LM Otero  / Associated Press

Southwest soon will fly from the West Coast to Hawaii, but it is also evaluating whether it should fly routes between the Hawaiian islands. LM Otero / Associated Press

Skift Take: For an airline, launching inter-island Hawaii flights sounds enticing. The weather is good, fares are relatively high, and demand is steady. But many carriers have failed in trying to build a franchise to compete with Hawaiian Airlines. It owns the market and has the right plane — the Boeing 717 — to serve it.

— Brian Sumers

Once Southwest Airlines Co. starts flying to Hawaii, it may well add a compelling wrinkle to its schedule: flights between the islands. The carrier is mulling whether to include some in-state travel along with its trans-Pacific routes, which the company plans to offer starting next year.

Southwest Chief Executive Officer Gary Kelly said last month that island-hopping flights are something it’s “obviously” considering—they’re attractive in terms of year-round demand, easy weather, and steady prices. While Southwest would face off against Hawaiian Airlines, a deeply entrenched competitor which enjoys a virtual monopoly in the state, it does have a secret weapon. Andrew Watterson, the Southwest executive who oversees revenue and is in charge of cracking the Hawaii nut financially, worked at Hawaiian for three years and knows the market well.

Flying in Hawaii is “a bigger business than people perhaps have in mind,” Mark Dunkerley, Hawaiian Holdings Inc.’s chief executive, told Bloomberg’s P&L podcast last month. Of the 6 million in-state passengers, about 30 percent are connecting from long-haul flights, he said. This traffic accounts for a quarter of the airline’s annual revenue.

“It’s a business that sort of carries everyday life here,” Dunkerley said of the 30- to 40-minute hops between six islands for school groups and even visits to the doctor. Fares are generally $70 to $100 each way. “It’s pretty big business,” he said.

More people flew between Honolulu and Maui—1.03 million—than between Boston’s Logan Airport and New York’s LaGuardia Airport, about 595,000, in the 11 months ended July 31, according to the most recent data from the U.S. Bureau of Transportation Statistics. By way of comparison, only three destinations from Chicago’s O’Hare Airport—New York, Los Angeles, and San Francisco—had more traffic than the Honolulu-Maui route during the same period. Hawaiian offers as many as 32 daily flights between Honolulu and Maui’s Kahului Airport; four of the top 10 destinations from the capital are intrastate, accounting for more than 3 million travelers.

The five largest routes in Hawaiian’s neighbor island network account for about 94 percent of the carrier’s in-state revenue and likely make up higher margins than the airline earns on its flying to the mainland, according to an Oct. 30 research note from Stifel Financial Corp. “Should Southwest come to believe that it can fly within the neighbor islands profitably, we believe this would represent a fairly significant headwind for Hawaiian,” analyst Joseph DeNardi wrote.

Getting a foothold on the islands won’t be easy

For now, Hawaiian Airlines flies 85 percent to 90 percent of traffic among the islands, with Hawaii Island Air Inc. carrying a sliver on its fleet of three Bombardier Q400 turboprops. Island Air filed for bankruptcy protection on Oct. 16 amid a dispute with its aircraft lessors. Billionaire Larry Ellison’s Ohana Airline Holdings LLC sold the airline to a local investment fund in early 2016. In an email, Island Air CEO David Uchiyama said the carrier “will continue to provide affordable, convenient and reliable inter-island service that rivals any competitor.”

Mokulele Airlines, based in Kona, has about 120 daily flights on its fleet of nine-passenger single-engine Cessna Grand Caravans.

For its part, Hawaiian Airlines isn’t publicly concerned about the potential incursion. Peter Ingram, Hawaiian’s chief commercial officer, cited the carrier’s 88 years of experience serving the state. “Throughout the years we have seen a variety of competitive models, and through it all our strategy has proven to be the winning combination,” he said.

Indeed, Hawaii has been inhospitable to interlopers in the past. Allegiant Travel Co. acquired a half-dozen Boeing 757s to serve the islands but ran into cost pressures and weak financial performance, quitting in August 2016 after four rocky years. Arizona based-Mesa Air Group Inc. operated CRJ-200 regional jets intrastate as Go! Airlines for seven years until early 2014, suffering heavy losses. Aloha Airlines filed for bankruptcy and shut down in 2008 after more than 60 years of flying in the state.

Hawaiian has been pretty much the last carrier standing. And there are reasons to think Southwest may face some rough surf trying to break into the local market.

For Southwest, intrastate flying is likely to be an exercise in assessing the costs of adding short flights among the multihour journeys from the mainland. Is it more advantageous to park 175-seat Boeing 737s for what could be hours per day or to fly short legs between the long California hauls? The airline also hasn’t disclosed when it will begin service to the state, which can occur only after U.S. regulators approve the carrier’s plans for extended overwater operations of its Boeing 737-800s. Over time, Southwest plans to transition Hawaiian service to its new 737 Max aircraft.

Southwest may find that its 737s are too large to work inside Hawaii economically, Mesa CEO Jonathan Ornstein said on Tuesday. “I think it’s going to be hard to make that work,” he said, citing “finite demand” in the local markets, even if fares were to drop.

And there are more potential problems. With Hawaii’s heavy skew toward leisure traffic—one-fifth of visitors also take local flights—many people travel there on airline reward points: 11.4 percent to Hawaii, compared with 6.8 percent for the rest of the country, according to an October client report from Wolfe Research LLC analyst Hunter Keay. At Southwest, 13.8 percent of customers fly using their reward points instead of paying for a ticket, Wolfe said. That means more than 18 percent of Southwest’s Hawaii traffic may fly on free tickets, Keay contends.

That situation creates “an unideal mix and is high enough to disrupt normal pricing and dampen revenue and cash production,” he wrote. “[Southwest] doesn’t likely want Hawaii to be a loss leader.”

Keay also noted there are already a lot of seats flying to Hawaii in the first place. Airline capacity by seat count to Hawaii will be 27 percent higher in January 2018 compared with January 2014, vs. a 15 percent increase for the rest of the country over that period. Visitor arrivals have increased 5 percent so far this year, to 7 million, compared with 2016, according to the Hawaii Tourism Authority.

Southwest declined to comment on the Wolfe report.

–With assistance from Mary Schlangenstein

©2017 Bloomberg L.P.

This article was written by Justin Bachman from Bloomberg and was legally licensed through the NewsCred publisher network. Please direct all licensing questions to legal@newscred.com.