"Airline industry is poised for shakeout"

Friday, September 16, 2005

Airline industry is poised for shakeout
The bankruptcies of Delta and Northwest are the latest signs of the steep
challenges facing major carriers.
By Alexandra Marks
The Christian Science Monitor 


NEW YORK - With Northwest and Delta airlines both in bankruptcy court this
week, four of the nation's "Big 7" airlines are now in Chapter 11, which
raises the question: Why don't they just raise their prices more, as other
industries struggling with high fuel prices have done? 

The answer is a complex mix of tight competition, not only with low-cost
carriers, but with buses, trains, and automobiles as well.
 
There's also the already-battered state of the traditional carriers' balance
sheets. They didn't have the cash to hedge cheap fuel, the way flush
low-cost carriers like Southwest did. So the majors will just keep racking
up losses, which could mean a very different aviation industry in years to
come.

"In order to fund those losses, the industry has taken on a huge load of
debt," says aviation economist Dave Swierenga of AeroEcon Consulting in
Vienna, Va. "When you talk about taking the longer view, that debt load will
have detrimental consequences for many years to come."

Indeed, with jet-fuel prices still astronomical compared to historical norms
and competition from efficient low-cost carriers fiercer than ever, the
future, in the words of James May, the airlines' top lobbyist, "is not
bright."

Since 2001, the US aviation industry has lost $32 billion. If fuel prices
stay about the same, as expected, it's on track to lose another $10 billion
by the end of this year. The chief culprit is the rising cost of jet fuel,
according to the airlines. It's jumped more than 240 percent in the past
four years, from 56 cents a gallon in 2001 to $1.92 today.

"It is clear that if not for the prices we must pay, the airline industry
would be profitable," Mr. May, president of the Air Transport Association,
told Congress Wednesday as he pleaded for them to suspend the jet-fuel tax.
"Indeed, we remain at the mercy of oil markets and the federal government."

But that's a much too simplistic reading of the problem, other analysts
contend, and one that in the end could hurt consumers. They note that while
most of the traditional carriers are struggling, low-cost carriers like
Southwest and JetBlue are thriving - so the future isn't so grim for all the
airlines after all.

They blame the majors' current woes on a history of poor management, overly
generous labor contracts, and a sometimes irrational reluctance to change in
the face of a clearly transformed marketplace. They do credit the big
airlines for working the past few years to increase their efficiency and
bring down labor costs, but for some it may be too little too late.

"It's not that airline travel is something whose time has come and gone, but
rather that these are difficult competitive times with a lot of change,"
says Clint Oster, a transportation economist at Indiana University at
Bloomington. "Some folks have positioned themselves better than others. So
while we may see some weeding out, I think we'll see other folks coming in
saying, 'We can do better on a different kind of business model.' "

When the airlines were deregulated back in 1978, an economic shakeout like
the one currently under way was expected, but it never materialized. The
major carriers quickly developed a powerful hub-and-spoke network system
that left each one with effective monopoly control over certain airports and
regions of the country. When small, discount carriers like People Express
and Freddie Laker Airlines started up, the majors managed to drive them out
of business. They did it by lowering their prices to match or even undercut
the discount fares on competing routes - even if they lost money doing it -
at the same they increased their capacity, a tactic called "dumping." Once
the discount carriers were gone, the majors would simply raise the prices
back up.

So despite deregulation's goal of spurring more competition, the major
carriers continued to effectively control the nation's skies and the prices
consumers paid. Then in the late 1990s, trouble appeared on the horizon in
the form of Southwest Airlines' success. The low-cost carrier had managed to
survive the majors' competitive wrath by, in the words of one analyst,
"running between the legs of the giants." Instead of competing head-to-head
on routes, which had already proved to be a losing proposition, Southwest
had built a highly efficient and successful operation flying point to point
- using second-tier airports near, as opposed to in, the nation's biggest
cities.

Then the recession of 2001 set in, and the majors began having trouble
competing with Southwest and its imitators' low prices and high
efficiencies.

In the end, it took Southwest's creativity to make deregulation work as
promised back in 1978, and only now is the economic shakeout under way.

Many analysts say the problem in this highly competitive market is that
there are too many airline seats and not enough passengers to make flying
profitable.

"We're about to hear the mantra of overcapacity over the winter, and the
premise will be too much capacity. There's nothing to do but get the
capacity out through consolidation," says Kevin Mitchell, president of the
Business Travel Coalition in Radnor, Pa. "That will be the tune by analysts
and consultants and airline managements, all of whom stand to make a lot of
money from consolidation."

He adds, "But personally, I don't think that's the solution." Mr. Mitchell
says the problem isn't too much capacity, but too much high-cost capacity.
That's a legacy of the major carriers' gambit to maintain dominance and
limit competition with their hub-and-spoke networks. As a result, some may
end up going the way of other great but now defunct airlines like Pan Am and
TWA.

And so the next six months could be crucial in determining just what the US
aviation industry will end up looking like.

It will be interesting to watch, says Mr. Oster of Indiana University. "The
only thing that gets tricky now is when you're planning to travel, you have
to figure out which one to book on and how far out to plan the trip - and
make sure you pay with a credit card."

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