a net reduction of about 25 employees. This carrier also said they have curtailed intra-island flights 25% as a result of the cost increase. Another airline indicated that they might have to eliminate its St. Croix service in the winter because the new costs associated with the tag operation do not justify the service. Also, the airlines felt the USVI should not be charging two landing fees on a St. Croix – St. Thomas combination flight, as an intermediary stop for fuel is required on certain St. Thomas departures. An airline commented about a perception that the airport users are bearing a higher load than the cruise ship users, in part because the cruise line industry association is very “cohesive” in their bargaining with the Port. The airlines do not exercise this bargaining power because of the Sherman anti-trust act. In conjunction with the concern over cost increases, a carrier expressed the opinion that the costs associated with the operation of VIPA were “out of control.” This airline wondered whether the Port had considered alternative sources of revenue before coming to the airlines. This carrier indicated that, as a signatory to the bonds, it might demand greater investigation and involvement in future management of the Port budget. T-48 EDWARDS AND KELCEY The passenger processing time for outbound flights was also a major concern expressed by the air carriers. While recognizing that many elements of the process were beyond its formal jurisdiction, several airlines commented that the Port could play a more active role in the efficient processing of passengers. Departure processing has been particularly inefficient. One airline noted the lack of coordination between the Port, TSA, INS, Customs and Agriculture. The increased processing time has complicated getting outbound passengers through lines in time. One airline recommended arriving at the airport three hours in advance of departure. In several cases, aircraft departures have been delayed, compromising onward connections at the arrival hub. Most airlines believe the physical plant is capable of processing the passengers, but the Port could play a more active role in seeking to ensure all areas staffed to maximum at peak periods. The airlines suggested that, while airport AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT managers have little control over the various agencies, they can take the lead in encouraging all parties to seek a solution to such problems. E. Incentives Issues Incentives play a large role in attracting additional air service to many leisure communities. Most of the airlines interviewed recognize the value of incentives, however they indicated that the market must be viable before incentives are requested. Most airports in the region offer incentives, the most common being the marketing incentive (co-marketing and co-branding). Temporary landing fee holidays are widespread and expected. The airline interviewees stated that they will first look at an asset (e.g. aircraft), estimate the amount of revenue the asset will generate, and take into consideration how much market funding the destination is willing to contribute. The destination with the greatest revenue potential after marketing funds contributed generally gets the asset. Several airlines expressed frustration with airports that give hefty incentives to new carriers to enter a market, when the incumbent airlines have spent the time necessary to grow and develop the market. These airlines have nothing against standard incentives, but they want to be treated equally. These airlines did not mention the landing fee rebates enjoyed by USVI incumbents who launch new services. Some airlines indicated that with new service or capacity additions, a waiver of airport fees for 60 – 90 days is general practice. This helps the airline “spool up” the new service and contribute to its early profitability. Another example includes Antigua, which in the post 9/11 environment eliminated landing fees to help airlines maintain services. The government is covering these expenses for the airlines. Other Caribbean airports have introduced incentives such as deferring office rents and renegotiating leases. One airline commented that St. Thomas did not need incentives beyond marketing assistance. St. Thomas is a developed and proven market with a higher average number of carriers than other Caribbean airports. St. Croix however is yet unproven and may require incentives not normally afforded to carriers serving St. Thomas. F. Summary Based on the feedback provided from the airlines, several key conclusions to help improve air arrivals to the USVI are summarized below: • Since the USVI comprises three distinct islands that can cater to several different groups of vacationers, there is an opportunity in marketing each island as a unique experience; • The perception of criminal activity on St. Croix hinders its full development; efforts to dispel this perception will improve the prospect of additional St. Croix air arrivals; • The enhancement of the cruise vacationers’ experience on St. Thomas and St. Croix has the potential to build a loyal repeat base of visitors; • Port Authority revenue derived from new or alternative sources (e.g. concessions) helps airlines maintain or even improve air access to the USVI during this difficult period in the airline industry; • Port Authority intervention in coordination of the airlines, TSA, INS, and Customs will improve passenger processing and in turn make their arrival and departures hassle-free; EDWARDS AND KELCEY T-49 USVI • Incentives, if implemented equitably, might provide needed stimulus to enhance air operations at St. Croix. T-50 EDWARDS AND KELCEY AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT EDWARDS AND KELCEY T-51 VII. Air Service Opportunities Analysis A. Introduction A program to increase air arrivals to the Virgin Islands must address both the demand and the supply for air services. Demand-based strategies encourage more people to fly to the USVI, through making them more appealing destinations, and publicizing their assets to prospective visitors. Supply-based strategies address the quality and quantity of air services, by attracting new carriers, routes and capacity. Supply and demand must be in balance for the airlines to make sufficient profits and for the Virgin Islands to obtain the capacity it needs. This section summarizes an evaluation of the supply of air services. It identifies the short and long term prospects for new services to St. Thomas and St. Croix. Its findings are based on an analysis of traffic and airline networks. The objective of the chapter is to identify, for St. Thomas and St. Croix, those air service improvements that provide the largest incremental value over the services already available. A description of the methodology follows. B. Route Evaluation Methodology Exhibit VII-1 EXHIBIT VII-1. EK ROUTE EVALUATION METHODOLOGY displays the methodology for evaluating new domestic routes from St. Thomas and St. Croix. Published Airline Schedules Airline Hub Networks Origin-Destination Traffic