5 Ways to Fix the Airlines


Aug 20, 2002
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Straighten Up and Fly Right
The U.S. airline industry is broke. Here are five ways to fix it.
Monday, February 3, 2003
By Shawn Tully

Imagine a jet in a tailspin: The earth rushes forward, the altimeter spins wildly, and the temple-thumping tension threatens to escalate into panic. Good pilots don''t panic. Escaping a death spiral isn''t about genius or improvisation or luck. It''s about knowing what to do and doing it. The five-step protocol that pilots learn begins with chopping the power and ends with pushing the throttle to provide a surge that levels the plane. The imperiled aircraft flashes skyward like a silver arrow, ready to fly another day. Passengers heave a sigh of relief--and reach for the booze cart.
Right now the U.S. airline industry is in an economic tailspin. The industry''s debt load has jumped from $55 billion to $90 billion since 1999 and stands at an extraordinary nine times equity. Sure, low-cost carriers like Southwest, JetBlue, and AirTran continue to thrive. But the majors, whose origins date back to the fat and happy (and expensive) era before deregulation in 1978, are reeling. Last year American, United, Delta, Continental, Northwest, and US Airways lost a combined $10 billion on $70 billion in revenues, after posting a $6.8 billion loss in 2001. Since 1998 the market capitalization of those majors has fallen from $44 billion to less than $4 billion at the end of 2002; United and US Airways have recently gone bankrupt.
So, yes, there is a lot of turbulence out there. But stay calm. The skies will not empty. For one thing, bankrupt airlines can and will still fly, as America West and Continental have shown. If not for bankruptcy, we wouldn''t be flying today, says Continental''s crusty CEO, Gordon Bethune. It could be a good thing for United and US Airways. For another, the carriers'' problems don''t have to be fatal. Quick, drastic action can work--as long as it is the right drastic action. Here is FORTUNE''s five-part protocol to yank the airline industry out of its tailspin.
1. Limit code sharing. Technically, code sharing simply allows two independent airlines to sell tickets on each other''s flights. But the agreements usually go further--by allowing reciprocal frequent-flier programs, for example, or privileges at each other''s airport lounges. To obtain permission for code sharing, airlines need approval from both the Department of Justice and the Department of Transportation; those agencies can approve an alliance, turn it down, or impose conditions.
Many airlines use code shares to, in effect, outsource service to small cities. In 1998, Continental and Northwest formed the first alliance among the major airlines; last fall United and US Airways followed suit. Market purists don''t like such deals because the spirit of cooperation can so easily morph into a coordinated attack on competition. In practice, they haven''t been too bad because few of the partners'' routes overlapped. When partners aren''t flying the same routes, the chance of collusion is minimal.
A proposed code-sharing arrangement among Delta, Northwest, and Continental, however, threatens to create a totally new, wide-body dimension to marketing alliances. Adding Delta to the existing partnership brings in a big layer of overlapping flights. The three airlines share 3,302 routes, six times the number now served by both United and US Airways. Even more troubling is that the carriers want to offer joint deals to corporate customers.
Despite the obvious market concerns, the Justice Department approved the proposed alliance in mid-January with few restrictions. The DOT was more cautious--giving the nod but proposing a raft of draconian rules. The allied airlines, said the DOT, would be blocked from offering joint deals in any market where the three held more than a 50% market share, and they had to provide 60% of their new code-shared flights to small or underserved cities. They''d also have to relinquish rights to gates they weren''t fully using. While such restrictions seem sensible, the DOT only muddled the skies even more. The Bush administration blundered by not rejecting the deal outright.
The government may get a chance to correct that mistake. The three carriers had the gall to publicly flout the agency''s restrictions, saying they would proceed with the alliance anyway. The partners argue that coordinated connections will bring seamless service and more frequent flights to more markets.
The DOT should stand its ground. If the airlines take it to federal court, the government will probably win. And in that case the carriers will no doubt scrap the deal on their own. That would be a good thing. If the airline industry is to be saved from itself, such anticompetitive alliances must be kept in check.
Code-sharing agreements cement the status quo. To run a code share, the partners need to talk all the time. With a wink and a nod, they could decline to challenge each other''s prices, leading to higher fares across the industry. Even now, without widespread code sharing, prices of the majors on busy routes tend to be eerily similar. It is only when budget airlines come into a market that robust price competition emerges. The danger of the proposed alliance is that they could act like one big airline, says Jeff Potter, CEO of upstart Frontier Airlines. Warns Clive Armitage, travel manager for drugmaker AstraZenica: The government needs to look at these alliances from a price-fixing perspective.
To paraphrase Adam Smith, competitors seldom convene to discuss the public good. The best code shares are dead code shares.
2. Cut taxes and fees. Here''s a shocker: Almost a third of the fare for some airline tickets goes not to the carriers, but to Uncle Sam or to airports. Take a roundtrip America West flight from Phoenix to Los Angeles with stops in Las Vegas. The base fare is $105.12. Not bad. But after taxes and fees that ticket ends up costing $150. That''s an obvious burden the government should address. Bethune is characteristically ballistic on the matter: Hell, we''re taxed somewhere between booze and cigarettes. Our customers are paying sin taxes. It''s like the government says you''re sinnin'' to fly on an airplane! Anything that raises the price of travel discourages people from leaving home. Moreover, no other part of the travel industry pays the range of charges airlines do.
