Commentary: What's Weighing Down the Big Carriers

Is the core business model broken? If so, some major airlines could go the way of Pan Am

It wasn't much, but for battered Continental Airlines Inc. (CAL ) it was a ray of hope: On Apr. 15, while the company reported a $166 million net loss, it also noted a $25 million pretax profit on improving traffic and revenues. It was Continental's first monthly profit since September 11. As other carriers report big first-quarter losses, too, they'll likewise be pointing to shreds of good news as the industry slowly rebounds from terrorism and recession.

But despite the steady recovery, it will take much more than an economic rebound to bring the biggest carriers back to vigorous health. Rising costs, expanding low-fare players such as Southwest Airlines Co. (LUV ) and JetBlue Airways Corp. (JBLU ), and thriftier business travelers may all put a serious damper on an industry that has never been known for rich profit margins or shareholder returns.

The stark question facing the major, hub-and-spoke carriers: Is their core business model permanently broken? Many in the industry fear it is. And that implies shrinking networks and profits over time, with some players eventually going the way of Pan Am and Eastern. "We could still be around in 15 years, but just be a mere shadow," laments a high-level exec at one of the three biggest carriers. Adds American Airlines Inc. (AMR ) CFO Thomas W. Horton: "Given the losses that our company and the other big airlines are sustaining now, we certainly have to look at every aspect of our product and cost structure."

With business travelers increasingly unwilling to pay pricey unrestricted fares, major carriers simply can't cover their high costs. True, productivity as measured by revenue per employee is up about 36% since 1990. Problem is, compensation is up 46%, says John P. Heimlich, director of economic and market research at the Air Transport Assn., the industry's trade group.

That leaves airlines with little choice but to go after labor costs. They account for about 40% of major carriers' expenses, compared with about 10% to 15% for fuel, the industry's second-largest expense. Airlines can't do much about fuel costs, of course. So some argue that labor costs need to come down by 20% or more for the industry to return to financial health. While big gains could come through changing inefficient work rules, that's unlikely to happen in the absence of an even deeper financial crisis. The federal bailout after September 11 only put off the inevitable. Yes, the $4 billion in grants undoubtedly saved some carriers from bankruptcy, but it also forestalled the need to attack fundamental problems.

The big roadblock remains the unions--particularly the pilots' unions, which can readily shut down an airline. But don't look for quick givebacks there. "As the recovery proceeds, the pressure is gradually lifted on the unions to do anything," says airline analyst Philip A. Baggaley of Standard & Poor's. Even the most beleaguered carriers, United and US Airways, may be hard-pressed to get relief. "Until we fundamentally change the balance of power, [major] airlines are never going to do well," warns one airline executive.

Distrustful union leaders, however, say mismanagement, not labor costs, is to blame for the industry's predicament. They point to such blunders as United's (UAL ) aborted merger with US Airways.

The blame game is of little concern to increasingly penny-pinching business travelers, who account for the bulk of major airline revenues. As online booking sites blur the difference in business and leisure fares, business travelers are getting smarter. The average fares paid by business travelers last year fell 2%, the first decline since 1994, despite rising unrestricted fares, notes American Express Co. (AXP ) "I don't think we'll ever go back to the days when somebody walks up to the ticket counter and plunks down $2,400 to fly across the country," says J. George Mikelsons, chairman of low-fare carrier American Trans Air Inc. If he's right, the big carriers are in for a long and bumpy ride.

By Wendy Zellner

With Michael Arndt in Chicago.

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