Air Service Gaps Hypothetical Flights Evaluation Current Flights Augmented Schedule Feedback Evaluation: Augmented Schedule New Route Performance Traffic Diversion Recommendation USVI The evaluation followed multiple steps: • A file of the over 800 U.S. and international destinations for passengers from St. Croix and St. Thomas was assembled from the Department of Transportation’s origin- destination Database 1B; • A file containing approximately 35,000 flights was assembled from the Official Airline Guide’s databases. This database includes the flights of every U.S. carrier that currently serves Virgin Islands or was considered a future prospect. The database includes an exhaustive list of flights connecting at each airline’s hubs that could or might conceivably be part of a multi-flight itinerary to or from the two airports in the Virgin Islands. • An evaluation of airline hub networks identified the routings each airline might employ in carrying passengers traveling to or from the Virgin Islands. This analysis provided instructions to a computer algorithm on how to construct feasible, relatively direct and attractive connections. • A computer algorithm examined each origin-destination city-pair in turn and determined feasible routings from the schedule. It searched the schedule and constructed feasible nonstop, 1-stop and two-stop routings, in a way that is very similar to that of a computer reservations system. It allows interline connections, but only between carriers belonging to the same “family” (e.g. Star Alliance), or those having a relevant pro-rate agreement. These itineraries included both existing and proposed services. The model followed all constraints for minimum connecting times at intermediate airports. • The model examined all feasible connections and discarded those that were inefficient (i.e. it will discard a potential routing if it can find a second routing within the same airline family that offers the same or later departure time with the same or earlier arrival time). • It assigned a score to each potential itinerary according to the “Quality of Service Index” (QSI) methodology. This considers the flight frequency, capacity of the smallest aircraft in the itinerary, number of enroute stops, number of connections, type of aircraft and elapsed time. • The model allocated the traffic of each city-pair to the various itineraries according to their QSI scores. • The allocations to each flight serving the Virgin Islands provided a benchmark on which the proposed air service improvements would be evaluated. • Current services to and from St. Croix and St. Thomas were examined in order to determine geographical areas currently poorly served or airlines that might be interested in initiating services. For each of these preliminary “air service gaps,” a series of potential new services and the carriers best able to operate them were identified. These proposals would be subject to a more detailed evaluation. • For each possible new route, a hypothetical flight schedule was developed specifying the operating airline, flight timings and aircraft capacities. • These hypothetical services were incorporated into the base schedule, and the allocation model was rerun. • If the proposed services performed poorly, by capturing limited traffic, the model would readjust their timings and repeat the preceding steps. • Once the correct timings were determined, a final run produced a detailed report on carrier market shares by city-pair. These results were adjusted to eliminate any city-pairs which appeared inappropriate, such as those involving excessively circuitous itineraries. • For each flight, the model would examine the number of passengers it carried and its impact on incumbent services. A new route would only be recommended if it could carry sufficient traffic to be profitable, while not unduly harming any existing services. T-52 EDWARDS AND KELCEY AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT This methodology was applied to 11 candidate routes. The prospective services to be examined were chosen so as to best complement the existing routes; adding new airlines, nonstop destinations, or serving new regions besides the well developed east coast markets. C. Findings of Domestic Route Evaluations Exhibit VII-2 EXHIBIT VII-2. RESULTS OF ROUTE ANALYSIS displays the results of the route analysis. VI Airport Mainland Hub Airline Aircraft Seats Passengers/Day Each Way Load Factor St. Thomas Dallas/Ft. Worth American 737-800 134 96.76 72.20% St. Thomas Memphis Northwest A-319 124 86.09 69.42% St. Thomas Detroit Northwest A-319 124 90.11 72.67% St. Thomas Houston Continental 737-700 124 80.73 65.10% St. Thomas Chicago Midway ATA 737-800 175 79.84 45.62% St. Thomas New York JetBlue 100 66.67% St. Croix Charlotte USAirways A-319 120 81.36 67.80% St. Croix Atlanta Delta 737-800 154 113.80 73.90% St. Croix Houston Continental 737-700 124 83.86 67.63% St. Croix Newark Continental 737-700 124 73.27 59.09% St. Croix Chicago Midway ATA 737-800 175 36.75 21.00% * WEEKLY SERVICE ALREADY OPERATES. ABOVE SCHEDULE CALLS FOR DAILY FLIGHTS The analysis considers traffic and scheduling issues only. However, runway constraints at the Cyril E. King Airport limit nonstop flying distances and payloads. The proposed St. Thomas routes lie outside the economical range of most aircraft. A more detailed feasibility analysis would consider serving St. Thomas in conjunction with San Juan, St. Croix or another destination. It would examine revenues from the other airport and the relatively large expenses of flying short sectors. According to the above analysis, the proposed routes would be mediocre performers. The load factors are slightly too low to justify seeking the proposed services. While the proposed routes would stimulate traffic to a modest extent, their primary impact would be to reduce the revenues of the incumbent airlines. This would not be in the best interests of the USVI. However, the analysis also suggests that a turnaround in the industry from its depressed state, and traffic growth, would create opportunities for more services from the USVI to the U.S. mainland. The issue becomes one of timing. If the economy and the industry begin a recovery, it would become appropriate to make presentations to the carriers in the winter of 2003-2004 for services to begin in the Fall of 2004. The key indicators will be the state of the economy airline yields and traffic in the 3rd and 4th quarters of 2003. The routes to Chicago, Dallas/Fort Worth, Detroit and Memphis would stimulate traffic from the small but growing markets in the Midwest and western states. ATA was selected as a candidate because it is a low fare airline focusing on leisure traffic. It has operated charter EDWARDS AND KELCEY T-53 USVI flights to the Virgin Islands. Of all low fare airlines, it is the most likely to begin regular services. Northwest and America West are the only network airlines not serving the Virgin Islands. While America West inaugurated services to Cancun in the Spring of 2003, it remains absent from the eastern Caribbean. Northwest