On a single ticket, passengers may pay four charges: a 7.5% federal excise tax; a $3-per-segment tax that also goes to federal coffers; up to $4.50 in facilities charges for each leg of the trip (which goes to the airports); plus a $2.50 charge per leg to fund the Transportation Security Administration, which polices airports.
Enough already. Excise taxes are a relic of the days when only rich people flew. This luxury tax should go. And why should the TSA be funded through the aviation industry? The TSA is part of a broader campaign to bolster national security and should be paid for on a national basis, not an industry one. Shippers are not solely responsible for funding port security. Why should passengers shoulder the burden of paying for safer airports?
3. Open the gates. An airline can have 1,000 jets and a zillion dollars--but if it can''t secure a gate for arrival, it ain''t gonna fly. Getting to the gate is the single biggest reason discount carriers aren''t challenging the majors in more markets. Here''s the rub: The dearth of gates is an artificial shortage. With the exception of LaGuardia, J.F.K., Chicago O''Hare, and Washington National, airports welcome new flights--that''s what they are for. The problem is that the major airlines, which hold the vast majority of gates, hoard them when they are not in full-time use. Gates are a huge problem, says Joe Leonard, CEO of AirTran. We want to expand in Atlanta and Boston--we''ve got one gate there!--but we can''t get the gates. Frontier''s Potter complains that he''s forced to sublet gates at many airports from the majors, often in remote locations.
The DOT is determined to make space for the discounters, and it has made some progress. JetBlue, the three-year-old airline whose market cap of $1.8 billion makes it more valuable than most of the majors, could not have gotten off the ground without making a deal at Kennedy. Increased access has been key to the discounters'' increasing their market share from 11% in the early 1990s to 20% now.
The DOT should hang tough on this one--and get tougher. Hoarded gates should be returned to the control of the airports. Nothing would do more to promote competition and increase the efficiency of America''s crowded airports. Yes, such a move could hurt the majors. But the point of aviation policy should not be to keep the big airlines happy or even to guarantee their existence. It is to create a market that sees consumers, not producers, as the priority.
4. Send in the umpires. In the balance of power in the airline industry between the unions and management, there is no balance: Unions rule. Labor''s immense power flows from the fatal, or near-fatal, damage a strike can inflict. To put it bluntly, a pilots'' strike can crash an entire airline--that huge, fixed-cost operation--overnight. In 1998, a 14-day pilots'' strike cost Northwest $1 billion--as much as it made from 1997-2000, among the best years the industry ever had.
Unlike the airlines, pilots, like all labor, are exempt from antitrust laws. Hence the Air Line Pilots Association represents five of the six pre-deregulation carriers. ALPA exploits that reach to extract breathtaking settlements. In 2000 it used a work slowdown and the threat of a strike to win a 28% pay increase from United. In a powerful display of pattern bargaining, it then used the United settlement to win fatter pay from Delta. In a labor negotiation, the strongest side wins, says airline consultant Michael Boyd. And in airlines, the strongest side is always the pilots.
To redress the balance, airlines need mandatory arbitration, like another poorly run American institution with perennial labor problems: baseball. That''s the position of Senator John McCain (R-Arizona), the new chairman of the Senate Commerce, Science and Transportation Committee. Under the McCain proposal, if negotiations with pilots and mechanics reach an impasse, a panel of five arbitrators could take charge. Both sides would present their last, best offers, and the panel would pick one. The key provision is that the panel must consider how much the airline can afford to pay. Given the dire condition of the industry, it''s likely that in the short term panels would side with management. In the long run unions could not simply ignore financial reality when they make their demands. The transition would be painful, but the result would surely be a more rational, financially sound industry.
Of course, ALPA hates the idea. In a message to the membership its president, Duane Woerth, calls the bill the management cramdown bill and says it would effectively end collective bargaining for airline workers. Hmm. Just as the airlines'' enthusiasm for code sharing should raise one''s suspicions, ALPA''s hostility to McCain''s bill suggests it''s worth looking at.
5. Bring on the foreigners. It''s a measure of how politicized the airline industry is that an obvious improvement--foreign competition--is an outrageous long shot. Today''s regulations are highly protectionist: Non-U.S. carriers can''t transport passengers from one American city to another or own more than 25% of a U.S. airline. But competition from the likes of Ryanair or Singapore Airlines would surely have the same bracing impact that Japanese competition had on the car industry in the 1970s. Consumers would love it. While the change may not happen anytime soon, one encouraging sign is that the European Union wants to take control of airline talks with the U.S., rather than having individual countries negotiate. And on airline policy, the EU has gone a long way toward creating a much more open regional market. Don''t be surprised if the EU offers to open its market to U.S. carriers in exchange for free access to the U.S. Like a lot of things in airlines, what''s dismissed as ridiculous could turn out sublime. And hey, the food would be a lot better!
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