Posted on: Sunday, September 12, 2004
COMMENTARY
The new formula for staying aloft
By Tom Belden
Two decades ago, and just five years into an experiment called airline deregulation, pundits were using the word "oligopoly" to describe what they saw happening.
Within a few years, the observers opined, the industry would be OPEC-like, controlled by as few as three huge global airlines. Hanging around the edges would be a few smaller carriers, feeding passengers to the big guys or occupying niches that didn't attract the heavyweights.
Oh, how cloudy those crystal balls were. Evolution has indeed taken place, as it inevitably does in business, but not in ways many people foresaw.
Two developments brought the industry to its current financial turmoil — one of them something the big airlines should have seen before it ran them over, the other something that few people predicted until the late 1990s.
What the older airlines missed was the growing anger of business travelers, who had tired of paying almost $3,000 to fly coast to coast — in coach — at the last minute. At the same time, airlines large and small began selling their flights on the Internet, unwittingly giving customers, in effect, the power to set prices. And when customers have that power, prices go down.
The impending result: In coming months, US Airways could disappear, and two or three other airlines may be in bankruptcy. Unlike other changed industries — passenger rail, Northeastern steel mills — this isn't a case of an obsolete product or technological advances. Instead, it is the formula (or "business model," in corporate-speak) that became unsustainable, and in another few years, half of the airline business could belong to low-cost, low-fare carriers that were once derisively called upstarts.
Until the mid-1990s, these upstarts — airlines such as Southwest, AirTran and JetBlue — were mostly an annoyance to the big airlines, and it's understandable why they thought that way. For most of its first 50 years, the industry was regulated, with the federal government deciding which airline flew each route and how much it could charge. Original thinking among airline managers was not encouraged. The carriers' work forces were unionized, and each time employees negotiated raises, the government let fares go up, too.
When the business was deregulated in late 1978, freeing the airlines to fly wherever they wished, some adjusted and others — Braniff, Eastern and Pan Am — did not. The winners in the 1980s were those that developed the best hub-and-spoke systems, with routes radiating out from a major city to dozens of destinations, offering travelers more choices of when to fly.
But hub-and-spoke systems cost more. Configuring a maximum of possible connections required more planes, employees, ticket counters and baggage carts, all used intensively during peak travel times and very little between the peaks. And that required higher and higher fares, especially from hub cities captive to a dominant carrier.
The formula worked well in the boom times of the 1990s, when business travelers were willing to pay $1,000 to fly to Chicago just to take a client to lunch.
By mid-2000, however, big cracks started to appear in the system, at the same time that the low-cost carriers had spread to more and more cities, using a different strategy. The bargain king, Southwest Airlines, has never used large connecting hubs, relying instead on a simpler, more limited point-to-point system that mostly serves major markets and makes more efficient use of planes and employees.
The Sept. 11, 2001, attacks made the big airlines' situation worse, because of their financial condition; so have record prices for jet fuel in recent months.
But not even Sept. 11 has caused as much disruption to the older carriers' way of life as has customer rebellion. The combination of customers' resistance to high fares and the choices available on the Internet has pushed down fares so much that only newer airlines, with the lower labor costs that come with a young workforce, are making a profit.
Today, Southwest has surpassed US Airways to be the No. 6 airline in revenue. By the end of the year, Southwest could be first in the number of passengers carried, passing perennial leader Delta.
"From the consumer's perspective, it's all good news," said William Warlick, the airline analyst for Fitch Ratings. "Look at what's happened since deregulation. ... It's still pretty easy — and cheap — to fly anywhere."
Indeed, the pressure on airlines to keep fares low is so intense that analysts who track every twitch in the industry say that even Southwest may have a labor-cost problem in a few years. The concern is that as Southwest expands, it will pay higher and higher wages to keep its employees happy and productive.
The airlines with the deepest financial problems are, more or less in worst-to-best order, US Airways, United, Delta, Northwest and Continental. American flirted with Chapter 11 last year before its unionized workforce agreed to take pay cuts and the airline made other changes in the way it operates to save money.
The big airlines also have a grave problem of underfunded pension plans, which could become a taxpayer problem. United's pension situation is worst, with $8.3 billion in obligations that it has already asked the federal Pension Benefit Guaranty Corp. to take on.
What is next — and who is affected — as the old formula dissolves?
US Airways is feverishly trying to get new cost-cutting agreements with its unions to avoid a second bankruptcy. This is the third time since summer 2002 that the airline has asked its workers for concessions.
The picture isn't much prettier for several other airlines. United has limped along in Chapter 11 since December 2002 and still has massive problems to overcome in order to reorganize. At Delta and Northwest, executives have warned investors and employees of bankruptcy.
If the new reality has been great for ticket buyers, it stinks for employees. At US Airways, most employees in the past two years have seen their compensation cut, for some pilots by as much as 40 percent. Senior US Airways flight attendants and ticket agents who once made $45,000 a year now make less than $40,000, and that's before the concessions the company is seeking now.
For customers anywhere, what an employee is paid usually makes little difference. Travelers generally choose an airline based on ticket price, flight schedule and frequent-flier plan, in that order.
That's where pressure from the post-'90s business traveler came in. Now, even on routes where older carriers have no upstart competitors, high fares find fewer and fewer takers.
"We're going to see the gradual diminishing of high fares in more places," said Kevin P. Mitchell, chairman of the Business Travel Coalition of Radnor, Pa., an advocacy group for corporate travel departments for 10 years. "A simplified, rational fare structure has been the holy grail, and it's come about."
Tom Belden is a reporter for the Philadelphia Inquirer.
