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Horizon Air and Regional Airlines:
Customer-centric approaches to changing times

Remarks of Jeff Pinneo, President and CEO
Aero Club of Washington, October 25, 2006

Introduction
Thank you, Debby, and good afternoon everyone. It’s a real privilege for me to be here today to address the Aero Club, in my capacity as CEO at Horizon Air and as the current Chair of the Regional Airline Association (RAA). These are, as they have always seemed to be, interesting and challenging times in our business, and I appreciate the opportunity to be with you to talk about them. As I flew back here last evening, it occurred to me that we’re just a few weeks out from the mid term elections and that there’d be a very real chance that I’d get to Washington and find NOBODY THERE, that is if my mailbox and TV are any indication—everyone’s out stumping. I was struck by the irony that I might be coming to Washington DC to ESCAPE political banter!

AAG Model and Progress
Let me turn to something I know a little bit more about than politics, and that’s our business, our company, Horizon Air and the somewhat unique business model we’re a part of as one of two carriers that comprise Alaska Air Group. It was back in September 1981 that Northwest entrepreneur Milt Kuolt, along with his band of aviation brothers--Bruce McCaw, Joe Clark and Scott Kidwell--founded Horizon Air. They seized the opportunity afforded by deregulation to give customers what they wanted—frequent, dependable service in markets in the Northwest that had been abandoned by larger carriers and a level of customer service that directly challenged the status quo with the motto “It’s our privilege to serve you”. In theearly 1980s, the airline grew quickly and, in 1984, it went public. In 1985, Alaska Airlines, then a fairly small regional airline themselves, formed a holding company to position it to make acquisitions in line with its strategic interests, which it first did with Long Beach based Jet America a year later. As Alaska’s own postderegulation expansion continued south of Seattle, they found themselves in more frequent competitive encounters with United and other much larger carriers. This led, in 1986, to Alaska Air Group moving to acquire Horizon as a way to solidify it’s position in the Northwest and to support Alaska’s expansion through the extensive feed network that Horizon was able to provide. I was working in marketing at Alaska back in those days, and I remember that early Horizon team not only for the Metros and Dash 8’s they flew, but for their entrepreneurial energy and passionate commitment to the enterprise they’d built and the communities they served. Today, Horizon has 69 modern regional aircraft, about 4,000 employees and serves 47 cities throughout the western United States and Canada. In addition, we currently provide contract service to Denver from 14 or so cities in the US and Canada in support of Frontier Airlines, operating as Frontier JetExpress. On our native network, we’ve recently added several new destinations from our Seattle hub, as well as from our focus cities of Portland, Boise and Los Angeles. Our recent order of 13 additional Bombardier Q-400 aircraft will bring to 33 the number of these modern turboprops that we operate along with 20 CRJ700’s and 28 Q200’s. With this fleet, we have the flexibility to shore up our presence in our traditional markets and expand even further.

Among regional airlines, Horizon remains a bit of a contrarian when it comes to our model of protecting our brand and remaining true to our founding traditions of customer-centric differentiation. If you fly with us today, you’ll find an airline that, while clearly related to a larger, well-known sibling, is proudly referred to byits own name. From there, you’ll encounter features you thought long ago relegated to the airline archives…freshly brewed Starbucks coffee served in our hub gate areas as well as inflight, a Wall Street or local business journal offered to you as you board, and featured complimentary Northwest wines, microbrews and snacks enroute. These features would amount to nothing were they not delivered by an amazing group of people who are naturally inclined toward making a difference for those around them. These are the founding traditions that remain vibrant today and which, we believe, have kept us solidly in the game through all the cycles we’ve lived through these past 25 years. They serve as the basis for any notoriety we’ve received, such as having been named the highest ranked regional
airline in the 2005 Conde Nast Traveler Magazine’s Business Travel Awards, as we have been for several years running. Just like our sister carrier, our focus remains on giving customers every reason we can to utter the three magic words in business: “I’ll be back”…and so far, it’s working out pretty well.

