cointyro
New Member
\"Why the big boys won\'t come back\" - Fortune says majors doomed
I found this article very interesting and thought you guys might be interested too.
*************************
Airlines: Why the Big Boys Won't Come Back
FOR THE NATION'S BELEAGUERED AIRLINE INDUSTRY, THE TIPPING POINT IS FINALLY HERE: THE DISCOUNTERS ARE WINNING.
Ask Dave Ulmer, chief of planning at JetBlue, about his industry and he can hardly contain his glee. To him, the towering fares charged by the major U.S. airlines are a gilt-edged invitation to make tons of money. As we speak, he's loading up on 100-seat Embraers--planes that are the perfect size to compete in the majors' regional markets. "We'll fly routes like JFK to Charlotte, Norfolk, and other East Coast cities where the average [one-way] fares are over $200," he says. "We could easily cut those fares to one-third, or around $70!"
For the six major airlines that date from pre-deregulation days-- American, United, Delta, Continental, Northwest, and US Airways-- that's a terrifying prospect. And it should be. While discounters have been nibbling away at the big guys for years, now the industry is at a crucial point. For the first time ever, the pricing pressure exerted by the discounters--which now have close to a quarter of the domestic air travel market--has become so severe that the majors can't raise prices significantly during a boom. On top of that add higher oil prices; a burgeoning threat from small regional carriers, some of which may take on their old major airline partners; and growing resistance in Washington to solving the industry's problems through bailouts.
The conclusion? Domestically, the majors are on a permanent path to decline. They will continue to shrink in the U.S. while maintaining their lucrative international routes. The only thing that can change this grim picture: If the big airline unions get religion and grant pay cuts so steep that the majors can compete head-to-head on costs with the discounters--an extremely unlikely scenario. "The long war will be lost, barring radical changes in the way these companies do business," says highly regarded airline analyst David Strine of Bear Stearns in a recent report.
Meanwhile, the skies are buzzing with robust airlines waiting to take their place. JetBlue, AirTran, America West, and Frontier are attacking the old-timers' most profitable, protected routes. Of the top 1,000 "city pairs" in the U.S.--New York to Houston, or Miami to Cincinnati, for example--the majors faced low-fare competition on just over half four years ago, says Darin Lee of LECG, a consulting firm in Cambridge, Mass. Now they tangle with discounters on 80% of those routes. That means that the majors simply can't raise prices to refill their coffers during the current economic recovery--as they did in every previous boom. "The low-cost carriers are now dictating pricing in our business," admits C. David Cush, the chief of sales at American Airlines. Says Bear Stearns's Strine: "Every time the majors match the fares of the discounters, they lose money. That situation is clearly unsustainable."
The recent spike in oil prices is making life even more difficult. Jet fuel accounts for 10% to 15% of the majors' operating costs, and every 1-cent-per-gallon increase drives up expenses by $180 million. (No one, not even the discounters, has succeeded in raising prices to cover the extra fuel bills.) It's no wonder the Big Six are on track to lose $5 billion this year; if oil prices stay at $40 a barrel, that figure will jump to over $6 billion. Those losses have saddled the majors with $41 billion in debt and a negative $3.2 billion in equity. By contrast, in the first quarter, Southwest, JetBlue, and AirTran earned a total of $45 million, and all posted strong increases in revenue. Wall Street has noticed: The market capitalization of the six biggest discounters, including America West, ATA, and Frontier, now dwarfs that of the six majors, $18 billion to $4 billion.
To be sure, the major airlines have come back from trouble before. That's because until recently they could rely on three things to protect themselves from low-cost competitors. They controlled most of the landing slots at half-a-dozen crowded airports such as New York's LaGuardia, Chicago's O'Hare, and Washington National. They maintained "fortress" hubs in which a Northwest or US Air controlled as much as 80% of the traffic. And they were just about the only game in town for transporting passengers on long-haul, coast-to-coast routes and from midsized cities to their big hubs.
But starting in the late '90s, the Department of Transportation and local governments pushed airports to give more gates to newcomers, helping Frontier, Spirit, and AirTran establish a presence at Washington National and JetBlue fly from New York's JFK. The fortress hubs are crumbling too. While they still exist in some spots--Northwest totally dominates Detroit, for instance--in May both Southwest and Frontier invaded Philadelphia, a longtime bulwark for US Airways, hammering away at US Airways' fares to dozens of destinations, from Tampa to Las Vegas.
