WSJ/Airlines' Woes Didn't Start on Sept. 11
By Frank Lorenzo. Mr. Lorenzo, chairman of Savoy Capital, is a former chairman and CEO of Continental Airlines.
Terrorism or accident, Monday's crash of an American Airlines flight in New York is bound to exacerbate the problems of the airline industry, which is already reporting shocking quarterly losses and disturbing estimates of average daily cash-burn. Combined third-quarter losses for the six largest U.S. carriers totaled $2 billion this year, before government subsidies. All reports, of course, cite the events of Sept. 11 and their enormous impact on the business.
But the fundamental problems of these companies didn't begin that day. Airline results were in decline for over a year. United, for one, reported a loss of over $600 million for the first six months of 2001. Sept. 11 is the day the airline industry's economic rubber band snapped, but it was already stretched to the breaking point.
Business travelers, who traditionally don't fly on restricted discount fares, provided a major boost to airline results in the 1990s. They contributed 35% to 40% of total revenue for many carriers. But revenue from these unrestricted fares dropped sharply starting in mid-2000, in concert with falling stock markets and bad business conditions. In the months before September, these drops amounted to 15% to 18% of total revenue -- enormous when you consider that major airlines rarely make a 5% profit.
Also during 1990s, airline cost structures, particularly labor costs, went galloping out of control. It wasn't uncommon to read of 20%-plus contract increases. Since labor costs comprise about 35% percent of total major-carrier costs, such increases led managers to compensate in the only way they were willing to -- through increases in unrestricted fares.
Management saw unrestricted-fare passengers as "price insensitive," sometimes hiking unrestricted fares four or five times in a 12-month period. One airline executive proudly told a group of Wall Street analysts a few years ago that his company's New York/Texas regular fare was $2,000 round-trip, and that it could be $3,000 and the market would pay it. This was at a time when one-stop fares subject to advance purchase, Saturday night stay, and other restrictions were as low as $300 to $400 round-trip.
How times have changed. The market isn't paying these fares as readily as it used to. The difference between high business fares and restricted pleasure fares, which had been increasingly stretched to compensate for bloated expense structures, proved far more than "price-insensitive" travelers could or would willingly take.
Now, on top of this major pre-Sept. 11 downturn, we have an environment of sharply decreased flying, including pleasure flying, that's going to stay with us for the foreseeable future. Of course, Monday's unfortunate accident isn't going to help. "Cocooning" -- Americans opting for fewer long vacations, and business travelers gravitating to video-conferencing and other electronic media to conduct their business, in addition to just plain fear of flying -- is likely going to stay with us for a long time. In the process, airlines will have to adjust to not only more price-sensitive travelers, but to fewer of them as well.
It's interesting to observe that Southwest Airlines, long noted for dependable and efficient operations, and importantly, for a fare structure that doesn't insult anyone's intelligence, has not had to cut flying or employment levels since Sept. 11. It's also worth noting that Southwest's equity market value is significantly more than the equity capitalization of the largest six airlines put together.
In the aftermath of Sept. 11, Congress rushed to provide $5 billion in direct grants to hemorrhaging airlines. The ferocity and abruptness of events on that day did not give carriers any opportunity to restructure themselves for the changed environment. But as we go forward, airlines will need to change substantially to adapt to reduced demand and increased price sensitivity. Absent constructive pressures, will they?
It is not unreasonable to have doubts, given the strong control unions exert. One only needs to note the union litigation at Delta contesting its attempts to trim employee levels to cope with the traffic drops. Another bad sign is the recent firing of United's president after he informed employees that the company might not be around in a year unless it cut costs.
The government must allow and encourage airlines to restructure and adapt to the marketplace. Antitrust enforcers must adopt a much more permissive attitude towards mergers, if carriers are brave enough to propose them, as well as asset sales and transfers. The government also should vigorously encourage competition and new entrants as opportunities present themselves, in order to restrain out-of-control labor costs.
As part of the airline stabilization package that was passed in September, airlines were granted a $10 billion loan-guarantee fund. Rather than use this fund to back new borrowing by loss-making airlines with bloated cost structures and overpriced product, administrators of these loans should require that loan applicants demonstrate realistic plans for long-term financial viability as a critical condition of approval.
In addition, these loans should be made available to reasonably financed new entrants and established airlines attempting to grow through purchases of hub or other assets from failing carriers, or through purchases of new aircraft.
Instead of focusing on providing liquidity as the sole elixir, our senators, congressmen and regulators must demand that airline companies take steps now to become financially viable in the long term, while at the same time ensuring safety and responsiveness to public needs.
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