New fare war adds to pressure on airlines

Even in an industry accustomed to financial turbulence, events last week laid down a marker: Airlines face the kind of pressures that a bankruptcy-as-usual approach won't resolve.

For the first time in aviation history, judges threw out two union contracts to help some of the largest and oldest carriers cut costs. And Delta Air Lines launched the industry's most aggressive fare-war yet, slashing prices and doing away with the onerous demand for Saturday night stayovers to get better fares. Most of the other major carriers quickly followed suit.

They hope the risky, last-ditch strategy stops the steady loss of customers to newer, low-cost carriers, which have upended the industry with their discount prices, flexible fares and quality service. In the process, these maneuvers could accelerate the transformation of the airline industry into one that analysts expect will be leaner, more efficient, and ultimately more consumer-friendly.

The major airlines, often called legacy carriers, have been fighting to bring down high fixed costs such as wages and pension obligations, so they can compete. But the spike in fuel costs ate up most of those savings, putting added pressure on the airlines to cut labor costs even more. With the Delta-inspired fare war, some analysts predict that one or two of the majors won't survive the year.

"Unless any restructuring increases the average price that an airline earns on a ticket, it will fail. And any airline that does that type of restructuring will fail with it," says Terry Trippler, president of the travel company TerryTrippler.com. "We cannot continue in this money losing cycle in the airline industry, 2005 has to be a watershed year when we sort this out." [Editor's note: The original version misnamed the site's URL.]

One of the key problems for the legacy carriers is excess capacity: There are too few passengers to fill the available seats, even as the number of passengers has rebounded since 9/11 to record levels. That makes it virtually impossible for airlines to raise their ticket prices to offset rising costs for fuel, as did virtually every other oil-dependent industry in the nation. Companies such as United and US Airways worried that even a small hike in their fares would cause even more customers to switch to the likes of JetBlue and Southwest. Meanwhile, the low-cost carriers are continuing to expand, adding capacity which adds even more pressure on the larger carriers.

So, unless the economy can expand rapidly enough to absorb all those extra seats in the sky, some carriers may disappear. But it's impossible to know which ones. It has long been assumed that US Airways will be the first major carrier to liquidate.

"This industry is so strange that a company that we think is solid today could fall apart by Labor Day, and one that we think on life support today, like US Airways, could be thriving," says Trippler.

Last Thursday a judge threw out USAirways' mechanics' contract, ensuring that thousands more workers will loose their jobs, but allowing the company to save money. The judge reasoned it was better that half the mechanics lose their jobs than that the company fail. So far, feared wildcat strikes haven't occurred.

At United, the other major carrier in a precarious bankruptcy, a judge Friday threw out a newly ratified agreement with United's pilots, contending that its provisions were unfair to other unions, because it required them to give up their pensions as well. Still, within hours the company reached tentative agreements with its flight attendants and mechanics. Analysts say that bodes well for the company, which has to come up with $725 million in savings in the next few weeks to avoid liquidation.

For all the cost-cutting, the Delta-inspired fare wars could squeeze revenues, increasing the risk of a liquidation.

"There are too many airlines and too many hubs, right now," says Ray Neidl, airline analyst with Calyon Securities in New York. "We're going to see certain hubs disappear, like Pittsburgh, and certain airlines as well - maybe US Airways or ATA."

The major legacy carriers could possibly strike back by reaching passengers that low-cost rivals can't. "We call it the Shanghai/Shreveport solution," says Michael Boyd, president of an aviation consulting business in Evergreen, Colo. "They're working on getting revenues to feed into their systems to compete with the low cost carriers from Shanghai or Shreveport. Those are markets that Southwest or JetBlue can't go to because the market isn't big enough."

So, if the economy continues to grow, fuel prices stabilize and unions are willing to work for less, the airline industry could emerge - maybe smaller by one or two carriers - but stronger.