Delta Lost the Fare War. Lesson Hopefully Learned.

(Bloomberg Opinion) -- An animal that’s cornered and fighting for its life is at its most dangerous. The same goes for airlines. Low-cost carriers, including Frontier Group Holdings Inc. and Spirit Airlines Inc., are in survival mode and feeling cornered after major airlines ate into their core customer base with basic economy fares. Now, they are striking back with lower fares and more choices on seating and boarding to claw back those bargain hunters.

Delta Air Lines Inc. doesn’t need to get into a mud-slinging fare war to hang on to passengers who base their choice of airline on price above everything else. Delta is the most profitable airline because of its premium strategy. It’s clear from second-quarter earnings that the effort to keep the main cabin full with lower fares became a drag on overall results. The Atlanta-based airline would do better to focus on its strengths: winning over international and business travelers while leaving the bargain hunters to its low-cost rivals. 

There’s too much US domestic capacity even amid record air travel as airlines have kept older planes around longer to meet demand. Carriers offered up too many seats and that’s dragging down fares, especially at the back of the plane, says Delta Chief Executive Officer Ed Bastian. That’s the big takeaway today from Delta, the first major US airline to release earnings.

For several quarters, Delta was hitting on all cylinders with hot-selling premium products, a rebound of international and business flyers as well as the basic-economy passengers it courted when leisure travel was the first to recover from the pandemic. The cylinder on those economy passengers is starting to sputter. Delta’s second-quarter earnings per share missed the consensus estimate by 2 cents and the airline gave a third-quarter forecast that’s lighter than what analysts expected. Delta didn’t change its full-year guidance, saying that the heated fare competition will subside as the industry pulls back on capacity. Delta’s shares tanked, dropping as much as 10%.

The news on the low-end fare fight spilled over to other major carriers. Shares of United Airlines Holding Inc. and American Airlines Group Inc. both dropped as much as 7.3%. Southwest Airlines Co. also stumbled, declining more than 4% in early trading. The low-cost carriers, though, rose as the fare battle shows they aren’t going down without a fight. Frontier jumped more than 5% and Spirit climbed as much as 4.6%. Both airlines have posted net losses in the last several quarters. This is good news for travelers, which had braced for higher fares due to rising demand and because the two main aircraft makers remain behind on deliveries.

Still, Delta’s earnings have more of a silver lining than the drop in the stock prices suggests. Premium products rose 10% from a year ago and business travel is recovering. These premium flyers are the drivers of Delta’s profit, not the low-ball fares that herd more people into basic economy. And make no mistake, Delta is the most profitable US airline, with an adjusted operating margin of 14.7% in the second quarter. In fact, Bastian said on a conference call that Delta is expected to generate 50% of the industry’s profits on its 20% share of the market’s capacity. The airline has free cash flow of $1.3 billion in the quarter and is rapidly paying down the mountain of debt it incurred to survive the pandemic lockdowns. If only all airlines would post such numbers, investors would sleep better at night.

Passengers are still seeking better travel experiences and are willing to pay for them. Delta is rolling out free internet for loyal customers and opening fancy lounges at large airports, including in Boston, Los Angeles and Seattle. Value in the industry used to mean only the lowest fare. Now, it’s about the best experience for the money, Bastian said. “The secular shift in consumer spend to prioritize experiences aligns perfectly with Delta’s strategy and premium focus across our global network,” he said on the call.

This puts the low-cost carriers at a disadvantage because they operate on thinner margins and costs — from labor to maintenance to fuel — are rising for everyone. That also means that as Frontier and Spirit look to add more premium options that raise expenses, such as checked bags or more leg room at the front of the plane, they will have to increase prices to protect margins, Bastian said. 

It’s unclear now how the low-cost carriers are holding up in the fare fight that broke out this summer. Spirit and Frontier usually report second-quarter earnings in early August. Bastian said airlines have reacted quicker than usual to curb the capacity that’s driving down fares, showing a newfound discipline to avoid the repeated cycles of overcapacity that have plagued the industry.

Let’s see if they’re able to cope and even cut costs enough to thrive. The more competition there is in the airline industry — from thinly padded economy seats to luxury lie-flat pods — the better for customers. For Delta, the decline in main-cabin revenue is a nuisance and a slight drag on its industry-leading profits. For the low-cost carriers, it’s a question of survival.

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Thomas Black is a Bloomberg Opinion columnist writing about the industrial and transportation sectors. He was previously a Bloomberg News reporter covering logistics, manufacturing and private aviation.

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