serves the Cayman Islands, Nassau, San Juan, Puerto Plata and Punta Cana, with some destinations served on a seasonal basis. It is arguably the strongest candidate not serving the USVI. Although Sun County has served St. Thomas seasonally, its network is very limited. Spirit Airlines, a low fare airline, recently inaugurated San Juan-Orlando services, and is a further candidate to serve the USVI. However, its network is very limited, and it would be unable to serve much of the very fragmented Virgin Islands-mainland traffic. Section IV showed that the current air services to St. Thomas and St. Croix could already accommodate a traffic increase. Load factors and average fares show that the supply of lift to the USVI does not pose a constraint. Because of the distressed condition of the airline industry, and the lack of any clear and immediate need for additional capacity, it would be inadvisable for the immediate term (until late 2003) to seek new air services between the USVI and the continental United States. The prospects for success would be too small to justify the costs of a properly researched and coordinated marketing initiative. However, a more limited initiative with the objective of retaining the incumbents would be fully appropriate. The earliest appropriate date for seeking new carriers or nonstop destinations would be in January 2004. Any such initiative would depend on clear signs of an economic recovery in the airline industry. The airlines will begin designing their winter 2004/2005 schedules in the Spring of 2004; thus efforts beginning early in 2004 would influence air services for the following peak season. D. Developing St. Croix or St. Thomas as a Hub for the Caribbean Businesses and legislators on the Virgin Islands have expressed a recurring interest in establishing an airline hub at St. Thomas or St. Croix. This hub would have spokes to several Caribbean islands, including San Juan, Anguilla, St. Maarten, St. Barts and the British Virgin Islands. While intended to serve primarily transiting traffic, the hub would also stimulate originating and terminating traffic. It is the latter traffic that, as persons transacting business on the USVI, or as tourists, provides the largest economic benefits. In 1999, the concept of a hub was explored in depth26. The report concluded that the concept is feasible, with sufficient traffic to support a profitable service. The advantages of a hub, when viewed superficially, are appealing. It would eliminate the need for many passengers traveling between the USVI and other Caribbean points to transit San Juan. By feeding long haul services, the proposed hub would increase the financial health of existing links and possibly support altogether new flights. Through helping the viability of long haul flights, raising the profile of the Virgin Islands, providing additional revenue sources to the airports (thereby promoting lower landing fees), and stimulating origin-destination traffic, the concept could promote the goal of increasing air arrivals and provide benefits to the economy. T-54 EDWARDS AND KELCEY 26 “Review of USVI Air Service and Potential for the Future Regional Airline Plan”, Kiehl Hendrickson Group, May 1999 AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT Because of the location of the USVI and the weakened condition of the airline industry, it is considered unlikely that any large, well established and robustly capitalized airline would establish a hub at either St. Thomas or St. Croix. Rather, the most likely airline to do so would be a small, local operator; possibly an altogether new entrant. It would face all of the difficulties and risks of a startup carrier. Despite the seeming benefits, the EK Team does not endorse the hub as a means to increase air arrivals to the Virgin Islands. Rather, the concept should be either promoted or discarded strictly on its commercial merits, and independently of all government support. The hub strategy should not be pursued as part of the specific initiatives recommended in this study. The rationale is as follows: • Commercial aviation is very risky, and exceptionally hostile to startup airlines. A new airline requires a substantial cash reserve. The venture’s business plan would address these factors, presumably to the satisfaction of investors. However, the very high level of risk is undeniable, and, we believe, excessive for the stakeholders of this study. The investment would have to be considered highly speculative, and only suitable for investors willing to bear very high risks. It would be an inappropriate use of public or resources. • According to the origin-destination survey and the Caribbean Tourism Organization Statistical Report, traffic between the USVI and Caribbean islands to the south is very limited. The public need for the service is therefore small, particularly in comparison to routes to the U.S. mainland. • The hub would compete with several carriers, including American Airlines at San Juan. American has an extensive network to the Caribbean, and in May 2003, extended services to Nevis. It will defend its Caribbean franchise aggressively. • Depending on its business plan, the airline operating the hub might depend partly on “friendly” connections with a large USVI-mainland carrier willing to interchange longhaul mainland-Caribbean traffic with it. However, the selection of partners is limited, and most large carriers are already expanding Caribbean services of their own. The joint fares the two airlines could negotiate would likely be significantly higher than the fares offered by airlines offering their own through services to the final destinations. The prospective hub operator would then be forced to rely on those few destinations that are too small to support direct services to San Juan or the U.S. mainland. • Passengers prefer nonstop services. As shown in Section IV, nonstop flights between the U.S. mainland and the Caribbean have been growing. One example is USAirways’ nonstop Philadelphia-St. Kitt’s service. Although such services in the long run will promote a wider interest in the Caribbean, and indirectly promote intra-Caribbean services, in the short run they will divert traffic from prospective hubs. Investors with a high tolerance for risk may find investing in a hub airline attractive, and should weigh the proposal accordingly. However, the hub/airline proposal is not appropriate for the public-private partnership that would implement the recommendations of this Study. E. Long Haul International Services The Virgin Islands has only begun to tap the large leisure markets of Europe. In 2001, this segment comprised only 1.5% of the USVI’ hotel registrations27, in contrast to 15.5% for 27 Source: Caribbean Tourism Statistical Report, 2001-2002, Caribbean Tourism Organization, Barbados (2003) EDWARDS AND KELCEY T-55 USVI Cancun and 48.7% for Barbados. The Virgin Islands ranked the very lowest among all areas mentioned by the Caribbean Tourism Association. The USVI’ past links with Europe and their historical and ecological attractions suggest that a