Airlines Cut Fat in Effort to Squeeze Profits From Shrinking Customer Base
NEW YORK – Sinking under the weight of multibillion-dollar losses for nearly a year, major airlines are scrambling to cut enough fat out of their networks to squeeze profits from a shrunken customer base.
The industry's basic problem is that a significant chunk of demand that disappeared shortly after Sept. 11 never came back. Sure, airlines chopped the size of their work forces and fleets last fall, but there are doubts about some of their fundamental business strategies.
"We have what appears to be a secular change" underway, said David Treitel, chairman of SH&E Inc., a New York-based airline consultancy. With average fares down to levels not seen since 1988, airlines "have to do something to get the price up," Treitel said.
So, with the economy still trying to recover from a recession and traditionally higher-paying business fliers choosing cheaper alternatives, major airlines are once again pruning capacity -- the fastest way to cut costs. Bloated flight schedules are being clipped, new plane orders are being put on hold and, of course, jobs are being eliminated.
In a 72-hour span this week US Airways began reorganizing under bankruptcy protection, American Airlines unveiled restructuring that includes 7,000 layoffs by March and United Airlines said it could file for Chapter 11 this fall if certain labor concessions aren't achieved by mid-September.
"I think the airlines have realized they need to take some drastic steps," said Meg VanDeWeghe, a former investment banker with J.P. Morgan Chase and now the executive-in-residence at the University of Maryland's business school. "There are still a lot of empty seats."
Even with average ticket prices down about 10 percent, passenger traffic has stayed roughly 9 percent below 2001 levels since the beginning of the year. The industry, saddled with high fixed costs for labor and equipment, lost more than $7 billion over the past three quarters and the forecast calls for more losses through the end of the 2002.
Sure, another wave of cutbacks will give discount airlines further room to grow. But that was happening anyway.
Besides, discount carriers are unlikely to expand aggressively into new markets just because large network carriers reduce capacity. That's especially true in smaller markets, which are less attractive to low-fare carriers that prefer flying routes with relatively heavy passenger traffic.
"Our business model is working today so there's no reason to change it," JetBlue Airways president Dave Barger said. "There's no reason to chase market share just because someone else is downsizing."
Along with low costs and simple fare structures, conservative growth has been a hallmark of the discount carriers' success. In other words, they focus on profit more than revenue.
By comparison, network carriers expanded rapidly throughout the 1990s, matching each other flight-for-flight in major markets. In rushing to build long-term market position, individual carriers probably sacrificed short-term profitability, Barger said.
That even held true over the past six months, analysts said, after the initial shock of Sept. 11 faded and passenger traffic began to improve. Rather than keep their work forces lean, some major carriers recalled workers and restored capacity too quickly, analysts said.
For example, United shrunk its work force by 8,489 shortly after the terrorist attacks, but 5,839 are back on the job, according to the company. In contrast, a healthier Delta Air Lines said last September it needed to eliminate some 13,000 jobs; it has reduced its work force by 11,700.
A recent analysis by industry consultants at SH&E concluded that the industry would have had to reduce capacity by an additional 13 percent, on average, during the first three months of the year just to break even. Instead, the nine largest airlines lost a combined $2.4 billion between January and March. They lost another $1.4 billion during the April-June quarter.
The industry's belief that low fares would stimulate enough traffic to fill existing capacity hasn't worked, said David Swerienga, chief economist of the Air Transport Association, an industry group.
"They followed that strategy pretty doggedly for almost a year," Swerienga said. "At some point you have to throw your hands up in the air and say we've done what we can on that and say maybe it's smarter to tailor our capacity to the actual number of people who want to fly."
Even if average fares rise once carriers trim capacity, fliers will benefit in other ways, said Bill McGee, editor of Consumer Reports Travel Letter. An overhaul will serve as a "release valve" on a system that has been troubled in recent years by runway delays, canceled flights and lost baggage, he said.
"There have to be tradeoffs for the greater good," McGee said.