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Texas International’s “Peanuts Fares” and the Rise of Frank Lorenzo

Texas International Airlines McDonnell Douglas DC-9-15

Houston-based Texas International Airlines began in 1944 as Aviation Enterprises and, with a fleet of surplus Douglas DC-3s, renamed itself Trans-Texas Airways in 1947. As Trans-Texas grew as a local service carrier (what we would today call a regional airline without the affiliation to a major airline), it expanded its services beyond the state as it added Convair 240 piston twins to its fleet. The Convairs were later re-engined with Rolls Royce Dart turboprops to become Convair 600s.

By the start of the Sixties, the airline flew as far west as Albuquerque and El Paso and east to Memphis, Jackson, and New Orleans. To maintain its competitive edge over the other Texas-based airline of the day – Braniff International – Trans-Texas added the Douglas DC-9 Series 10 to its fleet beginning in 1967. Route expansion continued steadily. In 1970, when it added a small handful of destinations in northern Mexico, the airline re-branded as Texas International. It unveiled a patriotic Lone Star livery in 1973 prior to the opening of the new Dallas Fort Worth Airport.

But Texas International’s upgrades to jet equipment had saddled the airline with quite a bit of debt, not unlike what had happened to Mohawk Airlines just a few years earlier. Through the 1960s, Texas International and its larger rival, Dallas-based Braniff International, had comfortably existed in a duopoly in the Texas airline market. That secure operating climate was upended in 1971 with the arrival of Southwest Airlines. Texas International joined Braniff in the legal battle to quash the nascent upstart and lost, putting Texas International in a competitive position unlike any it had faced previously. Combined with its mounting debts from the expansion in the 1960s and the upgrade to a jet fleet, the Houston-based operation was in need of help.

Frank Lorenzo at the time he took control of Texas International

In a similar financial situation, New York-based Mohawk Airlines had turned to the services of a small consulting firm called Jet Capital, run by the young and brash Frank Lorenzo. Lorenzo and his primary business partner, Bob Carney, a Harvard Business School classmate, were upstart darlings on Wall Street for their financial wizardry in creating Jet Capital. Investing only $44,000 of their own money, Lorenzo and Carney raised $1.5 million in the Jet Capital IPO, while retaining control of 75% of Jet Capital’s shares.

It was that seed money that Lorenzo used in his failed bid to takeover Mohawk Airlines. At the time of his Mohawk venture, Lorenzo made friends with Don Burr, a mutual fund manager who made a name for himself on Wall Street with some very astute aviation stock picks. With his clout as a mutual fund manager who held shares in Texas International, Burr convinced the airline to engage the consulting services of Jet Capital to effect a turnaround. Lorenzo arranged to have the airline’s debt refinanced with Burr offering the injection of $5 million from his mutual fund. In exchange, as with their proposed Mohawk deal, they would take control of the airline. Like the Mohawk board several years earlier, the board of Texas International was suspicious of Lorenzo and they might have scrapped the deal had it not been for two individuals who entered the ring to try to acquire Texas International for themselves: Howard Hughes and Herb Kelleher.

Since Hughes relinquished control of TWA in the late 1960s, he had been craving to get back into the airline business. He got the chance when he acquired local service carrier AirWest in 1970, immediately rebranding it Hughes Airwest. But Hughes wanted something on the scope of TWA and his new airline only gave him the West Coast. Acquiring Texas International would get him two-thirds of the way toward his goal of recreating a transcontinental airline. For Herb Kelleher, buying Texas International would not only knock out a competitor who had only recently tried to put Southwest out of business, it would also give Southwest the Texas International’s operating certificate, which permitted flights outside the state of Texas.

Herb Kelleher

Faced with a known eccentric and someone they felt was bent on revenge for their failed bid to quash Southwest, the Texas International board sold the airline to Lorenzo in 1972. Like his structuring of Jet Capital, Lorenzo controlled only 24 per cent of the shares in Texas International but structured the deal to give himself majority voting control of the airline. At only 32, Frank Lorenzo became the youngest airline chief since Juan Trippe at Pan Am.