stronger performance is in order. For European markets, air services are clearly a constraint. Commercial airline schedules do not serve St. Croix/St Thomas-Europe passengers well. Europe-Virgin Islands passengers arrive at hubs in the U.S. mainland in the afternoon, and must stay overnight in a hotel in order to board flights to the Virgin Islands that leave in the early to mid-morning. On the return trip, most inbound flights from the USVI miss eastbound trans Atlantic services. The four exceptions to this pattern, providing layover-free connections to and from Europe, are an American-Iberia28 link to Madrid via San Juan, American’s late evening arrival/morning departure St. Thomas-Miami flight, a LIAT-Air France/KLM connection at St. Maarten and a LIAT-British Airways connection to London via Antigua. Except for the San Juan-Madrid connection, these options are available only to passengers from St. Thomas. Most international traffic from St. Croix and St. Thomas travels via domestic flights to San Juan and the U.S. mainland. As shown previously, this traffic has grown significantly faster than domestic travel, in spite of the inconvenient schedules. Vacation traffic between Europe and the Caribbean is large and growing quickly, especially to Cuba, the Dominican Republic, St. Maarten and Barbados29. The outlook for further growth is excellent. Between 2002 and 2003, the trade-weighted value of the U.S. dollar fell by 11.5%30, making U.S. travel cheaper for the rest of the world. In the long term (5-10 years), the recommended goal for the Virgin Islands would be to obtain scheduled services to Europe. It would do so by a series of incremental steps. The immediate goal would be to obtain a limited series of trans Atlantic charter flights. At the outset, the flights would serve the USVI in conjunction with other Caribbean destinations, such as St. Maarten, Cancun, Belize or the Dominican Republic. Only a portion of the passengers on the aircraft would board or debark in the USVI. The hotel infrastructure, especially in St. Croix, would have difficulty accommodating a full planeload of visitors arriving at one time. This precludes a simple turnaround service. While most European- Caribbean flights operate on a simple nonstop out-and-back basis, some serve more than one Caribbean point. Such services would be the immediate target. The charter flights would be operated by carriers such as Air 2000, Monarch, Thomas Cook Flug (aka Condor) and LTU. The packaged tour wholesalers in the United Kingdom and Europe would be crucial to developing charter services. These organizations assemble and distribute tour packages that include air transportation. To the fullest extent possible, they purchase seats in bulk on scheduled operators. They use charter airlines (some owned by the wholesalers themselves) if scheduled services are not available. The charter airlines arrange the operational details of their flights, but otherwise exercise no autonomy in the routes they serve. Since charter services are governed by country-of-origin rules31, restrictive bilateral agreements such as 28 American and Iberia are closely allied through the OneWorld alliance. Their connections offer many of the advantages of a single-airline connection, such as attractive joint fares. 29 Source: Caribbean Tourism Statistical Report 30 Source: The Economist, May 3 2003 T-56 EDWARDS AND KELCEY 31 Most charter flights carry traffic originating in and returning to one nation, and are an integral part of a larger package of vacation services purchased. They are usually viewed as being under the exclusive purview of the nation of origin. The country of origin therefore stipulates the rules under which they operate, such as advance purchase requirements, membership in an affinity group, whether one flight can carry more than one such group, etc. AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT that between the United States and the United Kingdom do not pose a constraint. The Cyril E. King Airport has accommodated low frequency charter flights from the United Kingdom. It is recommended that the Virgin Islands target European charter operators, and seek weekly services. They could serve as a precursor to scheduled services. The runway at St. Croix’s Henry E. Rohlsen Airport, recently lengthened to 10,000’, could accommodate departures to Europe with no payload penalties. The Cyril E. King Airport at St. Thomas could serve inbound flights from Europe, although outbound operations would have to stop at another Caribbean airport with a longer runway. F. Services to Canada Canada is a second potential international destination. The Virgin Islands has only a 0.3% share of the Caribbean’s tourist arrivals from Canada. Canada-Caribbean traffic will benefit from the recent appreciation of the Canadian dollar, rising incomes in Canada and the reliably harsh Canadian winter. Canadians are fully familiar, and fascinated with, the United States, but are almost totally oblivious to the Virgin Islands. St. Thomas/St. John and St. Croix could therefore offer a mix of exoticism and familiarity. Air Canada has had a long presence in the Caribbean, and presently serves Haiti, the Bahamas, Bermuda, Barbados, Antigua, St. Lucia Trinidad and other destinations in the region. It operates a seasonal service to San Juan, and has recently inaugurated flights to Grand Cayman. Many of its Caribbean services operate only during the weekends, using equipment assigned to domestic services during the weekdays. Since these aircraft would otherwise remain idle, the airline’s incremental costs of serving the Caribbean are relatively small. Air TransAt is also active in the Caribbean and has served San Juan. American, Delta, USAirways and Continental offer reasonably direct one-stop services to the key Montreal and Toronto markets. Because of the more developed tourism infrastructure and the larger traffic volumes, charter or scheduled flights to Canada would likely operate only from St. Thomas, at least at the outset. However, the runway at the Cyril E. King Airport cannot accommodate nonstop flights to Canada without large payload penalties. It would therefore be necessary to serve St. Thomas in conjunction with another Caribbean destination. San Juan would be ideal, since the southbound flight could undergo preclearance in Canada.32 The key elements to developing a Canada-Virgin Islands service include: • Working with travel wholesalers and receptive operators to develop appropriate leisure tour products; • Promoting the Virgin Islands as a destination in Canada, especially in the key southern Ontario market; and • Meetings with Air Canada and Air TransAt to indicate interest, propose the economic rationale for a service, and establish lines of communication. 