Why Continental's Ceo Fell To Earth

No coincidence. Late in the afternoon of Oct. 25, Continental Airlines Inc. reported disappointing quarterly earnings, acknowledging that its new low-fare Continental Lite operation was still losing money. Minutes later came another announcement: Chief Executive Robert R. Ferguson III would resign.

Ferguson, blunt and often prickly, was the main architect of Continental's dramatic attempt to mimic Southwest Airlines Co. with its own Continental Lite. The offshoot has been seen both inside and outside the company as perhaps the best chance to turn around troubled Continental. But remaking the airline, which has twice made its way through bankruptcy, is proving tougher than even the steely Ferguson might admit.

A SHORTFALL. Indeed, sources close to the carrier say that Chairman David Bonderman, whose investor group is the controlling shareholder, had become disappointed at the pace of financial improvement. Lately, they say, Bonderman signaled his growing lack of confidence in Ferguson, a former banker, by giving more responsibilities to President Gordon Bethune. Bonderman and Ferguson wouldn't comment, but director Jack T. Trotter says his "understanding" is that the chairman ultimately asked Ferguson to resign. For now, Bethune will assume most of the CEO's duties; Ferguson will remain a director.

Problems at Continental Lite appear to be at the heart of Bonderman's impatience. Top executives had expected the no-frills operation, which now makes up about 35% of the airline's domestic capacity, to break even in July and August--but concede that it fell short. "It's not a disaster by any means," says analyst Paul P. Karos of CS First Boston, but "it's not a home run." And overall earnings for the third quarter, $7.2 million excluding a favorable adjustment, disappointed investors, who had expected profits closer to $15 million.

Continental insists that its rebound is on track. Excluding adjustments, the third-quarter results represented a $46 million swing over the year-ago period. "It's pretty hard to say this is not a dramatic improvement," says Chief Financial Officer Daniel P. Garton.

But Garton, like Trotter and other company officials, admits Continental Lite is not working as well as the airline once predicted. The problem, in short: "Their costs are still too high and their revenues are still too low," says a source close to the company.

For starters, some of Continental Lite's routes simply aren't traveled heavily enough to support frequent, Southwest-style flights. And Continental Lite relies more heavily on one-stop and connecting flights than Southwest, forcing more late flights and other operating problems, says analyst Philip Baggaley at Standard & Poor's Securities Inc. Dogged by such snags, the unit's operating costs remain well above the level targeted by management.

LACK OF IDENTITY. In addition, rivals such as USAir Inc. and Delta Air Lines Inc. have responded more aggressively to Lite fares than Continental expected. Given a choice, consumers are less likely to choose Continental, which has a higher rate of customer complaints. "It has been a bigger dogfight than we might have planned for," agrees Garton. Southwest, in contrast, is known for dominating markets and driving out competition, allowing it to build up frequent flights and push down unit costs.

Some observers also criticize Continental's marketing efforts. When the no-frills service was first launched a year ago, it lacked a distinct name or identity, missing its chance to make a splash. Now, Continental is trying to sell three "brands" at once--Lite, a premium international service, and its more traditional long-haul domestic flights. The effect: confusion. "You cannot be all things to all people," says one rival.

Garton says only 20% of Continental Lite's routes are losing money. To address those problems, the airline will adjust schedules on Oct. 30--reducing flights on such marginal routes as Dayton-Greensboro, N.C., and pulling out of other markets altogether. Except in markets where it competes directly with Southwest, it has also dumped its "Add-a-penny, add-a-pal" gimmick, which allowed two passengers to fly for the price of one.

Garton says such efforts should make Continental Lite profitable by the first quarter of next year. Analysts are skeptical but note that after virtually dismantling its unprofitable Denver hub, the carrier must redeploy its aircraft somewhere. "I don't think they have much choice but to press ahead," says Baggaley. Now it's up to Bethune--or some permanent replacement--to prove that a new leader can make the old game plan uork.

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