Where have you heard this before
Where have you heard this before HARVARDBUSINESSSCHOOL9-801-354REV:OCTOBER29.2001JODY HOPPER GITTELLCHARLESO’REILLYWhere have you heard this before? We’re startinga new low-fare airline.We’re going to offer low-faretickets and go to the big cities.’-FinancialIf you want to be a millionaire,Keep an eye on ]etBlue.start with a billion dollars and launch a new airline:-RichardBranson, Founder, VirginThat could prove to be a successful operation.3-HerbKelleher, Co-founder,AtlanticCEO, SouthwestAnalystAirwaysAirlinesAnn Rhoades looked up from the stack of papers in front of her and gazed out the window. Shewatched with pride as a JetBlue plane lifted off from Kennedy Airport. She knew from the departuretime that this one was bound for Buffalo. She paused for a moment to reflect on what had been avery exciting year for the start-up. JetBlue’s service had grown from 9 departures per day at launchin February 2000 to more than 50 per day in the past 11 months. The fleet had grown from 2 planesto 10 with the arrival of one new Airbus A320 every five weeks (se4~Exhibit 1 for first year growth).The business plan called for adding 10 new planes every year thrOllgh the end of 2003, bringing thefleet to 40.Rhoades,Executive Vice President for People, had been extremely busy -growing the JetBlueteam from the original 10 people to almost 1000. She knew that she would continue to addapproximately 100new "crew members" with the arrival of every Ilew airplane and that, if they hittheir plan, JetBluewould employ nearly 5000people within the next 4 years. Shewas charged withachieving this rapid growth while building a values-based,high conunitment organizational culture.Her experienceas head of human resourcesfor Southwest Airlines from 1988to 1994providedRhoadeswith both appreciation for the challenge and expertise to meet it. She was committed toattracting, developing and retaining outstanding people who could make the JetBlue concept areality. Still, she recognized that JetBlue’sexpansion goals were more aggressivethan any she hadmet before.ProfessorJody Hoffer Gittell and ProfessorCharles O’Reilly of Stanford University Graduate BusinessSchool prepared this casein cooperationwith the Global Airline Industry Program at the MassachusettsInstitute of Technology. HBS casesare developed solely as the basis for classdiscussion.Casesare not intended to serveas endorsements,sourcesof primary data, or illustrations of effective or ineffective management.Copyright @2001President and Fellows of Harvard College. To order copiesor requestpermission to reproduce materials, call 1-800-545-7685,write Harvard BusinessSchool Publishing, Boston, MA 02163,or go to http:/ /www.hbsp.harvard.edu. No part ofthis publication may bereproduced, stored in a retrieval system, used in a spreadsheet,or transmitted in any form or by any means-electronic, mechanical,photocopying, recording, or otherwise-without the permission of Harvard BusinessSchool.801-354JetBlue Airways: Starting from ScratchBirth of an AirlineJetBlue was the best-funded start-up in U.S. aviation history, founded in early 1999 with an initialcapitalization of $130 million. JetBlue’s strategy was to combine common sense with innovation andtechnology to "bring humanity back to air travel." To accomplish this, JetBlue aimed to be the first"paperless" airline, substituting computers and information technology for everything from flightplanning to aircraft maintenance to the sole use of e-tickets. But the company wasn’t only aboutefficiency, it was also focused on service. In the words of founder David Neeleman, "We like to thinkof ourselves as customer advocates. We believe that all travelers should have access to high qualityairline service at affordable fares."4Brave words in the face of the depressingreality that of the 51 U.S. airlines founded during the1980s,only two, America West and Midwest Express,were still in operation- and America West hadflirted with bankruptcy on several occasions.Between 1989and 1999,39 jet carriers began operatingwithin the U.S. In 2000,only 17 of theseremained in operation. Experts were mixed in their outlookfor the company. One airline analyst who was positive, commented that "When the big boys do asterrible a job as they’ve been doing, of course guys like ]etBlue have a chance.1I another airlineButobserver was less sanguine. lIlt’s a really risky business to take on these eight-hundred poundgorillas. You have to be a little nuts to want to do thiS.IISDavid NeelemanDavid Neeleman,the founder of JetBlue,had gotten his start in the airline businessin 1984whenhe partnered with June and Mitch Morris to run the Southwest Airlines’ look-alike, Morris Air.Neelemanraised $20 million in venture capital from Michael Lazarus of the Weston Presidio group,and in just over one year increasedthe value of Morris Air