32 Passengers flying from major Canadian airports to the United States must clear U.S. entry formalities in Canada. A Toronto-St. Thomas-San Juan flight could benefit from this service; a Toronto-St. Thomas-St. Maarten flight or any other serving a third country could not. EDWARDS AND KELCEY T-57 USVI G. Intra-Caribbean Services None of the statistical research or interviews for this Study identified severe deficiencies or concerns with intra-Caribbean services. The Team heard complaints about high prices to San Juan; however, competition is intense and the actual fares do not appear inappropriate. Both LIAT and Coastal Air Transport offer services to Caribbean points to the south and east of the USVI. They could expand services if traffic were greater. Again, few concerns were expressed about intra-Caribbean access. Caribbean Star, based in Antigua, recently ordered 6 50-seat Dash 8 turboprop aircraft. Its sister company, Caribbean Sun, has a U.S. operating license, and recently inaugurated San Juan-St. Kitts/Tortola services. It could be a candidate for serving the USVI. Both Air Jamaica and BWIA could operate intra-Caribbean services to the USVI. This Study recommends against soliciting new services to the U.S. mainland until the airline industry is recovering from its current crisis. This is driven by the fear of weakening the incumbents. Because of the limited intra-Caribbean services, no such concerns should drive regional air service strategies. The USVI therefore should, as it considers appropriate, seek additional links to neighboring islands by established carriers. H. St. Croix Technical Stops Program Manufacturers have steadily increased the range of commercial airplanes. Recent technological advances have permitted ultra-long routes such as New York-Hong Kong, Los Angeles-Sydney and London-Singapore to obtain nonstop services. Such trends are not confined to large intercontinental aircraft. Later versions of the 737 see extensive use on transcontinental, trans Atlantic, and mainland-Hawaii services, allowing many “long and thin” markets to obtain nonstop services. These advances mean that airlines seldom make enroute stops for purely reasons. This has dramatically reduced long haul transit activity at airports in Hawaii, Alaska and elsewhere. Nevertheless, there will remain a need for occasional technical stops on long overwater flights. Such stops could allow airlines to carry heavier payloads and rotate their crews more effectively. The economics of such stops would benefit if the airlines are allowed to serve revenue traffic. Several considerations could make a transit facility at the Henry E. Rohlsen Airport in St. Croix attractive: • The facility could serve U.S.-Africa and Europe-Central America/South America services. It would be especially valuable to charter flights serving non-traditional tourist destinations in the Caribbean, which are still unable to generate a full planeload of traffic; • The United States has liberal bilateral agreements with most European nations, the major exception being the United Kingdom. Even with the U.K., revenue services would be permitted to all airports except Heathrow and Gatwick airports. The USVI stops could therefore generate passenger and cargo revenues; • The services would be operated mostly by widebody aircraft, and could offer attractive cargo capabilities; • The U.S. federal inspections services could be used to preclear flights operating to the United States; and T-58 EDWARDS AND KELCEY AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT • The airport’s proximity to the Hovensa refinery might permit it to sell jet fuel at a relatively low price33. This would be a strong inducement for operators of charter flights; Other airports have successfully developed services for technical and transit stops. Bangor, Maine is an active enroute stop for trans Atlantic flights. It has U.S. federal inspections facilities for incoming flights and actively solicits stopover passengers. Gander, Canada, has an active and successful “Trans Oceanic Plane Stops” program. Anchorage and Fairbanks, Alaska serve many all-cargo services, and some passenger flights to Taipei. Ilha da Sol, in the Cape Verde Islands, accommodates Africa-United States passenger flights. A reasonable target would be one or two weekly stopover flights during the peak winter season. It would require the following: • Equipping a transit lounge with appropriate facilities and concessions; • Ensuring that the airport has suitable ground equipment for the flight. This would include a mechanized loader for baggage containers; • Obtaining the active support of a handling agent at the airport. This agent would work with airport management, U.S. federal inspections services and freight forwarders to perform much of the paperwork for processing the transit flights; • Obtaining U.S. Federal Inspections Services support, should the operation involve revenue passenger arrivals, or preclearance of flights to the mainland; • Obtaining commitments by freight forwarders to process inbound or outbound cargo for the flights. A cooperative forwarder would then work with the operator of each flight; • Ascertaining the possibilities for selling discounted jet fuel to the transit flights and other flights serving the Airport. This would require the cooperation of the Rohlsen Airport’s fixed base operators; • Obtaining DOT cooperation and regulatory clearance for any international arrivals or departures; • Developing a schedule of attractive user fees transit stop flights; and • Publicizing the service among scheduled and charter airlines and tour wholesalers. 33 As of June 2003, prices for jet fuel were identical at the Cyril E. King and Henry E. Rohlsen Airports. This may result from contractual obligations by suppliers. EDWARDS AND KELCEY T-59 USVI Recommended Air Service Marketing and Development Strategies VIII. A. Introduction A structured, current, and comprehensive air service marketing and development program is a competitive necessity in today’s economic environment. In the case of the USVI, a territory whose economy is so heavily dependent on the tourism industry, it is particularly critical. The strategies outlined below provide a “road map” and prioritized action plan, for both the near and long term, which, if professionally executed in a timely manner, will ensure optimization of air arrivals to STT and STX. Furthermore, the adoption and implementation of the plan will: • optimize the effectiveness of tourism marketing dollars; • facilitate consistency of management in the long term; • provide a framework for continuity, knowledge build up and professional development of USVI staff; • enhance the relationship and instill a sense of partnership between airport management, the local business community, the tourism industry and the airlines; and • ensure the highest level of customer service and vacation experience. The previous sections of this report have examined the economic and social context within which the Virgin Islands must operate to increase its air arrivals. The air transportation issues facing the USVI are the products of its geography, economic base, political institutions, the economic fundamentals of the airline industry, and the volatile and difficult environment faced by the airlines. This chapter builds upon these findings to propose strategies for the Virgin Islands to increase air