In coast-to-coast markets the discounters have made major inroads as well. JetBlue challenges American and United with increasingly frequent flights from JFK to the West Coast; since it arrived in 2000, those fares have dropped around 30%. Late last year, America West, a former major that reinvented itself as a discounter, started rolling out extensive West Coast service from both New York's JFK and Boston's Logan--including the Boston-to-San Francisco route dominated by United and American. (United was forced to match America West's three-day advance-purchase fare of $205 one way; its old fare was a breathtaking $1,166.) The battle extends to a host of routes between large cities. On June 20, Frontier will break United's monopoly on nonstop service from Nashville to Denver by offering two flights a day between those cities. Frontier will charge $199 for a three-day advance purchase one-way ticket; United charges $464, but it says it will match Frontier's fares.
Price isn't the discounters' only advantage. Back in the day, bad service was the tradeoff for low prices. No more. Now these airlines offer new planes, big smiles, and assigned seating. And discounters like JetBlue and Frontier provide every passenger with a seat-back monitor showing live TV and sometimes movies. AirTran, America West, and Spirit even offer business-class cabins just as plush as those of the old-line carriers.
The only routes the majors still fully dominate--and where they continue to extract premium fares--are those linking small and medium-sized cities to their hubs. For years big airlines have been using regional carriers to fly passengers from the smaller cities to those hubs. These airlines, which include Mesa, Chautauqua, and SkyWest, are separate companies. But they fly under the names of the airlines they serve, which sell the tickets and set the schedules. These regionals generally operate jets with between 30 and 70 seats. "The reason the majors use regional airlines is that under their union rules they can usually outsource flights only to planes that carry 70 passengers or fewer," says JetBlue's Ulmer. Because the regionals have far lower labor costs, the small-city business is quite lucrative for the majors, each of which face virtually no discount competition between the smaller city and its hub.
But now--you guessed it--the discounters are massing to offer competing nonstop service to those cities. Some regional airlines that now serve the big boys are itching to break free and join them. One former regional, Atlantic Coast Airlines, has reinvented itself as the appropriately named Independence Air. Starting this summer, it will fly hundreds of daily flights from Washington Dulles, a United hub, to places like Portland, Maine, Syracuse, N.Y., and Norfolk. Those routes from Washington are dominated by United and US Airways. Meanwhile, Jonathan Ornstein, CEO of Mesa, one of US Airways' regional carriers, may move into Pittsburgh now that US Air is cutting back there. "We're studying the opportunity of forming an ultra-low-cost carrier," he says. "We believe we could achieve costs lower than those of the existing discounters."
In addition, the discounters' low fares will attract new customers who wouldn't pay the higher prices charged by the majors. The result: Even more discounters will flock to the medium-sized markets. Southwest CFO Gary Kelly says that Southwest, which now uses only 737s, finds the regional markets so tempting that it is studying the possibility of adding a fleet of smaller jets to provide nonstop service to small and medium-sized cities.
To fight back, the majors have been piling on additional flights, hoping to avoid ceding even more market share. Problem is, that strategy simply drives prices lower. United and Delta's new "low- fare" airlines, Ted and Song, aren't likely to help either. They sidestep some of their parents' restrictive work rules, but they come nowhere near matching the discounters' low labor costs. Not surprisingly, the majors disagree. They claim that to prosper, they don't need to match the discounters' costs, just narrow the existing gap. And they're trying hard. Delta, for example, is seeking a 30% pay cut from its pilots. "We'll never have their cost structure," says American's Cush. "But with our revenue premium, we can compete effectively."
What will become of the majors? Right now, US Airways is the shakiest (the strongest are American, Continental, and Northwest). It's highly possible that US Air will simply sell its assets: If the airline's cash position falls below $700 million (it's about $1 billion now), the U.S. government can declare it in default of its loan guarantee, possibly forcing a liquidation. United, after 18 months in bankruptcy, is now seeking a $1.6 billion federal bailout. But given US Air's problems, United probably won't get it. As for Delta, it has told the SEC it may soon file for bankruptcy.
And that may be the industry's Hail Mary pass. In the airline business there are only two ways to get big cost reductions: Use the threat of bankruptcy to push the unions, or renegotiate the union contracts in Chapter 11. Unfortunately, the cuts the majors need to compete are so deep--on the order of 30% to 40%--that their hostile unions will never grant them. Even the savings from bankruptcy have never been sufficient to put the majors on a par with the discounters.
The smart money, then, says that we will see a combination of mergers, liquidations, and, finally, a group of fewer carriers concentrating on niche markets. An industry insider predicts that only three majors will be flying in five years. They will keep their lucrative international routes, especially the well-protected ones to Asia. They will also continue to connect medium-sized cities to other medium-sized cities--that's a business that's perfectly suited to their hub-and-spoke networks.
When you think about it, this all makes complete sense. After all, the deregulation of the airline industry was designed to give consumers lots of competition and lower prices. To achieve deregulation's promise, the discounters had to win. It just took 26 years for that to happen.