Don Burr left Wall Street in 1973 to work with Lorenzo in Houston running Texas International. At the time, Southwest was adding its fifth and sixth Boeing 737-200s to its nascent fleet and even though Texas International had routes outside of the state of Texas, it was beginning to lose market share within Texas to Herb Kelleher’s operation.

In order to better compete against Southwest, Lorenzo began making deep cuts in labor costs, sowing discord amongst the employees at Texas International. With labor contracts up for negotiation, the atmosphere became contentious. Lorenzo would often add or change agreed-upon contract terms at the last minute, a pattern that would repeat itself in his negotiations with both unions and investors throughout his career. This angered the unions at Texas International and they struck, the first strike in the history of the small airline. The airline was grounded for four months. However, because of the mutual aid pact in place in the days before deregulation to protect an airline if its operations were grounded by labor actions, Texas International got millions of dollars in aid from other airlines and the strike eventually ended.

With his labor concessions in hand, Lorenzo turned his attention to competing with Southwest. At the time, Southwest operated within the “Texas Triangle” of Dallas, Houston, and San Antonio, the state’s three largest cities. Kelleher had engaged the services of a seasoned airline executive, Lamar Muse, to guide Southwest’s growth. Muse picked the agricultural town of Harlingen in the Rio Grande Valley as Southwest’s next destination. The route was vulnerable; Harlingen was a seven hour drive from the nearest large city and therefore dependent upon the air services of Texas International.

The four month strike had hurt the city economically. Muse astutely noted that Harlingen was a short drive from South Padre Island, which was at the cusp of its tourist boom as a Gulf Coast beach destination. While Texas International charged a one-way fare of $40 to Harlingen, Southwest charged only $25. Soon, thousands of passengers were filling Southwest flights when only a year prior Texas International was averaging only a few hundred a month. Before long, residents from northern Mexico began crossing the border to take Southwest flights. Texas International tried various approaches, but it was clear to Lorenzo that he wasn’t able to compete head-to-head with Southwest.

Peanuts Fares didn't just apply to routes where TI competed with Southwest

In the days before deregulation, airline fares were set by the Civil Aeronautics Board (CAB) in Washington. Any airline that operated beyond a single state fell under CAB regulation. Because Southwest only operated in Texas it was therefore free to set its own fares as long as state authorities had no objections. In November 1976, Lorenzo petitioned the CAB to be allowed to cut Texas International’s fares. He didn’t just want to match Southwest, but to undercut them with a 50 per cent discount. Lorenzo called them “Peanuts Fares” since passengers could “fly for peanuts.”

For years, the CAB allowed airlines to implement fare discounts, but these were usually for charter flights, holiday flights, and red-eye flights. The discounts were rarely long-term and usually only applied to a few flights. What Lorenzo was asking for individual authority to set his own ticket prices across the board based on market conditions. Although this was unprecedented in the airline industry, there were deregulation forces at work in Washington following Jimmy Carter’s election to the presidency and the CAB approved Lorenzo’s petition. The “Peanuts Fares” were introduced not just to Harlingen, but across Texas International’s route system. By the end of the first week, passenger loads on the airline had shot up 600 per cent.

“Peanuts Fares” were a success for the airline and for Frank Lorenzo, who was hailed as a hero by consumer advocate groups. But Lorenzo didn’t want deregulation and he knew that with his fare experiment he had handed deregulation advocates ammunition in their battle to eliminate the CAB and deregulate the US airline industry. Lorenzo was aware that Texas International would be crushed instantly by the Dallas-based giant Braniff International if the industry was deregulated and that with its growing presence at the new DFW, American Airlines had the resources and deep pockets to make a quick snack of Texas International in a fully free-market environment. During press interviews at the time, Lorenzo was quick to stress the experimental and temporary nature of the “Peanuts Fares,” and he used the remaining time during which he enjoyed the shelter of the CAB’s bureaucracy to plan his next move.

Texas International Route Map
Texas International Route Map
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