from approximately $59 million to $130million.Herb Kelleher, CEO of Southwest Airlines, watched the growth of Morris Air and its routenetwork centered in Salt Lake City, Utah, and made Southwest’s first and only acquisition to date.Southwest Airlines was the most prominent success story in the U.S. airline industry , and had alwaysprided itself on growing from within at a steady rate of 12% to 18% per year. But Morris Air was sosimilar to Southwest, by design, that Kelleher believed the merger would be a success.Neeleman and the Morris family sold Morris Air to Southwest Airlines in 1993, and Neelemanjoined Southwest’s top management team as an executive vice president. Rumors abounded withinthe company that Neeleman was slated to be Kelleher’s successor. That, along with Neeleman’saggressive, restless personality , always seeking to innovate, created tension in Southwest’s topmanagement team. Ann Rhoades, as the executive vice president of human resources at the time,was given the task of letting Neeleman go in 1994. According to Rhoades:David came running into a closed environment. He was ahead of Southwest in technology .He initiated the e-ticket at Southwest. But he didn’t fit the culture. Herb can’t fire a living soulso after he talked to David, David and I discussed why this particular marriage would notwork!6Though disappointed, Neeleman did not drop out. Having signed a five-year non-competeagreement with Southwest as part of the Morris Air sale, he turned to developing anew reservationssystem called Open Skies (sold to Hewlett Packard in October of 1998). Neeleman then went on towork as a consultant to a Canadian low-fare start-up carrier, West Jet Airlines.2etBlue Airways: Starting from Scratch801-354In 1998,when the non-competeagreementwith SouthwestAirlines ran out, Neelemandecided tocapitalize on his Morris Air, Open Skiesand West Jet successes develop a new start-up airline. Hetowanted to follow the successfulexample of Southwest,stimulating demand in under-servedmarketswith low fares, enabled by the highly productive use of employeesand aircraft. But Neelemanalsofelt he could improve on the Southwest model. His new airline would improve the passengerexperience with technology, and would use technology to increase employee and aircraftproductivity even beyond the record levels achievedby Southwest.Neelemanillustrated his idea for anew type of airline by describing his experiencewith his localdry cleaners."1 hate long lines," he said. "When you go to the dry cleaners,why can’t they alreadyhave your credit card number so all you do is pick up your clotheswithout having to stand in line?"While at Southwest,he noticed that in spite of the emphasison efficiency, passengerswould have tostand in as many as three lines; one to checkbags,another to get a boarding pass,and again to get inthe boarding queue to avoid being stuck in a middle seat.In talking about airlines, Neeleman said,"I’m not a pilot, and I don’t even like to fly. But when I do, I’ve always thought, this could be better."7Basedon his earlier industry experience,Neeleman had several ideas about how to start anewairline that would capitalize on technology and make the customer experiencebetter than existingofferings. First, he believed that a start-up neededto be well capitalized.A number of airline start-ups did many things correctly but were not adequatelycapitalized. There’s nothing worse than running a businessand scraping for capital. I decidedthat I wouldn’t do another start-up without enough funding. With an airline, there are so manymoving parts that it’s important to have enough capital.8Neeleman was a great admirer of Kelleher and Southwest. But he also noted that there were twoseemingly contradictory forces at work if an airline was to be successful. First, there was the need tostay focused on one’s strategy–in the words of Peters and Waterman, "to stick to your knitting." But,he also noted that markets and consumer tastes change and there was also a need to continuallyadapt to these changes.For his new airline, Neeleman began with several fundamental beliefs. "First," he said, "you needto go where people want to fly." He noted that one of the interesting things about the airline businessis that virtually all numbers about operations are in the public domain. This means that you caneasily see what the demand for air travel is in different markets and at different prices. "This lets youdo lots of computer modeling to check sensitivities of loads at different prices," he said. Reflecting onan unsuccessful attempt to open a new route while at Morris Air, he said "If people don’t want to go,you can’t even fill seats by giving them away for free."Second, Neeleman wanted to set up a new kind of airline; one that would leverage technology forsafety and efficiency and with a commitment to people. In describing