I found this article very interesting and thought you guys might be interested too.
*************************
Airlines: Why the Big Boys Won't Come Back
FOR THE NATION'S BELEAGUERED AIRLINE INDUSTRY, THE TIPPING POINT IS FINALLY HERE: THE DISCOUNTERS ARE WINNING.
Ask Dave Ulmer, chief of planning at JetBlue, about his industry and he can hardly contain his glee. To him, the towering fares charged by the major U.S. airlines are a gilt-edged invitation to make tons of money. As we speak, he's loading up on 100-seat Embraers--planes that are the perfect size to compete in the majors' regional markets. "We'll fly routes like JFK to Charlotte, Norfolk, and other East Coast cities where the average [one-way] fares are over $200," he says. "We could easily cut those fares to one-third, or around $70!"
For the six major airlines that date from pre-deregulation days-- American, United, Delta, Continental, Northwest, and US Airways-- that's a terrifying prospect. And it should be. While discounters have been nibbling away at the big guys for years, now the industry is at a crucial point. For the first time ever, the pricing pressure exerted by the discounters--which now have close to a quarter of the domestic air travel market--has become so severe that the majors can't raise prices significantly during a boom. On top of that add higher oil prices; a burgeoning threat from small regional carriers, some of which may take on their old major airline partners; and growing resistance in Washington to solving the industry's problems through bailouts.
The conclusion? Domestically, the majors are on a permanent path to decline. They will continue to shrink in the U.S. while maintaining their lucrative international routes. The only thing that can change this grim picture: If the big airline unions get religion and grant pay cuts so steep that the majors can compete head-to-head on costs with the discounters--an extremely unlikely scenario. "The long war will be lost, barring radical changes in the way these companies do business," says highly regarded airline analyst David Strine of Bear Stearns in a recent report.
Meanwhile, the skies are buzzing with robust airlines waiting to take their place. JetBlue, AirTran, America West, and Frontier are attacking the old-timers' most profitable, protected routes. Of the top 1,000 "city pairs" in the U.S.--New York to Houston, or Miami to Cincinnati, for example--the majors faced low-fare competition on just over half four years ago, says Darin Lee of LECG, a consulting firm in Cambridge, Mass. Now they tangle with discounters on 80% of those routes. That means that the majors simply can't raise prices to refill their coffers during the current economic recovery--as they did in every previous boom. "The low-cost carriers are now dictating pricing in our business," admits C. David Cush, the chief of sales at American Airlines. Says Bear Stearns's Strine: "Every time the majors match the fares of the discounters, they lose money. That situation is clearly unsustainable."
The recent spike in oil prices is making life even more difficult. Jet fuel accounts for 10% to 15% of the majors' operating costs, and every 1-cent-per-gallon increase drives up expenses by $180 million. (No one, not even the discounters, has succeeded in raising prices to cover the extra fuel bills.) It's no wonder the Big Six are on track to lose $5 billion this year; if oil prices stay at $40 a barrel, that figure will jump to over $6 billion. Those losses have saddled the majors with $41 billion in debt and a negative $3.2 billion in equity. By contrast, in the first quarter, Southwest, JetBlue, and AirTran earned a total of $45 million, and all posted strong increases in revenue. Wall Street has noticed: The market capitalization of the six biggest discounters, including America West, ATA, and Frontier, now dwarfs that of the six majors, $18 billion to $4 billion.
To be sure, the major airlines have come back from trouble before. That's because until recently they could rely on three things to protect themselves from low-cost competitors. They controlled most of the landing slots at half-a-dozen crowded airports such as New York's LaGuardia, Chicago's O'Hare, and Washington National. They maintained "fortress" hubs in which a Northwest or US Air controlled as much as 80% of the traffic. And they were just about the only game in town for transporting passengers on long-haul, coast-to-coast routes and from midsized cities to their big hubs.
But starting in the late '90s, the Department of Transportation and local governments pushed airports to give more gates to newcomers, helping Frontier, Spirit, and AirTran establish a presence at Washington National and JetBlue fly from New York's JFK. The fortress hubs are crumbling too. While they still exist in some spots--Northwest totally dominates Detroit, for instance--in May both Southwest and Frontier invaded Philadelphia, a longtime bulwark for US Airways, hammering away at US Airways' fares to dozens of destinations, from Tampa to Las Vegas.
