The Blog

Fly Me to the Moon

The airline industry is a mess with bad times here now and worse times ahead. Will even Southwest survive?

12:00 AM, Jun 10, 2003 • By IRWIN M. STELZER
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IT IS EXACTLY 100 years since the Wright Brothers took off from Kitty Hawk. Over that century America's airlines have operated at a net loss, repeatedly turning to the government for bail-outs. The most recent subsidies are dressed up as reimbursement for post-September 11 security losses and costs. The first post-attack package included $5 billion in cash and $10 billion in loan guarantees. The latest added $2.3 billion of taxpayer money to cover security costs that should more properly be borne by passengers. Delta led the parade of beneficiaries ($390 million), followed by American Airlines ($361 million), United Airlines ($300 million), and US Airways ($216 million).

Europe's airlines get no such handouts. For example, in the past 16 months British Airways has incurred additional security costs of L100 million for steel cabin doors and other security measures. Compare that with the L135 million in pre-tax profits that the airline earned in the year ending March 31, 2003 and you can see why the difference in government policies places BA and other European carriers at a competitive disadvantage.

America's carriers blame their financial plight on security costs and the fall-off in travel following September 11. But they were bleeding oceans of red ink before the world ever heard of bin Laden, and long before the paucity of merger deals grounded the high-flying Wall Street bankers that filled their first- and business-class cabins.

The hard truth is that the managers of America's carriers never did learn to control costs. What the unions demanded, the unions got, the alternative being costly and disruptive strikes, and rows with the congressmen whom the unions carefully cultivated. The killing blow for America's carriers came when United inflated the industry's cost base by granting its pilots a 30 percent wage increase in 2000. The result: an industry that has $100 billion in debt, and a puny market capitalization of $4 billion. Nothing in the recent cheery reports about an upturn in traffic can counter that fact, or its huge under funded pension liability, or its historic ability to turn temporary good fortune into enduring disaster.

Add a few more ingredients and you have a prescription for economic madness. Governments refuse to allow air space and airports to be used in an efficient way, and many persist in propping up loss-making national flag carriers. In addition, U.S. bankruptcy laws permit carriers to remain in business no matter how badly managed, how trivial and uncertain the concessions offered by the unions, and how inadequate their managements' plans are for coping with the changes in the air travel market.

Thanks to deregulation, millions of people who could never contemplate air travel made visits to grandma and took exotic vacations. Business travelers, who frequently travel with little advance warning, did not have the flexibility that leisure travelers have, and so ended up paying much higher fares than their vacationing seatmates.

The major carriers fed passengers into and out of hubs. But a few point-to-point, no-frills carriers operating from secondary airports emerged--and made money--while the bigger carriers contrived to destroy shareholder value at an astonishing rate. Worse still from the point of view of the major airlines, the gap between the fares they charged business travelers and the fares offered by the no-frills carriers became so great that businessmen began to accept less leg room and a bag of peanuts in order to keep travel costs down.

So where does the industry go from here? I put the question to British Airways CEO Rod Eddington, one of the industry's most thoughtful executives. He credits the no-frills carriers with being smart enough to uncover an under-served market--witness the success of Southwest, JetBlue, and AirTran in America and RyanAir, and easyJet in the United Kingdom.

True. But I would add that load factors at Southwest are declining, easyJet ran up $76 million in losses in the most recent half year, RyanAir is in a fare war that is forcing it to cut its yields to fill seats in its expanding fleet, and Brussels-based Virgin Express chalked up a loss of almost $20 million in the first quarter of this year. Which may explain why United Airlines has abandoned plans to become a no-frills carrier when it emerges from bankruptcy.

IN SHORT, the no-frills airlines may have seen their best days, and may find profits harder to come by in their now more fully served market. Eddington, not a man to knock unsubsidized competitors, confines himself to noting that these carriers are starting to "bump against one another" as the market for their product begins to grow less slowly, making it more difficult for them to find bums for the flock of planes ordered two years ago but only now being delivered.