Is Cost The Answer?

BoeingBoy

Veteran
Nov 9, 2003
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I've posted some comments on efficiency vs cost, if effect saying that cost reductions alone will not get U where it needs to be. Thought I'd add a little historical perspective for anyone's comments - especially those who thing "giving till it hurts" is the answer.

The 2nd quarter of 2001 was the last full quarter before the events of 9/11. In that quarter U had total expenses of $2.473 billion, employee costs of $959 million, revenue of $2.493 billion, and CASM of 12.13 cents.

Fast forward to the 3rd quarter of 2003. Reported total expenses were $1.808 billion, employee costs were $656 million, revenue was $1.771 billion, and CASM was 10.98 cents.

What happened between these two periods? Obviously, 9-11 had a profound effect on revenue - pax numbers plummeted initially and have been slowly rebounding since, those that have been flying are shopping smarter, and LCC's have been taking advantage of the cut-backs at the network carriers to expand. Hence, revenue is down 29.2%.

At U, employee headcount had dropped roughly 50%, the employees that remain have taken significent wage & benefit cuts (excluding senior management I might add), the fleet has been reduced nearly 40%, etc. Where has this gotten us?

According to my calculator, total expenses are down 26.9%, employee costs are down 31.6%, and CASM are down a whopping 9.5%.

As I've said elsewhere, to reach LUV's CASM would require reducing employee costs 87.5% from where they are now, since 3rd quarter employee costs are about 4 cents per seat mile and U's CASM is 3.5 cents higher than LUV's. Obviously, this isn't going to happen.

Some have proclaimed that the EMB-170 will be U's salvation. I disagree - smaller planes have a lower operating cost than larger planes, but also produce less ASM's. While there aren't a lot of 70-seat jets operating yet, a look at the carriers operating the 50-seaters is illuminating. They all have CASM higher than U's, usually considerably higher.

So, what is the answer? CASM is not a true cost index - reducing costs 10% does not reduce CASM 10%. It is more of an efficiency index - how efficiently does an airline produce ASM's.

A hub-and-spoke carrier will be hard pressed to match a point-to-point carrier in CASM. Hubbing is inefficient. Airplanes can't be turned in 30-35 minutes if the pax are to make their connections. Since the planes sit on the ground longer, they don't fly as much per day, so generate less ASM's. Since the gates are tied up longer with each airplane, the gates can't handle as many flights per day and the gate cost per pax goes up (which negatively affects CASM). You need personnel & equipment for each gate to handle the flights (all the gates at a hub are generally used at the same time) even though each gate handles less flights (that's the "headcound per plane" blame game).

While hubs are inefficient, they do have advantages on the revenue side. Fares are generally higher since there are more non-stop flights to justify the premium. Pax can be brought in from smaller cities to fill the seats on longer-haul flights. (There's the use of smaller jets - serving cities that can't justify larger equipment). Cities that would have little point-to-point service get connecting service to the world - would Erie, NY or Columbia, SC have service to the west coast or Europe if it weren't for hubs?

For a hub-and-spoke carrier to compete with the LCC's, efficiency is part of the answer. Notice I said efficiency, not cost. Efficiency means using your assets (personnel, facilitiey, and equipment) as efficiently as possible while realizing that the LCC will be more efficient. It does not mean (for example) having all the gates in PIT for what was once a large (for U) hub but using them for an express hub with almost spoke status for mainline.

The other side of the competitive equation is revenue. Hub-and-spoke carriers offer something that LCC's can't - access to broader geographic areas. Leverage that to increase the revenue per seat mile. While the cost conscious traveler might drive 2-3 hours to access a LCC (like from CLT to RDU to ride LUV), the business traveler probably won't as long as the fare difference is not exorbitant.

The other part of being competitive with the LCC's is product differentation. U management has been so focused on cost that our product (at least domestically in coach) is no better than their's. In fact, with JBLU's inflight TV and now increasing legroom, their product could be seen as superior to our coach product. The current crystal palace thinking of "if it costs anything don't do it" must end. Until we give the higher fare passenger a reason to choose us over the LCC's our fate is sealed since we can't compete on the cost side of the equation.

I've had my say. Surely there will be those that think the solution is "give one more for the gipper", but I believe they are wrong. Giving one more might delay the inevitable, but it is no solution (unless executive bonuses and golden parachutes are the solution being sought). Being as effecient as possible while offering a superior product is the solution.