his new approach, Neelemansaid:We’re a new kind of low-fare airline, with deep pockets, new planes, leather seats withmore legroom, great people and innovative thinking. With our friendly serviceand hassle-freetechnology,we’re going to bring humanity back to air travel.9The strategy was to use new airplanes, offer great personal service, create a state-of-the-artrevenue management system, and a single class of service with fares averaging 65% less than thecompetition. In doing this, all seatswould be assigned,all travel would be ticketless,there would beno discount seats,and all fares would be one-way with a Saturday night stay over never required.JetBluewould strive to be truly customer-friendly, with computer terminals that could be rotated toshow the customer what the agent was looking at, giving a $159 voucher whenever a flight was3801-354JetBlueAirways:StartingfromScratchdelayed for more than four hours for reasons other than weather or air traffic, and giving a $25voucher for misplaced bags. Like Southwest, however, JetBlue did not sell tickets to coordinate withother airlines, nor would they transfer a passenger’s bags to another airline.JetBlue’s target market, in the words of Amy Curtis-McIntyre, Vice President of Marketing, was". ..people who aren’t going to travel, people who are disgusted with their current choices, peoplewho would drive, or people who wouldn’t go at all."tO An important part of this segment wasbusiness travelers who the major airlines had targeted with high fare differentials for walk-up seats.Venture Capital FundingNeeleman knew that getting adequate capital for the start-up would be essential to its success.It’s a capital-intensive business, but without a lot of capital available. Not a lot of equityhas been raised in the past, but airlines need to be set up properly from the beginning. Youneed a cushion to do things right, to make the right decisions. People try to hoard ownership,and they don’t raise enough capital. I said, "If I get $130 million, I’ll do it." I was told I don’tneed that much. My own business plan said I would only spend $30 million before becomingcash flow positive. I said, "1 don’t care.1111Most recent start-ups in the industry had taken advantage of the growing opportunities to leaserather than purchase aircraft. But Neeleman had sat on the board of a leasing company and had seenhow lucrative the leasing business was. "Leasing companies make a ton," he observed. "I decidedwe are going to buy our airplanes."Turning to those who had invested in Morris Air and who had done well when Neeleman soldMorris Air to Southwest, Neeleman raised his target $130 million in short order. Michael Lazarus ofWeston Presidio once again became Neeleman’s lead investor with an equity stake of $30 million.Lazarus’ enthusiasm was based on the fact that Morris Air had been Weston Presidio’s secondinvestment ever and had been one of its first big successes. Chase Capital invested $20 million, andGeorge Soros unexpectedly joined in to the tune of $40 million. With three others participating at the$10 million level, and Neeleman’s own equity stake of $10 million, the first round of venture capitalfunding was completed …months after he began circulating his plan. "My philosophy is that youcan never have too much cash in the airline business…An IPO is a necessary evil, but the beauty ofour funding is that the timing is up to us. We don’t have to go public simply to raise capital."Reflecting on his efforts to get funding for JetBlue, Neeleman said:It was all "chicken and egg." I got the money with no deal on planes, no airport slots,without certification to fly. And the management team wasn’t all tied up yet. There was a lotof trust involved?Buildingthe Top ManagementTeamThe next order of business was putting the management team together. Neeleman himself wouldserve as the chairman and CEO of JetBlue. He drew upon veterans of the industry who were lookingfor a chance to start from scratch and "do it right." With his own record of success in the industry andthe funding he had amassed, he was able to attract some of the industry’s top talent, including:Thomas Kelly, executive vice president and general counsel, and a long-time partner ofNeelemanfrom his days at Morris Air and Open Skies.4JetBlue Airways: Starting from Scratch801-354Dave Barger, president and chief operating officer, who had ascendedthrough the ranks ofNew York Air during the 1980s,then spent 10 years running Continental Airlines’ Newarkhub.John Owens, chief financial officer, the treasurer of Southwest Airlines for 14 years.Ann Rhoades, executive vice president of human resources, with more than 30 years ofexperience in service-based businesses. Six of these years were spent at Southwest Airlinesduring its rapid growth years. (See Exhibit 2 for Rhoades’ resume)Other members of the new management