December 6, 2002
"No Clear Way Forward for Airlines"--A Commentary by Michael E. Levine
(This essay was originally published in the December 6, 2002, edition of the New York Times.)
No Clear Way Forward for Airlines
By Michael E. Levine
Now that the Air Transportation Stabilization Board has rejected United Airlines' application for a $1.8 billion loan guarantee, perhaps the airline industry can finally begin the painful process of restructuring. Most airlines have a business model created in a time of high traffic and high fares. Those days aren't coming back -- and the sooner the airlines realize that, the better.
The board's actions, and its reasons for them, signal that we are now at a turning point in the 25-year saga that has been airline deregulation. In an unusually detailed letter, the board said that United's problems were not temporary but structural, and that United's recovery plan "does not position the company to meet the challenges of the current airline industry environment and to achieve long-term financial stability."
United's plight is not unique. To a greater or lesser degree, its situation is shared by all of the large hub-and-spoke airlines that survived deregulation -- American, Continental, Delta, Northwest and US Airways (which is already in bankruptcy). Put simply, these airlines are competing for customers with a greatly expanded discount airline sector, and they all have contractual commitments -- labor, fleet and infrastructure -- that they can no longer meet.
These discount airlines -- Southwest, JetBlue, Frontier and others -- are one artifact of deregulation. They were meant to provide the competitive spur that would ensure that deregulation benefited the public by offering customers more choice and forcing the established airlines to become more nimble. The early flowering of the discount sector required the old-line carriers to adapt with hub-and-spoke systems, discounted fares, frequent-flyer programs and the like.
It worked. Given more convenient service at competitive fares, customers stuck to the airlines they knew. By the mid-1980's, the first wave of discount carriers had subsided, with discounters reduced to a slowly growing single-digit percentage of the domestic industry.
The industry then endured its usual boom-and-bust cycles. Some airlines (Pan Am, Eastern, TWA) simply disappeared; the ones that survived expanded or were forced to contract along with the economy. In good times they bought more planes, upgraded their facilities and agreed to ever more generous labor contracts. During bad times employees accepted "givebacks" or wage freezes, but they bargained hard to preserve the underlying contract structure. During the late 1990's, when the economy was vibrant and growing, the airlines expanded rapidly. Unions took advantage of the growth to negotiate favorable contracts that raised labor costs to unprecedented levels.
In part to pay for these higher costs, airlines attempted to raise fares. But leisure travelers do not buy expensive tickets. So the airlines looked to business travelers booking tickets on short notice, who valued the convenience of frequent service at nearby airports. Business fares rose almost 50 percent between 1999 and 2001; walkup business fares often were 10 times more than leisure fares booked in advance.
This strategy backfired. First business travelers looked to travel on leisure fares even if it meant advance purchases and Saturday night stays. Then they started to look for airlines with cheaper fares. In this environment, the discount sector flourished again. Southwest Airlines grew rapidly and is now the most profitable airline in the industry. Soon other discount airlines appeared, and today one of every four tickets sold in America is on a discount airline, compared to fewer than one in 10 four years ago.
Then came Sept. 11. In the aftermath of the terrorist attacks, many business travelers stayed home. When they finally did start to fly again, they found that they had more alternatives than ever before -- they didn't have to pay the exorbitant prices of the late 1990's. They could fly on a discount airline or find a cheap Internet fare on one of the traditional airlines.
Thus we arrive at the present day. What the Air Transportation Stability Board recognized -- but United did not -- is that even when business improves, the old fare structure isn't coming back. Business customers will no longer pay $600 or $900 each way to go from Sioux Falls, S.D., or Newark to New Orleans. They'll find another airline to take them for much less, even if they have to drive to Omaha or Kennedy Airport. The hub-and-spoke airlines will have to offer more competitive fares to all customers.
The very same hub-and-spoke system that the airlines created in response to deregulation is now being exploited by the discount airlines, which operate on its fringes. Yet the established airlines need not abandon the hub-and-spoke system, which has served both airlines and passengers well. They simply need to operate it more efficiently.
Airlines now have to do the restructuring that they have been putting off for the better part of a decade. This restructuring can be done under the protection of bankruptcy or outside it. But it will succeed only if bankruptcy is a threat, which means no more federal loan guarantees. An aircraft lessor, for example, will insist on its monthly payments even if the airplane is sitting in the desert -- but only as long as it is confident that its customers can't go to bankruptcy court and send the keys back. A pilot will insist on the right to make $200,000 a year or more flying 50 hours a month -- unless he or she faces the prospect of a job at another airline involving more flying and less pay.
If they can reduce labor, equipment and other costs to more reasonable levels, these airlines will find that the hub-and-spoke system will allow them to prosper. By concentrating their flights at a hub, they can offer more frequent service to more destinations than the discount airlines. And they can offer reasonable fares on many seats by using the Internet or other technology.
Only this kind of restructuring will enable airlines like United, American, Delta and Northwest to run their businesses profitably. Only actions like the Airline Transportation Stabilization Board's will force these airlines, and their workers, to face this reality.
Michael E. Levine, a former airline executive and government official involved with deregulation, teaches at Yale Law School.