The Alaska-Horizon relationship exists to provide long-term profitable growth for both companies, not for one at the expense of the other. In the years since Horizon became Alaska’s sister company in 1986, major steps have been taken to solidify and optimize the relationship, culminating in 2001, in something we’ve termed“harmonization.” While keeping operations separate, harmonization seeks to deploy the Alaska and Horizon fleet as if it were one, mixing both airlines’ aircraft to better match capacity to demand. Horizon adds flight frequencies, feed traffic
and connections for Alaska that they could not efficiently provide on their own. And Alaska, in several cases, provides the added capacity of the Boeings in markets and at times of day where demand is better served by the larger aircraft. By 2005, Air Group’s bottom line had improved by over $30 million from what it would otherwise have been as a result of these harmonization initiatives.

Together, our two airlines serve a combined 23 million passengers a year and 88 cities, with nearly 1,000 daily departures. We have a hybrid network route structure that focuses tightly on the west coast, broadly defined from Alaska to Mexico, where our combined frequencies and customer preference have earned us a dominant position in the north-south corridor markets. In our hometown of Seattle, Alaska and Horizon account for over 50% of all enplanements at Sea-Tac. In addition, Alaska has successfully introduced transcontinental services, as well as new flying into Canada and Mexico. Air Group’s code-share and mileage plan alliances with several other domestic and international carriers expand our scope and utility even further.

Of course, our companies have not been immune to the industry’s challenges. We, too, have been grappling with high fuel costs, aggressive new competition and ever-increasing government-mandate taxes and fees. Success in this environment has required us to honestly appraise the brutal facts facing the industry and to adapt as necessary to meet them, while not losing sight of the values and core strengths that got us here in the first place. Among those is clarity on the absolute centricity of the customer – in being fixated on their needs and wants and in aligning our product to match. With these commitments as guides, both Alaska and Horizon have adapted and made significant progress in our long-term plan for meaningful profits, with both airlines combining their unique strengths in harmonized efforts to that important end.

Impact to AAG of RAA Policy Issues
Of course, there are many external forces outside the direct influence of any one airline that are impacting our ability to efficiently deliver on what customers want and need. Among them, as everyone here knows, is the role of the Federal Government which, even in this deregulated era, remains huge in nearly every aspect of the industry. In my role as Chair of the RAA this year, I have had opportunity to be more actively engaged in the public policy debates surrounding the issues of the day, including the key policy issue to confront the industry next year: Of course, I am referring to the upcoming reauthorization of the FAA and the Trust Fund. All sectors of the industry, including the regional airlines, are keenly interested in the many reauthorization issues under debate.

Let me first address the funding issue, which is undoubtedly the most
controversial topic under review. The need for sufficient funding is not in question–the model for generating it is. While the devil will be found in the details, there are some very basic funding principles that RAA believes ring true from a fairness perspective: First, we must find an equitable funding solution – one that ensures that each aviation sector pay for the costs they impose on the system. Currently, commercial airlines pay for a significantly larger portion of the ATC services than
they actually consume. In return for this overpayment, airlines face avoidable delays wasting fuel, crew time and other resources in the process, due to an outdated ATC system that is unable to accommodate growing demand. Second, any new funding scheme should maintain a robust general fund contribution, in recognition of the importance of aviation to the American economy and the value of the system to the public in general. And third, we must ensure that the system is funded in such a way that service to the many hundreds of small communities who depend on access to the nations air transportation system is not disadvantaged.

Of course the goal is not only to develop an equitable funding echanism, but one that provides a long-term, stable funding source for the modernization initiatives that are essential to meet the pressing requirements of the aviation community. The FAA must be provided the funds that are necessary to both fully utilize existing technologies and invest in next-generation technologies, including satellite-based navigation. Such modernization is crucial to the ATC system’s ability to accommodate the forecasted growth in passenger demand, a growing percentage of which will be served by regional airlines. We should not suppress or rechannel this increased demand through differential pricing or other such demand management mechanisms, as has been proposed at LaGuardia and enacted at Boston Logan. This demand exists because customers drive it. Instead, the focus should be on providing airlines serving both small and large cities the opportunity to bring high levels of service and price competition to these markets.