team included marketing executives with experience atVirgin Atlantic.Why were these talented people, with established reputations in the industry , attracted to theJetBlue venture? According to Barger, who was simultaneously offered a leading role at Delta’sAtlanta hub, it was the chance to " create something new, unencumbered and fun."I thought it would be like it was at New York Air when I was 22, with a focus on people,teamwork and esprit de corps. That was before I knew that New York Air was part of [Frank]Lorenzo’s scheme to bust the unions. At Newark, I was at Ground Zero for the turnaround ofContinental Airlines under [Gordon] Bethune. But we were always facing union organizingefforts. JetBlue is a chance to do it right from the start!3Rhoades joined the JetBlue top management team for similar reasons.I loved my time at Southwest, and was personally close to Herb [Kelleher].DoubleTree.move on.ButI ama builder,nota maintainer.I liketo putthebasicsystemsLikewise atinplaceand14JetBlue’s top management team was in many respects a virtual team. Several members of theteam lived in locations other than New York City. Rhoades’ home was in Phoenix, Arizona, Kelly’sin Salt Lake City, Utah and Owens’ in Darien, Connecticut. David Neeleman maintained homes inboth Salt Lake City and in Westchester, NY. Only Dave Barger lived in Manhattan.Thisgeographical dispersion reflected the diverse lifestyles and preferences of JetBlue’s top managementteam. Some members had been persuaded to join the team based in part on the possibility of doingso without disrupting their families and personal lives.In addition, JetBlue’s corporate offices were geographically split. The operations and humanresource functions were housed in Kew Gardens, New York, near JetBlue’s hub in JFK Airport. TheCEO, financial and legal functions were based in JetBlue’s Connecticut offices, about 45 minutesaway.Senior management meetings were conducted weekly, every Tuesday morning, via a two-hourtelephone conference call. In addition, senior managers met face-to-face each quarter in a two-dayoff-site meeting, held alternately in New York City and Salt Lake City.Critical DecisionsJetBluehad to make severalcritical decisionsat the outset: where would the new airline be based,what type of aircraft would it fly, and how could JetBlue deliver on the vision of leveragingtechnology and people to deliver a low-cost high serviceexperience?5801-354JetBlue Airways: Starting from ScratchHome BaseNew York City was designatedin the businessplan asJetBlue’shome base.The logic for this wasclear: the New York area was an enormous population center,with 19 million people living within a60-mile radius. More importantly, the city was seen to be at the heart of several under-servedmarkets. Sincederegulation occurred in the early 1980s,origin and destination traffic had increasedthroughout the U.S. except in New York City. For instance,low fares offered by People ExpressandNew York Air stimulated traffic enormously in the mid-1980’s, but once they were taken over byContinental, high prices returned and traffic fell to near previous levels. As an example, there were230enplanementsper day from Buffalo to New York City in 1981,rising to 2400per day in 1986withthe help of People Express’ low fares, then, after People Express’s failure, returning to 310enplanementsper day in 1996.Using these kinds of calculations, Neeleman’s initial business plan identified several under-servedroutes to New York City. For instance, he found that former People Express and New York Air citieswere complaining of poor service and high fares. Unrestricted round trip fares to New York Cityfrom Buffalo, Rochester, Syracuse and Burlington were $500 to $800. As a comparison, anunrestricted round trip fare on American Airlines from La Guardia to Fort Lauderdale was $509 ($222if booked two weeks in advance and including a Saturday night stay). At the same time, anunrestricted round trip fare on JetBlue was $158. Local and state leaders were demanding improvedfares and service for their constituents. JetBlue stood to benefit from these political forces.But with the congestion in La Guardia and Newark airports, it was not obvious where JetBluewould establish its New York City base. Initially, the JetBlue team approached Islip Airport on LongIsland. But officials at the airport had recently enticed Southwest Airlines and were not interested in"another start-up airline." The team then considered John F. Kennedy International Airport. But asDave Barger, the COO, noted, "This is an airport no one wanted to go to. It’s a terrible place." Likeseveral other major urban airports, including La Guardia and Chicago’s O’Hare, JFK was heavilyused and slot-controlled, not an obvious choice for a start-up airline. Under the system of slotcontrols, which was managed by the Department of Transportation