A legacy of problems
James Doran says America’s major airlines are in urgent need of new strategies to cope with soaring operating costs, inefficient fleets, over-extended route networks and a weak economy
An unofficial graveyard of the American airline industry hangs from the rafters of the Smithsonian Air and Space Museum in Washington. An old TWA mail plane dives across the flight path of a propeller-driven Eastern passenger plane which in turn passes precariously close to the wing of a fabled Pan Am Clipper, the aircraft that came to define the glamour and adventure of flight in the 1930s. But all of these once-great pioneers of American commercial aviation are no more. They were driven out of business by the forces of competition. They were the so-called legacy carriers – big airlines that lived high on government subsidy and cheap oil until deregulation in 1978.
But as markets were thrown open, it soon became apparent that this glamorous business, with its sharp-suited captains, pretty hostesses and free champagne for all, was completely and utterly unviable. A quick look at the finances of the combined US airline industry makes for startling reading: in the three decades since deregulation, US carriers have made a combined loss of more than $13 billion, a sum larger than the annual gross domestic product of Bolivia.
During the same three decades, more than 200 airlines have gone bust in America.
If the business model of the average airline made little sense back when aviation fuel was cheap, it is hardly worth the paper it is written on today, with oil soaring past $130 a barrel and jet fuel north of $161. By early June, jet fuel prices had surged by more than 65 per cent – with every extra dollar on the price of a barrel adding $465 million in costs to the US airline industry.
Small wonder, then, that in the first six months of this year alone, six US airlines have been forced to close down while another has filed for Chapter 11 bankruptcy protection.
‘There has certainly been an acceleration of shutdowns in the past month or so,’ said David Castelveter of the Air Transport Association, an airlines lobby group based in Washington, adding that a total of ten carriers have been forced to close down since 25 December last year. ‘This is all to do with the cost of jet fuel. Carriers simply cannot afford it,’ Castelveter added.
EOS was one of the higher profile companies to go bust this year. The business-class-only transatlantic carrier filed for Chapter 11 at the end of April, just four months after rival MaxJet threw in the towel. Aloha Airlines, the regional carrier based in Hawaii for more than 60 years, said goodbye on 31 March while others such as SkyBus, Champion and Air Midwest all cited increasing jet fuel costs as a primary reason for going out of business in the first half of this year. Today’s Big Six legacy carriers – American, United, Continental, Delta, Northwest and US Airways – have responded to the huge increase in overhead by cutting flights, planning layoffs and increasing the cost of tickets and stowing luggage. But many industry-watchers see the airlines’ responses thus far as too little, too late.
Delta and Northwest – having only recently emerged from Chapter 11 – are going one step further in forging a $3.6 billion merger. But in the current climate, the deal is widely seen as one born of desperation and panic rather than sound management and a desire to change the face of the industry.
‘We cannot survive this downturn simply by raising fares, by grounding aircraft or by increasing charges. Even consolidation by itself is not enough,’ Castelveter says. ‘There has to be a change in the economics of operating commercial aircraft.’
But in this climate of unfettered market hostility, changing the economic fundamentals of an industry established in a time of protectionism and subsidy is easier said than done.
Competition is fierce and fuel costs are higher than anyone in the industry ever forecast. At the same time, the underlying economic environment is so bad that even if a workable business model could be devised in time to save the most troubled of America’s carriers, it is doubtful that there will be sufficient numbers of paying passengers to allow them to bring the model to fruition.
‘The legacy carriers have created this environment for themselves in the decisions they have persistently made over three decades since deregulation,’ says Bob Mann, chief executive of RW Mann & Company, a leading airline-industry analyst based in New York. After deregulation, Mann says, the biggest airlines in America spent billions of dollars building hub-and-spoke networks all over the US. They ignored the fundamental economics of the industry, which dictate building capacity in areas where both geography and the general wealth of the population indicate high demand for air travel. Instead, the likes of American, Continental and the rest built major hubs in cities all over the map, regardless of the potential returns. They just wanted to be able to offer direct flights to every point on the compass.
‘It was never going to work,’ Mann says. ‘Not only do you not generate revenue at large numbers of airports, but you have to build and run infrastructure that isn’t making money. You also have to have large numbers of idle aircraft at these locations waiting for passengers. It has never made any sense.’
Meanwhile, the smaller low-cost airlines – such as South West, one of the most efficient and profitable airlines in the world – came in underneath to put the squeeze on fares, forcing the legacy carriers to take the knife to costs wherever they could.
Then, of course, there is the fact that the pilots, flight attendants and mechanics of the airline industry belong to the most aggressive trades unions in America. They have fought tooth and nail for the same kinds of wages and benefits that crippled the US auto industry in Detroit: yet another layer of cost the industry could ill afford. This confluence of financial pressures was bad enough when the economy was buoyant. But as soon as a downturn rears its head, airlines are the first to buckle. ‘We have seen it in every downturn – in the early 1990s, in 2000 and much more severely today,’ says Mann.
When times are bad people spend less on leisure travel and businesses tend to get by with smaller travel budgets. Yet right now, perversely, America’s private executive jet sector continues to flourish, flying super-rich financiers wherever and whenever they want to go. ‘Business travellers who value reliability and efficiency are essentially opting out of the traditional market and hiring their own lift,’ says Mann.
Commercial airlines, meanwhile, are left with fleets of empty planes and legions of idle staff waiting for the market to pick up. Add to this the current record price of jet fuel and it is easy to understand why this has become a make-or-break year for airlines in America.
So how can the legacy carriers survive? United Airlines said in June it would reduce domestic capacity by 14.5 per cent in the fourth quarter and 18 per cent in 2009. Continental is planning to slash capacity by 16 per cent in September while American Airlines said in May that it also plans a drastic fourth-quarter domestic capacity cut of up to 12 per cent. Delta is targeting capacity cuts of up to 10 per cent by the end of the year, US Airways is planning to cut 4 per cent, while Northwest plans to shed 8.5 per cent.
Thousands of aircraft will be idled and thousands of staff will be laid off.
But the carriers will still own fleets of outdated gas-guzzling aircraft that they will never be able to afford to run with oil above $100 a barrel, which is where many experts expect it to stay, even through an extended economic downturn. Those fleet will eventually have to be replaced with more modern, fuel-efficient aircraft. But with the cost of one narrow-bodied regional jet coming in anywhere from $40 million to $50 million in today’s market and fleets comprising hundreds of aircraft, you can see how the losses mount up.
‘Whatever they’re planning today, it’s not enough,’ says Mann, who believes as many as 50,000 airline jobs will have to go in the next few years to keep the legacy carriers in the air. There is also broad consensus that airlines will have to cut at least 20 per cent of US capacity to stand a chance of survival with oil at current prices, which will mean a major shift in the way Americans use air travel.
Flying has become affordable and convenient for everyone in America. Until recently, you could get a flight from coast to coast for under $100. To be able to fly from Dallas Fort Worth to Minneapolis-St Paul in a single bound for some god-awful sales convention is so enshrined in the American psyche it might as well be added as an amendment to the constitution.
Today, however, it seems such a modestly priced luxury of choice is headed to the graveyard along with Pan Am and TWA. There’s plenty more room up there in the Smithsonian’s rafters: it only remains to be seen who will be first to fill it.
James Doran is a former Wall Street bureau chief for the Times and is now a syndicated columnist and business writer based in New York