August 14, 2002
"Another Airline Nose-dives; Who's Next?"--A Commentary by Adj. Prof. Michael E. Levine
(This essay was originally published in the Tuesday, August 13, 2002, edition of the Wall Street Journal.)
Another Airline Nose-dives; Who's Next?
By Michael E. Levine, professor (adjunct) of law
If the US Airways bankruptcy filing is a weathervane, what does it tell us about which way the wind is blowing? Are US Airways' problems unique, or do they portend a whole series of airline bankruptcies? Will the airline industry as we have known it survive?
We know the industry is beset with problems. All six of the remaining major "network" carriers (American, United, Northwest, Continental, Delta and US Airways) are losing money in large quantities. In the boom years of the 1990s, they made commitments to labor unions, manufacturers and infrastructure providers that they simply cannot cover with current or anticipated revenue. Demand has dropped as a consequence of an economic slowdown and terrorism- related woes. Discount airlines are growing rapidly and capturing passengers from their full-service competitors. Passengers are returning to the air in fairly robust numbers, but the fares necessary to attract them are much lower than before. There is real doubt as to whether they will recover.
Some say that these losses, especially when compared with the impressive results achieved by Southwest Airlines and JetBlue, prove the big hub-and-spoke airlines are obsolete. But that is wrong. A business passenger wanting to fly out of Boston doesn't want to drive to Providence, R.I., or Manchester, N.H. -- the nearest airports served by Southwest. Carriers like Southwest are able to keep their fares so low by eschewing the convenience offered by their "network" competitors, which are able to offer one-stop connections to just about anywhere through their hub system. But many passengers are willing to pay for convenience.
The problem is that during the boom years of the 1990s, network airlines were able to charge so much for convenience that their cost-structure became bloated. Business fares rose by over 40% between 1998 and 2000, supporting more flights, more infrastructure and big pay raises for unionized workers.
These commitments became unsustainable even before Sept. 11 as customers refused to pay the very high fares demanded for business flights on short notice. Instead, they bought "back-to-back" leisure tickets or exploited other loopholes in the system, or they increasingly accepted some inconvenience in order to save money on discount airlines.
Faced with these facts, network airlines have no choice but to restructure contractual commitments to labor, aircraft suppliers and infrastructure providers. Restructuring will be painful. It means aircraft returned to lessors and manufacturers. It means construction projects cancelled or delayed. It means "haircuts" for suppliers of capital. And it means dramatic reductions in unit-labor costs through a combination of wage reductions and productivity improvements. None of this is pleasant, and none of it is easy.
Under ideal circumstances, it can be done voluntarily in a set of "workout" negotiations. But, as the US Airways example shows, if the process goes on too long, voluntary discussions can yield to mandatory solutions imposed by a bankruptcy court.
Every major network airline will require some kind of restructuring. Most have already started the process with their aircraft suppliers and infrastructure providers. Because airline labor unions are democratic, discussions with them can only get serious when the edge of the abyss is reached and the members accept that they have to make concessions.
Again, the US Airways filing is a harbinger. Having gotten important concessions from its pilots and flight attendants, US Airways turned to the International Association of Machinists and Aerospace Workers, which represents many of its other employees. When the union leadership was unable to commit to the savings necessary, US Airways was forced to turn to the bankruptcy process. It undoubtedly hopes to reach an accommodation with the union, and has carefully avoided demonizing it in its public statements, but the bankruptcy filing raises the pressure on the union.
Is it impossible for the market to support six network carriers? No one really knows, but as long as four survive there is no need to worry about lack of competition. US Airways could be one of the survivors, especially if it downsizes a bit. US Airways' bankruptcy, possibly followed by a similar filing by United, will facilitate this process.
It is important that the government not try to micromanage this process, or attempt to monkey with the markets by keeping ailing carriers afloat. The immediate post-Sept. 11 concerns have receded, and it's clear that the private capital markets, and the normal bankruptcy courts, are now perfectly capable of dealing with failing airlines. Any money that the Air Transport Stabilization Board pumps into the system, in the form of government cash and loans, will simply delay the inevitable and add to the final bill.
There is perhaps some case to be made for offering some support to US Airways, the airline hit hardest by Sept. 11 because of the prolonged closure of Reagan National Airport in Washington. But if US Airways does receive government money, it's important that Uncle Sam insist on the kind of reorganization plan and terms that would be forced on the air carrier by private capital markets. The Air Transport Stabilization Board should strenuously resist making any loan to United Airlines, which has resisted changing its fundamental economics. Only if airlines and their creditors and unions come to understand that there is no choice but to restructure, will they finally make the difficult decisions necessary to survive.
Mr. Levine, a former airline executive and airline regulator, is a law professor at Yale.