arrivals. B. The Need for Strategies for Each Island The strategies for increasing air arrivals, while implemented by a single group of persons, and addressing the needs of the Virgin Islands as a whole, must address the distinct needs of the two major airports. No single, and all-encompassing set of recommendations would be appropriate for both. St. Thomas/St. John and St. Croix possess different issues. The Cyril E. King Airport at St. Thomas is well positioned because: • It is the gateway to the most populous, and most economically active parts of the Virgin Islands; • It is the gateway to the renowned tourist resorts and the national park on St. John; • Its catchment area boasts many excellent hotels and upscale resorts; • Many prospective visitors are already familiar with St. Thomas through its prominent place as a cruise ship port; • It is served by five network airlines nonstop to Puerto Rico and the U.S. mainland; • It has high volume origin-destination markets to New York and Miami; • It obtains charter and seasonal services by carriers such as Sun Country; and T-60 EDWARDS AND KELCEY • Its traffic has grown in the recent past; even its post-2000 contraction was milder than those of most airports. AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT In contrast, the Henry E. Rohlsen Airport on St. Croix faces several problems: • The economy of St. Croix, while boasting a strong industrial base, lacks the strength, vitality and diversification of the other USVI; • Air traffic at St. Croix is only 36.78% of that at St. Thomas; • The St. Croix Airport is served by only two large carriers, USAirways and American; • American recently rationalized its staff at the Airport and now uses American Eagle employees to handle both commuter and mainline services; • The USAirways service originates in St. Thomas and boards only a small share of its traffic in St. Croix. The short St. Thomas-St. Croix leg involves very high operating costs. This service should be considered at risk;34 • The hotel infrastructure on St. Croix tends to be smaller and less developed than elsewhere in the Caribbean; • St. Croix has an undeserved reputation for crime; • The attractions of St. Croix; historical areas, climatic diversity, and opportunities for ecotourism; are different from what most people associate with the Virgin Islands. Those who visit the USVI are therefore somewhat unlikely to visit St. Croix; those who would most enjoy St. Croix are likely to go elsewhere in the Caribbean; • Total air traffic at St. Croix has followed a lengthy period of decline. This resulted from decreased traffic to Puerto Rico. The post-2000 contraction of traffic was relatively severe; The Airports also face different operating issues. St. Thomas Airport suffers from severe congestion during its mid-afternoon peak, and its runway strictly limits the feasible services. It already has nonstop scheduled flights to virtually all hubs on the mainland that are operationally feasible. The St. Croix airport has no congestion problem, and a 10,000’ runway. Its facilities pose no immediate constraints, but many opportunities. C. Recommended Strategies Strategies for Immediate Implementation (1 month) The following strategies should be pursued with urgency. 1. Apply for Federal Assistance Under the Small Community Air Service Development Pilot Program. The Small Community Air Service Development Pilot Program (Appendix M) provides communities with the funding to solicit improved air services. It covers market research, promotional funds, and the resources needed to solicit additional services. The FAA encourages communities to apply in groups, and limits the number in any state that may receive assistance. It is recommended that St. Thomas and St Croix jointly apply for this grant and share the proceeds equally. Each island would exercise the responsibility for using the funds, subject to the oversight of a single group comprising persons from both islands. The funds would be used to publicize each island as a tourist destination, and would support carriers now serving the Virgin Islands. Air service retention and increased traffic on existing routes would be the goal. 2. Develop Fees/Charges Incentives for Airlines now Serving the USVI. The Virgin Islands Port Authority should explore any and all ways to offer temporarily lower user 34 Retrospective note: On May 28, 2003 USAirways announced the cancellation of this route. EDWARDS AND KELCEY T-61 USVI fees. Some form of assistance to incumbent airlines is appropriate given the stressed environment. The recent fee increase has sent harmful signals to the airline industry. It will likely result in further reduction of service. St. Croix is especially vulnerable. Airlines develop their winter schedules in the spring and early summer, and the recent fees hike will be reflected in their schedules for the winter of 2003/2004. The Port Authority’s financial problems, and its limited room for action are recognized. Strategies for Short Term Implementation (1-6 months) 3. Designate an Air Service Development Manager. The USVI requires one individual to manage and coordinate its air services program. This person would be the sole contact between the USVI interests and the route planning/regional marketing offices of the airlines. Responsibilities would include supervising development of an air service plan, and implementing it. It is essential that any and all efforts for marketing the Virgin Islands to the airlines be professional, well integrated, highly structured, and creative. The marketing efforts must address the issues facing the airlines, both in the Virgin Islands and elsewhere. It requires a sophisticated knowledge of the airline industry and the local market. Airlines are continually being approached by communities seeking services; one carrier has a list of over 160 communities which have officially sought scheduled services. The struggle among communities for airline resources is intensely competitive. Success depends on: • Clearly identifying the Virgin Islands’ air service needs and seeking the airlines to fill them. A “shotgun” approach to carriers is seldom successful; • Approaching the true decision makers in the airline, almost always at the headquarters level; • Obtaining a meeting with senior planners of the carrier; recognizing that their time is very scarce and that they are inundated by requests for service from communities; • Identifying a clear and realistic and defensible set of air service improvements, including new routes; • Obtaining full and ongoing community support from the private and public sectors, particularly those involved in tourism, economic development and the airports, with commitments to assist in any “pitch” to a target airline; • Demonstrating loyalty to incumbents through not seeking new competitors if the economic environment is especially poor or if some airlines have just begun services; • Preparing and delivering a strong, analytically sophisticated, creative and convincing presentation. This usually includes a detailed traffic/yield analysis and comprehensive