I cannot talk about the importance of funding modernization without also highlighting the imperative of cost control. The FAA must be empowered to pursue greater efficiencies and, in the process, reduce their costs. This means undertaking the politically unpopular task of eliminating inefficiencies and streamlining operations. Commercial airlines are well versed in the agony of cost reduction. We have undertaken the difficult and often painful process of bringing costs in line with market realities. The FAA must continue progress on this cost reduction front, and the industry must stand ready to assist in that effort.

Industry Overview in Role as Chair
As the reauthorization debate heats up next year, regional jet service will surely be noted as a key contributor to the forecasted growth in use of our ATC system, and for good reason, as demand for regional airline service continue to grow. Currently, regionals provide scheduled air service to virtually every airport in the country. We also account for a growing percentage of service from our hub airports, which ultimately drive the economics of our network carrier partners. For example, in our hometown of Seattle, a third of all nonstop daily flights are flown by regional airlines—most of them, I’m happy to say, by Horizon. The same percentage holds true in Dallas, while regionals serving Chicago O’Hare operate an astounding 51% of nonstop daily flights. And in Portland, Horizon is the airports largest carrier in both enplanements and departures. In short, regional airline service has grown dramatically because it plays a vital role in connecting American communities to each other. Today, one out of five passengers travels on a regional airline in the United States.

Like the majors, regional airlines must constantly adjust to the new realities of our world and to the security measures that have stemmed from them. Five years ago last month, the horrific attacks of 9-11 collectively challenged the entire industry to reinvent existing systems for passenger, baggage and cargo security. In partnership with the DOT, the airlines and their employees, along with our passengers, worked together and met that challenge. We continue to modify and improve the system to meet current and future threats, as we did this August in response to the foiled UK terror plot. While it may not have been pretty, the industry did effectively implement major changes in security procedures in less than five hours. That is no small feat.

But in order to move forward toward an efficient and cost effective security system, we need to not only focus on what is being carried on a person or in their luggage, but also better understand who is traveling. I recognize and strongly believe that such a system must address the legitimate privacy concerns surrounding the transmission and use of passenger data. However, a system based on accurate, up-to-date intelligence and law enforcement data will only serve to enhance our current scheme. It will also be scaleable to address increasing passenger traffic levels, without so inconveniencing passengers that they will choose not to fly, especially on the short-haul routes served by regional airlines.

All of this is playing out in an industry environment that can best be characterized as fragile. In the past year alone, we’ve seen as much as 45% of industry capacity in bankruptcy at one time, the merger of two proud, hobbled carriers and the failure of an aspiring LCC. While post 9-11 restructurings and related capacity reductions combined with an extended economic recovery to restore a measure of health, the industry is far from being out of the woods. Needless to say, our plate remains full as we wrestle with the weighty issues I’ve touched on.

Against this volatile backdrop, regional airlines have adapted to the changing landscape in a continual bid to add greater value and remain a key part of the solution to the challenges we face. We’re focused on those who most depend on us--our customers: those individual passengers who count on us for access to the country and the world and the network airlines that many of us support. Regional airlines succeed because we remain efficient, dependable and flexible, allowing us to respond to the evolving demands of our network airline partners. We also remain vigilant against increasing costs that do not improve safety or add value to our operations. This fundamental tenet has not changed since Horizon – and other regional airlines – began operating more than 25 years ago. The challenges of this complex, tight-margin business are as real today as they were then, when the pioneers of the then commuter airline industry—legendary figures like Dawson Ransom and Ralph Atkin-- were responding to the challenges and opportunities of deregulation. Now, as then, our focus must remain locked on anticipating and understanding the needs of our customers and doing everything we can to address them in the most efficient manner possible.

In this, our 25th anniversary year, we at Horizon are reminded that our traditions of service and resourcefulness are what got us here. Both Horizon and the regional airline industry will be well served not to abandon them going forward, no matter how much the landscape shifts.

Thank you for your time and attention.