Though they were touted as a customer favorite, the real value in regional jets was that these aircraft were bigger and flew farther than turboprops, so regional carriers could fly these planes on routes that major carriers used to fly. (While the planes were advertised as preferable to turboprops, in reality they replaced larger jets.) The major airlines could outsource flying to their lower cost regional affiliates.

Fifty-seat regional sets were at the heart of this revolution, because in general airline pilot contracts allowed the majors to pay smaller regional airlines to fly the planes. Anything larger and the majors would run into contract problems with their pilots union (since they’d be contracting out flying of aircraft close to the size that their own pilots flew, something often verboten under collective bargaining agreements).

Over 1000 of Bombardier’s 50 seat Canadair Regional Jets are now in operation, with 152 having been delivered in Bombardier’s fiscal year 2004. Now, though, they’re all out of orders and they’ve announced layoffs of 660 employees.

[S]ome analysts warned it could be a long time before the company books another order for a 50-seat RJ. “The market is glutted,” Canaccord Capital analyst Bob Fay said.

There’s several reasons for that. RJs, introduced by Bombardier in 1992, caught on primarily in the U.S., and by early this decade the market was getting saturated. Then, major carriers were hit by plunging traffic (after the Sept. 11, 2001 attacks) and growing competition from discount airlines. That pushed some into bankruptcy; more followed after fuel prices soared. With fewer passengers, cheaper tickets and higher costs, 50-seat RJs became less economical on some routes.

The industry-wide restructuring also forced unionized pilots to give up concessions, freeing airlines to add more large regional jets to their non-unionized feeder networks. They were previously limited to RJs with 50 seats or less, which weren’t always optimally-sized for some routes.

After predicting demand would gradually shift to larger RJs, Bombardier and rival Embraer had to throw out their earlier projections, as demand accelerated for the larger planes, and fell off for 50-seaters.

Airline bankruptcies have another financial consequence for Bombardier, a function of their aggressive sales agreements:

Some of Bombardier’s largest customers are expected to unleash dozens of 50-seaters onto the used market. That will whipsaw back at Bombardier: the company guarantees part of the resale value of its planes, and faces a maximum exposure of US$2.6-billion in the worst case scenario over the next 20 years or so.

Meanwhile, production of Bombardier’s turboprops (e.g. Dash-8s) – the very planes that regional jets were supposed to send to the dustbin of history – are on the rise. Offering fewer seats, they were less attractive to major airlines and their regional partners who sought to replace mainline flying.

But the world has turned upside down. Major airlines have brought down their labor costs, so the cost advantages to outsourcing flying are lower. Major carrier bankruptcies have meant renegotiating down pilot and pension costs. Meanwhile, the cost of fuel has risen markedly and turboprops are more fuel efficient. Those two factors have the pendulum swinging back towards the ‘old’ prop planes.

Fast forward and we have a window into a key driver of the financial disaster that is Washington Dulles-based low fare carrier Independence Air.

Independence Air is the airline formerly known as Atlantic Coast, a long-time regional affiliate of United Airlines. When United entered bankruptcy it sought to reduce its payments to United Express carriers. Atlantic Coast wouldn’t take lower fees, and threatened to go off on its own and start a new airline. Everyone, myself included, thought this was a bluff. It wasn’t.

The airline owned planes and leased its own gates at Dulles, where it was already the largest carrier. It didn’t have the luxury of starting slowly and building up markets. It had to fully utilize these assets on day one. Hence eight flights a day between DC and Lansing, Michigan. (At the time I thought they should at least split their fleet and operate half as a regional feeder for a major airline and only half as a startup low-fare carrier, allowing them to offer fewer flights at least until they built a customer base).

They had planes to fill, and while they advertised heavily in Washington, DC they didn’t want to pay fees to the computer reservation systems like Sabre and Galileo. If customers booked direct on the Southwest website, they’d book direct at flyi.com too! Only not too many customers in Lansing thought of doing so. Even when Independence had the lowest price, Orbitz or Expedia didn’t display it, and customers didn’t book it. $39 fares to Pittsburgh without any advance purchase or minimum stay requirements weren’t enough to fill planes.

Independence Air finally gave back aircraft and started paying for displays in CRS systems. But that only put the lie to their fundamental business model – which is that you can’t be a low cost carrier if you have high costs, and your costs won’t be low if you operate primarily a fleet of regional jets. (While a 50-seat regional jet costs less to fly than a 737, there are also a whole bunch fewer seats to amortize your fixed costs across.)

Only one carrier had tried the low-fare regional jet model before. Midway Airlines, in its second incarnation (when it no longer even flew to Chicago’s Midway airport), operated primarily RJs (along with some Fokkers and a single Airbus). It survived for awhile through its marketing partnership with American, essentially operating as a feeder carrier, since American had scaled back its once near-hub operations at Midway’s hub of Raleigh. When that partnership ended, so did Midway’s revenue stream. The airline shut down operations in the days after 9/11, but was given enough cash to make once last failed attempt when the government paid out cash subsidies to all commercial carriers post-9/11 based on prior year traffic.

Insiders tell me Independence would love to scrap their whole business model, get rid of all the regional jets, and go for an all-Airbus fleet. But when they entered the third quarter of 2005 with less cash than they lost in the second quarter, they had to give up several Airbus orders, raising cash by getting deposits back.

The future appears to be a convergence between mainline aircraft and regional jets, with the most successful RJs being larger than in the past. Here’s the latest move by United:

United Airlines is slowly rolling out its latest weapon in its battle to fight off low-cost carriers and win over business travelers: new 70-seat regional jets.

Unlike most small jets, these aircraft for short-haul flights of up to three hours on United Express have three seating sections — first class, “economy plus” and coach. In first class, the Embraer 170 twin-engine planes also have extra legroom (38 inches) and meals (a cold sandwich). Coach passengers get a soft drink and a snack.

Bombardier is a fairly diversified company, making smaller turboprops, larger regional jets, and even firefighting aircraft. But it’s not clear how in the world Independence Air can possibly survive…