forecasts of the routes’ performance and its impact on current services. It should also include an assessment of services by the incumbent airlines, in order to argue that there is a genuine need for the route; • Follow-ups with the carrier with an ongoing exchange of information and insights; Continually monitoring airline industry trends and carrier strategies so that opportunities could be spotted quickly and acted on; and • Maintaining data and knowledge on origin-destination traffic flows, load factors, fares, schedules, the demographics and economic bases of all the Virgin Islands. This will provide a “quick response” capability to respond to unforeseen opportunities, or to respond quickly and aggressively to any airline request for information. T-62 EDWARDS AND KELCEY AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT The Manager must serve, and be accepted by the community, as the sole interface with the airlines where air services development is concerned. Parallel and uncoordinated efforts by different parties will be unsuccessful, counter-productive, expensive, and ultimately self-defeating. Airlines targeted by these efforts could become confused as to the community’s need. A common complaint is “nobody’s in charge.” An airline receiving an amateurish and ill-considered or uninformed pitch by one party might refuse to meet later on with a better qualified group that has made a large investment in time and resources. The various piecemeal efforts from well- meaning persons and organizations in the Virgin Islands, the Department of Tourism’s initiatives, and the Port Authority’s growing participation in the marketing process have already fragmented the process and reduced its effectiveness. The air service specialist should market both the Cyril E. King and Henry E. Rohlsen Airports. At most large airports, a Vice President of Air Services, reporting to the General Manager, coordinates the process, and orchestrates community interest. The air service function is sometimes combined with community relations functions. The scale of operations at the USVI is as yet insufficient to justify a full-time air service specialist. This position could report through the Port Authority, although other arrangements would be effective. Full cooperation of all entities concerned would be a sine qua non. 4. Develop an Air Service Task Force. An air service task force should be assembled from representatives of the Port Authority, the Department of Tourism (or any organization replacing it) and business, tourism and hotel interests throughout the USVI. The Task Force would be chaired by the Air Service Manager described above. The Task Force would receive input from the Tourism Department, the Port Authority, chambers of commerce, hotel associations and other parties. Its primary function would be to serve as a broad-based information resource for the Air Service Manager. It would contribute in setting priorities, managing professional contracts, and helping in any airline recruitment efforts. However, the Air Service Manager and his supervisor would be in charge. 5. Meet With Incumbent Airlines for Air Services Retention. The Air Service Manager, assisted by the Task Force, should meet with airlines serving the Virgin Islands to encourage them to maintain and increase services. Some of the routes serving the USVI are at definite risk. The Manager would prepare presentations on the economic rationale for continued services. The presentations would also propose new routes, while recognizing the limits of the current economic climate. These meetings would enhance communications between the community and the airlines. They would send a clear signal to the airlines that they are welcome. 6. Review Port Authority Costs, Rates and Charges. Airlines are increasingly sensitive about airport fees and charges. High fees can dramatically reduce carrier profits, and the industry already operates on very narrow margins. The Virgin Islands Port Authority should therefore review all aspects of its operations from the ground up with the goal of reducing costs. It must continue to manage the tightest cost control possible. 7. Address Facilities Congestion at Cyril E. King Airport, St. Thomas. The afternoon peak results in long lineups at security, outbound baggage claim and federal inspections services. The airlines are especially concerned about passengers missing outbound flights. The design of the terminal and the passenger flow patterns are largely fixed and EDWARDS AND KELCEY T-63 USVI cannot be easily changed. However, the Port Authority should work with the airlines, Transportation Security Administration and federal inspections services with the aim of shorter lineups and faster passenger flows. The airlines believe that simple and creative measures could be effective if all parties worked closely together to pursue this objective. The airlines believe that the airport management should play the lead role in encouraging all parties to resolve this problem. 8. Seek Improvements in Service By United Airlines and USAirways. The short-term focus of the Manager should target air service retention rather than attracting new capacity. However, targeting United’s token service would be appropriate. United Airlines presently serves the Virgin Islands with weekend-only services to Washington and Chicago. Inbound services operate nonstop; outbound flights transit San Juan because of payload restrictions from St. Thomas. The Task Force should meet with United Airlines and encourage it to upgrade the service with additional frequencies. Additionally, the Task Force should propose that the flight serve St. Croix rather than San Juan. A similar strategy for USAirways would seek incremental improvements in the St. Croix- Charlotte service, with the ultimate target being a daily standalone flight. Strategies for the Medium Term (6 months- 3 Years) 9. Upgrade Tourism Promotion Strategies. Strategies to increase airline capacity to the Virgin Islands will be most effective if accompanied by aggressive measures to stimulate interest in people visiting them. This is especially true for St. Croix, which is a poorly known and appreciated destination, and which does not conform to the prevailing attitudes about the USVI. Air services to St. Croix are struggling, and it faces a genuine risk of further losses of capacity. It is therefore strongly recommended that the Department of Tourism or other body continue and expand its promotion of the Virgin Islands. This cannot be overstressed. Furthermore, the promotional campaign should explicitly differentiate between the different Virgin Islands and communicate their unique attributes to prospective visitors. The objective would not be to “sell” the Virgin Islands; rather to promote St. Thomas, St. John and St. Croix. The airline interviews stressed the importance of promotion again and again. Additionally, the Department of Tourism could target the cruise traveler as a potential repeat customer and enhance their brief stay by taking steps to improve the attractiveness and aesthetics of the cruise arrival area. Efforts to upgrade the business areas around the cruise ports (e.g. pedestrian areas) will help in attracting future air visitors to the islands. 