Airline industry is poised for shakeout

The bankruptcies of Delta and Northwest are the latest signs of the steep challenges facing major carriers.

With Northwest and Delta airlines both in bankruptcy court this week, four of the nation's "Big 7" airlines are now in Chapter 11, which raises the question: Why don't they just raise their prices more, as other industries struggling with high fuel prices have done?

The answer is a complex mix of tight competition, not only with low-cost carriers, but with buses, trains, and automobiles as well.

There's also the already-battered state of the traditional carriers' balance sheets. They didn't have the cash to hedge cheap fuel, the way flush low-cost carriers like Southwest did. So the majors will just keep racking up losses, which could mean a very different aviation industry in years to come.

"In order to fund those losses, the industry has taken on a huge load of debt," says aviation economist Dave Swierenga of AeroEcon Consulting in Vienna, Va. "When you talk about taking the longer view, that debt load will have detrimental consequences for many years to come."

Indeed, with jet-fuel prices still astronomical compared to historical norms and competition from efficient low-cost carriers fiercer than ever, the future, in the words of James May, the airlines' top lobbyist, "is not bright."

Since 2001, the US aviation industry has lost $32 billion. If fuel prices stay about the same, as expected, it's on track to lose another $10 billion by the end of this year. The chief culprit is the rising cost of jet fuel, according to the airlines. It's jumped more than 240 percent in the past four years, from 56 cents a gallon in 2001 to $1.92 today.

"It is clear that if not for the prices we must pay, the airline industry would be profitable," Mr. May, president of the Air Transport Association, told Congress Wednesday as he pleaded for them to suspend the jet-fuel tax. "Indeed, we remain at the mercy of oil markets and the federal government."

But that's a much too simplistic reading of the problem, other analysts contend, and one that in the end could hurt consumers. They note that while most of the traditional carriers are struggling, low-cost carriers like Southwest and JetBlue are thriving - so the future isn't so grim for all the airlines after all.

They blame the majors' current woes on a history of poor management, overly generous labor contracts, and a sometimes irrational reluctance to change in the face of a clearly transformed marketplace. They do credit the big airlines for working the past few years to increase their efficiency and bring down labor costs, but for some it may be too little too late.

"It's not that airline travel is something whose time has come and gone, but rather that these are difficult competitive times with a lot of change," says Clint Oster, a transportation economist at Indiana University at Bloomington. "Some folks have positioned themselves better than others. So while we may see some weeding out, I think we'll see other folks coming in saying, 'We can do better on a different kind of business model.' "

When the airlines were deregulated back in 1978, an economic shakeout like the one currently under way was expected, but it never materialized. The major carriers quickly developed a powerful hub-and-spoke network system that left each one with effective monopoly control over certain airports and regions of the country. When small, discount carriers like People Express and Freddie Laker Airlines started up, the majors managed to drive them out of business. They did it by lowering their prices to match or even undercut the discount fares on competing routes - even if they lost money doing it - at the same they increased their capacity, a tactic called "dumping." Once the discount carriers were gone, the majors would simply raise the prices back up.

So despite deregulation's goal of spurring more competition, the major carriers continued to effectively control the nation's skies and the prices consumers paid. Then in the late 1990s, trouble appeared on the horizon in the form of Southwest Airlines' success. The low-cost carrier had managed to survive the majors' competitive wrath by, in the words of one analyst, "running between the legs of the giants." Instead of competing head-to-head on routes, which had already proved to be a losing proposition, Southwest had built a highly efficient and successful operation flying point to point - using second-tier airports near, as opposed to in, the nation's biggest cities.

Then the recession of 2001 set in, and the majors began having trouble competing with Southwest and its imitators' low prices and high efficiencies.

In the end, it took Southwest's creativity to make deregulation work as promised back in 1978, and only now is the economic shakeout under way.

Many analysts say the problem in this highly competitive market is that there are too many airline seats and not enough passengers to make flying profitable.

"We're about to hear the mantra of overcapacity over the winter, and the premise will be too much capacity. There's nothing to do but get the capacity out through consolidation," says Kevin Mitchell, president of the Business Travel Coalition in Radnor, Pa. "That will be the tune by analysts and consultants and airline managements, all of whom stand to make a lot of money from consolidation."

He adds, "But personally, I don't think that's the solution." Mr. Mitchell says the problem isn't too much capacity, but too much high-cost capacity. That's a legacy of the major carriers' gambit to maintain dominance and limit competition with their hub-and-spoke networks. As a result, some may end up going the way of other great but now defunct airlines like Pan Am and TWA.

And so the next six months could be crucial in determining just what the US aviation industry will end up looking like.

It will be interesting to watch, says Mr. Oster of Indiana University. "The only thing that gets tricky now is when you're planning to travel, you have to figure out which one to book on and how far out to plan the trip - and make sure you pay with a credit card."