under the High Density Rule,JetBlue would have to purchase departure slots from the airlines that currently held them.But it turned out that the slot controls were in force only from 3:00 p.m. to 8:00 p.m. Except forthat five-hour period, JFK was under-utilized. In addition, TWA was looking to reduce its presenceat JFK as its financial woes increased, opening up new space in Terminal six. JFK therefore lookedattractive compared to the more-congested La Guardia and Newark airports.JetBlue would still need authority to operate during the slotted hours at JFK. Through a politicalalliance with New York State’s congressional delegation, JetBlue received an exemption to the HighDensity Rule at JFK for 75 take-off and landing slots in September 1999. The exemption allowedJetBlue to gain these slots without going through the usual process of purchasing them from one ofthe major airlines that currently held those slots. In return, JetBlue promised service to Buffalo,Rochester and Syracuse. Vermont also promised support for JetBlue’s service to Burlington.In describing the state support, Governor Pataki of New York said, "Our administration hasworked with UetBlue) to help them succeed in providing low-cost accessible air service that is longoverdue for so many New Yorkers."15U.S. Senator Charles Schumer reinforced this view, "The highfares at Buffalo, Rochester, and Syracuse Airports have had a crippling effect on the local economyand the prospect of adding anew, low-cost air service will provide a boost to the region’s economy."In announcing a one-way fare from Rochester to Florida of $89 or connecting service to California for$129, Neeleman commented that "The people of Rochester have been paying some of the highest6JetBlue Airways: Starting from Scratch801-354airfares in the country for a long time, so it is especially rewarding for us to be the carrier who willforce other airlines to drop their prices to this city."’6But Neeleman wasn’t being altruistic. He noted that one of the factors that he believed had helpedSouthwest succeed during its early days was its lock on traffic at Love Field in Dallas that provided asecure revenue base to help finance expansion. He believed that JetBlue had a similar beachhead atJFK through its protected landing slots. Neeleman estimated that these 75 protected slots wouldtranslate into $60 million in annual revenue, based on the fact that there were a potential 2.5 millionpassengers living within 10 miles of JFK. Furthermore, he also noted that so long as aircraft weren’tflying transcontinental or transatlantic, they would be able to avoid air traffic congestion by usingalternative flight paths into JFK. Most flights in and out of JFK were transcontinental or transatlanticand their arrival and departures paths were above 30,000 feet. This would allow JetBlue aircraft tocome in during crowded times at under 16,000 feet and avoid congestion. For these reasons,"crowding and congestion won’t be a problem," Neeleman argued.’7JetBluecould use its protected slots to get up and running, relatively safe from immediate threats.Then, Neeleman explained, "once we get our costs per available seat mile down, we can goeverywhere. (SeeExhibit 3 for JetBlue’sroute structure.),,18Boeing versus AirbusAnother critical decision faced by JetBlue was the type of aircraft to fly. Neeleman had alreadydecided that JetBlue would rather own than lease its aircraft, and the initial investors insisted that theaircraft be new, to counteract the image of low cost start-ups as shoe string operations. GivenNeeleman’s experience with Morris Air and Southwest, he felt that the obvious choice was the Boeing737, made famous as the only aircraft Southwest Airlines would fly. In the end, however, JetBlueentered into a contract to purchase more than 80 Airbus A320s instead of Boeing 737s. Neelemandescribed this unanticipated change.It was a classic American negotiating story. We had John Owen, who did the aircraftpurchasing for Southwest Airlines. He knew what Southwest was paying for its 737s. Wewrote down a number and Hoeing choked. More for due diligence than for anything, we wentto visit Airbus. They asked, " Are you using us as a foil to get a better deal from Hoeing?" Iasked, "Did anyone ever come in here using you as a foil and you convinced them that Airbuswas the right decision?" They said, "Yes." I said, "OK, so sell us."And they did. We were surprised. The A320 was better on so many dimensions. It burnsless fuel, it has better cabin technology, and it has a wider cabin. Each seat gets an extra inch,relative to the Hoeing 737,and the back rows don’t get narrower like they do on the Hoeing.Passengerslove it. We talked to airlines flying both side-by-side and they all said theypreferred the Airbus. The financial and the operational a.
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