10. Participate in Air Service Development Seminars and Fora. The Air Service Manager should invest in obtaining air service development expertise. Professional organizations such as the Airports Council International (ACI) and Association of American Airport Executives (AAAE) run regular seminars, training programs and meetings in air service development. These activities will help the Manager obtain expertise, learn new techniques, and develop industry contacts. T-64 EDWARDS AND KELCEY 11. Seek Improved Services to the U.S. Mainland. The Air Service Task Force would meet with incumbent and prospective carriers to seek new capacity, particularly new routes to AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT the mainland. This step would only be launched after there is clear evidence of a recovery in the airline industry, or if traffic to and from the USVI is restored to its level of 2000. Specific targets from St. Thomas would include: • Northwest Airlines to Detroit or Memphis. Northwest is the largest network carrier not serving the Virgin Islands. The Manager should originally target seasonal, weekend- only services, using aircraft idled by the weekly lull in domestic traffic. • JetBlue to New York. This carrier tends to serve only high volume routes. It is a “long shot” but is still worth consideration. • USAirways to Pittsburgh • Delta Airlines to Cincinnati • American TransAir to Chicago-Midway • Continental Airlines to Houston These services, to new hubs would help expose the USVI to growing markets in the Midwest, central and western states. Because of the runway limitations at St. Thomas, nonstop flights to these destinations may be infeasible. The flights would then serve St. Thomas in conjunction with existing routes to Puerto Rico or, ideally, St. Croix. Target routes from St. Croix would include • USAirways to Charlotte on a daily basis • American to New York • A second American Airlines flight to Miami • Delta Airlines to Atlanta • Continental Airlines to Newark Current traffic to and from St. Croix is not sufficient to make a credible case for the above services on a standalone basis. At the outset, these proposals may depend on support from St. Thomas. With USAirways retaining a weekly service, a priority should be for expanded frequencies before new airlines or destinations. 12. Evaluate Incentives for Services to St. Croix. Many destinations use financial incentives to encourage new services. Rebates on landing fees are very common and non-controversial. The VI Port Authority has launched such a program. Some destinations such as hotels in both the Caribbean and at Colorado ski resorts often agree to guarantee flight loads. They will compensate the airline for any shortfall. Besides showing a tangible commitment to the services, these incentives discourage the community from seeking or supporting competing services. A common strategy is to finance airline promotional expenses. The community pays the airline a lump sum to assist in promoting the route. A concept of growing popularity is a travel bank, in which members of a community prepay transportation on a new entrant. Deposits not used become the property of the airline. Finally, some communities simply offer large cash payments. These measures were recently summarized in a study by the General Accounting Office35. 35 “Commercial Aviation: Factors Affecting Efforts to Improve Air Service to Small Community Airports”, GAO-03-330, United States General Accounting Office, (Washington, January 2003) EDWARDS AND KELCEY T-65 USVI Revenue guarantees would not be appropriate for St. Thomas. It already has several large and well-established services. However, revenue guarantees, offered by resorts on St. Croix, could be an effective means to attract improved services. Resort and hotel operators on St. Croix should be prepared to offer incentives, if these are necessary to attract additional services. Guarded caution is necessary for any such assistance. Airlines commonly eliminate unprofitable services once the guarantees expire. Some openly play off different communities for financial aid. An assistance package should only be assembled if the community is convinced that a route would eventually be profitable in the absence of any such help. 13. Pursue Charter Services to the United Kingdom or Europe. The Air Service Task Force would seek a low frequency charter service as a precursor to a scheduled flight. The Department of Tourism or Tourism Authority would meet with overseas travel wholesalers and their North American receptive operators to develop an attractive product including air transportation. The wholesaler would then assign a charter airline to operate the route. 14. Pursue Scheduled or Charter Services to Canada. This step would involve direct discussions with Air Canada, Air TransAt and their Caribbean tour wholesalers. It would emphasize the southern Ontario market. 15. Develop an International Transit Product for St. Croix’s Henry E. Rohlsen Airport. The Port Authority would develop the St. Croix Airport to serve as a technical stop for trans oceanic traffic. The service would offer incentive landing fees and, if possible, low fuel prices. While the original emphasis of the plan would be purely for technical stops, the Authority, the Task Force and the Department of Tourism/Tourism Authority would develop products to appeal to tourists. The technical stops would become low volume revenue stops. The recommended strategies – Immediate, Short-Term and Medium-Term and schematically presented in Exhibit VIII-1. T-66 EDWARDS AND KELCEY AIR SERVICE MARKETING AND DEVELOPMENT STRATEGY UNITED STATES VIRGIN ISLANDS TECHNICAL REPORT EDWARDS AND KELCEY T-67 EXHIBIT VIII-1. RECOMMENDED AIR SERVICE DEVELOPMENT STRATEGIES AND IMPLEMENTATION PROGRAM Apply for Small Community Air Service Grant Develop Fees / Charges Incentives Assemble Air Service Development Task Force Port Authority Tourism Department Chambers of Commerce Hotel Association Appoint Air Service Manager One Point of Contact Input MEET WITH CURRENT AIRLINES • Encourage incumbent airlines to retain services. • Seek Improvements by United, USAirways Seek Improved Services to the U.S. Mainland. MEET WITH NEW AIRLINES • Market new access to Canada, Europe (via REVIEW RATES AND CHARGES • Review rates in charges from airline perspective. • Determine conditions for rates and charges incentives. ADDRESS FACILITIES CONGESTION / PAX PROCESSING • Develop strategies to facilitate coordination of airlines, passengers and federal services. UPDATE TOURISM PROMOTION STRATEGIES • Consider island differentiation strategies. MEDIUM TERM STRATEGIES (6 MOS – 3 YRS) PARTICIPATE IN ANNUAL AIR SERVICE DEVELOPMENT SEMINARS AND FORA • Remain in contact with Planning staff at airlines. • Reiterate value of existing services and potential for new routes. Review Report IMMEDIATE STRATEGIES (1 MONTH) SHORT TERM STRATEGIES (1-6 MONTHS)