"Seven Solutions to the Airlines' Woes"

Tuesday, August 24, 2004

NEWS ANALYSIS
Seven Solutions to the Airlines' Woes
By Amy Tsao 
Business Week


Old-style carriers need to radically change the way they do business. Here's
how the experts think they should start 

These are dark days for the airline industry, particularly for the
traditional, so-called legacy carriers: Delta, American Airlines, US
Airways, United, Continental, and Northwest. All are well along the way to
posting huge losses this year. One, United, is in bankruptcy proceedings,
and several more may be headed that way. 

Between record fuel costs, an uncertain economy, and a lingering
post-September 11 travel slowdown made worse by the SARS disease scare in
Asia and Canada, the industry hasn't been able to catch a break.

"This is by far the worst airline downturn ever," says Standard & Poor's
airline-credit analyst Phil Baggaley. Baggaley recently downgraded Delta's
credit rating, as well as that of US Airways, and he sees a possibly severe
shakeout in the year ahead.

HOPES DASHED.  Since World War II, airlines have rarely been a high-growth
business, with high overhead and huge labor costs. But the old-style
carriers have been barely muddling through with the aid of numerous
restructurings and lots of government help since September 11. This year --
as the economy strengthened and carriers made changes -- some airlines were
expected to turn profits. But this summer's record surge in fuel prices
derailed that hope.

Even with the continuing advantage of having the international market to
themselves, legacy carriers still must remodel their businesses along the
lines of successful domestic discount carriers such as America West
Holding's (AWA ) America West Airline and JetBlue Airways, most analysts
agree. Even those in relatively strong shape will need to make major changes
if they want to thrive.

What must they do? BusinessWeek Online asked several airline experts to list
the important changes they would like to see. Here are the seven top
recommendations that could go a long way toward curing what ails the big
airlines:

1) Reduce labor costs. This is Job No. 1, though it's far easier said than
done. In order for the most financially strapped carriers -- Delta, United,
and US Airways -- to avoid Chapter 11, managements will have to win
significant concessions from their workers in the coming weeks. Lower labor
outlays, says Baggaley, would consist of a mix of reduced wages, more
flexible work rules, and trimmed benefits. Pension changes might also be
needed.

Reducing the actual dollar amount that legacy carriers spend on labor is
key, but more flexibility in setting employees' workloads is arguably as
important. "There has to be more give and take," says Mike Miller, partner
of Velocity Group, an aviation consulting firm in Washington, D.C. Elastic
work rules have helped low-cost carrier Southwest remain profitable for
decades. "Workers there are paid very well but have very flexible work rules
in their contract, so they do more work for the same pay," Baggaley says.

2) Simplify flight operations. Low-cost carriers like Southwest and JetBlue
use just a few types of aircraft, a strategy that cuts training and
maintenance expenses. It's more complicated for the bigger airlines. They
fly internationally, to more remote destinations, and require more varied
fleets of both large and small planes. But they can and should work toward
streamlining the types of planes they fly.

Another way to simplify operations would be to modify the hub-and-spoke
model, which uses designated headquarter airports for transfers.
Traditionally, the big airlines have sent many of their flights through hub
airports at peak business-travel hours. That way, since carriers typically
charge heaps more for business fares, they can get more revenues per flight.
But many experts argue that it's time to give up on that model -- especially
as low-cost carriers increase service along heavily traveled routes.

Experts like the idea of so-called rolling hub operations, where flights are
scheduled throughout the day so that an airline's assets -- from employees
to planes to hangars -- can be used more efficiently. In a traditional hub
system, planes and workers spend more time waiting for connecting flights to
come in at peak operating times. With rolling hubs, travelers may end up
waiting a little longer to get a connecting flight, but planes end up in the
air for more hours of the day.

"If you spread more evenly, you can use your facilities more efficiently,
rather than bunching them up at certain parts of the day," says Baggaley.
American Airlines has been lauded for its experiment with a stretched-out
schedule at some of its connecting airports.

3) Offer more transparent pricing. The legacy carriers have long had an
exotic, almost incomprehensible pricing system. However, these days, with
the Internet allowing travelers to shop for the cheapest tickets easily, and
low-cost airlines offering uncomplicated set prices, traditional carriers
have to follow suit or risk losing more and more passengers. 

"Airline pricing is one of the issues that legacy carriers have to deal with
for people to be loyal to them," says Miller. To the industry's credit, in
recent years the gap in pricing between different types of tickets
(last-minute business vs. leisure) has closed. And former legacy carrier
America West has successfully made the transition to a simplified pricing
structure. Any other takers?

4) Get smart on fuel. With oil near $50 a barrel, airlines must be smarter
about how they incorporate its price into their costs. "Fuel is killing
airlines," says Velocity Group's Miller.

Discount carriers such as Southwest hedge as much as 80% of their jet-fuel
costs. Essentially, that means that they lock in prices on future fuel when
the price drops. Small wonder Southwest is one of the few success stories in
the airline business. "Airlines need to look at how Southwest is doing it
and copy that the best they can," says Miller.

Granted, this is no easy task, given that legacy carriers are so low on
cash. Still, it's integral to a successful business model. "As a credit
analyst, I like to see companies take measures to lower risk, even if it's
costly," notes Baggaley in reference to fuel hedging.

5) From bailouts to government partnership. Although the industry was
largely deregulated in 1978, plenty of lingering rules and regs have made it
"nearly impossible for carriers to be efficient," says Michael Boult, chief
operating officer of travel advisory Eclipse Advisers, a subsidiary of
American Express. Restrictions on foreign ownership and labor laws have kept
the industry from innovating, many believe. So instead of lobbying for
protective measures like bailouts, airlines need to work with government to
tackle longer-term projects like building more runways, running airports
more efficiently, and reining in labor costs.

6) Stop chasing market share. Airlines need to be savvier about capacity. At
the start of 2004, many planned to add more flights amid signs of an
improved economy. When it became clear that demand wasn't as strong as
originally forecast, most carriers still wouldn't retrench from their plans
for fear of losing out if the market snapped back.

"There have been too many seats added into the market and not enough people
to fill them," says Miller. That dynamic makes it harder to raise prices and
plays a part in the legacy carriers' inability to make money. Rather than
scrambling to add seats in fear of missing out on the party, airlines would
do well to take a more cautious approach and focus on efficiency and
margins.

7) A new model for premium pricing. Most of the industry's improvement
efforts have focused on whittling down costs. However, boosting revenues
also needs to be a priority. After all, people are willing to pay more if
they believe they're getting more value. This issue is bigger than providing
on-board meals and plush seats with more legroom.

The traditional carriers need to do a more effective job of playing up their
unique features. They still travel to far more places in both the U.S. and
overseas than low-cost rivals, notes Patrick Murphy, a partner at aviation
consulting firm Gerchick-Murphy Associates in Washington, D.C. "Legacy
carriers still offer certain advantages, especially to the business
traveler" including airport lounges and more comfortable seating, Murphy
says. Leverage is key.

Certainly, some of these changes may be too little, too late for the
carriers with the heaviest debts and least cash. But for the legacy carriers
that survive the prolonged downturn, a revolution in how they do business is
all but certain.


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