In coast-to-coast markets the discounters have made major inroads as well. JetBlue challenges American and United with increasingly frequent flights from JFK to the West Coast; since it arrived in 2000, those fares have dropped around 30%. Late last year, America West, a former major that reinvented itself as a discounter, started rolling out extensive West Coast service from both New York's JFK and Boston's Logan--including the Boston-to-San Francisco route dominated by United and American. (United was forced to match America West's three-day advance-purchase fare of $205 one way; its old fare was a breathtaking $1,166.) The battle extends to a host of routes between large cities. On June 20, Frontier will break United's monopoly on nonstop service from Nashville to Denver by offering two flights a day between those cities. Frontier will charge $199 for a three-day advance purchase one-way ticket; United charges $464, but it says it will match Frontier's fares.
Price isn't the discounters' only advantage. Back in the day, bad service was the tradeoff for low prices. No more. Now these airlines offer new planes, big smiles, and assigned seating. And discounters like JetBlue and Frontier provide every passenger with a seat-back monitor showing live TV and sometimes movies. AirTran, America West, and Spirit even offer business-class cabins just as plush as those of the old-line carriers.
The only routes the majors still fully dominate--and where they continue to extract premium fares--are those linking small and medium-sized cities to their hubs. For years big airlines have been using regional carriers to fly passengers from the smaller cities to those hubs. These airlines, which include Mesa, Chautauqua, and SkyWest, are separate companies. But they fly under the names of the airlines they serve, which sell the tickets and set the schedules. These regionals generally operate jets with between 30 and 70 seats. "The reason the majors use regional airlines is that under their union rules they can usually outsource flights only to planes that carry 70 passengers or fewer," says JetBlue's Ulmer. Because the regionals have far lower labor costs, the small-city business is quite lucrative for the majors, each of which face virtually no discount competition between the smaller city and its hub.
But now--you guessed it--the discounters are massing to offer competing nonstop service to those cities. Some regional airlines that now serve the big boys are itching to break free and join them. One former regional, Atlantic Coast Airlines, has reinvented itself as the appropriately named Independence Air. Starting this summer, it will fly hundreds of daily flights from Washington Dulles, a United hub, to places like Portland, Maine, Syracuse, N.Y., and Norfolk. Those routes from Washington are dominated by United and US Airways. Meanwhile, Jonathan Ornstein, CEO of Mesa, one of US Airways' regional carriers, may move into Pittsburgh now that US Air is cutting back there. "We're studying the opportunity of forming an ultra-low-cost carrier," he says. "We believe we could achieve costs lower than those of the existing discounters."
In addition, the discounters' low fares will attract new customers who wouldn't pay the higher prices charged by the majors. The result: Even more discounters will flock to the medium-sized markets. Southwest CFO Gary Kelly says that Southwest, which now uses only 737s, finds the regional markets so tempting that it is studying the possibility of adding a fleet of smaller jets to provide nonstop service to small and medium-sized cities.
To fight back, the majors have been piling on additional flights, hoping to avoid ceding even more market share. Problem is, that strategy simply drives prices lower. United and Delta's new "low- fare" airlines, Ted and Song, aren't likely to help either. They sidestep some of their parents' restrictive work rules, but they come nowhere near matching the discounters' low labor costs. Not surprisingly, the majors disagree. They claim that to prosper, they don't need to match the discounters' costs, just narrow the existing gap. And they're trying hard. Delta, for example, is seeking a 30% pay cut from its pilots. "We'll never have their cost structure," says American's Cush. "But with our revenue premium, we can compete effectively."
What will become of the majors? Right now, US Airways is the shakiest (the strongest are American, Continental, and Northwest). It's highly possible that US Air will simply sell its assets: If the airline's cash position falls below $700 million (it's about $1 billion now), the U.S. government can declare it in default of its loan guarantee, possibly forcing a liquidation. United, after 18 months in bankruptcy, is now seeking a $1.6 billion federal bailout. But given US Air's problems, United probably won't get it. As for Delta, it has told the SEC it may soon file for bankruptcy.
And that may be the industry's Hail Mary pass. In the airline business there are only two ways to get big cost reductions: Use the threat of bankruptcy to push the unions, or renegotiate the union contracts in Chapter 11. Unfortunately, the cuts the majors need to compete are so deep--on the order of 30% to 40%--that their hostile unions will never grant them. Even the savings from bankruptcy have never been sufficient to put the majors on a par with the discounters.
The smart money, then, says that we will see a combination of mergers, liquidations, and, finally, a group of fewer carriers concentrating on niche markets. An industry insider predicts that only three majors will be flying in five years. They will keep their lucrative international routes, especially the well-protected ones to Asia. They will also continue to connect medium-sized cities to other medium-sized cities--that's a business that's perfectly suited to their hub-and-spoke networks.
When you think about it, this all makes complete sense. After all, the deregulation of the airline industry was designed to give consumers lots of competition and lower prices. To achieve deregulation's promise, the discounters had to win. It just took 26 years for that to happen.
